Rule 86B ITC Restriction Explained: Scope, Carve‑outs and Practical Impact

Rule 86B of the CGST Rules, 2017 introduced a specific cap on how much of an assessee’s output GST liability can be settled through Input Tax Credit (ITC). The broad idea is that where certain turnover conditions are met, at least a small fraction of the tax must be paid in cash through the electronic cash ledger, even if adequate ITC is available.

This provision was notified via Notification No. 94/2020–Central Tax, dated 22nd December 2020, and has been applicable from 1st January 2021. The underlying policy objective is to counter fake invoicing and fraudulent ITC usage.

However, Rule 86B does not apply across the board. It operates only when specific monetary thresholds are breached and is further diluted by several carefully drafted exceptions. Understanding both the trigger and the exceptions is crucial for accurate compliance and for avoiding unnecessary cash outflows.

Core Rule: 99% Cap on ITC Utilisation

What Rule 86B Provides

Under Rule 86B, where the value of taxable supplies (other than exempt and zero-rated supplies) in a month exceeds Rs. 50 lakh, the registered person is restricted from using ITC to discharge more than 99% of the output tax liability for that period.

In effect:

  • If the threshold is crossed, minimum 1% of the total output GST liability for that month must be discharged in cash, and
  • Only the remaining 99% (or less) can be adjusted against the ITC balance in the electronic credit ledger.

Important: The test is based on taxable turnover in a single month (excluding exempt and zero-rated supplies). The assessee’s status in one month does not automatically determine applicability for all other months; the test must be repeated for each month.

Six Exceptions Where the 1% Cash Requirement Does Not Apply

Rule 86B contains multiple provisos that carve out situations in which the 1% cash payment obligation is removed. There are six broad categories of exceptions:

1. Income Tax Payment Exception

If key persons associated with the entity have paid income tax beyond a specified threshold, the assessee is completely outside the ambit of Rule 86B, even if monthly taxable supplies consistently exceed Rs. 50 lakh.

Who are these “key persons”?

  • Proprietor (in case of proprietorship)
  • Karta (in case of HUF)
  • Managing Director
  • Any two partners (in case of firm)
  • Any two whole-time directors
  • Any two members of the managing committee of an association
  • Any two members of the board of trustees

Condition:
The above person(s) must have paid income tax of more than Rs. 1 lakh in each of the two financial years immediately preceding the financial year in which Rule 86B is being examined, and the due date for filing return under Section 139(1) for those years must have expired.

If this test is satisfied:

  • Rule 86B’s 1% cash usage requirement does not apply, irrespective of the assessee’s monthly taxable turnover.

2. Refund of Unutilised ITC – Zero-Rated Supplies (Section 54(3)(i))

Where the assessee, in the preceding financial year, has received a refund of unutilised ITC for zero-rated supplies without payment of tax, the restriction under Rule 86B does not apply, subject to a monetary threshold.

Key elements:

  • The supplies should be zero-rated (e.g., exports) made without payment of tax under LUT/Bond.
  • Refund must have been sanctioned under Section 54(3)(i) of the CGST Act.
  • The aggregate refund amount received on this ground in the immediately preceding financial year must be more than Rs. 1 lakh.

Once this condition is fulfilled, the assessee need not comply with the 1% cash requirement for the current financial year.

3. Refund of Unutilised ITC – Inverted Duty Structure (Section 54(3)(ii))

A similar relaxation is extended where the assessee has obtained refund of accumulated ITC on account of inverted duty structure in the immediately preceding financial year.