Understanding the Reverse Charge Mechanism Under GST: A Complete Guide

Since the GST was introduced, it has caused massive structural change to indirect taxation for business in India. Of all the provisions under the new GST law, the most important is the Reverse Charge Mechanism, which has been a handy tool for tax collection due to unregistered suppliers, or unorganised suppliers. Business owners, mainly Small and Medium enterprises (SMEs) must be entirely conversant with RCM to avoid falling foul of compliance issues, leading to penalties and penury. For expert assistance with your GST registration and compliance needs, platforms like Foxtax can help streamline the process.

 

In early years of GST, industry estimates showed as many as 30% of the tax notices were issued due to errors in transactions involving RCM. This guide explains to small business owners and business intermediaries, the essentials of reverse charge mechanism, from bare basics to compliance essentials.

 

What Is the Reverse Charge Mechanism (RCM) Under GST?

 

Reverse charge mechanism of GST is a mechanism in which the recipient of the supply of goods or services is liable to pay GST instead of the supplier. The suppliers in a normal Forward Charge Mechanism (FCM) receive the tax from the buyer and deposit it with the exchequer. Here, the recipient needs to self-assess and pay the tax. The RCM was to take care of the cases where the supplier is not registered under GST, or falls under a specified category of persons (like an unorganised transport operator), or deals with notified goods or services like cashew nuts or GTA services.

 

The mechanism is covered under Sections 9(3) and 9(4) of the CGST Act. For supplies of notified goods/services, regardless of whether suppliers are registered or not, RCM becomes a must (Section 9(3) of the CGST Act). For registered persons purchasing from an unregistered person, the provision is contained in Section 9(4) of the CGST Act. In both the cases, the registered subscriber has to pay GST on RCM basis and is entitled to Input Tax Credit (ITC) to the extent the purchase is used in business.

 

Types of Reverse Charges Under GST: Section 9(3) vs Section 9(4)

 

There are 2 different categories of reverse charge mechanisms known to each and every business.

 

First Type – Notified Goods and Services (Section 9(3))

 

The government has notified a table of certain goods (e.g., tobacco leaves, silk yarn, cashew nuts) and certain services (e.g., GTA services, legal services by an advocate to a business entity, sponsorship services) for which RCM is automatic.

 

The supply can be by either a registered or an un-registered person—Though the liability is on the recipient. The list is revised from time to time.

 

Second Category – Supply from Unregistered Persons (Section 9(4))

 

When the receipt of goods and services from unregistered suppliers of such goods/services, the recipient who is a registered person becomes liable to pay tax under RCM.

 

Yet, for operational ease such provision was kept suspended for many categories temporarily but not for all as it is still applicable only for those goods/service items that have been notified as such. That’s why, businesses need to carefully check if their procurement from unregistered suppliers of such goods/services falls within this rule.

 

GST Reverse Charge List: Goods and Services Covered

 

It is essential for companies to refer to the official GST reverse charge list to avoid any penalty. The government issues these lists from time to time under Notification No. 4/2017, Central Tax (Rate) and respective State notifications. Below mentioned are some of the most common types of the products and services that fall in the category of a reverse charge mechanism.

 

Goods under RCM:

 

Item	HSN Code	Example of Application
Cashew nuts, not shelled or roasted	0801	Importers buying from unorganised farmers
Bidi wrapper leaves (tobacco)	2401	Manufacturers purchasing from individual growers
Silk yarn	5004	Weavers buying from small producers
Supply of some types of scrap	72xx / 74xx	Steel mills buying from scrap dealers

 

Services under RCM:

 

Service	SAC	Common Scenario
Goods Transport Agency (GTA) services	9965	A factory hiring a local trucking company that does not charge GST
Legal services by advocate to business	9982	A company paying a lawyer for litigation
Sponsorship services	9997	A brand sponsoring an event
Services by an arbitral tribunal	9985	A business engaging an arbitration firm
Services by a director of a company (not as employee)	9983	Payment of sitting fees to independent directors

 

This list of service items and goods may also be expanded or revised with time. That means, businesses must consult the latest version of the GST Council’s official file or, for better compliance purposes, can get registered on a compliance platform. You can also refer to our detailed GST benefits for business in India guide for more insights.

 

Understanding the RCM in GST with Practical Examples

 

Having a grasp of real-life situations where a reverse charge mechanism is used helps one understand better.

 

Example 1 – GTA Services

 

A company in Mumbai that processes raw material for the end product engages the services of transport agencies for its movement. This company’s invoice does not bear any tax as the transport company has selected to pay tax under the composition scheme.

 

The buyer (manufacturer) under reverse charge has to discharge 5% GST (2.5% CGST + 2.5% SGST) through the value of the transport bill. After that, he prepares an invoice for himself (called Self Invoice), pays the amount via the GST portal, and then claims the same quantity of tax as GST credit (in short, GST input credit or ITC).

 

Example 2 – Purchase from Unregistered Vendor

 

A retailer who is registered as a dealer at Delhi purchases stationery worth ₹50,000 from a local petty shop (unregistered). As the supplier is not registered in any category, the goods are not notified as exempt either, the company has no option but to bear the taxes themselves (i.e., pay GST by the customer through reverse charge mechanism).

