If I had a penny for every time I opened a prospective client’s books for a health check and saw this non-compliance, I would already be a millionaire!
Last month, we were onboarding a listed company as a client, and spotted this in their books too! And their previous consultants were a very renowned firm!
Welcome to Rule 86B – a hidden rule in GST which most businesses and finance functions miss.
Rule 86B says: if your taxable supplies in a month (exclude exempt and zero-rated supplies) exceed ₹50 lakh, you cannot discharge more than 99 percent of that month’s GST liability from your electronic credit ledger.
At least 1 percent must be paid from the electronic cash ledger.
That’s the headline.
Which means that atleast 1% of your GST liability must be paid in cash!
Why this matters
For mid-to-large companies with thin margins or working-capital stress, even 1 percent of GST can be a big cash call, because GST liabilities scale with turnover and margins.
Rule 86B is aimed at reducing fake-ITC and making taxpayers have some skin in the game. Or so they think.
Let’s break it down with numbers
A company records taxable supplies (excluding exempt and zero-rated) of ₹5 crore in a month.
Assume GST liability for the month is ₹90 lakh.
99 percent of ₹90 lakh = ₹89.1 lakh can be paid by ITC.
1 percent of ₹90 lakh = ₹90,000 must be paid from cash (electronic cash ledger).
That ₹90,000 is not trivial for businesses operating on slim margins or seasonal cashflows.
Cumulative relief and the other exceptions
Thankfully, there are exceptions in the rule.
For normal businesses, the restriction does not apply where any one of the following is true:
The proprietor/karta/MD or any two partners/whole-time directors have paid more than ₹1 lakh income tax in each of the last two financial years (for which the ITR filing date has expired).
The registered person received refunds of more than ₹1 lakh last year on account of unutilised ITC under section 54 (export refunds).
The registered person has already discharged, cumulatively in the current financial year up to that month, cash payments exceeding 1 percent of total output tax liability.
A note on the cumulative 1 percent: what it means practically
Suppose in April you paid cash equal to 0.6 percent of the cumulative output tax so far, and in May you paid another 0.5 percent cumulatively now you are at 1.1 percent. The restriction should cease to apply for May onwards because the cumulative cash-paid threshold is met.
The problem is not in understanding, the problem is in documentation.
It is still easy to understand this rule. The real problem which I see across businesses is that there is no compliance with this rule in finance functions.
Document the monthly cumulative math. You will need it if the department queries you.
How the rule sits with section 49 and ITC utilisation rules
Section 49 and related provisions (Sections 49A/49B and Rule 88A) govern how ITC and cash are applied to liabilities. Rule 86B is a restriction on using the electronic credit ledger and operates within that payment framework.
In short: order-of-utilisation rules determine which ledger is used first; 86B restricts how much of the output tax can be discharged from the credit ledger where the threshold is met.
Read them together when designing your payment logic.
Practical compliance checklist for businesses (which my Firm uses)
This is an actionable list which I give to all my clients to avoid surprises.
Monthly taxable-supplies monitoring
Compute taxable supplies each month excluding exempt and zero-rated sales. If it crosses ₹50 lakh, trigger the Rule 86B workflow.Maintain a cumulative cash-paid tracker (financial year basis)
Create a simple ledger that shows cumulative output tax liabilities and cumulative cash payments (electronic cash ledger) month-by-month.Evidence for exceptions
If you intend to use the income-tax-paid exception, keep Form 26AS, ITR acknowledgment and bank proofs showing tax payment > ₹1 lakh for the proprietor or the specified persons for each of the two FYs.For export-refund exception keep refund sanction orders/credit advices showing amount > ₹1 lakh. The rule requires these as proof in departmental checks.
Reconcile ECL (electronic credit ledger) vs cash ledger and GSTR-3B entries every single month
Don’t wait for year-end audits. Automate a reconciliation file that maps: (a) tax computed on ERP/P&L, (b) ITC credited in ECL, (c) cash ledger debits, and (d) GSTR-3B payments. This prevents late discovery.Be ready to deposit cash if needed to avoid suspension/cancellation fights
Authorities have in several cases suspended registrations citing non-compliance with Rule 86B. Many courts have restored registration where deposit corrected the shortfall. But litigation is costly and disruptive. If you get a show-cause or suspension notice, depositing the required amount while contesting the merits is often the practical move.
Legal uncertainty — what business owners must note
A few High Courts have questioned the statutory backing of Rule 86B and have, in some cases, held the rule to be illegal.
A few other courts have restored registration after compliance.
The practical takeaway is this -
The rule remains on the statute book and officers will apply it. Courts may intervene in particular facts. So you cannot ignore Rule 86B on a legal theory alone if the administration enforces it.
Document everything and be ready to prove compliance or cure the shortfall.
Operational controls to prevent surprise liquidity hits
· Set an automated flag in your billing/ERP when monthly taxable supplies hit ₹45 lakh so treasury has a 5 lakh buffer to plan for 1 percent cash payment.
· Put a weekly cash forecast line item called Rule 86B requirement and fund it from collections.
· Reconcile supplier credits and GSTR-2B early. Excessive unmatched ITC can create a false sense of available credit.
· If you rely on the income-tax-paid exception, ensure the persons named are those specified in the rule and the taxes were actually paid. Keep the tax deposit proof and ITR V ready within your GST documentation workflow to avoid surprises during GST audits.
What to do if you get a show-cause, suspension or demand
Immediately check cumulative cash-paid position and if short, firstly deposit the shortfall in the electronic cash ledger and file proof. Courts have often restored registration post-deposit.
Collate documentary proof for any exception you claim (ITR, Form 26AS, refund orders).
Prepare a concise reply showing calculations, screenshots of the cash ledger, and a reconciliation.
Final word
Rule 86B is small in words but big in impact.
It’s not a tax, in all honesty. It’s a liquidity rule.
The good news is the compliance steps are simple: monitor taxable turnover, keep two quick reconciliations (monthly taxable supplies and cumulative cash-paid), and store the documentary proof for exceptions.
If you plan ahead, the rule becomes a controllable cash-management item, not a surprise hit.
I try not to sound preachy and exclusively talk about my own experiences. Your feedback and reviews will only help me curate more relevant content.
Please email me your feedback at [email protected].
Thank you!
To all those with a mission in life,
VijayBhava!
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