Key Takeaways
- Rule 86B applies to a registered person whose taxable supply in a month exceeds Rs 50 lakh (exempt and zero-rated supplies are excluded from this test).
- For such a person, input tax credit (ITC) cannot discharge more than 99% of the output tax liability for that month. At least 1% of the output tax must be paid in cash through the electronic cash ledger.
- The rule was inserted by Notification No. 94/2020-Central Tax dated 22 December 2020 and applies from 1 January 2021. It targets fake-invoice and pass-through ITC fraud.
- Five exceptions remove the restriction, including a Rs 1 lakh income tax payment test, certain GST refunds, and government bodies.
- The 1% is calculated on output tax liability, not on turnover, so the actual cash outflow is usually small.
- Most genuine, regular taxpayers either fall below the threshold or qualify for an exception.
If your business has high monthly sales and you settle almost the entire GST bill using input tax credit, Rule 86B may require you to pay a small portion in cash. The rule looks intimidating, but it affects a narrow set of taxpayers, and the actual amount is modest once you understand how it is computed.
This guide explains who Rule 86B applies to, how the Rs 50 lakh threshold and the 1% cash payment work, the exceptions that take you out of its scope, and the steps to stay compliant in 2026.
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What Is Rule 86B?
Rule 86B of the Central Goods and Services Tax (CGST) Rules, 2017 places a restriction on how much of your monthly output tax liability you can pay using the electronic credit ledger (ITC).
The core rule: where the value of taxable supply in a month exceeds Rs 50 lakh, the registered person cannot use ITC to pay more than 99% of the output tax liability for that month. The balance, a minimum of 1% of the output tax liability, must be paid in cash.
The provision was introduced through Notification No. 94/2020-Central Tax dated 22 December 2020 and took effect from 1 January 2021. Its stated purpose is to curb the misuse of fraudulent or pass-through ITC, where shell entities issue fake invoices and the credit is used to wipe out almost the entire tax liability without any real cash reaching the government.
The Rs 50 Lakh Threshold: How to Test It
The threshold is checked month by month, not on annual turnover.
| What counts | Included in the Rs 50 lakh test? |
|---|---|
| Taxable supplies (standard-rated sales) | Yes |
| Exempt supplies | No |
| Zero-rated supplies (exports, SEZ) | No |
| Inward supplies (purchases) | No |
So the test is: in a given month, does your taxable supply (other than exempt and zero-rated) cross Rs 50 lakh? If yes, Rule 86B applies for that month unless an exception is met. If your taxable supply in a month is Rs 50 lakh or below, the rule does not apply for that month at all.
Because the test resets every month, a seasonal business may fall within Rule 86B in peak months and outside it in lean months.
The 1% Cash Payment: How It Works
The 1% is applied to the output tax liability for the month, not to turnover. This is the point most often misunderstood.
Consider a manufacturer with taxable supply of Rs 80 lakh in a month and an output tax liability of Rs 14.4 lakh (18% GST). Suppose available ITC is Rs 14.4 lakh, enough to cover the entire liability.
| Step | Amount |
|---|---|
| Output tax liability for the month | Rs 14,40,000 |
| Maximum that ITC can discharge (99%) | Rs 14,25,600 |
| Minimum payable in cash (1%) | Rs 14,400 |
So even though the business had enough credit to pay the full Rs 14.4 lakh, Rule 86B requires at least Rs 14,400 to be paid in cash. The unused ITC of Rs 14,400 simply stays in the credit ledger and carries forward, it is not lost.
The Five Exceptions
Rule 86B does not apply, even above the Rs 50 lakh threshold, if any of these conditions are met.
| Exception | Condition |
|---|---|
| Income tax paid | The person, or the proprietor, karta, managing director, any of the two partners, or whole-time directors, has paid income tax exceeding Rs 1 lakh in each of the last two financial years for which the time limit to file the return has expired |
| Refund on exports | The registered person has received a refund exceeding Rs 1 lakh in the preceding financial year on account of unutilised ITC from zero-rated supplies made without payment of tax |
| Refund on inverted duty | The registered person has received a refund exceeding Rs 1 lakh in the preceding financial year on account of an inverted duty structure |
| Cash already paid | The registered person has discharged output tax liability through the cash ledger in excess of 1% of the total output tax liability, applied cumulatively, up to the said month in the current financial year |
| Government and notified bodies | The registered person is a government department, public sector undertaking, local authority, or statutory body |
The Commissioner or an officer authorised by the Commissioner may also remove the restriction after suitable verification.
