Table of contents:

• What is Reverse charge mechansim (RCM)?
• Key Features and purpose of RCM
• Applicability under RCM including Goods and Service list
• Liabilities under RCM
• GSTR Forms Relevant to RCM (GSTR-1, GSTR-2)
• Input Tax Credit (ITC) on RCM
• Time of Supply under RCM
• Calculation and Compliances
• Recent updates from Sep. 2024
• Conclusion

The introduction of the Goods and Services Tax (GST) brought several key changes to how businesses operate in India, and one of these changes is the Reverse Charge Mechanism (RCM). This article provides a comprehensive guide to help you understand the RCM under GST and changes changes happened over the last few years.

Reverse Charge Mechanism (RCM) Under GST

Reverse Charge Mechanism (RCM) is a unique provision under the Goods and Services Tax (GST) law in India. Unlike the traditional system where the supplier of goods or services is liable to pay GST, RCM places the tax liability on the recipient of the supply. This mechanism is applicable to specific categories of goods and services, as notified by the government. Businesses operating in sectors subject to RCM must understand its implications and ensure compliance to avoid penalties and maintain accurate tax records. Important considerations and notes:

• Notification Changes: The government may modify the list of notified supplies subject to RCM from time to time. Businesses should stay updated on these changes.
• Record-Keeping: Recipients must maintain proper records of RCM transactions, including invoices, payment details, and ITC claims.
• Compliance Obligations: Failure to comply with RCM provisions can lead to penalties and interest charges.

For instance, a business purchasing raw cotton from a farmer (who is not registered under GST) will need to pay the tax under the reverse charge mechanism, unless raw cotton qualifies for GST exemption in certain cases. This ensures that GST is collected at every stage of the supply chain, even if the supplier is outside the formal tax network. This should be reported as liability in GSTR 3B. Additionally, any tax deducted at source, such as in certain government contracts, would be recorded in GSTR 7, further ensuring transparency and accurate reporting under the reverse charge mechanism.

Must Read: Detailed guide on GSTR 10

Key Features and Purpose of RCM

The RCM was introduced with multiple objectives, the foremost being to bring unorganized sectors and small suppliers into the GST regime. It reduces tax evasion by ensuring tax is collected even when the supplier is not registered. Moreover, it helps in better compliance tracking, as the registered recipient needs to record these transactions in their returns and claim input tax credit (ITC) appropriately.  Key features of RCM include: 

• Shift in Tax Liability: Unlike the regular forward charge mechanism where the supplier pays tax, RCM shifts this responsibility to the recipient.
• Applicability on Unregistered Suppliers: It’s particularly relevant when the supplier of goods or services is unregistered under GST.
• Specific Goods/Services: RCM is applicable only to notified goods and services, which are detailed under various sections and notifications of the GST law.

The primary purpose of RCM is to ensure that tax collection is streamlined and to reduce the instances where suppliers evade tax by operating outside the GST framework. It also promotes accountability among buyers, especially in sectors with high unregistered suppliers, like agriculture or real estate. 

Difference Between Forward Charge and Reverse Charge

To understand RCM, it’s essential to distinguish between the forward charge mechanism and reverse charge mechanism.

• Forward Charge Mechanism: This is the default tax mechanism where the supplier of goods or services collects the GST from the buyer and remits it to the government. The claim should be initiated as ITC against the tax paid on purchases.
• Reverse Charge Mechanism: The GST should be paid to the government directly under RCM. The buyer can then claim ITC, provided the goods or services are used for business purposes and the necessary documentation is maintained.

The difference lies in who is responsible for collecting and remitting the GST. In forward charge, it’s the supplier; in reverse charge, it’s the recipient.

Applicability under RCM (Sections 9(3) and 9(4))

Sections 9(3) and 9(4) of the CGST Act, 2017, outline the goods and services to which RCM applies:

• Section 9(3): lists goods and services where the reverse charge is applicable, irrespective of whether the supplier is registered or not. Examples of goods include cashew nuts (in their natural state), bidi wrapper leaves, and raw cotton. On the services front, legal services provided by individual advocates or sponsorship services are also subject to RCM.
• Section 9(4): was initially introduced to cover all supplies from unregistered persons but was later amended. Now, it applies only in specific cases, such as the real estate sector, where developers and builders are required to source at least 80% of their inputs from registered suppliers.

For instance, if a registered company purchases raw cotton from an unregistered farmer, the company must pay GST under RCM, as raw cotton falls under the goods notified in Section 9(3).

Special Cases (Real Estate, Government Services, etc.)

Certain industries have unique implications for RCM, and two sectors where RCM is commonly applicable are real estate and government services:

1. Real Estate Sector: Builders and developers are required to source 80% of their goods and services from registered suppliers. If they fail to meet this threshold, they must pay GST under RCM on the shortfall. Additionally, if they purchase cement from an unregistered supplier, GST at 28% must be paid under RCM, irrespective of the 80% compliance rule.
2. Government Services: Businesses that receive services from government entities (excluding renting of immovable property) are required to pay GST under RCM. This is particularly applicable for services provided by departments such as the Department of Posts, which offers services like speed post and parcel delivery to business entities. These services attract GST under RCM.

