The Goods and Services Tax framework in India places significant reliance on the self-assessment mechanism. Among all GST components, Input Tax Credit (ITC) is the most sensitive, both from a revenue protection and a compliance standpoint. Recognising the risk of tax leakage through misuse of electronic credit ledgers, the government introduced Rule 86B, imposing conditional restrictions on the utilisation of ITC. This regulatory shift has fundamentally changed how businesses must design internal control systems for GST compliance.

Rather than being viewed as a mere procedural hurdle, Rule 86B should be treated as a trigger for strengthening internal governance, tightening controls, and improving audit preparedness. Businesses that align their ITC processes with robust internal controls are better positioned to manage cash flows, reduce litigation exposure, and withstand departmental scrutiny.

Understanding Rule 86B and Its Compliance Implications

Rule 86B restricts the use of ITC beyond a specified threshold when a taxpayer’s taxable turnover exceeds a defined limit in a tax period. In such cases, a minimum portion of the GST liability must be discharged through cash, even if a sufficient ITC balance is available. While certain categories of taxpayers are exempt from this restriction, the rule’s broader intent is to discourage circular trading, fake invoicing, and artificial inflation of credit balances.

From an internal control perspective, Rule 86B demands heightened visibility into turnover calculations, real-time tax liability assessments, and credit utilisation planning. Failure to anticipate its applicability can lead to last-minute cash outflows, interest exposure, and compliance lapses. Therefore, internal systems must be proactive rather than reactive.

Segregation of Duties: The Foundation of Control Integrity

One of the most effective safeguards against ITC misuse is a well-defined segregation of duties. In many organisations, GST compliance is handled by a small team, increasing the risk of control concentration. When the same individual is responsible for vendor onboarding, invoice booking, ITC availing, and return filing, the scope for error or manipulation rises significantly.

A sound control framework clearly separates responsibilities. Procurement teams should verify commercial terms and vendor credentials. Accounts teams should record invoices and perform tax classification checks. A separate compliance or review function should validate ITC eligibility, Rule 86B applicability, and return disclosures before filing. This layered approach reduces dependency on a single point of failure and ensures that discrepancies are detected early.

Segregation also strengthens accountability. When roles are clearly documented, audit trails become stronger, making it easier to demonstrate control effectiveness during departmental audits or internal reviews.

Reconciliation as a Continuous Control, Not a Periodic Task

Reconciliation is often treated as a post facto exercise, conducted only when notices are received or annual returns are due. This approach is incompatible with the control expectations under Rule 86B. Continuous reconciliation should be embedded into monthly compliance routines.

Key reconciliations include matching purchase registers with supplier filings, comparing ITC claimed with electronic credit ledger balances, and aligning turnover figures used for Rule 86B evaluation with financial books. Discrepancies must be investigated promptly, not merely adjusted in subsequent periods.

Automated reconciliation tools can assist, but technology alone is insufficient without defined review protocols. Management oversight is essential to ensure that reconciliation exceptions are not ignored or rolled forward indefinitely. Timely resolution of mismatches not only protects ITC claims but also demonstrates control maturity to auditors.

Cash Flow Planning Under Rule 86B Constraints

One of the practical challenges of Rule 86B is its impact on working capital. Businesses accustomed to settling liabilities largely through ITC may face unexpected cash requirements. Internal controls must therefore extend beyond compliance and integrate with treasury planning.

Forecasting models should incorporate scenarios where Rule 86B becomes applicable due to turnover spikes or seasonal sales. Advance identification of such periods allows finance teams to arrange liquidity without stress. Linking GST liability projections with cash management systems ensures that compliance obligations do not disrupt operational continuity.

This forward-looking approach reflects a shift from transactional compliance to strategic tax management.

Fraud Prevention Through Control Design

Fraud in ITC claims often arises from weak controls rather than deliberate intent at senior levels. Fake vendors, backdated invoices, and inflated purchase values can go undetected in the absence of structured checks. Rule 86B, while restrictive, acts as a deterrent by limiting credit utilisation in high-risk scenarios.

Effective fraud prevention begins with vendor due diligence. Periodic validation of GST registrations, monitoring the filing behaviour of key suppliers, and flagging abnormal credit patterns are essential controls. Internally, access controls over GST portals should be role-based, preventing unauthorised modifications or filings.

Exception reporting is another powerful tool. Sudden increases in ITC ratios, repeated reversals, or frequent amendments should trigger internal reviews. These indicators, when monitored consistently, help identify potential issues before they escalate into investigations.

Audit Readiness as a By-Product of Strong Controls

Audit readiness should not be a separate objective; it naturally follows from disciplined control practices. When segregation of duties is enforced, reconciliations are documented, and decision-making is traceable, responding to GST audits becomes significantly easier.

Documentation plays a critical role. Internal control manuals, process flowcharts, reconciliation statements, and approval logs form the backbone of audit defence mechanisms. In the context of Rule 86B, maintaining clear working papers that show turnover calculations, exemption checks, and cash payment compliance can help prevent interpretational disputes.

Regular internal audits further enhance readiness. These reviews should focus not only on numerical accuracy but also on process adherence. Identifying control gaps internally is far less costly than defending them before tax authorities.

Creating a Culture of Compliance Ownership

Ultimately, internal controls are effective only when supported by an organisational culture. GST compliance, including ITC management, should not be viewed as the sole responsibility of the tax team. Procurement, sales, finance, and management must collectively understand the implications of non-compliance.

Training sessions, periodic updates on regulatory changes, and clear escalation mechanisms foster shared ownership. When teams recognise that ITC errors can affect cash flows, profitability, and reputational standing, compliance becomes a business priority rather than a statutory burden.

Conclusion

Rule 86B has transformed the landscape of ITC utilisation by introducing cash-based safeguards against misuse. While the rule may appear restrictive, it also presents an opportunity for businesses to reassess and strengthen their internal control frameworks. Through effective segregation of duties, continuous reconciliation, proactive cash planning, and fraud-focused controls, organisations can not only comply with Rule 86B but also achieve a higher level of audit readiness.

In an environment of increasing GST scrutiny, strong internal controls are no longer optional. They are the cornerstone of sustainable compliance and financial resilience.

For any clarifications or queries, please feel free to reach out to us at:
admin@fintracadvisors.com

Disclaimer

The material presented on this blog is intended solely for informational purposes. The opinions expressed here are solely those of the respective authors and do not necessarily reflect the views of Fintrac Advisors. No warranties are made regarding the completeness, reliability, or accuracy of this information. Any actions taken based on the information presented in this blog are solely at the reader’s risk, and we will not be liable for any losses or damages resulting from its use. Seeking professional expertise for such matters is strongly recommended. External links on this blog may direct users to third-party sites beyond our control. We do not take responsibility for their nature, content, or availability.