Rule 42 ITC Reversal: Calculation Method, Formula, and Worked Example (2025)

If your business makes both taxable and exempt supplies — or uses inputs partly for personal use — you cannot claim full ITC. Rule 42 of the CGST Rules 2017 defines exactly how much ITC must be reversed. Get this wrong and a Section 73/74 demand follows.

Why Rule 42 Exists

ITC is available only for inputs used in taxable outward supplies. When the same inputs serve exempt supplies or non-business purposes, the proportionate ITC must be reversed. Common businesses affected: banks, NBFCs, builders, hospitals, exporters with exempt domestic sales.

The Rule 42 Formula

Step 1 — Classify ITC into four buckets

T1: Exclusively taxable — fully claimable. T2: Exclusively exempt — fully blocked. T3: Exclusively non-business/personal — fully blocked. C1 (Common credit): Used for both taxable and exempt. Formula: C1 = Total ITC − T1 − T2 − T3

Step 2 — Calculate reversals

D1 = C1 × (Exempt Turnover / Total Turnover). D2 = C1 × non-business use % (usually 5% of C1 if not separately determinable). Total reversal = D1 + D2 → reported in GSTR-3B Table 4(B)(1).

Step 3 — Eligible remaining ITC

C2 = C1 − D1 − D2. This is the ITC available for offset against output tax.

Worked Example — Builder with Mixed Supplies

Business: Builder selling residential apartments (exempt) and commercial offices (taxable). Total ITC: Rs. 50,00,000 | T1: Rs. 20,00,000 | T2: Rs. 8,00,000 | T3: Rs. 2,00,000 | C1 = Rs. 20,00,000. Taxable turnover: Rs. 3 crore | Exempt: Rs. 1 crore | Total: Rs. 4 crore. D1 = 20L × (1/4) = Rs. 5,00,000. D2 = 20L × 5% = Rs. 1,00,000. Total reversal = Rs. 6,00,000. C2 = Rs. 14,00,000. Total eligible ITC = T1 + C2 = Rs. 34,00,000.

Common Rule 42 Errors Caught in Audit

1. Not doing reversal at all — most common finding for mixed-supply businesses. 2. Wrong turnover in denominator — use aggregate turnover including zero-rated. 3. No annual reconciliation — monthly estimates without year-end true-up attracts interest. 4. Applying Rule 42 to capital goods — use Rule 43 for those. 5. T2/T3 not correctly identified — understates D1, overstates available ITC.

Frequently Asked Questions

Q: Does Rule 42 apply if exempt turnover is zero? D1 is zero for that month. Annual true-up captures the correct reversal. Q: Does Rule 42 apply to exporters? No — exports are zero-rated, not exempt. Q: What if T1/T2/T3 can't be identified? Treat all as C1 and apply the formula. Q: Can I revise after year end? Yes — mandatory annual recalculation in GSTR-9. Q: Where in GSTR-3B? Table 4(B)(1) — Rule 42 and 43 reversals are clubbed here.

Last updated: June 2025 | Legal basis: Rule 42, CGST Rules 2017; Section 17(2), CGST Act 2017. For case-specific calculations, consult your CA.