Detailed List of Goods under RCM

The government has notified several goods that are subject to RCM under GST. These goods are outlined under Section 9(3) of the CGST Act and require the recipient to pay the tax. Some of the commonly traded goods that fall under RCM include:

• Cashew nuts (without shell)
• Bidi wrapper leaves (tendu)
• Raw cotton
• Silk yarn
• Used vehicles, seized and confiscated goods, old and used goods, waste and scrap

Detailed List of Services under RCM

Several services are also notified under RCM, meaning the recipient must pay the GST. Some of the important services covered include:

• Legal services
• Sponsorship services
• Services provided by a director to a company

All the services are listed on govt. portal – https://cbic-gst.gov.in/pdf/List%20of%20Services%20under%20reverse%20charge.pdf 

Liabilities Under RCM

Registration Liability:

Businesses that are required to pay tax under the reverse charge mechanism must register for GST, regardless of whether their turnover is below the usual registration threshold. Normally, businesses are required to register under GST only if their annual turnover exceeds INR 20 lakhs (INR 10 lakhs for some special category states). However, if a business is liable to pay GST under RCM, it must register irrespective of its turnover.  RCM has a significant impact on businesses that engage with unregistered dealers. Prior to the GST regime, many businesses, especially in rural and unorganized sectors, operated without formal registration. When a registered business purchases from an unregistered supplier, the responsibility to pay GST shifts to the recipient, prompting businesses to prefer registered suppliers to avoid complications.

GST Payment Liability under RCM

In the standard GST framework, the supplier is liable for collecting and remitting GST. However, under the Reverse Charge Mechanism (RCM), this obligation shifts to the recipient of the goods or services.  This shift usually applies in the following scenarios: 

• Unregistered suppliers: When goods or services are procured from an unregistered supplier, the registered recipient must pay GST on behalf of the supplier under RCM.
• Notified goods and services: For certain specific goods and services, the government has notified that RCM will apply. In these cases, even if the supplier is registered under GST, the recipient is liable to pay the tax.

It’s important to note that even in cross-border transactions, such as imports, the reverse charge mechanism is applicable. Here, the importer, as the recipient of goods or services, is liable to pay GST.

GSTR Forms Relevant to RCM (GSTR-1, GSTR-2)

When filing GST returns, RCM transactions must be reported separately to ensure compliance. The two primary forms relevant to RCM transactions are:

• GSTR-1: This form is used to report outward supplies of goods and services. Businesses must declare any RCM transactions in a separate section, detailing the nature of the supply and the tax paid.
• GSTR-2: In this form, businesses report their inward supplies, including those covered under RCM. In this form, the GST paid under RCM is documented, allowing businesses to apply for input tax credit (ITC) on those transactions. Additionally, GSTR 2A is an auto-populated form that reflects details of inward supplies based on the supplier’s GSTR-1 filing, while GSTR 2B is a static statement that helps businesses reconcile their ITC claims. It is important for businesses to review both GSTR 2A and GSTR 2B to ensure accuracy when claiming ITC on RCM transactions.

Reporting RCM Sales in GST Return

RCM transactions must be carefully documented in the respective GSTR forms. For instance, in GSTR-1, the recipient must declare the RCM transaction under a specific section and report the tax liability they incurred as the recipient of the goods or services.

Checking GST Paid by Supplier in RCM

When engaging with suppliers, businesses need to verify whether the supplier is registered under GST and whether the transaction falls under RCM ensuring that businesses are reporting and paying correct GST.

Input Tax Credit (ITC) on RCM

• ITC Eligibility for RCM: Businesses paying GST under RCM can claim input tax credit, provided the goods or services are used for business purposes. ITC allows businesses to offset the tax they paid under RCM against their output tax liability. For example, a company paying GST under RCM on legal services can claim ITC if the service is used in the course of business.
• Claiming ITC in the Same Month: One of the benefits of RCM is that businesses can claim ITC in the same month in which they pay the tax. This ensures that there is no delay in tax offsetting. For instance, if a company pays RCM tax in August, it can claim the ITC for the same in the August return itself.
• ITC Restrictions and Compliance: While businesses are generally eligible to claim ITC on RCM, it is crucial to comply with all documentation requirements. The input tax credit can be claimed only if the RCM transaction is properly documented and reported in the GSTR-2 form. Additionally, businesses must ensure that the goods or services for which ITC is claimed are used for business purposes.

Time of Supply Under RCM

#1 – Time of Supply for Goods under RCM

• The date of receipt of goods
• The date of payment to the supplier
• 30 days from the date of the supplier’s invoice

For instance, if a company receives goods on September 1 and makes the payment on September 10, the time of supply will be September 1, and GST must be paid accordingly.

