How to Reverse ITC When Your Goods Are Exempt
GSTZone Desk · Updated 2026
Short answer
If your business makes both taxable and exempt supplies, the portion of input tax credit attributable to the exempt side has to be reversed — calculated using a proportion-based formula under Rule 42 for regular inputs and Rule 43 for capital goods.
In detail
GST’s core principle is that credit should only flow through to taxable, tax-paying supplies — exempt supplies aren’t meant to carry any hidden ITC benefit. When a business genuinely can’t tell which specific input went into which supply (a common cost like rent, electricity, or general overheads used across both taxable and exempt lines of business), the law doesn’t ask you to guess — it gives you a formula.
Rule 42 handles inputs and input services: it works out the exempt supply’s share of your total turnover, and reverses that same proportion of your common ITC. Rule 43 does the equivalent for capital goods, spread over a defined useful life rather than reversed all at once.
A related but different situation is Section 18(4): if your ENTIRE business switches from taxable to exempt (or you move into composition), any ITC sitting on your stock and capital goods as of that switch date has to be reversed in full — that’s a one-time event, distinct from the ongoing monthly Rule 42 apportionment for a business that runs both types of supply side by side.
GSTZone tip
Set up this reversal calculation as a standard monthly routine rather than an annual afterthought — Rule 42 requires a final annual recalculation too, and getting the monthly numbers roughly right makes the year-end true-up far less painful.
Related questions
Does this apply if my exempt turnover is very small?+
Yes, technically the formula applies regardless of how small the exempt proportion is, though the actual reversal amount will scale down accordingly if exempt supplies are a minor part of the business.
What if I made a mistake in an earlier reversal calculation?+
Rule 42 itself has a built-in annual reconciliation mechanism (by September of the following year) that catches and corrects earlier monthly estimates, with interest on any shortfall.
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