Rule 86B, the 1% cash requirement, its exceptions and how to test it

The rule in one sentence

Rule 86B was inserted with effect from 1 January 2021 by Notification No. 94/2020-Central Tax. Where the value of taxable supply, other than exempt supply and zero-rated supply, exceeds ₹50 lakh in a month, the registered person may not use the electronic credit ledger to discharge more than 99% of the output tax liability. At least 1% has to come from the electronic cash ledger.

It was introduced as a measure against fake-invoice networks, where a business with large turnover pays nothing in cash because every rupee of liability is offset by credit that never had tax behind it.

Reading the trigger

The month. The ₹50 lakh is tested month by month on the value of taxable supply in that month. A quarterly filer who crosses it in any month of the quarter is inside the rule for that month.

The value. It is the value of taxable supply, and the rule expressly excludes exempt supply and zero-rated supply. Exports and supplies to SEZ units therefore do not count towards the ₹50 lakh, whether or not tax was paid on them. Inward supplies on reverse charge are not supplies made by the person and do not count either.

The base for the 1%. The restriction applies to "output tax liability". Output tax, as defined in Section 2(82), is tax on taxable supply made by the person and excludes tax payable on reverse charge. Reverse-charge tax has to be paid in cash in any event, but that cash does not count towards the 1%, and neither does cash used for interest or late fee.

The five exceptions

The first proviso switches the restriction off where any of the following applies:

1. Income tax. The person, or its proprietor, karta or managing director, or any two of its partners, whole-time directors, members of the managing committee or trustees, as the case may be, paid more than ₹1 lakh as income tax in each of the last two financial years for which the time to file the return of income under Section 139(1) has expired.
2. Refund on zero-rated supply. The person received a refund of more than ₹1 lakh in the preceding financial year of unutilised credit on zero-rated supply made without payment of tax (Section 54(3), first proviso, clause (i)).
3. Refund on inverted duty. The person received a refund of more than ₹1 lakh in the preceding financial year of unutilised credit on account of an inverted duty structure (clause (ii) of the same proviso).
4. Cash already paid. The person has discharged output tax through the cash ledger of more than 1% of the total output tax liability, applied cumulatively up to that month in the current financial year.
5. Public bodies. The person is a Government department, a public sector undertaking, a local authority or a statutory body.

A second proviso allows the Commissioner, or an officer authorised by him, to remove the restriction after verification and with such safeguards as he considers fit.

Clause (d) in practice

The cumulative exception is the one that matters most, and it is often misread. It is tested at the end of each month on the financial year to date: total output tax paid in cash from April up to that month, against total output tax liability for the same months. If the cash share already exceeds 1%, the rule does not bite in that month even if that month's own cash payment is nil.

A business that pays some tax in cash every month, or that paid a large cash amount early in the year, will usually sit outside the rule for the rest of the year. A business that has paid everything through credit from April onward will usually be inside it from the first month its taxable supply crosses ₹50 lakh.

What happens if the rule is breached

Rule 86B restricts the use of credit; it does not create a separate levy. Where credit has been used beyond 99% of output tax while the rule applied, the view taken in practice is that the excess part of the liability has not been validly discharged, so it remains payable in cash, with interest under Section 50(1) for the period of delay, and is recoverable through the demand provisions for the year (Section 73 or 74 up to FY 2023-24, Section 74A from FY 2024-25). The credit itself is not lost; it stays in the ledger.

For the working paper

Officer:

• Test the ₹50 lakh trigger on the month's taxable outward supply excluding zero-rated and exempt supply (GSTR-3B Table 3.1(a), not 3.1(b) or (c)).
• Test clause (d) on the year-to-date cash payment of output tax before treating any month as a breach. Most apparent breaches disappear here.
• Exceptions (a) to (c) cannot be tested from GST returns. Ask for the income tax payment records of the persons named in clause (a) and the refund orders for clauses (b) and (c).
• Desktop check A4 computes the shortfall head-wise for review; the head-wise allocation is a working method, not a statement that the rule applies head by head.

Practitioner:

• If the business is close to the trigger, paying slightly more than 1% of each month's output tax in cash keeps the year-to-date share above 1%, so clause (d) stays satisfied throughout the year.
• Keep the income tax and refund evidence for the exceptions on file each year; the exception is for the person to show.

The Rule 86B calculator works through a whole financial year month by month: it applies the ₹50 lakh trigger to each month, tests clause (d) on the cash paid from April up to that month, and shows the shortfall for each month where the rule applies.