Issuing Credit Notes? Here’s the One Document That Can Save You from GST Demands

Introduction

In the dynamic landscape of GST compliance, credit notes have often been a convenient tool for businesses to adjust prices, settle post-sale discounts, and correct billing errors. But what was once a straightforward mechanism has now become a potential compliance minefield. With the issuance of CBIC Circular No. 212/6/2024, the Government has drawn a clear line—you can’t reduce your output tax liability unless you prove that your customer has reversed the corresponding ITC.

This new mandate shifts the compliance burden squarely onto the supplier. Whether you’re a tax consultant, CFO, or business owner, it’s no longer enough to issue a credit note and move on. Without documented proof of ITC reversal—either through a customer’s declaration or a Chartered Accountant’s certificate—you risk facing tax demands, interest, and penalties during audits.

This article the legal requirements, practical steps, and real-world implications of this circular—so you can ensure your credit notes don’t come back to you in the form of a GST notice.

Legal Background: Credit Notes, Section 34, and ITC Reversal

Under Section 34 of the CGST Act, a supplier may issue a credit note to adjust (reduce) the taxable value and GST amount of a supply in cases like post-sale discounts, rate changes, returns, or invoice corrections. However, such adjustments are conditional. The CGST Act (Section 15(3)(b)) specifies that a post-supply discount can be excluded from the original taxable value only if two key conditions are met:

• Pre-agreed Terms: The discount must have been established in terms of an agreement entered into at or before the time of the original supply, and it must be linked to the relevant invoice (e.g. a volume discount agreement, year-end rebate, etc.).

• ITC Reversal by Recipient: The proportionate input tax credit attributable to the discount must have been reversed by the recipient of the supply. In other words, the buyer who initially claimed ITC on the full value must reduce their ITC by the amount of GST relating to the discount.

If these conditions are not satisfied, the discount cannot be deducted from the taxable value, meaning the supplier’s output tax liability cannot be reduced via a GST credit note for that discount. Only a “financial credit note” (without GST adjustment) would be possible in such cases. Thus, Section 34’s allowance to issue credit notes with GST is contingent on Section 15(3)(b)(ii) compliance. The recent circular addresses how suppliers can prove that the second condition (ITC reversal) has been fulfilled, which has been a gray area in GST compliance.

New Requirement: Proof of ITC Reversal for Credit Notes

CBIC Circular 212/6/2024 mandates that a supplier must obtain documentary proof from the customer (recipient) that the requisite ITC reversal has been carried out, in order to claim a deduction of output tax via a credit note. In practical terms, when you issue a GST credit note to give a post-sale discount and reduce your output tax, the supplier now bear the burden of showing evidence that the buyer has proportionately reduced their ITC. Without such proof, the tax authorities may disallow the credit note adjustment. This ensures the GST department doesn’t lose revenue by a situation where the supplier reduces their tax while the buyer also keeps full ITC.

Certification Thresholds under the Circular

The circular provides a two-tier mechanism depending on the total tax amount involved in the credit notes given to a particular recipient in a financial year:

• Total tax is less than INR 5,00,000 per annum (CGST+SGST+IGST, combined) – The supplier can obtain a simple undertaking or self-certificate from the recipient (on the customer’s letterhead) confirming that the input tax credit attributable to the discount has been reversed by them. This self-declaration should include relevant details such as the credit note and invoice references, the amount of ITC reversed, and any proof of reversal (for example, a reference to the GST return or Form DRC-03 used to reverse the credit). A letter or email from the customer with these details, on their official letterhead and signed by an authorized person, would suffice for this category.

• Total tax is more than INR 5,00,000 per annum – The supplier must obtain a certificate from a Chartered Accountant (CA) or Cost & Management Accountant (CMA) engaged by the recipient, verifying that the recipient has reversed the proportionate ITC related to the discount/credit note. In other words, for larger annual discount amounts, a third-party professional certification is required. The CA/CMA’s certificate should contain a Unique Document Identification Number (UDIN) and detail the credit notes, corresponding invoices, the GST amounts, and confirmation that an equivalent ITC reversal was made by the buyer. It may also cite evidence of the reversal (e.g. a GST DRC-03 reference number or relevant GSTR-3B entries) for completeness.

