Indirect Tax Laws · Input Tax Credit

ITC in Special Situations: Registration, Composition Switch, Constitution Change and Transfer (Section 18)

Updated 5 October 2026 · Fact-checked

Section 18 of the CGST Act deals with ITC when your status changes. On new registration or a switch from composition to regular, you claim ITC on stock and capital goods held the day before. On opting for composition or exempt supplies, you reverse it. On sale or merger, unutilised ITC moves to the transferee.

Understand Special Situations: Change in Constitution, Transfers and Composition

ITC normally flows from purchases made while you are a regular taxpayer making taxable supplies. But businesses change status. A trader may register late, move from composition to regular, shift to exempt supplies, or be sold or merged. Section 18 tells you what happens to ITC at that point.

The core idea is simple. Credit is earned only while you are in the regular taxable system. When you enter it, you may claim credit on goods already in hand. When you leave it, you must give back credit on goods still in hand. When the business moves to another person, the unused credit moves with it.

Entering the system (Section 18(1)). You can take credit on inputs held in stock, inputs contained in semi-finished or finished goods held in stock, and capital goods. This applies in four cases: you apply for registration within 30 days of becoming liable; you register voluntarily; you stop paying tax under composition (Section 10); or your exempt supplies become taxable. The stock is counted on the day immediately before the change. The credit is available only if the invoice is not older than one year (Section 18(2)). Services are not covered here, because the section speaks of inputs (goods) and capital goods.

Leaving the system (Section 18(4)). If you opt for composition, or your supplies become wholly exempt, you must pay an amount equal to the ITC on inputs in stock, inputs in semi-finished or finished goods, and capital goods. For capital goods, the ITC is reduced by 5 percentage points for every quarter or part of a quarter from the invoice date. Any balance left in the electronic credit ledger after this payment lapses.

Change in constitution (Section 18(3)). If a registered business is sold, merged, demerged, amalgamated, leased or transferred, and the transfer of liabilities is specifically provided for, the unutilised ITC in the electronic credit ledger can be transferred to the new entity. This is done through the prescribed form with a certificate from a practising chartered accountant or cost accountant. Rule 41 governs the procedure.

If you later sell capital goods on which you took ITC, Section 18(6) makes you pay the higher of two amounts: the ITC taken (reduced by the prescribed percentage points) or the tax on the transaction value.

Key rules to remember

Entry credit: eligible stock: ITC = tax on inputs in stock + tax on inputs in semi-finished/finished goods + eligible tax on capital goods (all on the day before the change); Applies on timely registration, voluntary registration, exit from composition, and exempt supplies becoming taxable. Invoice must not be older than one year. Services are excluded.
Capital goods percentage reduction: Eligible ITC = ITC on capital goods × (100 − 5 × number of quarters or part of quarter from invoice date) ÷ 100; Any part of a quarter counts as a full quarter. Applies to entry credit (Rule 40), reversal on exit (Rule 44) and sale of capital goods (Section 18(6)).
Exit reversal (Section 18(4), Rule 44): Amount payable = ITC on inputs in stock + ITC on inputs in semi-finished/finished goods + reduced ITC on capital goods; Compute separately for CGST, SGST/UTGST and IGST. Pay by debit to the credit ledger or by cash. Balance credit in the ledger lapses.
Time limits and forms: Entry: ITC-01 within 30 days of becoming eligible. Exit: ITC-03 within 60 days (extendable by up to 30 days). Transfer: ITC-02 with CA/CMA certificate.; Learn the form numbers. They are often asked directly.
Sale of capital goods (Section 18(6)): Payable = higher of (ITC taken, reduced by prescribed percentage points) or (tax on transaction value); Applies when capital goods on which ITC was taken are supplied.

How to solve Special Situations: Change in Constitution, Transfers and Composition questions

Use this method for any question on ITC when status changes. The scenario will always fit one of the Section 18 situations.

1Identify the event: late or timely registration, voluntary registration, composition to regular, regular to composition, exempt to taxable, or sale/merger/transfer.
2Decide the direction. Entering the regular system means claim credit (Section 18(1)). Leaving means reverse (Section 18(4)). Transfer of business means move ledger credit (Section 18(3)).
3Fix the date of computation: the day immediately preceding the date of the change.
4List the eligible items: inputs in stock, inputs in semi-finished or finished goods, and capital goods. Drop services, and drop blocked credits under Section 17(5).
5Check conditions: invoice not older than one year, registration applied within 30 days (for claim at the liability date), and the transferor's liabilities specifically transferred (for Section 18(3)).
6For capital goods, count the quarters or part quarters from the invoice date and reduce 5 percentage points for each.
7Compute CGST, SGST and IGST separately, then total. For exit, compare with the ledger balance: pay any shortfall in cash and let the excess lapse.
8State the form and time limit (ITC-01, ITC-02, ITC-03) and conclude.

Quickest way: Direction, date, items, quarters

When to use it: Use it for numerical or short-answer questions where time is limited.

Write 'claim', 'reverse' or 'transfer' beside the scenario.
Mark the cut-off date as the day before the change.
Add tax on inputs and on inputs inside finished goods at full value, provided invoices are within one year.
Reduce capital goods ITC by 5% per quarter or part of a quarter, then add.
Write the form and time limit in one line at the end.