#2 – Time of Supply for Services under RCM

• The date of payment
• 60 days from the date of the supplier’s invoice

This helps in determining when the GST under RCM is due and ensures timely payment of the tax.  Implications for Tax Payment Deadlines: The time of supply is crucial in determining when the GST liability must be fulfilled under the Reverse Charge Mechanism (RCM). It directly impacts the deadlines for payment, ensuring businesses stay compliant with GST regulations by paying the tax at the correct time. Businesses must ensure that they pay GST within the stipulated deadlines to avoid interest or penalties for late payment.

Calculation and Compliance Under RCM

RCM Liability = (Value of Goods/Services) × (Applicable GST Rate) 

This formula calculates the GST amount the recipient needs to pay under the reverse charge mechanism.  For example, let’s assume: 

• Value of Legal Services = INR 50,000
• GST Rate on Legal Services = 18%

Now applying the formula: 

RCM Liability = 50,000 × 18% = 50,000 × 0.18 = INR 9,000

In this case, the recipient must pay INR 9,000 as GST under RCM.  If you’re dealing with multiple goods or services, you calculate the RCM liability for each line item separately based on its applicable GST rate, and then sum up the total liability.  Here’s another example involving goods: 

• Value of Raw Cotton Purchased = INR 1,00,000
• GST Rate on Raw Cotton = 5%

The RCM liability calculation would be: 

RCM Liability = 1,00,000 × 5% = 1,00,000 × 0.05 = INR 5,000

Thus, the recipient is liable to pay INR 5,000 under RCM for this transaction.

Invoice and Documentation Requirements

For accurate tax reporting, the recipient must maintain proper invoices and documentation. The recipient needs to ensure that:

1. Invoices: A self-invoice is raised for RCM transactions (since the supplier may not issue an invoice with GST).
2. Records: The RCM liability paid is recorded in the accounting system.
3. GSTR Filings: The RCM payments are reported in the respective GSTR forms, such as GSTR-1 and GSTR-3B, and input tax credit (ITC) is claimed accordingly.

Penalties for Non-Compliance

Failure to comply with RCM provisions can lead to:  #1 – Interest on Late Payment: If the RCM liability is not paid within the stipulated time, interest at a rate of 18% per annum may be levied.  For example, if the RCM liability of INR 10,000 is delayed by 30 days, the interest would be: Interest = (RCM Liability) × (Interest Rate) × (Days of Delay) / 365 Interest = 10,000 × 18% × 30 / 365 = INR 148. #2 – Penalties: In cases of repeated non-compliance or incorrect reporting, a penalty up to 10% of the tax due or INR 10,000 (whichever is higher) may be imposed.

Recent Updates

54th GST Council Meeting (September 9, 2024):

• Introduction of RCM on Metal Scrap: The Council recommended introducing RCM on the supply of metal scrap from unregistered suppliers to registered persons. This means the buyer (registered person) will be liable to pay the GST directly to the government.
• Tax Deducted at Source (TDS): A 2% TDS was introduced on the supply of metal scrap by registered persons in business-to-business transactions.

Previous Meetings (Before September 2024):

• 45th GST Council Meeting (July 18, 2023): While specific details about RCM discussions are not publicly available for this meeting, it is likely that the Council discussed ongoing issues related to RCM implementation and compliance.
• 44th GST Council Meeting (May 19, 2023): Similar to the 45th meeting, the 44th GST Council meeting likely addressed RCM-related matters, such as clarifications, amendments, or potential changes to the RCM rules.

Ongoing Discussions:

• RCM Simplification: The GST Council has been continuously working on simplifying the RCM process to reduce compliance burdens for businesses. This could involve streamlining documentation requirements, clarifying rules, or introducing technological solutions.
• Rate Rationalization: While not directly related to RCM, rate rationalization efforts can indirectly impact RCM as it affects the overall GST burden on businesses.

Conclusion

In conclusion, the Reverse Charge Mechanism (RCM) under GST is crucial for maintaining tax compliance, particularly in transactions with unregistered suppliers or specific goods and services. By shifting the tax responsibility to the recipient, it ensures accurate tax collection and enhances transparency. Understanding the intricacies of RCM, including proper GST registration, is essential for businesses to remain compliant and avoid penalties. Additionally, businesses must maintain accurate records and timely file their GST returns, which can involve specific GST registration charges and tender filing processes. As GST evolves, businesses, especially those involved in industries like construction and government contracts, must stay updated on changes to RCM rules and ensure compliance through accurate tender filings and GST reporting. Staying compliant not only helps avoid penalties but also maximizes Input tax credit opportunities, making it a critical aspect of business operations.

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Author: Anirban Sinha

A product manager with a writer’s heart, Anirban leverages his 6 years of experience to empower MSMEs in the business and technology sectors. His time at Tata nexarc honed his skills in crafting informative content tailored to MSME needs. Whether wielding words for business or developing innovative products for both Tata Nexarc and MSMEs, his passion for clear communication and a deep understanding of their challenges shine through.