These thresholds apply per recipient per financial year. A supplier should aggregate the GST amount of all credit notes issued to the same customer over the year to determine which category applies. For instance, if you give small post-sale rebates to a distributor throughout the year totaling ₹3 lakhs GST, a self-declaration from them suffices; but if the total GST on discounts to that distributor crosses ₹5 lakhs, you’ll need a CA/CMA-certified letter from them. This certification must be obtained and kept on record by the supplier. Till an automated solution is in place, this procedure is now considered “suitable and admissible evidence” of compliance with the law.

Why Is This Required? – Lack of System on GSTN Portal

The reason behind this additional requirement is a systemic gap in the current GST framework. As of now, the GSTN portal has no functionality for suppliers or tax officers to verify if a recipient has actually reversed ITC related to a discount or credit note. When a supplier issues a credit note and reduces output tax, the tax authorities had no direct way to confirm the buyer adjusted their ITC in tandem. This lack of visibility created compliance challenges and potential revenue leakage.

CBIC acknowledged that numerous representations were made by industry and GST field officers highlighting this issue. Without a verification mechanism, honest suppliers faced uncertainty, and unscrupulous players could theoretically abuse the system (e.g. claiming a tax reduction via credit note while the buyer kept full ITC). In fact, prior to this circular, tax officers often denied or closely scrutinized credit note adjustments during audits, due to the inability to confirm ITC reversals.

The new circular’s interim solution is to enforce a manual proof mechanism – i.e. certificates or declarations as evidence of ITC reversal. The burden of proof now squarely lies on the supplier to collect and furnish this evidence. This is explicitly a stop-gap measure “till a functionality is made available on the common portal” for ITC reversal verification. The GST Council has indicated plans for such a system in the future, but until then, these CA certificates or self-declarations are the only defense a supplier has to demonstrate compliance during GST audits or assessments. In summary, the requirement exists because GSTN currently cannot automatically match a supplier’s credit note with the recipient’s ITC reversal – so manual certification is the solution.

Practical Steps for Compliance

Given this new requirement, businesses should take proactive steps to incorporate ITC reversal proof into their credit note process. Below are recommended steps for tax professionals and GST-registered suppliers to ensure compliance:

1. Identify Affected Credit Notes: Determine which credit notes issued (or to be issued) by your business relate to post-sale discounts or incentives after the supply (as opposed to those for sales returns or invoice errors). The circular’s requirements mainly apply to post-supply discount credit notes (since those invoke Section 15(3)(b)(ii) conditions).

2. Track Tax Amounts by Customer: Implement a system (e.g. in your accounting or ERP software, or a simple spreadsheet) to track the cumulative GST amount of such credit notes for each customer per financial year. This running total will tell you whether the ₹5,00,000 threshold is likely to be exceeded for any customer. It may be prudent to start this tracking from April 1, 2024 (the start of FY 2024-25) if not earlier.

3. Obtain Declarations or Certificates: For each credit note issued, request the appropriate proof from the recipient:

• If the year-to-date GST amount of discounts for that customer is less than ₹5 lakhs: obtain a written undertaking or self-certificate from the customer. This should be on their letterhead, dated and signed, explicitly stating that they have reversed the input tax credit related to the credit note. Ideally, it should mention the credit note number, original invoice reference, and amount of GST reversed (and possibly attach proof like a screenshot of their GST return working or DRC-03 form used).

• If the cumulative tax amount for that customer exceed ₹5 lakhs: inform the customer that you will require a certificate from their Chartered Accountant or CMA confirming the ITC reversal. Provide them the details needed (credit note/invoice refs, GST amounts) so they can issue the certificate with a UDIN.

4. Time the Requests Appropriately: In practice, it’s wise to request the certificate/undertaking as soon as you issue the credit note (or shortly thereafter). This improves the chance of timely compliance. Customers might delay or forget if asked much later. You could even make the issuance of the credit note conditional upon the customer’s agreement to provide the ITC reversal proof. If multiple credit notes are issued to the same customer over the year, coordinate with them on whether a single consolidated certificate after the last credit note is feasible or if individual certificates each time are preferred (the circular does not forbid a single annual certificate covering all credit notes, but clarity on this is evolving).

