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Direct and Indirect Taxation · Exemption from Tax

Exempt Supplies and Their Treatment under GST

Updated 10 October 2026 · Fact-checked

Exempt supplies are supplies that attract a nil rate of tax or are wholly exempted by notification. The definition in section 2(47) of the CGST Act also includes non-taxable supplies. Under section 17(2), input tax credit is restricted to the part attributable to taxable and zero-rated supplies, so you reverse credit for the exempt part.

Understand Exempt Supplies and Treatment under GST

GST is charged on a supply. Sometimes no tax is collected on a supply. Three kinds of supply lead to this result: nil-rated, wholly exempt by notification, and non-taxable. They arise in different ways, so name the right one in your answer. For ITC, however, all three fall within exempt supply as defined in section 2(47) of the CGST Act. That definition covers a supply that attracts a nil rate of tax, a supply wholly exempted from tax under section 11 of the CGST Act or section 6 of the IGST Act, and it includes non-taxable supply.

For exempt supplies, section 17(2) restricts credit to the input tax attributable to taxable and zero-rated supplies. Credit on inputs used only for exempt supplies is not available, and common inputs must be apportioned. Section 17(3) then adds specific items to the value of exempt supply, as explained below.

Nil-rated supply is a supply that appears in the rate schedule with a 0% rate. Tax is not payable because the rate itself is nil. Wholly exempt supply is a supply that would normally be taxable, but the Government has exempted it by notification under its power to grant exemption. Non-taxable supply is a supply of goods or services that is not leviable to GST, such as alcohol for human consumption.

Do not confuse exempt supply with zero-rated supply. Zero-rated supply means export of goods or services, or supply to an SEZ developer or unit. The supplier can claim ITC on it, and can claim refund. Section 17(2) says credit is restricted to the input tax attributable to taxable supplies including zero-rated supplies. So zero-rated supplies do not cause any reversal.

The ITC consequence is the heart of this topic. If you use inputs, capital goods or input services partly for taxable supplies and partly for exempt supplies, you can take credit only for the taxable part. Section 17(3) says the value of exempt supply includes supplies on which the recipient pays tax under reverse charge, transactions in securities, sale of land and, subject to clause (b) of paragraph 5 of Schedule II, sale of building. It does not include activities in Schedule III, except paragraph 5 of that Schedule and such transactions in paragraph 8(a) as may be prescribed. Section 17(6) says the Government may prescribe the manner of attribution, and the rules do that. Learn the method from your study material.

A separate rule applies to a banking company or financial institution, including an NBFC, that accepts deposits or extends loans or advances. Under section 17(4) it can either follow section 17(2), or take every month 50% of the eligible ITC on inputs, capital goods and input services and let the rest lapse. The option cannot be withdrawn during the rest of that financial year. The 50% limit does not apply to tax paid on supplies between registered persons having the same PAN.

Key rules to remember

Section 17(2) restriction
Eligible ITC = ITC attributable to taxable supplies (including zero-rated supplies)
Input tax attributable to exempt supplies is not available as credit.
Common credit proportion (working idea)
ITC to be reversed = Common credit × Value of exempt supplies ÷ Total turnover
Use this as the working ratio for common inputs. Direct inputs used only for exempt supplies are fully ineligible; inputs used only for taxable supplies are fully eligible. Confirm the exact rule wording and the turnover definition from your study material.
Section 17(4) option for banks and NBFCs
Credit taken = 50% × eligible ITC of the month; the rest lapses
The option cannot be withdrawn in the rest of the financial year. The 50% limit does not apply to tax on supplies between registered persons with the same PAN.
Zero-rated supplies
Exports and supplies to SEZ: ITC allowed; no reversal
Not exempt supplies for the purpose of section 17(2).
Value of exempt supply includes (section 17(3))
Reverse charge supplies + transactions in securities + sale of land + sale of building (subject to clause (b) of paragraph 5 of Schedule II)
Sale of building is included only subject to clause (b) of paragraph 5 of Schedule II. Schedule III activities are excluded, except para 5 and prescribed transactions under para 8(a).

