From Choice to Compulsion: The New ISD Mandate Under GST Explained

[Harshit Jain]

Globalisation has driven economic integration, allowing multinational companies to operate seamlessly across borders. In India, this has led companies to establish multiple offices across India, fostering PAN India presence. Company produces, manage and provide goods & services nationwide, leveraging diverse market across India. To maintain operational efficiency and effectiveness in company, majority of MNC works under the “Head Office – Branch Office Model”,  wherein Head office is principal office of business constituted for administration, management & various day to day function such as accounting, IT, human resource, taxation and other ancillary services to day-to-day operations and branches use to produce, procure & sale goods. Under the erstwhile service tax regime, company used to register under single registration across PAN level. Whereas In GST, company is required to obtain registration in each state from where they operate & is treated as a “distinct person” under GST law.

Under GST law, company faced challenges by employing various mechanism in order to streamline input tax credit distribution across various branch office across India. The industry had adopted varied positions relating to the implementation of ISD framework vis-à-vis the cross-charge framework.

Cross vs. Input Service Distribution

Since inception of GST, there has been ambiguity in determining whether certain ITC are to be apportioned by way of cross charge or ISD mechanism. Tabulated below is difference between both:

Aspect	ISD	Cross Charge
Meaning	ISD mechanism involves distribution of ITC on input services which are commonly received (predominantly received from third party vendors) across various states (branches)	Cross charge is allocation of ITC of internally generated goods and services to branches. Cross charge is to be used for charging of cost of support services provided by HO to various branches
Transactions	Only Input service received for or on behalf of branch/s	Inputs, input services and capital goods are covered
Legal Requirement	Mandatory registration required for office receiving tax invoices of services for or on behalf of other offices (Branches) under section 24 of CGST Act 2017	No separate registration required. However, company is required to issue tax invoice as supply to distinct person is considered as deemed supply under Schedule I of CGST Act 2017.
Compliance	Company is required to file GSTR-6 by 13th of subsequent month	No separate return required to be filed
Valuation	Distribution mechanism prescribed in Rule 39 (i.e. on basis of turnover)	As each branch in each state is treated as distinct person. Valuation shall be in with Rule 28, Rule 30 & Rule 31 of CGST Rules 2017. Furthermore, in accordance with second proviso to Rule 28, if recipient is eligible for 100% ITC, value of supply may be Nil.
Documentation requirement	Required to issue ISD Invoice under Rule 54 of CGST Rules & same may be required by recipient for availing ITC in accordance with Rule 36	Required to issue regular tax invoice in accordance with Rule 46
Examples of services covered	Audit fees, legal fees, insurance expenses, advertisement expenses, IT related expenses etc.	Management Services, Admin Cost, Employee Cost, or any type  of internally generated services.

There has been controversy regarding distribution of credit through ISD Mechanism and Cross Charge. The AAAR of Karnataka in case of M/s Columbia Asia Hospitals Private Ltd shed some light on this issue, wherein it was held that fundamental difference regarding both is ISD is mere mechanism for distribution of credit whereas cross charge includes service rendered by person (i.e. Supply) who cross charge certain expenses. Also, company should cross charge internally generated service which includes employee cost. Similarly, Haryana Advance Ruling Authority in case of M/s Tupperware India Private Limited, held that the HO would be required to cross charge the other units, the cost of rendering its services which benefit its other units, by raising a tax invoice and charging applicable GST. Whereas, in case of IN RE: M/S. CUMMINS INDIA LIMITED - 2022 (1) TMI 660 - APPELLATE AUTHORITY FOR ADVANCE RULING, MAHARASHTRA, it was held that HO is not entitled to avail ITC for common services by it / on behalf of branches is liable to take ISD Registration and it was ruled that cross charging common expenses were not permitted under GST law. However, all these ambiguities were cleared by issuance of circular 199/11/2023-GST & amendment in ISD provisions under GST law.

Understanding Circular 199/11/2023-GST for Cross Charge

By issuance of this circular, it was clarified that company could distribute ITC for third party vendor invoices either through ISD Mechanism or via cross-charge. However, this flexibility was removed by the Finance Act 2024, which mandated ISD registration for entities receiving services on behalf of branches.

Further, in respect of Internally generated services, if recipient is eligible for full ITC, value declared in invoice may be treated as open market value for Rule 28. Even, if HO does not raise any invoice, Nil Value shall be deemed as value of supply. However, if recipient is not eligible for full ITC, the cost of salary of employee is not mandatorily required to be included for purpose valuation of supply.

