Revised ISD Mechanism under GST: Comprehensive 2025 Guide for Multi-State Businesses

The introduction of the Goods and Services Tax (GST) in July 2017 marked a major shift in India’s indirect tax landscape. For businesses operating across multiple states under a single Permanent Account Number (PAN), one of the critical challenges has been the management and fair distribution of Input Tax Credit (ITC) on common services.

While companies had the option to choose between the ISD (Input Service Distributor) route or the cross-charge method to allocate ITC, this choice will no longer be available starting April 1, 2025.

To promote consistency and transparency in ITC distribution, the Government of India has made the ISD mechanism mandatory from the beginning of FY 2025-26. This article provides a comprehensive understanding of this transformation, including its purpose, mechanism, rules, implications, and preparations businesses must undertake.

Understanding the ISD Mechanism

An Input Service Distributor (ISD) is a special category of taxpayer under GST. The ISD mechanism enables a centralized unit—typically a head office—to receive invoices for services used commonly across multiple branches and redistribute the ITC to the relevant GSTINs (GST registrations) of those branches.

This mechanism ensures a seamless transfer of credit without the need for raising supply invoices (as in the case of cross-charging), thereby simplifying internal financial coordination between different units of the same legal entity.

Previous Position: ISD Was Optional

Until March 31, 2025, businesses could freely opt between:

• ISD mechanism: Ideal for central procurement of services that are used by various branches.
• Cross-charge: Treating inter-branch transactions as a supply and issuing tax invoices accordingly.

This flexibility allowed businesses to adopt models that suited their internal structure and compliance capabilities.

In July 2023, the Central Board of Indirect Taxes and Customs (CBIC) reiterated that using ISD was not mandatory. Companies had discretion to continue with either route for ITC distribution based on operational convenience.

Change in Law: ISD Mandatory from April 1, 2025

Effective from April 1, 2025, the government has enforced that only the ISD mechanism will be permissible for allocating ITC related to common input services received at a central location but used across multiple branches.

Cross-charging will remain valid only for certain in-house services provided by the head office to other branches (for example, internal IT support, HR services, or admin functions), not for third-party common service ITC distribution.

This move aligns with the government's aim to ensure accurate credit flow, minimize misuse, and bring consistency in credit apportionment across the GST framework.

New ISD Distribution Rules in Practice

Important Note: If services are used by the head office in providing support services to branches (e.g., internal accounting), then the head office must issue a cross-charge invoice. However, third-party service ITC like audits, consultancy, and software licenses must be routed through ISD.

Examples of Services That Must Follow ISD Route

• External audit (statutory or tax)
• Legal or compliance-related services
• Consulting services (financial, operational, or strategic)
• IT infrastructure and software subscriptions
• Manpower and recruitment services
• Shared security or housekeeping arrangements
• Banking or financial advisory services
• Regulatory and certification services

Why the ISD Mechanism Is Being Made Compulsory

1. Prevent ITC accumulation in one state: Often, head offices were availing full ITC for services consumed across states, resulting in surplus and unmatched credit.
2. Ensure fairness: By distributing ITC in proportion to actual usage, the tax credit mirrors real consumption.
3. Curb tax evasion: Cross-charging often went underreported or inconsistently applied, leading to leakage in the credit chain.
4. Enforce compliance uniformity: A single rulebook helps both businesses and tax authorities streamline processes and monitoring.

Treatment of GST Types Under ISD

This classification determines the type of tax credit being passed and must be correctly captured in returns and internal ledgers.

Mandatory Conditions for ITC Distribution

To ensure timely and accurate ITC transfer under ISD, the following conditions will apply:

• ITC—whether eligible or ineligible—must be distributed within the same month it is received.
• Distribution must happen even for branches involved in exempt supplies or those not registered under GST.
• When services are exclusive to one branch, credit should only be passed to that location.
• For services used in more than one branch, the credit must be split proportionately based on pre-defined allocation ratios (e.g., turnover, headcount).

Key Challenges Taxpayers Will Face from April 2025

The mandatory ISD transition is not just a policy change but requires significant procedural adjustments, including:

1. Vendor Communication

Businesses must inform all vendors to address invoices for shared services to the newly created ISD GSTIN rather than the head office GSTIN.

2. Invoice Reorganization

Companies will need to evaluate and reassign invoice destinations—services consumed by specific branches should be directly invoiced to those branches instead of being centralized.

3. New ISD GST Registration

All entities that need to follow the ISD route will have to obtain a separate GST registration as ISD, even if they already hold a regular GSTIN.

4. Service Classification

Every input service must now be tagged as either:

• ISD-eligible: Services consumed by multiple branches.
• Cross-charge eligible: Services consumed by the head office for supporting other branches.

5. System and Software Changes

IT systems will need upgrades to:

• Record ISD purchase orders and invoices.
• Maintain distinct ledgers for ISD credit and debits.
• Enable automated allocation logic for proportionate ITC.
• Generate outbound ISD distribution invoices and credit notes.

6. Compliance and Returns

Separate monthly returns (Form GSTR-6) must be filed by ISD units. These include:

• Reporting ISD inward invoices.
• Recording credit notes.
• Reflecting allocation to each receiving branch.

Receiving branches must, in turn, report this ITC in Table 4 of GSTR-3B.

7. Employee Training

Cross-functional teams—procurement, finance, tax—must be trained on:

• How ISD transactions differ from cross-charge.
• Required documentation and invoice flows.
• Timely reconciliation and GST return compliance.

Consequences of Not Complying with ISD Rules

Businesses ignoring the new ISD mandate may face serious penalties and tax disallowances. Some key risks include:

• Recovery of excess ITC: Any wrongly distributed ITC will be reclaimed with applicable interest from the recipient branch.
• ITC denial: Where cross-charge is used instead of ISD, the receiving branch may lose its right to claim the input tax.
• Monetary penalties: A penalty may be imposed equal to the incorrectly allocated ITC or ₹10,000, whichever is higher.

Additionally, such violations may invite scrutiny from GST auditors, leading to more stringent investigations in subsequent years.

The transition to a mandatory ISD mechanism from April 1, 2025, represents a significant compliance milestone under the Indian GST regime. Businesses with multiple registrations under the same PAN must prepare thoroughly—both procedurally and technologically—to avoid disruption and ensure timely, lawful credit allocation.

With proactive planning—such as registering for ISD early, informing vendors, upgrading systems, and training teams—organizations can smoothly transition into the new model and maintain clean ITC ledgers across all branches.

As the effective date approaches, it is advisable for companies to consult GST professionals, update SOPs (Standard Operating Procedures), and perform a mock ISD run in FY 2024-25 to identify and fix potential bottlenecks.