5. Maintain Organized Records: Keep a dedicated file (physical and/or digital) of all obtained declarations and CA/CMA certificates. Ensure each document clearly identifies the credit note(s) it pertains to. These may need to be produced during GST scrutiny, audits, or investigations to substantiate the reduction in output tax. Tax officers have been empowered by this circular to ask for such evidence, so organized records will facilitate smooth audits.

6. Educate Your Team and Customers: Inform your sales, finance, and compliance teams about this requirement so that everyone internally is aware that credit notes now carry this extra step. It’s also advisable to educate or notify major customers about the rule – especially those who regularly receive rebates or incentives. Early communication can help manage customers’ expectations and obtain their cooperation. Some businesses are even updating their contracts or credit note terms to state that the customer must furnish proof of ITC reversal as a condition for the discount.

7. Monitor GST Council/CBIC Updates: Since this is an interim measure, stay alert for any future changes. A technological solution on the GST portal could alter the compliance requirements. Regularly check for new circulars or amendments that might supersede or refine Circular 212/6/2024.

By following the above steps, businesses can integrate the certificate-collection process into their operations. Admittedly, obtaining such certificates can be challenging in practice (some customers may be unfamiliar or hesitant), but it is now a necessary compliance step. Firms may consider reaching out to customers’ accountants directly or aligning the certificate request with periodic reconciliation routines to ease the process.

Retroactive Applicability (FY 2024–25 Onwards and Past Credit Notes)

One important aspect of Circular 212/6/2024 is its applicability timeframe. The circular was issued on 26th June 2024 and is effective for the financial year 2024–25 onward. This means all credit notes issued in FY 2024-25 and future periods for post-supply discounts must comply with these requirements. Even if some credit notes were issued in April–June 2024 (before the circular’s release), the clarifications apply to those as well – suppliers would be expected to gather the necessary undertakings or CA certificates for any such credit notes to ensure they can defend the corresponding tax deductions.

Moreover, CBIC explicitly addressed past periods in the circular. It clarified that the same mechanism can be used for earlier periods if needed. In practical terms, if a GST officer or auditor asks a supplier to provide evidence of ITC reversal for credit notes issued in prior financial years (before 2024-25), the taxpayer is now allowed to procure similar CA/CMA certificates or recipient declarations for those past transactions. This is a retroactive facilitation – even though the requirement was not spelled out in those years, the certificates/undertakings will be accepted as proof that Section 15(3)(b)(ii)’s condition was met.

For example, suppose during a GST audit of FY 2022-23, the officer questions a large discount credit note issued in that year. Earlier, there was ambiguity on how the supplier could conclusively prove the buyer reversed ITC. Now, by virtue of this circular, the supplier can go back to that customer, obtain a CA-certified letter (or self-declaration if the tax amount was small) confirming the ITC reversal, and present it to the authorities as evidence. Tax professionals should be aware of this retroactive applicability, as there may be ongoing or upcoming audits where such evidence could bolster the defense of credit note adjustments. Essentially, from FY 2024-25 onwards, and even for past credit notes under scrutiny, obtaining these certificates is advisable and can protect the supplier’s position.

Do note that this doesn’t mean every historical credit note must be revisited proactively. It means if questions arise for past years, this method is an accepted way to demonstrate compliance. Going forward, however, it is wise to implement the process for all new credit notes to avoid future complications.

Risks and Penalties for Non-Compliance

Non-compliance with the circular’s directives can have serious repercussions for a business. If a supplier fails to obtain the required ITC reversal proof and yet goes ahead to reduce output tax (i.e. claims a discount in GST returns via a credit note), they run the risk of that reduction being disallowed by the authorities. Key risks include:

• Tax Demand on the Supplier: In the event of an audit, GST scrutiny or investigation, officers will likely review credit notes issued and ask the supplier to produce the customer’s declaration or CA certificate as per Circular 212/6/2024. If the supplier cannot produce acceptable evidence for a given credit note, the tax officer may conclude that the condition in Section 15(3)(b)(ii) was not proven. Consequently, the output tax that was reduced could be treated as short-paid tax, and the department can raise a demand for that GST amount to be paid by the supplier. Essentially, the supplier could lose the benefit of the credit note adjustment.

