[Analysis] GST Inverted Duty Structure – ITC Refunds | Rate Cuts | Case Laws

GST Inverted Duty Structure (IDS) arises when the tax rate on inputs is higher than the tax rate on output supplies, leading to accumulation of unutilised Input Tax Credit (ITC). Under Section 54(3) of the CGST Act, taxpayers can claim refunds of ITC in IDS cases, except for nil-rated or exempt supplies and certain notified goods or services. While intended to prevent working capital blockage, IDS refunds are restricted only to input goods, excluding input services and capital goods. This structure often impacts industries like textiles, pharma, and consumer goods, making IDS refunds a critical compliance and cash flow issue under GST.

Table of Contents

1. Introduction
2. The Practical Concern – Stock in Trade & Supply Chain Disruptions
3. Legal Framework – Understanding the Inverted Duty Structure
4. CBIC Circulars & Administrative Guidance
5. Conclusion

1. Introduction

The Government of India has recently announced its intent to rationalise Goods and Services Tax (GST) rates across sectors to reduce complexities, broaden the tax base, and address revenue leakages. While such rationalisation is expected to bring uniformity and curb classification disputes, it also raises a practical challenge for businesses—what happens to input tax credits (ITC) accumulated on account of higher taxes already paid on inputs when output supplies suddenly face lower tax rates?

This dilemma particularly surfaces in the context of the inverted duty structure (IDS), where the rate of tax on inputs exceeds that on outputs.
The issue is far from academic; for companies holding significant stock in trade, especially in fast-moving sectors such as textiles, consumer durables, and pharmaceuticals, the impact could be immediate. Businesses risk being saddled with stranded credits, thereby affecting cash flows, pricing strategies, and overall competitiveness.

2. The Practical Concern – Stock in Trade & Supply Chain Disruptions

When the government reduces GST rates on finished goods, businesses often find themselves with inventory procured at a higher tax rate. While these credits are genuine, their utilisation becomes difficult if the output tax liability shrinks disproportionately. This scenario results in the accumulation of ITC, which not only creates a working capital blockage but also disrupts pricing parity across the supply chain.

For distributors and retailers, the sudden drop in output tax rate can lead to valuation disputes on unsold stock, increased compliance burden to reconcile invoices, and potential denial of refunds. Manufacturers, on the other hand, face the risk of unutilised credits piling up in their books, with no clarity on refund entitlement unless the law specifically permits it.
Thus, what appears as a consumer-friendly policy of reducing GST rates can translate into an operational and financial burden for businesses caught in this transitional phase?

3. Legal Framework – Understanding the Inverted Duty Structure

The GST law creates a narrow gateway for claiming refunds of unutilised Input Tax Credit (ITC). Section 54(3) of the Central Goods and Services Tax (CGST) Act, 2017 specifies that refunds are permitted in two situations:

1. Zero-rated supplies, which include exports and supplies to Special Economic Zones (SEZs), and
2. Inverted duty structure (IDS), where the rate of GST on inputs is higher than the rate on output supplies.

The first proviso to Section 54(3) (ii) makes it clear that refunds will be allowed in cases of IDS, but with two key exclusions: refunds are not permitted if the output supply is nil-rated or fully exempt and in case of a select category of goods or services as notified by the government.

To operationalise this framework, Rule 89(5) of the CGST Rules prescribes a formula for computing the maximum refund. This formula was amended via Notification No. 14/2022 dated 5 July 2022 after concerns were raised that the earlier methodology created distortions. The amended formula proportionately accounts for ITC on both inputs and input services used for payment of output tax, making the calculation more realistic.

Importantly, the Hon’ble Supreme Court in Ascent Meditech Ltd. [2025] 173 taxmann.com 154 (SC) and Gujarat High Court in Filatex India Ltd. [2025] 174 taxmann.com 79 clarified that this amendment is curative in nature and hence applies retrospectively, benefitting taxpayers even for past refund claims filed within the limitation period.

A crucial restriction is that IDS refunds are limited only to ITC on input goods. ITC on input services and capital goods is excluded.

The Supreme Court in Union of India v. VKC Footsteps India (P.) Ltd. [2021] 130 taxmann.com 193 settled this controversy by holding that a refund is a statutory right, not an inherent entitlement, and Parliament has consciously chosen to restrict IDS refunds to input goods. The Court emphasised that including services within the definition of inputs would “do violence” to the legislative text of Section 54(3).

4. CBIC Circulars & Administrative Guidance

The CBIC has issued multiple circulars shaping the understanding of IDS refunds:

Circular No. 135/05/2020-GST (31 March 2020): This took a restrictive approach, stating that refunds would not be admissible where IDS arose purely because of a reduction in the GST rate on the same product. For example, if a good was initially taxed at 18% but later reduced to 12%, CBIC argued that accumulated ITC in such cases did not qualify under Section 54(3).

This restrictive view was challenged in several courts. The Gauhati High Court in BMG Informatics v. UOI (2021) 130 taxmann.com 182, the Rajasthan High Court in Baker Hughes Asia Pacific Ltd. v. UOI (2022) 140 taxmann.com 326, and the Calcutta High Court in Shivaco Associates v. Joint Commissioner of State Tax (2022) 137 taxmann.com 213 all disagreed with CBIC’s stance. They held that the Act itself does not restrict refunds only to situations where input and output are different goods. As long as the tax rate on inputs was higher than on outputs, refund entitlement arose.

Circular No. 173/05/2022-GST (6 July 2022): In response, CBIC revised its guidance. The circular clarified two key points:

• • If the same goods attract different rates of GST at different points in time due to a rate cut, refunds are not admissible.
  • However, where the inversion results from concessional notifications that impose a lower output tax rate compared to input tax at the same point in time, refunds are admissible.

This nuance was later upheld by the Telangana High Court in Micro Systems & Services Sole Proprietorship v. UOI (2022) 143 taxmann.com 228, which noted that Circular No. 173/05/2022 was clarificatory in nature and would apply retrospectively.

Together, these rulings highlight two principles:

(i) refund entitlement under IDS is circumscribed by the statute
(ii) courts remain vigilant against arbitrary restrictions or retrospective application of adverse rules.

However, the shifting position of CBIC from outright denial in 2020 to a nuanced acceptance in 2022 has created uncertainty during transitional periods, especially for businesses holding significant inventory when rate reductions are announced.

5. Conclusion

The Government’s push towards GST rate rationalisation is a welcome step for ease of doing business. However, businesses face genuine hardships when sudden rate cuts result in stranded credits under the inverted duty structure. While the CBIC has clarified its position, judicial precedents suggest that taxpayers may still find relief.

As the rate rationalisation is round the corner, policymakers must ensure that rate rationalisation is accompanied by transitional relief mechanisms through refund schemes so that the very reform meant to simplify taxation does not become a source of litigation and financial strain for industry.

In the larger scheme, the issue of IDS refunds reiterates a core principle of GST: the system must remain true to its promise of avoiding cascading of taxes. Any deviation not only burdens businesses but also risks eroding the credibility of the GST framework itself.