Amendment in ISD Mechanism under GST Law

The Finance Act 2024 has amended section 2(61) & section 20 of CGST Act which are as summarised below:

• HO is mandatorily required to obtain ISD Registration, in case HO receives services on behalf of branch office;
• Inclusion of distribution of ITC on tax paid under reverse charge basis in definition of “Input Service Distributor”;
• Amendment in manner of distribution of ITC through ISD mechanism by way of amendment in section 20.

In summarised way, the amendment made in definition of ISD under section 2(61), wherein word “liable to distribute the input tax credit” has inserted, indicates compulsory nature of ISD compliance. Furthermore, in section 20(2), wherein “may distribute” has been substituted with “shall distribute”, indicates the same.

Also, amendment in definition of ISD has led to inclusion of RCM transactions in ISD mechanism as well, which gives arises to another question that what is manner of payment of RCM Liability through ISD Returns . Since, there is no specific mechanism for payment of RCM liability in Form GSTR-6. Company is required to pay tax under regular GSTIN in state having same state of ISD Registration. After discharging the liability, company is required to issue an invoice to ISD GSTIN for such transactions, allowing ISD to distribute the credit to respective distinct person accordingly.

Compliance procedure under ISD

1. Company shall record such expense in its books of account & maintain separate ITC ledger for ISD purpose
2. Company shall reconcile ISD ITC Register (inclusive of ISD not availed till previous return) with GSTR-6A (downloaded from GST portal)
3. Determine eligible recipients on invoice level basis for reconciled ITC, Further, classify the ITC into eligible as well as ineligible ITC u/s 17(5) of CGST Act 2017
4. Distribute ITC on pro rata basis to each eligible recipient on their turnover basis, relative to the total turnover of all eligible recipients Act on invoice level basis in accordance Rule 39 of CGST
5. File GSTR-6 by 13th of subsequent month by disclosing details of availment and distribution thereof.
6. Raise tax invoice in accordance with rule 54 to recipient to whom ITC has been distributed.
7. Recipient may avail such ITC under Table 4(A)(3) of GSTR-3B on basis of reconciliation with ITC appearing in GSTR-2B under ISD head with ITC as per books of account.
8. Company shall pass entry in books of account for above arrangement

Action plan  

In order to ensure smooth compliance with ISD Compliance under GST law, company is suggested to take following actions:

• Review of expenses to determine eligibility

Company shall identify & prepare list of expense which are required to be cross charged or ITC is to be distributed through ISD Mechanism. This will ensure to bring consistency for distribution of ITC to distinct person. Further, company shall prepare list of vendors from whom company has availed services on which ITC is distributed to distinct person through ISD mechanism. Such list of expenses should be exclusive of expenses which are being considered for distribution though cross charge mechanism.

• Obtain ISD Registration

In case, company has not taken ISD Registration, company shall apply for GST registration as soon as possible in order to comply with legal requirement under GST law.

• Communication of ISD Registration to Vendors

Company shall communicate their ISD GSTIN Registration instead of regular GSTIN to their vendors of services where ITC will be distributed through the ISD mechanism & instruct them to issue invoice under ISD GSTIN. This will ensure that all invoices will be raised on ISD GSTIN & same will be auto populated in GSTR-6A, so that company may avail and distribute ITC to recipients through GSTR-6.

• Updation in ERP system

he company must update its ERP system to ensure ISD compliance, including incorporating the ISD GSTIN, creating new ledgers, and generating invoices as per Rule 54.

• Preparing set of procedure (SOP) & communication to team

Company may prepare SOP in order to bring effectiveness in ISD Implementation process. This will ensure that company follow proper procedure in accordance with ISD Compliance under GST law.

Company may conduct a training program for accounting and tax team for introducing them to ISD mechanism & its compliance & also inform them about changes made in ERP.  

In summarised way, before amendment, company uses to follow either ISD or cross charge mechanism interchangeably for third party invoices. However, effective from 01 April 2025, company is mandatorily required to take registration and distribute such ITC through ISD Mechanism. With respect to internally generated goods and services & cost of support services, company may continue to cross charge such expenses.

Now with ISD provisions becoming mandatory, organisations with operations in multiple States would reassess their compliance approach. It advisable to undertake due analysis of their business models and evaluate ISD applicability and develop & implement proper system to identify services for ITC distribution through ISD and cost which are required to be recovered from distinct person through Cross charge. This will not only be ensuring smooth compliance but leads to operational efficiency and effectiveness.