GST on UPI Payments 2026 | MDR, 18% Tax & Merchant Impact

What Happened?

The GST Council and Central Board of Indirect Taxes and Customs (CBIC) have issued clarifications on GST applicability on UPI (Unified Payments Interface) transactions, effective from 15 October 2026. The new framework introduces a Merchant Discount Rate (MDR) threshold of ₹2,000 per transaction, with 18% GST applicable on MDR charges for merchants exceeding this limit. This is a significant development that impacts digital payment adoption, merchant costs, and consumer pricing across India.

Background & Legal Context

To understand this development, we need to examine the GST law and its applicability on financial services:

• GST Act, 2017 & GST Rules: Financial services like payment processing fall under Schedule II (Supply of Services). UPI payments were previously considered a zero-rated or exempt supply under certain conditions, but the recent clarification reclassifies MDR as a taxable service.
• Supply Definition: Under Section 7 of the CGST Act, 2017, any consideration paid for a service constitutes a supply. MDR (the fee merchants pay to payment aggregators) is now clearly defined as a taxable supply attracting 18% GST.
• Input Tax Credit (ITC) Eligibility: Under Section 16 of the CGST Act, 2017, registered merchants can claim ITC on GST paid on MDR charges, provided they maintain proper documentation and the payment aggregator issues valid GST invoices.
• Income Tax Act, 2025: For income tax purposes, MDR remains a business expense deductible under Section 37 of the ITA 2025 (corresponding to old Section 37 of IT Act 1961). The GST paid on MDR will also be considered as allowable expenditure.
• Threshold Rule: Transactions below ₹2,000 are excluded from this GST framework, making small digital payments more affordable and encouraging digital adoption in the informal economy.

What Does This Mean for You?

For Merchants & Small Business Owners:

• If you process UPI payments exceeding ₹2,000 per transaction, your payment aggregator will now charge you MDR (typically 0.5% to 1% of transaction value) plus 18% GST on that MDR. For example, on a ₹10,000 transaction, if MDR is ₹50, you'll pay an additional ₹9 as GST (18% of ₹50).
• This increases your cost of accepting digital payments. A merchant accepting ₹10,00,000 in UPI payments monthly could see an additional ₹1,500 to ₹3,000 per month as GST on MDR.
• If you are a registered GST taxpayer, you can claim ITC on the 18% GST paid on MDR charges. This means the effective cost is neutral if your business has sufficient output GST liability. However, if you're not registered or have nil/low tax liability, you bear the full burden.
• Unregistered merchants (turnover below ₹40 lakhs, or ₹20 lakhs in specific states) cannot claim ITC, making UPI payments relatively costlier for them.

For Payment Aggregators & Fintech Companies:

• Payment service providers must now clearly segregate MDR charges and issue GST invoices separately. This improves tax compliance but increases administrative burden.
• They must ensure transactions below ₹2,000 are flagged separately for GST purposes.
• Non-compliance with GST invoicing can result in GST penalties under Section 122 of the CGST Act, 2017 (up to ₹25,000 per occurrence).

For Consumers:

• Direct impact is minimal since GST on MDR is typically borne by merchants. However, some payment aggregators may pass on this cost, leading to marginal increases in prices or service fees.
• Transactions below ₹2,000 remain unaffected, encouraging small digital payments.

For Assessment Year (AY) 2025-26 & AY 2026-27:

• Merchants must carefully track MDR expenses separately for income tax deductions and GST ITC claims. Ensure payment aggregator invoices clearly mention GST components.
• During income tax assessments, the Assessing Officer may examine whether merchants have correctly claimed business expense deductions for MDR and properly availed ITC.

What Should You Do Now?

Immediate Actions (Before 15 October 2026):

• Review GST Registration Status: If your business turnover is above the threshold, ensure your GST registration is active and valid. This allows you to claim ITC on MDR charges.
• Communicate with Payment Aggregators: Contact your UPI/payment service provider (Google Pay, PhonePe, Paytm, ICICI Bank, HDFC Bank, etc.) and confirm how they will implement the new MDR and GST structure from 15 October 2026. Request them to send you a detailed cost breakdown.
• Update Accounting Systems: Modify your accounting software to separately track MDR charges and GST paid on MDR. This is critical for ITC reconciliation and audit purposes.
• Prepare GST & Income Tax Documentation: Maintain a register or spreadsheet of all MDR transactions, GST amounts paid, invoices received, and ITC claims. This protects you during GST audits and income tax assessments.

Ongoing Compliance (After 15 October 2026):

• File GSTR-1 & GSTR-3B Accurately: Report ITC claimed on MDR charges correctly in your GST monthly returns. Misreporting can trigger GST notices under Section 62 of the CGST Act.
• Maintain Invoice Trail: Keep all payment aggregator invoices for a minimum of 6 years for GST audit purposes (as per GST record-keeping rules).
• Monitor Income Tax Deductions: While filing your income tax return for AY 2026-27, clearly show MDR as a business expense. The gross MDR amount (including GST) is deductible under Section 37 of ITA 2025.
• Seek Professional Guidance: If your business processes significant UPI volumes, consult a CA or tax advisor to optimize your GST planning and ensure compliance.

Key Takeaways

• Effective Date: GST on UPI MDR applies from 15 October 2026. Transactions below ₹2,000 are exempt from this GST framework.
• Tax Rate & Impact: 18% GST on Merchant Discount Rate (MDR) will increase costs for merchants accepting UPI payments above ₹2,000 per transaction.
• ITC Benefit: Registered GST taxpayers can claim Input Tax Credit on 18% GST paid on MDR, effectively neutralizing the tax burden if they have sufficient output tax liability.
• Documentation Critical: Merchants must maintain separate records of MDR, GST paid, and ITC claims for GST audits and income tax assessments (AY 2025-26 onwards).
• Unregistered Merchants Disadvantaged: Small businesses without GST registration cannot claim ITC, making UPI payments relatively costlier. They should consider GST registration if turnover permits.

Need expert help with this? EaseValue CAs in Jaipur — WhatsApp 63677 44602