• Interest Liability: Along with the tax demand, the supplier would be liable for interest on the short-paid tax, calculated from the date the output tax was reduced (i.e. from the tax period in which the credit note was accounted). Under Section 50 of the CGST Act, interest is often levied at 18% per annum on such unpaid tax. This interest can accumulate quickly, especially if the issue is caught much later.

• Penalties: Failure to comply can also attract penalties. At minimum, a general penalty could be imposed (for contravention of GST rules or circulars). If the tax authority views the adjustment as an undue claim, they may invoke Section 73 or 74 of the CGST Act. Under these provisions, a penalty of 10% of the tax (up to a maximum of ₹10,000) is typical for bona fide cases (Section 73), whereas in cases of willful misstatement or fraud (Section 74), a penalty of 100% of the tax shortfall can be imposed. Even if we assume no malintent, the lack of proper documentation is a compliance lapse that could at least lead to the 10% penalty in addition to tax and interest. The circular itself warns that non-compliance with Section 15(3)(b) and the circular can result in recovery of tax with penalty and interest.

• Litigation Costs and Disputes: A supplier caught in non-compliance may end up in protracted disputes or litigation with the department. For instance, if a tax demand is raised due to lack of ITC reversal proof, the supplier might choose to contest it legally (especially if they believe the recipient did reverse ITC but just didn’t provide a certificate). This can lead to costly appeals in tribunals or courts. In fact, some large companies have already challenged the CA certification mandate itself in court, arguing it to be onerous. However, unless and until a court provides relief or the law is changed, the requirement stands – and not following it could embroil businesses in avoidable litigation with uncertain outcomes.

In summary, the cost of non-compliance far outweighs the inconvenience of obtaining certificates. Tax professionals should impress upon their organizations or clients that ignoring this requirement could convert a simple post-sale discount into a future tax liability with added interest and penalties. During GST audits, officers are now justified in demanding these documents; lacking them puts the supplier on a weak footing, potentially turning a credit note into a “tax notice” scenario.

Conclusion:

CBIC Circular 212/6/2024 brings a critical compliance checkpoint for any business issuing GST credit notes for post-sale discounts. In a nutshell, to lawfully reduce your output tax via a credit note, you must secure proof that the buyer has reversed the corresponding ITC – either through a customer’s self-declaration (for smaller amounts) or a CA/CMA’s certificate (for larger discounts). This requirement aligns with the fundamental GST principle that both sides of the transaction must adjust their tax records for a discount: the supplier reduces output tax only when the recipient gives up the equivalent credit.

Businesses are advised to take this circular seriously and integrate its mandates into their GST compliance processes. The effort spent now on designing an internal system to request and store ITC reversal certificates will pay off by safeguarding the company during departmental audits. Remember that GST authorities will treat these certificates as the evidence of compliance with Section 15(3)(b)(ii). In the absence of an official IT platform solution, this paperwork is your proof and protection.

In conclusion, tax professionals and businesses should view Circular 212/6/2024 as a call to strengthen their compliance controls around credit notes. By following the guidelines and steps outlined above, you can continue to offer legitimate post-sale discounts and adjust your GST liability without inviting trouble. The motto to remember is: “Don’t let a credit note turn into a tax notice – ensure you have the ITC reversal proof in hand.” By doing so, you honor both the letter and spirit of the GST law, and protect your business from unwelcome tax demands, interest, or penalties. Stay diligent, keep communication open with your customers and consultants, and your credit notes will remain a beneficial tool rather than a compliance risk.

Sources: The above advisory is based on CBIC Circular No. 212/6/2024-GST dated 26-June-2024 and relevant provisions of the CGST Act (Sections 15(3)(b)(ii) and 34) along with analyses by tax experts. All taxpayers dealing in post-supply discounts should review the circular and ensure adherence to avoid any adverse consequences. Compliance today will save you from disputes tomorrow.

This article is written by Himanshu Singh who is a Chartered Accountant, master’s in law and Visiting Faculty of Central GST and UPGST Department Officers Training Institutes in Uttar Pradesh. He can be reached through email mr.himanshu@icai.org