As per section 17(2) if input or input services are partially used for taxable supplies and partially for exempt supplies then the Input tax credit shall be restricted to so much of the input tax as is attributable to taxable supplies. Further section 17(3) defines exempt supplies for the purpose of computation of restriction on ITC under section 17(2). As per this section the supplies on which recipient is required to pay tax under reverse charge shall be considered as exempt supply.
Hence, for the purpose of computing proportionate ITC reversal under Section 17(2), the following shall be treated as exempt supplies, even if they are technically taxable supplies under RCM :-
Supply of goods or services or both which are taxable under RCM, where recipient is liable to pay tax.
This is a very important distinction. While such supplies are not "exempt" in general parlance (since tax is payable), they are deemed exempt only for the limited purpose of ITC apportionment under Section 17(2).
Let us assume :-
A registered person provides taxable interior design services to clients.
In addition, the same person also receives sitting fees from the director which is covered under RCM
The Company (recipient) pays GST under reverse charge on the sitting fees.
During the month, the registered person incurs Rs. 1,00,000 GST on common input services like rent, professional fees, and utilities.
Here, although sitting fees are taxable under reverse charge, Section 17(3) deems such outward supplies as exempt for the purpose of input tax credit apportionment under Section 17(2).
ITC Reversal Calculation :-
Common input tax credit: Rs. 1,00,000
Proportion of exempt supplies (RCM services) : Rs. 2,00,000 out of Rs. 7,00,000