GST 2.0 is settling down nicely. The benefits of the reduction in rates reflecting now in a reduction in prices too — not perhaps to the extent of the reduction in the tax rate, but prices are certainly lesser than what they were earlier. But what the reduction in rates has brought in sharper focus is the issue of inverted duty structure and its corollary, refund of such accumulated, unutilised duty.
Inverted duty structure refers to a situation where the tax on the input supplies is more than the tax on the outward supplies. In an ideal situation it should be possible to utilise the taxes paid in the discharge of liability of the outward supplies. To balance the two is challenging and not always possible.
At the outset, a misconception which persists despite GST being in its eight year needs to be clarified. Input Tax Credit (ITC) is the USP of GST and is available on all goods, including capital goods and services, used during the furtherance of business. This is subject to the entity claiming the ITC benefit is a registered person and has a valid tax invoice or debit note which is compliant with the GST law. What this means details of the supplier, recipient, HSN/SAS code of the goods /services, description of the goods/services and the amount of tax charges are available. The goods /services should have been received. The tax must have been paid by the supplier to the government —this ensures that there is actual tax remittance.
This is a much-debated requirement with various courts holding that ITC should not be denied without the tax authorities first attempting to recover the tax from the seller, that the recipient cannot be punished for the faults of the supplier. And the final requirement is that the tax returns must be filed — be it monthly or quarterly.
The availing of ITC impacts revenue; the government necessarily must impose reasonable conditions so that the entity who avails it is indeed eligible to do so. Hence all the conditions to be fulfilled. Despite all these requirements, ITC related fraud has been rampant and is the bane of GST. As per the data available, in 2024-25 more than ₹61,545 crore of such cases of fraud have been detected. Over 25,000 fake firms who are in the business only to generate invoices of non-existent supply of goods or services have been detected. And the trend continues.
In the first quarter of FY 25, more than ₹12,000 crore fake ITC claims have been detected involving more than 3600 fake firms. The government’s stipulation on requirements of documentation, on the procedure to be adopted for registration which have been criticised as being onerous, must be viewed in this background. Where it is not possible to exactly balance the total tax paid with the outward supply liability in respect of all value chains across commodities, there is an accumulation of such tax paid credits with the taxpayer. The tax ceases to be pass-through.
What should be ensured in such a situation is to have an effective refund mechanism in place so that the accumulated credit is refunded to the taxpayer. The GST law does recognise the need and has provisions spelling out the procedure and the calculations. Section 54 of the CGST Act and rule 89 of the CGST rules specifically address this issue.
But while the government does efficiently collect moneys due to it there is an inbuilt lethargy bordering on reluctance in the field administrative units in giving refunds.
The fact that the Act and Rule have several requirements/documentations before a refund application can be processed makes the whole process even more challenging. Thus, even though the law has prescribed timelines they become effective only after all prescribed documents have been submitted. This has been a problematic area for the central and state governments adding to the costs of the taxpayer.
The GST Council has recognised this problem and in its 56th meeting taken several steps to simplify the process of claiming refunds in an inverted duty structure situation. The Council has recommended that a risk-based approach for sanction of refunds arising out of inverted duty structure should be adopted. Thus section 54 of the CGST Act dealing with refunds is to be amended to provide for sanction of 90% of the refund claimed on a provisional basis, as is presently available for refund in respect of zero-rated supply. The Central government has gone a step further to assure that instructions will be issued that this be implemented pending amendment of the Act based on evaluation of risks.
However, a key issue remains unresolved. As pointed out by Kelkar et al., the current law and rules do not permit refunds arising from the inverted duty structure (IDS) on capital goods and services. Following the intervention of the Supreme Court, the Central Board of Indirect Taxes and Customs (CBIC) amended the refund formula, allowing partial relief in respect of input services (Notification No. 14/2022–CT dated 05.07.2022). Nevertheless, no refund is allowed for credit accumulated from the payment of tax on capital goods or services. It must be noted—though it may come at the cost of perception—that such credit is not denied; it can be claimed immediately and utilised to discharge future tax liabilities.
As per news reports the government is said to be seriously considering allowing refunds of unutilised ITC on capital goods in the first instance under the IDS. There is little justification in not doing so at this juncture; this could bring much needed liquidity to manufacturing sectors who have invested heavily in procuring capital equipment. This will be in keeping with the reform agenda unleashed by GST 2.0.
This will also address the unfair criticism of Kelkar et all that GST has become an example of ‘isomorphic mimicry’ where we have merely mimicked the outward form of a good GST. So, while a long-term solution would be to move towards the utopian dream of a single rate, with no exemptions, in the short-term fixing the refund process in IDS would help in removing yet another bottle neck and in achieving an efficient GST.