How to solve Exempt Supplies and Treatment under GST questions

Use this method for any question on exempt supplies and ITC. It works for classification questions and for reversal calculations.

  1. 1Read each supply and classify it: taxable, nil-rated, wholly exempt, non-taxable, or zero-rated. Write the class next to each. Nil-rated, wholly exempt and non-taxable supplies all count as exempt supplies under section 2(47).
  2. 2Treat zero-rated supplies (exports, SEZ) as taxable for ITC purposes. They do not reduce credit.
  3. 3Sort the inputs, capital goods and input services into three groups: used only for taxable supplies, used only for exempt supplies, and used for both (common).
  4. 4Allow full credit on the taxable-only group, subject to blocked credits under section 17(5). Disallow the exempt-only group fully.
  5. 5For the common group, work out the exempt-supply value as per section 17(3). Include reverse charge supplies, securities, land and, subject to clause (b) of paragraph 5 of Schedule II, building, as the section says.
  6. 6Apply the ratio: common credit × exempt value ÷ total turnover to find the ineligible part. Subtract it from the common credit to get the eligible part.
  7. 7Add up the eligible credit. State clearly the credit allowed, the amount reversed and the reason.
  8. 8If the person is a bank or NBFC, check whether the 50% option under section 17(4) is better or has been chosen.

Quickest way: Three-bucket ITC split

When to use it: Use it in MCQs and short numerical questions where inputs are given and you must find eligible ITC.

  1. Mark each supply T (taxable or zero-rated) or E (exempt).
  2. Mark each input as T-only, E-only or common.
  3. Eligible ITC = T-only credit + common credit × (taxable turnover ÷ total turnover).
  4. Check the options for a trap: a zero-rated export counted as exempt, or a blocked credit left in.

Common mistakes in Exempt Supplies and Treatment under GST

  • Treating exports as exempt supplies and reversing ITC on them.

    Both exports and exempt supplies carry no tax in the invoice, so they look alike.

    Fix: Remember that section 17(2) allows credit for zero-rated supplies. Exports need no reversal.

  • Saying nil-rated, exempt and non-taxable supplies are the same thing.

    All three result in no GST charged to the customer.

    Fix: Nil-rated has a 0% rate in the schedule. Wholly exempt comes from a notification. Non-taxable is not leviable to GST. Name the category first. Then state the ITC result: under section 2(47) all three are exempt supply, so section 17(2) restricts credit for all of them.

  • Forgetting to include reverse charge supplies, securities, land and building in the value of exempt supply.

    Students count only goods and services with an exemption notification.

    Fix: Section 17(3) includes reverse charge supplies, transactions in securities, sale of land and, subject to clause (b) of paragraph 5 of Schedule II, sale of building in the value of exempt supply. Add them when you work out the ratio.

  • Reversing credit even on inputs used only for taxable supplies.

    Students apply the ratio to all inputs, not just the common ones.

    Fix: Split inputs first. Only the common credit is apportioned.

  • Applying the 50% option under section 17(4) to any taxpayer.

    The rule is remembered without the persons it covers.

    Fix: It applies to a banking company or financial institution including an NBFC engaged in accepting deposits or extending loans or advances. Once exercised it cannot be withdrawn for the rest of that financial year.

Worked examples

Example 1

Shree Traders of Pune makes taxable supplies of ₹60,00,000 and exempt supplies of ₹20,00,000 in a month. It has no other turnover. Input tax on inputs used only for taxable supplies is ₹3,00,000. Input tax on inputs used only for exempt supplies is ₹40,000. Input tax on common inputs is ₹1,20,000. Find the eligible ITC, assuming no blocked credits and using the proportion method.