Common mistakes in Special Situations: Change in Constitution, Transfers and Composition

Claiming ITC on services or on blocked items when switching from composition to regular.
Students treat Section 18(1) like the general ITC provision.
Fix: Section 18(1) covers inputs (goods) in stock and capital goods only. Blocked credits under Section 17(5) stay blocked.
Ignoring the one-year invoice limit.
The limit sits in Section 18(2), away from the main clauses, and students overlook it.
Fix: Check every invoice date against the date of the change. Older invoices give no credit.
Reducing capital goods ITC by 5% per full year, or counting only complete quarters.
Students confuse the 5% per quarter rule with straight-line depreciation over years.
Fix: Reduce 5 percentage points for every quarter or part of a quarter from the invoice date. For example, 7 months counts as 3 quarters, so 15 points.
Forgetting that leftover credit lapses after opting for composition.
Students stop once they have computed the amount payable.
Fix: After paying the Section 18(4) amount, state that the balance in the electronic credit ledger lapses.
Allowing transfer of ITC on a merger without conditions.
Students assume ITC always follows the business.
Fix: Transfer under Section 18(3) needs specific provision for transfer of liabilities and a CA/CMA certificate. Only unutilised credit in the electronic credit ledger moves.
Mixing the forms and time limits for entry and exit.
ITC-01, ITC-02 and ITC-03 look alike.
Fix: Remember: 01 is for claim on stock (30 days), 02 is for transfer, 03 is for reversal on exit (60 days).

Worked examples

Example 1

Mehta Traders, a composition dealer, becomes liable to pay tax under the regular scheme from 1 October. On 30 September it holds inputs with GST of ₹1,80,000 (invoices within one year), finished goods containing inputs with GST of ₹36,000, and machinery with GST of ₹90,000 on an invoice dated 7 months earlier. All are eligible. Compute the ITC under Section 18(1).

Show the solution

Event: exit from composition. Direction: claim ITC. Date: stock as on 30 September.
Inputs in stock: ₹1,80,000.
Inputs in finished goods: ₹36,000.
Machinery: 7 months means 2 full quarters plus part of a third, so 3 quarters. Reduction = 3 × 5 = 15 percentage points. Eligible ITC = ₹90,000 × 85% = ₹76,500.
Total = ₹1,80,000 + ₹36,000 + ₹76,500 = ₹2,92,500.
Mehta Traders must file ITC-01 within 30 days of becoming eligible.

Answer: ITC of ₹2,92,500 is available under Section 18(1), claimed through FORM GST ITC-01 within 30 days.

Example 2

Kumar Industries, a regular dealer, opts for composition from 1 April. On 31 March it holds inputs with ITC of ₹1,20,000, finished goods with input ITC of ₹30,000, and a machine with ITC of ₹2,00,000 on an invoice dated 14 months earlier. Its electronic credit ledger balance is ₹4,50,000. Compute the amount payable and the effect on the ledger.

Show the solution

Event: opting for composition. Direction: reverse under Section 18(4). Date: 31 March.
Inputs in stock: ₹1,20,000. Inputs in finished goods: ₹30,000.
Machine: 14 months means 4 full quarters plus part of a fifth, so 5 quarters. Reduction = 25 percentage points. Reversible ITC = ₹2,00,000 × 75% = ₹1,50,000.
Total payable = ₹1,20,000 + ₹30,000 + ₹1,50,000 = ₹3,00,000.
Ledger balance ₹4,50,000 is more than ₹3,00,000, so payment is made by debit to the ledger. Remaining balance = ₹1,50,000.
The remaining ₹1,50,000 lapses on opting for composition. The details go in FORM GST ITC-03 within 60 days.

Answer: Kumar Industries must pay ₹3,00,000 under Section 18(4). The remaining ledger balance of ₹1,50,000 lapses.

Exam tips

Always state the direction first: claim, reverse or transfer. Markers look for it.
Show the quarter count for capital goods in one line. It is the most common place to lose marks.
In MCQs, check the invoice age and whether the item is a good, a capital good or a service before computing.
For merger or transfer questions, quote the two conditions: liabilities specifically transferred and a CA/CMA certificate.
Write the answer as provision, facts, conclusion, and end with the form number and time limit.

Practice questions from Input Tax Credit

Special Situations: Change in Constitution, Transfers and Composition in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

CFA Level IIIPrivate Special Situations Overview

Special Situations: Change in Constitution, Transfers and Composition: frequently asked questions

Can I claim ITC on goods in stock when I register under GST?

Yes, under Section 18(1), if you apply within 30 days of becoming liable (credit from the liability date) or register voluntarily (credit from the grant date). Credit covers inputs in stock, inputs in semi-finished or finished goods and capital goods. The invoice must not be older than one year.

What happens to ITC when I switch from composition to regular scheme?

You can take credit on inputs in stock, inputs in finished goods and capital goods held on the day before the switch. Capital goods credit is reduced by 5 percentage points per quarter or part from the invoice date. You file ITC-01 within 30 days.

Is ITC transferred on merger or transfer of business?

Yes, under Section 18(3), unutilised ITC in the electronic credit ledger can be transferred to the new entity. The transfer of liabilities must be specifically provided for, and a certificate from a CA or cost accountant is needed. ITC-02 is used.

What happens to the credit ledger balance when I opt for composition?

You first pay an amount equal to the ITC on stock and capital goods, with the capital goods reduction. Any remaining balance in the electronic credit ledger lapses. If the ledger falls short of the amount payable, you pay the difference in cash.