When it comes to Input Tax Credit (ITC), most businesses follow the normal rules under Section 16, Section 17, Rule 42–43, and all those big formulas. But when you talk about banks, financial institutions, and NBFCs, the story changes a little.
Banks and NBFCs deal with two types of services daily:
- Taxable Services (like loan processing, card fees, forex services)
- Exempt Services (like interest on loans, EMI interest, deposits, savings account interest)
This creates a huge challenge. Interest income is exempt from GST, so technically, proportionate ITC reversal should apply (Rule 42 & 43).
But banks have crores of transactions and billions of rupees in interest income. Doing monthly proportionate reversals becomes almost impossible.
So the government introduced a simplified ITC method for banks, NBFCs and financial institutions — and that is Rule 38.
Let’s break it down in the simplest language.
1. Why Banks & NBFCs Have a Special Rule for ITC?
A normal business might have 50–200 invoices for inputs and input services every month. Banks have:
- Thousands of services
- Millions of customers
- Multiple exempt + taxable supplies
- Interest-based revenue dominating everything
If banks followed Rule 42 every month, their reversal would run into crazy calculations. So government gave them a straightforward option to simplify life.
2. Rule 38 – The Heart of ITC Rules for Banking Sector
Rule 38 says:
“Banks and NBFCs have an option to reverse 50% of total eligible ITC every month and take the remaining 50%.”
This is called the 50% ITC rule.
- They don’t need to calculate proportionate ITC
- They don’t need Rule 42 & 43 formulas
- They simply take half & reverse half
That’s the entire essence of Rule 38.
3. Who Can Use Rule 38?
Only the following:
- Banks
- NBFCs (Non-Banking Financial Companies)
- Financial institutions
- Any company engaged in lending of loans, advances, deposits
This option must be applied:
- PAN level
- Not branch level
- Applies across the entire business
4. What Is Included in the 50% Reversal?
The 50% reversal applies to:
- Inputs
- Input services
- Capital goods (except those on which ITC is not allowed anyway)
It covers almost everything, including:
- Office supplies
- Rent
- IT services
- Outsourced services
- Legal, audit, security
- AMC, software, infrastructure
- Equipments & machinery
All these will fall into 50–50 rule.
5. What Is Not Included in the 50% Reversal?
Rule 38 gives some exclusions.
These ITC amounts are allowed 100%:
(A) Tax paid on supplies between branches with same PAN
Example: Bank head office in Mumbai supplies IT services to its Delhi branch. Even though GST applies (cross-charge), ITC on such invoices is fully allowed.
(B) Tax paid on imports RCM
If the bank pays GST under reverse charge, it's fully eligible. RCM on:
- Legal services
- GTA services
- Sponsorship
- Security
- Import of services
… all are allowed 100%.
(C) ITC that falls under Section 17(5) (blocked credit)
Blocked ITC cannot be claimed anyway. So Rule 38 doesn't change that.
RCM ITC and inter-branch ITC are the biggest exceptions.
6. Example of Rule 38 – Simple Breakdown
Suppose a bank has the following ITC in a month:
- Inputs: ₹50,000
- Input services: ₹2,00,000
- Capital goods ITC: ₹1,00,000
- RCM ITC: ₹30,000
- Inter-branch ITC: ₹20,000
Now apply Rule 38:
Step 1: Compute total ITC eligible (excluding RCM + branch transfers)
Eligible for Rule 38 = 50,000 + 2,00,000 + 1,00,000 = ₹3,50,000
- Reverse 50% = ₹1,75,000
- Take 50% = ₹1,75,000
Step 2: Add ITC available 100% (RCM + branch transfers)
= 30,000 + 20,000 = ₹50,000
Final ITC Available:
- ITC under 50% rule = 1,75,000
- Full ITC allowed = 50,000
- Total ITC available = ₹2,25,000
Simple. No proportionate calculations.
7. Is Rule 38 Optional or Mandatory?
Rule 38 is optional.
Banks/NBFCs can choose between:
Option 1 → 50% blanket reversal (Rule 38)
Option 2 → Rule 42/43 proportional reversal every month
99% institutions choose Option 1 because:
- easy
- predictable
- no turnover-based math
- no exempt supply calculations
- no year-end adjustment
8. Once Chosen, Can Bank Change the Option?
No.
As per GST law:
“Once the bank/NBFC chooses the 50% ITC method, they must apply it for the entire financial year.”
Cannot switch mid-year.
9. Why This Rule Exists (Real Practical Reason)
Interest income is exempt. And interest portion in bank’s income is massive.
Example:
- Interest income: ₹3000 crore
- Fee/charges taxable income: ₹200 crore
If Rule 42 was followed:
- Exempt revenue = 93%
- Taxable revenue = 7%
That means the bank will lose 93% ITC — almost everything!
To avoid this unfair result, the government said: “Just reverse 50% and take 50%.”
Fair enough.
10. What Happens If They Don't Choose Rule 38?
Then they must follow Rule 42 & 43:
- Proportionate ITC reversal
- Monthly calculation
- Annual adjustments
- Using turnover ratio
- Filing annual adjustments in September return
Practically impossible for huge banks.
11. How Rule 38 Affects Capital Goods ITC?
Capital goods normally follow:
- 5% per quarter
- 60 months usage period
- Annual turnover-based reversal
But for banks/NBFCs under Rule 38:
Capital goods also follow 50% ITC allowed / 50% reversed, except for:
- Capital goods exclusively for taxable supply → 100% allowed
- Capital goods exclusively for exempt supply → 0% allowed
So Rule 38 is much simpler.
12. What Happens in Case of Mixed Use Assets?
Example: A financial institution buys a server system costing ₹50 lakh with GST ₹9 lakh.
Usage:
- 40% for taxable services
- 60% for exempt services
- Under Rule 42 → complex calculation
- Under Rule 38 → simply take 50%
So banks always choose Rule 38.
13. Pros & Cons of Rule 38
✔ Advantages
- Extremely easy
- No complex turnover calculations
- No month-to-month variation
- No year-end reconciliation
- Predictable ITC value
- Works well for big financial institutions
❌ Disadvantages
- You lose 50% ITC straight
- Cannot choose invoice-wise
- Cannot claim more even for taxable-only services
- Fixed rule even if taxable revenue increases
But still, 50% loss is much lower than 90% reversal under Rule 42.
14. Common Mistakes in Rule 38
- Applying 50% on RCM ITC (wrong)
- Applying 50% on inter-branch invoice ITC (wrong)
- Not excluding blocked credit from computation
- Not applying 50% consistently for the whole year
- Using Rule 38 at branch level instead of PAN level
- Taking full ITC on common capital goods
15. How Banks/NBFCs Should Manage ITC (Practical Tips)
- Maintain RCM ITC separately
- Maintain branch transfer ITC separately
- Maintain capital goods separately
- Distinguish exclusive taxable/exempt capital goods
- Ensure vendor compliance (GSTR-1 & GSTR-3B match)
- Keep system-generated monthly reversal sheet
16. Conclusion – Human Style Summary
Rule 38 is honestly a lifesaver for banks, NBFCs, and financial institutions. If they were forced to follow Rule 42 & 43, more than 90% of their ITC would get reversed due to massive exempt interest income. Instead, through Rule 38, they get to claim a fair 50% ITC without any headache.
The idea is simple:
- Bank wants to claim ITC?
- Okay, reverse half and take half.
- No calculations, no adjustments, no formulas.
This 50% method may look harsh but is actually a blessing because banks would lose much more under proportionate reversal.
And that’s why almost every bank chooses Rule 38 and sticks to it.
