Introduction
The term “inverted tax structure” refers to a scenario where the tax rate applicable to inputs used in the production process is higher than the tax rate on the final goods or services sold. Simply put, it arises when the tax paid on inward supplies (inputs) exceeds the tax payable on outward supplies (outputs). This imbalance creates challenges for taxpayers, particularly in pricing and compliance, often leaving them uncertain about how to address this issue. To alleviate this burden, the GST law provides relief by allowing refunds under specific conditions for taxpayers facing an inverted duty structure.
Section 54(3) of the CGST Act, 2017
Section 54 of the CGST Act lays down the provisions for refunds under GST in various scenarios. Specifically, Section 54(3) permits the refund of unutilized input tax credit (ITC) under the following conditions:
- Zero-rated supplies made without payment of tax.
- Inverted duty structure, where the credit accumulates due to a higher tax rate on inputs compared to the tax rate on outputs (excluding nil-rated or fully exempt supplies).
However, the government may notify specific goods or services excluded from such refunds based on recommendations from the GST Council.
Situations Eligible for Refunds under the Inverted Duty Structure
Taxpayers can claim refunds under the inverted duty structure in the following illustrative cases:
- Composite Supplies: When the output supplies attract a lower tax rate than the inputs used in the composite supply.
- Export of Goods with IGST Rebates: When the IGST rate on exported goods is lower than the GST rate on inputs.
- Accumulation of ITC due to Tax Rate Changes: Refunds are allowed when ITC accumulates due to a decrease in output tax rates.
- Same Tax Rates for Inputs and Outputs: Even if the tax rates on inputs and outputs are identical, ITC accumulation due to other factors can warrant a refund.
- Special Rate for Government Supplies: Supplies to government departments where the output rate is lower than the input rate, as per specific notifications, are eligible for refunds. For instance, services rendered under government contracts with a reduced GST rate.
Exceptions to Refunds under the Inverted Duty Structure
The following situations exclude taxpayers from claiming refunds under the inverted duty structure:
- Nil-rated or Fully Exempt Output Supplies: Refunds are not available for supplies categorized as nil-rated or fully exempt unless specified otherwise by government notifications.
- Duty Drawback or IGST Refunds: Taxpayers who avail of duty drawback or claim IGST refunds on such supplies are not eligible.
- Export Duties: When goods exported from India are subject to export duties, refunds under the inverted duty structure are disallowed.
- Construction Services: As per Notification No. 15/2017-Central Tax (Rate), dated June 28, 2017, construction services are specifically excluded from such refunds.
Calculation of Maximum Refund Under Inverted Duty Structure: Rule 89(5) of the CGST Rules
Formula for Maximum Refund
The formula for calculating the maximum refund amount under Rule 89(5) is as follows:| Turnover of inverted rated supply of goods & services × Net Input Tax Credit ——————— | Tax payable on such inverted rated supply of goods and services | × | Net Input Tax Credit ————— | |
| Adjusted total turnover | ITC availed on Input and Input Services |
Key Components of the Formula
1. Net Input Tax Credit (Net ITC):
Net ITC refers to the ITC availed on inputs during the relevant period. However, it specifically excludes:
- ITC availed on input services and capital goods, as refunds on these components are not permissible under the inverted duty structure.
- ITC for which refund claims have already been made under sub-rules (4A), (4B), or any other provisions of the CGST Rules.
Important Note:
Net ITC is restricted to inputs used directly in the production or supply of goods or services, reinforcing the exclusion of ITC related to capital goods and input services.
2. Adjusted Total Turnover:
The Adjusted Total Turnover is calculated as follows:
Adjusted Total Turnover = Turnover in a State/Union Territory (excluding turnover of services) + Zero-rated supply of services
Components of Adjusted Total Turnover:
- Turnover in a State/Union Territory:
- This includes the value of taxable supplies within a State or Union Territory, excluding services.
- Zero-rated Supply of Services:
- Value of zero-rated services made without payment of tax under Bond or LUT, calculated as:
- Payments received during the relevant period for zero-rated services.
- Payments for services completed before the relevant period if received in advance.
- Excluding advances received for services not completed within the relevant period.
Exclusions in Adjusted Total Turnover:
- Value of exempt supplies other than zero-rated supplies.
- Turnover related to supplies for which refund claims have already been made under sub-rule (4A) or (4B) during the relevant period.
3. Relevant Period:
The Relevant Period refers to the tax period (monthly or quarterly) for which the refund claim is being filed.
Legal Interpretation
Examples to Understand the Calculation of Maximum Refund Amount Under Rule 89(5)
To clarify the application of Rule 89(5) of the CGST Rules, here are two illustrative examples demonstrating the computation of the maximum refund amount under the inverted duty structure.
