Probable Mistakes & Risks Companies May Face with the ISD Amendment (Effective April 1, 2025) & How to Ensure Compliance.

27 Mar, 2025

3450 View

The Finance Act, 2024, has introduced a significant change by making the Input Service Distributor (ISD) mechanism mandatory for businesses that avail common input services across multiple branches. This is achieved by amending the following provisions vide Notification NO.16/2024 dated 06/08/2024 and Notification No12/2024 dated 10/07/2024

Section 2(61) : Definition of ISD,
Section 20: Manner of distribution of credit by Input Service Distributor. And
Rule 39 Procedure for distribution of input tax credit by Input Service Distributor:

ensuring that ITC (Input Tax Credit) on such services can only be distributed through ISD instead of cross-charging.

This change impacts businesses operating with multiple branches and CAs advising such clients, requiring a structured approach to compliance, ITC distribution, and risk mitigation. Let’s analyze the key implications, challenges, and strategies to ensure smooth transition and adherence to the new provisions.

Key Changes in the Amended Definition section 2(61):

Aspect	Old Definition	New Definition (Post-Amendment)	Impact
ISD Rregistration	Optional	Mandatory	Businesses must register as ISD if they receive input service invoices for multiple branches.
RCM Services Covered?	Not included	Now includes Reverse Charge Mechanism (RCM) services under Section 9(3) & 9(4)	Businesses must distribute ITC for RCM services through ISD instead of claiming them at branch level.
Cross-Charge Allowed?	Possible alternative to ISD	Prohibited	Businesses can no longer cross-charge ITC for common input services.
Applicable to Distinct Persons?	No direct mention	Explicitly covers distinct persons under Section 25	Ensures branch-wise ITC distribution, avoiding ambiguity in tax credits.
Credit Distribution Scope	Based on PAN (Entity level)	Based on GSTIN (State-wise distribution)	Tax credit must be allocated per GSTIN, preventing misuse by multi-location businesses.
Invoice Handling	Allowed input services invoices only	Covers all input services invoices, including RCM	RCM credit distribution must follow ISD compliance, avoiding incorrect ITC claims.

Comparison Table: Old vs. New Section 20

Aspect	Old Provision (Before Amendment)	New Provision (After Amendment)	Impact on Businesses
ISD Registration	Optional	Mandatory	All multi-branch businesses must obtain ISD registration.
Scope of Credit Distribution	Only input services	Covers input services, including RCM invoices	RCM ITC must be distributed instead of being claimed at the branch level.
Cross-Charge Allowed?	Yes	No	Companies must stop cross-charging and use ISD for ITC allocation.
RCM Credit Handling	Claimed directly by recipient branch	Must be routed through ISD	Prevents RCM ITC mismatches and incorrect claims.
Distribution Method	Based on turnover of branches in previous financial year	Based on actual usage by distinct persons under Section 25	Ensures accurate ITC distribution and avoids tax evasion.
Compliance Complexity	Moderate	High	Requires strong internal controls and automated compliance tools.

Understanding of the Risk of Mistakes-

Failure to comply with the provisions of these amendments results in

Disallowance of ITC: Ineligibility to claim Input Tax Credit (ITC), which will be treated as wrongful availament.
Interest u/s 50: interest under Section 50 for the wrongful availament of ITC.
Penalty u/s 122(1A): Additionally, as per Section 122(1A), a penalty equivalent to the disallowed ITC will be imposed, along with

Kind Attention: If the wrongful ITC claim or tax evasion exceeds ?5 crore, it can lead to prosecution under Section 132 of the CGST Act, which includes criminal penalties such as imprisonment.

Here’s a detailed breakdown of the common mistakes, risks, and how to fix them.