The fourth exception is practically important. If you have already paid more than 1% of your cumulative output tax in cash during the financial year, you do not need to keep paying the 1% each subsequent month in that year.
Worked Example: When the Exception Saves You
A trading company has taxable supply above Rs 50 lakh every month. Both of its partners individually paid income tax of more than Rs 1 lakh in each of the last two financial years.
Because the income tax exception is satisfied, Rule 86B does not apply to the company at all. It can discharge 100% of its monthly output tax through ITC without setting aside the 1% in cash. The company should keep the income tax payment proof and acknowledgements on record to support the exception during any GST scrutiny.
Who Is Actually Affected
| Profile | Rule 86B impact |
|---|---|
| Small business, monthly taxable supply below Rs 50 lakh | Not applicable |
| Exporter receiving regular ITC refunds above Rs 1 lakh | Usually exempt under the refund exception |
| Promoter or partners paying income tax above Rs 1 lakh each | Usually exempt under the income tax exception |
| High-turnover business with almost entirely credit-funded liability and no exception | Must pay at least 1% in cash each qualifying month |
| Government department, PSU, local authority | Not applicable |
In practice, the rule mainly affects newer or high-turnover entities that have not yet built an income tax track record or a refund history, and that run on very thin cash GST payments.
How to Stay Compliant
-
Check the threshold every month. Before filing GSTR-3B, confirm whether your taxable supply for the month crossed Rs 50 lakh. Exclude exempt and zero-rated supplies from this figure.
-
Test the exceptions in order. Income tax paid, export refund, inverted-duty refund, cumulative cash already paid, or government status. If any applies, document the evidence.
-
Compute 1% of output tax liability where no exception applies, and pay at least that amount through the electronic cash ledger before offsetting the rest with ITC.
-
Keep the proof. Income tax challans, refund sanction orders, and a working sheet of cumulative cash paid during the year support your position if questioned.
Common Mistakes
-
Applying 1% to turnover instead of output tax. The 1% is on the output tax liability for the month, not on sales value. Computing it on turnover overstates the cash payable.
-
Counting exempt or zero-rated supplies in the threshold. Only taxable supply is tested against Rs 50 lakh. Including exports or exempt sales can wrongly pull a business into the rule.
-
Forgetting the cumulative cash exception. If you have already paid more than 1% cumulatively in cash during the year, you do not need to add the 1% again in later months of that year.
-
Not documenting the exception. Claiming the income tax or refund exception without keeping challans or sanction orders leaves you exposed during assessment.
-
Treating the 1% as a lost cost. The cash you pay still discharges your tax. The ITC you could not use this month stays in the credit ledger and carries forward, so there is no permanent loss of credit.
Frequently Asked Questions
What is Rule 86B in GST?
Rule 86B of the CGST Rules restricts the use of input tax credit to a maximum of 99% of the output tax liability in a month for registered persons whose taxable supply in that month exceeds Rs 50 lakh. At least 1% of the output tax must be paid in cash. It applies from 1 January 2021.
Who does Rule 86B apply to?
It applies to a registered person whose value of taxable supply, other than exempt and zero-rated supply, exceeds Rs 50 lakh in a month, unless one of the five exceptions is met. The threshold is checked each month, not on annual turnover.
How is the 1% cash payment calculated?
The 1% is applied to the output tax liability for the month, not to turnover. For example, on an output tax liability of Rs 14,40,000, the minimum cash payment is Rs 14,400, and ITC can cover the remaining Rs 14,25,600.
What are the exceptions to Rule 86B?
The restriction does not apply if income tax above Rs 1 lakh was paid in each of the last two financial years by the entity or its key persons, if the business received a refund above Rs 1 lakh on zero-rated supplies or an inverted duty structure in the preceding year, if more than 1% of cumulative output tax has already been paid in cash during the year, or if the person is a government department, PSU, local authority, or statutory body.
Is the unused ITC lost under Rule 86B?
No. The credit you could not use because of the 1% cash requirement remains in your electronic credit ledger and carries forward to the next period. Rule 86B affects the timing of how you pay, not the total credit available to you.
Sources: Rule 86B of the CGST Rules 2017, inserted by Notification No. 94/2020-Central Tax dated 22 December 2020 and effective 1 January 2021 (cbic.gov.in); the proviso to Rule 86B listing the exceptions (income tax payment, refund on zero-rated supplies, refund on inverted duty structure, cumulative cash payment, and government or notified bodies); and the CBIC clarifications accompanying Notification No. 94/2020. Confirm the current text and any amendments on cbic.gov.in before relying on this for a specific filing.
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