 

So, the company estimates that GST payable is amounting only to ₹6,000 and pays it. Later on the amount is claimed as ITC (input tax credit). Had the customer not paid reverse charge, he would have been in no position to claim the input credit.

 

Example 3 – Import of Services

 

There is a software house at Bengaluru that is using cloud infrastructure services supplied by a US-based provider. Since the provider is situated outside India, the Indian company has to get ready to be able to bear the tax and pay IGST under RCM on the service value. This kind of payment is considered as a deemed supply.

 

Time of Supply Under Reverse Charge

 

Figuring out when GST is paid if someone is a recipient under reverse charge is very important for return filing. The time of supply differs if it is a good or a service.

 

For Goods: The time of supply is the earliest of the three:

• Date on the receipt of goods
• Date when the supplier made an entry in the records for payment
• Or the date when the bank got debited (the date comes right after 30 days of when the supplier’s account was debited)

 

For Services: The time of supply is the earliest of:

• Date the payment took place
• Date of the day 60 days have passed since the invoice was issued by the supplier

 

Provided that the date on the invoice or the supplier or the date of receipt can’t be found, the time shall be the date of the entry in the accounts books of the person availing the service. The Government will charge you interest and penalty on tax, if you don’t pay within these timeliness periods. For proper GST filing compliance, it’s crucial to track these timelines accurately.

 

Accounting for RCM – Journal Entries and Self-Invoicing

 

For tax on a business’s reverse charge mechanism, proper bookkeeping for these transactions has to be maintained. In such cases a receipt has to be prepared by the person who gets the goods or services. A self-invoice should be issued from the customer in favor of the supplier as generally the supplier may not raise the GST invoice. Then these entries will be passed in the accounts:

 

When the Goods/Services Are Being Taken:

• Debit: Cost of goods sold/Cost of sales
• Credit: Creditor/supplier’s account

 

Payment of Input Taxes/CGST under Reverse Charge:

• Debit: Input GST (CGST + SGST/IGST) account
• Credit: Input GST (CGST + SGST/IGST) account

 

On making a payment to supplier:

• Debit: Supplier Account
• Credit: Bank

 

When the tax is paid to government:

• Debit: Output GST liability Account
• Credit: Bank

 

Filling of entries after payment gives rise to the same amount which would qualify as input tax credit. Double taxation is, in effect, avoided. All GST software systems automate the generation of these entries.

Quick Glance at the Reverse Charge Mechanism – Key Points for Businesses

 

• RCM shifts tax payment liability from supplier to recipient.
• Applies in two cases: notified goods/services (Section 9(3)) and supply from unregistered persons (Section 9(4)).
• The recipient must issue a self-invoice and pay tax within the prescribed time of supply.
• Tax paid under RCM is eligible for ITC, provided the purchase is for business use.
• Common items under RCM include GTA services, legal services, silk yarn, cashew nuts, and sponsorship.
• Use a compliance platform like Foxtax to automate identification, invoicing, and return filing.

 

Reverse charge is one of the key areas of GST compliance that a business of a resident Indian cannot possibly ignore. To the extent of being an exception, the rules of RCM may seem daunting at a glance. Still, knowing the various forms of RCM, the time of supply, and how the accounting steps are done make the execution quite easy.

 

With experts like Foxtax, one can get to the point without manual input errors, evade the penalties altogether and still focus on growing the business. If you need help with GST registration or filing, our expert team is ready to assist you.

 

Frequently Asked Questions About GST Reverse Charge

 

Q1: What is the difference between forward charge and reverse charge?

The term forward charge simply means that the GST was paid directly by the supplier to the government while in case of reverse charge (RCM) situation GST liability is with the buyer. RCM is not the default, and is used for only certain supplies to ensure the proper compliance of tax laws.

 

Q2: Can I claim ITC on tax paid under RCM?

Absolutely, as long as it is utilized for business. The ITC is available for the period of tax payment same as the return.

 

Q3: Do I need to issue an invoice if I pay RCM?

Definitely, because if the payer issues an official invoice bearing the supplier’s name together with a payment voucher, he can only be able to take advantage of claiming ITC.

 

Q4: Where can I find the updated GST reverse charge list?

Besides the official list of Notification No. 4/2017, Central Tax (Rate) plus its amendments, you can get a PDF downloaded from the website of the GST Council or even be updated about the new developments via Foxtax’s compliance dashboard.

 

Q5: What if I forget to pay RCM on a purchase from an unregistered vendor?

A demand note with a tax amount of interest (18% per annum) and penalties of not exceeding 10% will be issued by the revenue department to a defaulter. It is so better to keep a track of the deadlines or use a digital solution for it. You can also read our guide on GST late fees and penalties for more details.

 

Q6: Does RCM apply to e-commerce operators?

Retailers online who facilitate business have provisions under GST that are different from RCM. RCM does not supplant the Tax Collected at Source (TCS) regime. So, the collectors will be obligated to TCS collection and also RCM may be triggered under scenarios like supply of a particular service. For more information, check our guide on GST for e-commerce sellers.