Reverse charge mechanism example
Reverse Charge Mechanism Example: How It Works Under GST
In this post, we will talk about the Reverse Charge Mechanism (RCM) under GST, how it works, and why it is essential. We will also examine two common scenarios to help you understand its practical application.
Let’s look at each section in detail:
What is Reverse Charge Mechanism (RCM)?
Under GST, the reverse charge mechanism (RCM) moves the responsibility for tax payment from the supplier to the recipient. This typically applies to transactions with unregistered dealers and certain service imports. The system helps improve tax compliance, especially in unorganised sectors, ensuring better revenue collection.
Reverse Charge Mechanism Example
To understand how the Reverse Charge Mechanism (RCM) works, let’s look at two everyday situations:
Example 1: Buying Goods from an Unregistered Supplier
XYZ Ltd., a registered business, buys raw materials for ₹50,000 from a local supplier who is not registered for GST. Normally, the seller would collect GST and pay it to the government, but because this supplier is unregistered, they cannot charge GST.
Here is what happens under RCM:
- Applicable GST Rate: 18%
- GST Amount: ₹9,000 (18% of ₹50,000)
- Who Pays the Tax? XYZ Ltd. must pay ₹9,000 directly to the government instead of the supplier.
- Claiming ITC: XYZ Ltd. can later claim this ₹9,000 as Input Tax Credit (ITC), provided all GST rules are followed.
Example 2: Cab booking Services and E-Commerce Operators
A cab driver, Raj, offers services through a cab booking app but is not registered under GST. Since Raj cannot collect GST himself, the service provider (say, Uber) must handle it through RCM.
Here’s how it operates:
- Ride Fare: ₹1,000
- GST Rate: 5%
- GST Amount: ₹50 (5% of ₹1,000)
- Who Pays the Tax?: Uber collects and pays ₹50 GST to the government under RCM.
These examples show why RCM exists: it guarantees tax compliance whether a supplier is unregistered or follows a specific business strategy. The tax burden shifts from the provider to the customer or platform, improving GST collection efficiency.
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