Understanding Reverse Charge Mechanism (RCM) under GST: Examples, Advantages, and Disadvantages

Overview

The introduction of Goods and Services Tax (GST) in India has brought significant changes in the way businesses operate. One such change is the introduction of the Reverse Charge Mechanism (RCM), which has been implemented to increase tax compliance and prevent tax evasion. The RCM is a system where the liability to pay tax is shifted from the supplier to the recipient of goods or services.

In this blog post, we will discuss the Reverse Charge Mechanism under GST and its impact on businesses. We will provide a comprehensive understanding of RCM, the types of supplies covered under RCM, who is liable to pay tax under RCM, and when RCM is applicable. Additionally, we will also discuss some examples of RCM, its advantages, disadvantages, and ways to overcome the disadvantages of RCM.

So, if you are a business owner or a tax professional, this blog post is for you. Read on to gain a deeper understanding of Reverse Charge Mechanism under GST and its impact on your business.

Understanding RCM under GST

The Reverse Charge Mechanism under GST is a system where the liability to pay tax is shifted from the supplier to the recipient of goods or services. This means that the recipient of goods or services is liable to pay the tax instead of the supplier.

Explanation of RCM

Under the regular scheme of GST, the supplier of goods or services is liable to pay the tax to the government. However, under the RCM, the liability is shifted to the recipient. This means that the recipient has to pay the tax on behalf of the supplier. The recipient can then claim the input tax credit (ITC) of the tax paid under RCM.

Types of supplies under RCM

The RCM applies to certain types of supplies, such as:

1. Goods or services purchased from an unregistered dealer
2. Services received from a non-resident supplier
3. Hiring of transport services from a Goods Transport Agency (GTA)
4. Services provided by an advocate or a firm of advocates
5. Services provided by a director of a company or a body corporate

Who is liable to pay tax under RCM

In the case of goods or services purchased from an unregistered dealer, the liability to pay tax under RCM lies with the recipient. For other types of supplies, the liability to pay tax under RCM may lie with the recipient, the supplier, or both.

When RCM is applicable

The RCM is applicable in certain situations, such as:

1. When goods or services are purchased from an unregistered dealer
2. When services are received from a non-resident supplier
3. When transport services are hired from a GTA
4. When services are provided by an advocate or a firm of advocates
5. When services are provided by a director of a company or a body corporate

Impact of RCM on small businesses

The RCM has a significant impact on small businesses, as it increases their compliance burden. Small businesses may not have the infrastructure or the resources to comply with the RCM provisions, leading to additional costs and administrative burdens. However, the RCM also ensures that tax compliance is maintained and helps prevent tax evasion.

Examples of RCM under GST

To understand RCM better, let’s take a look at some examples:

Example 1: Goods purchased from an unregistered dealer

Suppose a registered dealer purchases goods worth Rs. 50,000 from an unregistered dealer. In this case, the liability to pay tax under RCM lies with the registered dealer. The registered dealer has to pay the tax applicable under GST (e.g. 18% in case of goods) on the value of the goods purchased from the unregistered dealer. The registered dealer can then claim the ITC of the tax paid under RCM.

Example 2: Services received from a non-resident supplier

Suppose a registered dealer receives services worth Rs. 1,00,000 from a non-resident supplier. In this case, the liability to pay tax under RCM lies with the registered dealer. The registered dealer has to pay the tax applicable under GST (e.g. 18% in case of services) on the value of the services received from the non-resident supplier. The registered dealer can then claim the ITC of the tax paid under RCM.

Example 3: Hiring of transport services from a GTA

Suppose a registered dealer hires transport services worth Rs. 75,000 from a Goods Transport Agency (GTA). In this case, the liability to pay tax under RCM lies with the registered dealer. The registered dealer has to pay the tax applicable under GST (e.g. 5% in case of GTA services) on the value of the transport services hired from the GTA. The registered dealer can then claim the ITC of the tax paid under RCM.

These are just a few examples of RCM under GST. It is essential to understand the types of supplies covered under RCM and the liability to pay tax under different scenarios. Failure to comply with RCM provisions can lead to penalties and interest. Therefore, it is crucial for businesses to understand and comply with the RCM provisions under GST.

Advantages and Disadvantages of RCM

Advantages of RCM

1. Increased tax compliance: RCM helps to increase tax compliance by shifting the responsibility of paying tax to the recipient. This reduces the chances of tax evasion by unscrupulous suppliers.
2. Prevents tax cascading: RCM prevents tax cascading, which is a situation where tax is paid on tax. By allowing the recipient to claim the ITC of the tax paid under RCM, it ensures that tax is paid only on the value added at each stage of the supply chain.
3. Level playing field: RCM ensures a level playing field for both registered and unregistered dealers. Under the regular scheme of GST, registered dealers may not be able to compete with unregistered dealers who do not pay taxes. RCM ensures that tax is paid even on supplies made by unregistered dealers.

Disadvantages of RCM

1. Administrative burden: RCM imposes an additional administrative burden on businesses, especially small businesses. Small businesses may not have the infrastructure or the resources to comply with the RCM provisions, leading to additional costs and administrative burdens.
2. Cash flow impact: RCM can have a cash flow impact on businesses, especially small businesses. Businesses have to pay the tax under RCM upfront, which can affect their cash flow. The ITC of the tax paid under RCM can be claimed only after the payment of tax is made.
3. Complexity: RCM provisions can be complex and confusing, especially for businesses that have to deal with different types of supplies. This can lead to errors and mistakes in compliance, leading to penalties and interest.