Example 1: Refund for a Manufacturing Company
Scenario:
ABC Manufacturers produces Product Z, which falls under the 12% GST rate category. In the production process, the company uses the following raw materials:
- Raw Material A: GST rate of 5%
- Raw Material B: GST rate of 18%
No input services or capital goods are included in this calculation.
Details for the Relevant Period:
- Total Sales Value of Product Z: ₹4,500
- Purchase Value of Raw Material A: ₹2,000
- Purchase Value of Raw Material B: ₹3,000
- ITC Availed for Raw Material A: ₹100
- ITC Availed for Raw Material B: ₹540
Step 1: Net ITC Calculation
Net ITC = ₹100+₹540 = ₹640
Step 2: Adjusted Total Turnover
Since the company exclusively manufactures and sells Product Z, the adjusted total turnover equals the total sales value of Product Z, i.e., ₹4,500.
Step 3: Maximum Refund Amount
Using the formula as mentioned above:
Maximum Refund Amount = (4500*640)
— [4500*12%*640/640]
—————
4500
Maximum Refund Amount =₹ 100
Example 2: Refund for a Manufacturing Company
XYZ supplier is engaged in supply of taxable goods. Given below are the details of the turnover and applicable GST rates of the final products manufactured by company. Input tax credit (ITC) availed on inputs used in manufacture of each of the final products and GST rates applicable on the same, during a relevant Tax period:| Products | Turnover | GST Rate on Sale | ITC Availed | GST Rate on Inputs |
| A | 600000 | 5% | 54000 (Goods) | 18% |
| B | 500000 | 5% | 48000 (Goods) | 18% |
Is Refund Allowed When Inversion is Caused by GST Rate Changes on the Same Goods?
Clarification:
As per the GST law, when the GST rate on goods is revised downward by the GST Department through notifications, resulting in an inverted duty structure, taxpayers are not eligible to claim a refund of unutilized Input Tax Credit (ITC) under Section 54(3)(ii).
Example to Illustrate:
- A taxpayer procures Goods A taxed at 18% GST. Subsequently, the GST rate for these goods is reduced to 12%.
- In such cases, the refund of accumulated ITC is not permissible, as this scenario is explicitly excluded from Section 54(3)(ii).
Reasoning Behind the Restriction:
This provision ensures that refunds are not triggered by transitional rate changes, protecting the government from revenue loss and maintaining system integrity.
Is Refund Permitted When Inversion is Due to Concessional Output Rates?
Clarification Provided by Circulars:
Refunds under the inverted duty structure are permitted if the tax rate on output supplies is lower than the tax rate on inputs due to concessional notifications. This is outlined in:
- Circular No. 135/05/2020-GST dated 31.03.2020
- Circular No. 173/05/2022-GST dated 06.07.2022
Taxpayers are eligible for a refund of accumulated ITC under clause (ii) of the first proviso to Section 54(3), provided:
- The output supply is not Nil-rated or fully exempted.
- The goods or services supplied are not among those excluded from refund eligibility as per government notifications.
Eligibility for Merchant Exporters:
Suppliers offering goods to merchant exporters at concessional rates, such as 0.1% GST (0.05% CGST and 0.05% SGST/UTGST or 0.1% IGST) under specific notifications, are also entitled to claim refunds on account of the inverted tax structure.
Example of Concessional Rates:
- A taxpayer supplies Goods B at a GST rate of 5%, while the inputs used in manufacturing these goods are taxed at 18%.
- Here, the taxpayer qualifies for a refund of accumulated ITC under the inverted duty structure.
Purpose of Allowing Refunds in These Cases:
The provision aims to ease the tax burden on businesses affected by government-mandated concessional rates, ensuring fair treatment and supporting compliance.
Key Comparison Between the Two Scenarios
| Aspect | Inversion Due to Rate Change | Inversion Due to Concessional Rates |
| Refund Eligibility | Not Eligible | Eligible |
| Reason | Refunds are not triggered by rate changes under Section 54(3)(ii). | Concessional rates cause genuine inversion, qualifying for refunds. |
| Supporting Circular/Notification | Not applicable | Circular Nos. 135/05/2020 and 173/05/2022 clarify refund eligibility. |
Conclusion
The inverted duty structure under GST creates challenges for taxpayers by causing an accumulation of unutilized input tax credit due to higher tax rates on inputs compared to outputs. However, the GST law provides relief mechanisms, such as refunds under Section 54(3), governed by Rule 89(5) of the CGST Rules, ensuring fairness in the system. By clearly defining eligible and ineligible scenarios, the law balances taxpayer benefits with revenue considerations. Understanding the nuances, such as exclusions for nil-rated supplies or restrictions due to GST rate changes, is crucial for compliance and effective tax planning.
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