New GST rule: Input Service Distributor mechanism takes effect from April 1; details here

Starting April 1, a significant change is imminent in the GST system with the enforcement of the Input Service Distributor (ISD) mechanism. This mandatory alteration is designed to ensure that state governments collect the appropriate amount of taxes on shared services acquired at a singular location. According to experts, this adjustment is intended to guarantee the fair distribution of tax revenues among the states.

The compulsory implementation of the ISD mechanism was facilitated through an amendment in the CGST Act under the Finance Act (Number 1) of 2024. This mechanism allows businesses operating in multiple states to centralize the invoicing of common input services (whether obtained domestically or imported) at one branch or the headquarters, thereby facilitating the equitable distribution of related input tax credit among the branches utilizing these shared services.

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What is ISD mechanism?

The Input Service Distribution (ISD) mechanism will enable businesses with branches in multiple states to consolidate invoices for common input services (domestically sourced or imported) at a central branch or the head office. The input tax credit pertaining to these common input services can then be distributed among the branches that utilize them.

The Input Tax Credit (ITC) is the tax paid on business purchases that can be deducted when paying tax on output tax. It represents the GST amount paid by a registered individual on goods or services utilised for business purposes. Utilizing input tax credit reduces the GST liability for the sale of goods or services by the registered person.

Previously, businesses had the option to utilize either the ISD mechanism or the cross-charge method for allocating common ITC to their other GST registrations. However, the Central Board of Indirect Taxes and Customs (CBIC) clarified in July 2023 that the ISD mechanism is not mandatory for distributing common ITC availed from third parties to other GST registrations. This provided businesses with the flexibility to choose between the two methods. Nonetheless, as of April 1, 2025, all businesses will be required to use the ISD mechanism exclusively for the distribution of common ITC. 

Why ISD is being made mandatory

To prevent the aggregation of Input Tax Credit (ITC) for services utilised at various sites under a single location and guarantee the accurate distribution of ITC to the actual consumption sites, the Input Service Distributor (ISD) is responsible for receiving invoices for those services under one registration and subsequently distributing the ITC to the relevant registrations where the services were consumed.

Before the amendment in the CGST Act, businesses had the freedom to allocate common input tax credits through either the Input Service Distributor (ISD) mechanism or a cross-charge model. ISD registration was discretionary, and credits could be assigned using cross charges as needed. Following the amendment, ISD mechanism is now compulsory for offices that receive tax invoices for input services (including RCM transactions) on behalf of distinct persons.

Conditions of distributing ITC by the ISD

Ashish Karundia, founder of Ashish Karundia & Co., in an article highlighted: 

All eligible or ineligible ITC available for distribution in a month must be distributed within the same month.
ITC should be distributed to all offices, including unregistered offices or offices supplying exempt supplies, if they have utilized common input services.
If input services are utilised at a single location, ITC should be distributed only to that specific location.
In cases where input services are utilixed at multiple locations, ITC should be distributed to each location on a pro-rata basis according to the turnover ratio.

Harpreet Singh, a partner at Deloitte, has outlined a checklist to ensure timely compliance with the ISD provisions: 

Initially, taxpayers must secure ISD registration for offices where tax invoices are received for input services on behalf of distinct persons.

Next, identify expenses incurred by the head office that are common across all locations.

Following the identification of common expenses, pinpoint the vendors that need to be transferred to ISD registration.

Once the ISD registration is obtained, notify selected vendors to issue invoices using the ISD registration going forward.

Be prepared to make any necessary IT system modifications, such as updating the procurement module for purchase orders, to implement the ISD mechanism effectively.

A training session will be necessary to cover the booking of ISD invoices, vendor follow-ups, onboarding of new vendors under ISD, and other related tasks.

Additionally, post-implementation, ISD registration will be essential to reconcile credits with GSTR-6A, distribute credit to branches, and file GST returns in GSTR-6 on a monthly basis.

If someone fails to follow ISD mechanism

Failure to adhere to the ISD mechanism could result in various repercussions:

Disputes over the eligibility of common ITC distributed through cross charge route, leading to the denial of ITC for the recipient location.
Incorrect distribution of ITC may result in recovery by tax authorities from recipient locations, along with interest.
Penalties may be imposed for irregular distribution of ITC, with the amount being either the irregular ITC distributed or Rs. 10,000, whichever is higher.