Show the solution
  1. Total turnover = ₹60,00,000 + ₹20,00,000 = ₹80,00,000.
  2. Taxable-only credit of ₹3,00,000 is fully eligible.
  3. Exempt-only credit of ₹40,000 is ineligible.
  4. Exempt proportion = 20,00,000 ÷ 80,00,000 = 25%.
  5. Common credit reversed = ₹1,20,000 × 25% = ₹30,000.
  6. Common credit eligible = ₹1,20,000 − ₹30,000 = ₹90,000.
  7. Eligible ITC = ₹3,00,000 + ₹90,000 = ₹3,90,000.

Answer: Eligible ITC is ₹3,90,000. Ineligible credit is ₹70,000 (₹40,000 on exempt-only inputs plus ₹30,000 on common inputs).

Example 2

Classify each supply and state the ITC effect on the supplier: (a) export of garments under LUT by Meera Exports Ltd; (b) a supply that the Government has exempted by notification under its power to grant exemption; (c) supply of alcohol for human consumption.

Show the solution
  1. (a) An export of goods is a zero-rated supply. It is treated as taxable for ITC purposes.
  2. Section 17(2) restricts credit to taxable supplies including zero-rated supplies, so Meera Exports Ltd keeps full credit on inputs used for the export and no reversal arises.
  3. (b) A supply exempted by notification is a wholly exempt supply. It forms part of exempt supplies.
  4. Input tax attributable to it is not available as credit. Common inputs need apportionment.
  5. (c) Alcohol for human consumption is not leviable to GST, so it is a non-taxable supply.
  6. Section 2(47) includes non-taxable supply in the meaning of exempt supply, so section 17(2) applies to it.
  7. Credit attributable to it is therefore not available. Inputs used only for it are fully ineligible, and common inputs need apportionment.

Answer: (a) Zero-rated: full ITC, no reversal. (b) Wholly exempt: ITC attributable to it is not available. (c) Non-taxable: no GST, but it counts as exempt supply under section 2(47), so ITC attributable to it is not available under section 17(2).

Exam tips

  • In MCQs, first spot whether the supply is an export or SEZ supply. If so, no reversal arises.
  • Write the category name (nil-rated, wholly exempt, non-taxable, zero-rated) before giving the ITC result. It earns step marks. Remember that the first three are all exempt supply under section 2(47).
  • In a numerical, show the three-way split of credit as a small list, then the ratio, then the final eligible credit.
  • Remember that section 17(3) adds reverse charge supplies, securities, land and, subject to clause (b) of paragraph 5 of Schedule II, building to exempt value, and know the Schedule III exception.
  • For banks and NBFCs, mention both choices under section 17(4) and the rule that the option cannot be withdrawn for the rest of the financial year.

Practice questions from Exemption from Tax

Exempt Supplies and Treatment under GST in other exams

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

Exempt Supplies and Treatment under GST: frequently asked questions

What is the difference between nil-rated, exempt and non-taxable supply?

A nil-rated supply has a 0% rate in the rate schedule. A wholly exempt supply is taxable in principle but exempted by notification. A non-taxable supply is not leviable to GST, as with alcohol for human consumption. For ITC, section 2(47) treats all three as exempt supply, so section 17(2) restricts credit for each.

Is a zero-rated supply an exempt supply?

No. Zero-rated supplies are exports and supplies to SEZ. Section 17(2) allows credit for inputs used in them, so no reversal arises. Refund is also available.

How do I calculate ITC reversal on exempt supplies?

Split credit into taxable-only, exempt-only and common. Disallow exempt-only credit. Reverse the common credit in the ratio of exempt value to total turnover. Section 17(6) allows the Government to prescribe the manner of attribution.

Do banks have a special ITC rule for exempt supplies?

Yes. A bank or NBFC that accepts deposits or extends loans or advances can either follow section 17(2) or take 50% of eligible ITC every month, with the rest lapsing. The choice cannot be withdrawn in the remaining part of that financial year.