Rule 42 Worked: The Monthly Formula and the Annual True-Up

Rule 42 Worked explained: this guide covers what it means, who it applies to, the step-by-step process, documents required, fees, due dates and penalties in India — so you can stay compliant with confidence and avoid costly mistakes.

Section 17(2) says credit is restricted to so much as is attributable to taxable supplies including zero-rated supplies. Rule 42 is the arithmetic that implements it — and it is written in a notation that puts people off a computation that is, in substance, one ratio.

Start with T, the total input tax on inputs and input services in the period. Strip out T1 (exclusively non-business), T2 (exclusively exempt) and T3 (blocked under s.17(5)). What remains is C1. Take out T4 (exclusively taxable, including zero-rated) and you have C2 — the common credit. Then reverse D1 = C2 × (exempt turnover ÷ total turnover), and D2 = 5% of C2 for non-business use. C3 = C2 − D1 − D2 is the common credit you keep. The whole exercise is redone annually before 30 November, with the difference paid with interest or claimed as credit.

The monthly computation

Where E is the aggregate value of exempt supplies during the tax period and F is the total turnover in the State or Union territory during the tax period.

T1, T2 and T3 are declared at the invoice level in GSTR-3B. D1 and D2 are added to the output tax liability, except where the credit relates to a tax period before the person became liable to register.

A full worked month

A manufacturer with both taxable and exempt outputs, for October 2026:

Turnover for October: exempt supplies E = ₹40,00,000; total turnover F = ₹2,00,00,000.

• D1 = (40,00,000 ÷ 2,00,00,000) × 6,00,000 = 0.20 × 6,00,000 = ₹1,20,000
• D2 = 5% × 6,00,000 = ₹30,000
• C3 = 6,00,000 − 1,20,000 − 30,000 = ₹4,50,000

Credit retained for the month: T4 ₹10,00,000 + C3 ₹4,50,000 = ₹14,50,000. Reversed: D1 + D2 = ₹1,50,000, added to output tax liability in GSTR-3B.

Where E and F need care

E — exempt supplies for this purpose is wider than it looks. Section 17(3) provides that the value of exempt supply includes:

• supplies on which the recipient is liable to pay tax on reverse charge;
• transactions in securities — taken at 1% of the sale value under the Explanation to Chapter V;
• sale of land; and
• subject to Schedule II paragraph 5(b), sale of building.

And excludes, by the Explanation inserted from 01.02.2019, the value of activities in paragraph 8(a) of Schedule III — supply of warehoused goods before clearance for home consumption. Merchant trade and out-and-out supplies →

F — total turnover is the turnover in the State or Union territory, which for a multi-State business means the computation is done per registration, not at entity level.

Rule 42(1) provisos also require, where the aggregate value of exempt supplies or total turnover is not available for the tax period, the values of the last tax period for which details are available to be used.

The annual recomputation

Rule 42(2) requires the whole exercise to be redone for the financial year, using annual figures for E and F, before the due date for furnishing the return for September — read now with the 30 November deadline.

If the annual D1 + D2 exceeds the sum of the monthly figures, the excess is added to output tax liability in a return not later than the September return following the year, with interest under s.50 from 1 April of the succeeding year till the date of payment.

If it is less, the difference is claimed as credit in a return not later than that September return.

The annual true-up is not optional and it is not a formality. Businesses with seasonal exempt turnover — where a heavy exempt month distorts the monthly ratio — frequently find a material adjustment.

Practical notes

• Tag credits at the invoice level into T1, T2, T3, T4 and common. Retrofitting the tagging at year end is where errors originate.
• The 5% D2 is a flat deeming. It applies whenever there is common credit, even where actual non-business use is nil.
• Rule 42 covers inputs and input services. Capital goods are under Rule 43, on a 60-month basis.
• Zero-rated supplies are taxable for this purpose — they go into T4 or the taxable side of the ratio, not into E.
• Reconcile to GSTR-9 Table 7 and to GSTR-9C, where the reversal is a standing source of variance.
• Interest runs from 1 April of the succeeding year on an annual shortfall — not from the return due date.

Key takeaways

• C1 = T − (T1+T2+T3); C2 = C1 − T4; D1 = (E/F) × C2; D2 = 5% of C2; C3 = C2 − D1 − D2.
• D1 and D2 are added to output tax liability each month.
• E includes reverse charge supplies, securities at 1% of sale value, sale of land and building.
• F is turnover in the State or Union territory — computed per registration.
• The annual recomputation is due before 30 November, with interest from 1 April.
• Capital goods are outside Rule 42 — Rule 43 applies.

Read next

• ITC Reversal Under Rules 42 and 43
• Rule 43: Capital Goods and the 60-Month Rule
• Proportionate ITC on Exempt and Taxable Supplies
• Merchant Trade and Out-and-Out Supplies Under GST

Disclaimer: Positions stated as on 5 September 2026, based on the CGST Rules as amended to 31 March 2026 (ICAI Bare Law, 12th edition).