1-Probable Mistakes & Risks After ISD Becomes Mandatory

Incorrect ITC Distribution (Wrong Proportion of ITC to Branches)
Missed Reverse Charge Mechanism (RCM) ITC in ISD Distribution
Not Registering ISD (Delaying Compliance Setup)
Incorrect Reporting in GSTR-6 (ISD Return Filing Errors)
Overlooking ITC Reversal for Ineligible Expenses

Issue	Mistake	Risk	Example	Compliance Solution
Incorrect ITC Distribution (Wrong Proportion of ITC to Branches)	Companies may allocate ITC incorrectly due to: • Lack of proper tracking of which branch received the service. • Incorrect formula-based distribution of ITC.	Wrong ITC allocation → Tax authorities may disallow credits, leading to penalties and interest.	ABC Ltd. has a head office (HO) in Mumbai and branches in Delhi and Bangalore. HO receives a software license invoice worth Rs 5,00,000 + Rs 90,000 GST. Instead of distributing ITC based on actual usage, HO allocates Rs 70,000 to Delhi and RS 20,000 to Bangalore. However Bangalore actually used 50% of the software, so its ITC share should have been Rs 45,000. Wrong allocation leads to excess ITC for Delhi and shortfall for Bangalore, causing compliance issues during tax audits.	Maintain proper records of service usage at each branch. Use actual service consumption data for ITC allocation instead of arbitrary percentages.
Missed Reverse Charge Mechanism (RCM) ITC in ISD Distribution	Businesses may forget to distribute RCM ITC through ISD and instead claim it incorrectly at the HO.	Double ITC claims or non-compliance notices due to incorrect treatment of RCM ITC.	XYZ Ltd.pays Rs 2,00,000 to a legal consultant and Rs 36,000 GST under RCM at the Mumbai HO. Before the amendment, HO directly claimed RCM ITC in its own GSTR- 3B. Now, RCM ITC must be distributed through ISD. If HO forgets to distribute it and claims it directly, tax authorities may reject the ITC during audit.	Separate tracking for RCM ITC in accounting systems. Ensure RCM ITC flows through ISD before being claimed by branches.
Not Registering ISD (Delaying Compliance Setup)	Some companies fail to register ISD before April 1, 2025, assuming there is no urgency.	Non-compliance notices and penalties for distributing ITC without an ISD registration.	A company continues to cross-charge ITC to branches after April 1, 2025. GST authorities audit and reject the ITC, stating that cross-charge is no longer allowed. The company has to pay back ITC with interest and penalty.	Apply for ISD registration well before April 1, 2025. Stop using cross-charge for ITC distribution after the new rules apply.
Incorrect Reporting in GSTR-6 (ISD Return Filing Errors)	Errors in GSTR-6 filing, such as: Wrong GSTINs of recipient branches. Mismatch in ITC distribution figures.	ITC mismatch in GSTR-2B and GSTR-3B → May lead to tax notices and reversal of ITC.	A company distributes Rs 50,000 ITC to three branches but files the wrong GSTIN for one branch. •ITC does not reflect correctly in that branch’s GSTR-2B, causing discrepancies and delays in claiming ITC.	Verify GSTIN details before submitting GSTR-6. Perform monthly reconciliations between ISD invoices, GSTR-6, and GSTR-2B.
Overlooking ITC Reversal for Ineligible Expenses	Distributing ITC on ineligible services, such as: Personal expenses. Employee-related services (not business-related). ITC on goods/services used for exempt supplies.	Reversal of ITC along with interest and penalties in tax audits.	A company wrongly distributes ITC on canteen services, which are ineligible. Later, during GST audit, tax authorities demand ITC reversal with penalties.	• Maintain a checklist of ineligible ITC items. • Exclude personal and non-business expenses from ISD calculations.

Best Practices to Ensure ISD Compliance

Consider Whether Restructuring Your Business is a Better Option Than ISD Registration:

Instead of obtaining an ISD registration and managing the complex process of ITC distribution, businesses with multiple branches should evaluate whether restructuring is a better alternative to reduce compliance burdens

Automate ITC Tracking & Distribution