Inverted Duty Structure and Refund of Input Tax Credit under GST

Introduction

The Goods and Services Tax (GST) revolutionized India’s indirect tax landscape when it was introduced on July 1, 2017. This comprehensive, multi-stage, destination-based tax system replaced a complex web of indirect taxes previously levied by both central and state governments. The primary objectives of GST were to create a unified market, streamline the indirect tax regime, enhance compliance, and mitigate the cascading effect of taxes on goods and services. At the heart of the GST mechanism lies the concept of Input Tax Credit (ITC). This system allows businesses to offset the tax paid on inputs (inward supplies) against the tax payable on outputs (outward supplies). The ITC mechanism is designed to ensure that tax is levied only on the value added at each stage of the supply chain, thereby minimizing the tax burden on end consumers and preventing tax cascading. However, despite the many improvements brought about by GST, certain challenges persist. One such challenge is the phenomenon known as the “Inverted Duty Structure.” This article delves deep into the concept of Inverted Duty Structure, its implications for businesses, and the intricate process of claiming refunds for accumulated Input Tax Credit under this structure.

Understanding Inverted Duty Structure

Definition and Concept

An Inverted Duty Structure arises when the GST rate on inputs (raw materials or components) is higher than the GST rate on the finished products. This mismatch in tax rates can lead to an accumulation of unutilized Input Tax Credit, as businesses end up paying higher taxes on their inputs than they collect on their outputs. It’s important to note that the Inverted Duty Structure is not merely about the absolute quantum of taxes paid, but rather about the rate of taxes. The structure is considered “inverted” when the rate of tax on inward supplies exceeds the rate of tax on outward supplies, regardless of the total amount of tax paid or collected.

Prevalence and Impact

The issue of Inverted Duty Structure is particularly prevalent in industries where the manufacturing process involves inputs taxed at higher rates than the finished goods. This situation can have significant implications for businesses operating in such sectors:

1. Cash Flow Issues: The accumulation of unutilized ITC can lead to cash flow problems for businesses, as they have effectively paid more tax than they can utilize.
2. Increased Working Capital Requirements: To manage the excess tax paid on inputs, businesses may need to allocate additional working capital, potentially impacting their overall financial health.
3. Competitive Disadvantage: In sectors affected by Inverted Duty Structure, businesses may find themselves at a competitive disadvantage compared to those in sectors with a more balanced tax structure.
4. Complexity in Tax Management: The Inverted Duty Structure adds another layer of complexity to tax management and compliance for affected businesses.

Legal Framework for ITC Refund under Inverted Duty Structure

The GST law recognizes the challenges posed by the Inverted Duty Structure and provides for a mechanism to refund unutilized ITC accumulated due to this structure. The legal framework for such refunds is primarily outlined in Section 54 of the Central Goods and Services Tax (CGST) Act, 2017, and the corresponding rules.

Section 54 of the CGST Act, 2017

Section 54 of the CGST Act deals with refunds under various scenarios, including the Inverted Duty Structure. Specifically, clause (ii) of the proviso to Section 54(3) addresses the issue of refund where credit has accumulated due to the rate of tax on inputs being higher than the rate of tax on output supplies.

Key points from Section 54:

1. Eligibility: The section allows for refund of unutilized ITC in cases of Inverted Duty Structure, except for certain supplies of goods or services as notified by the Government on the recommendations of the GST Council.
2. Time Limit: The refund application must be filed within two years from the relevant date, which is typically the end of the financial year in which such claim for refund arises.
3. Documentary Evidence: The section also outlines the requirement for documentary evidence to support the refund claim.

Rule 89 of the CGST Rules, 2017

Rule 89 of the CGST Rules, 2017, provides the detailed procedure and formula for calculating the refund amount in cases of Inverted Duty Structure. Sub-rule (5) of Rule 89 is particularly relevant, as it prescribes the formula for calculating the maximum refund amount:

Maximum Refund Amount = {(Turnover of inverted rated supply of goods and services) x Net ITC ÷ Adjusted Total Turnover} – {tax payable on such inverted rated supply of goods and services x (Net ITC ÷ ITC availed on inputs and input services)}

where:

• “Net ITC” means input tax credit availed on inputs during the relevant period, excluding the ITC availed for which refund is claimed under sub-rules (4A) or (4B) or both.
• “Adjusted Total Turnover” and “relevant period” have the same meanings as assigned to them in sub-rule (4) of Rule 89.

This formula aims to provide a standardized method for calculating the refund amount, taking into account various factors such as the turnover of inverted rated supplies, net ITC, and the tax payable on such supplies.

Procedure for Filing Inverted Duty Refund

The process of claiming a refund for accumulated ITC due to Inverted Duty Structure involves several steps and requirements. Understanding this procedure is crucial for businesses seeking to recover their unutilized ITC.

Eligibility and Pre-requisites

Before initiating the refund process, businesses must ensure they meet certain eligibility criteria and have fulfilled necessary pre-requisites:

1. Filing of Returns: The applicant must have filed Form GSTR-1 and GSTR-3B returns for the relevant tax period for which the refund is being claimed.
2. No Drawback: The applicant should not have availed drawback of all taxes under GST (IGST/CGST/SGST) while claiming the refund of accumulated ITC under Section 54(3)(ii) of the CGST Act, 2017.
3. Time Limit: The refund application must be filed within two years from the due date for furnishing the return for the period in which the claim for refund arises.

Application Process

The refund application process involves the following steps:

1. Form Submission: The refund application must be filed electronically in Form RFD-01 through the GST portal.
2. Statement Preparation: The applicant must prepare and submit Statement 1 and Statement 1A of Form GST RFD-01A, which provide detailed information about the refund claim.
3. Declaration: A declaration stating that drawback has not been availed forms part of Form GST RFD-01A.
4. Calculation of Refund Amount: The refund amount claimed should be calculated carefully, ensuring that: a. The amount in each tax head (CGST, SGST, IGST) is equal to or lower than the balance in the respective head of the electronic credit ledger. b. The total refund amount does not exceed the “Maximum Refund amount to be claimed” as calculated in Statement 1A. c. The total refund amount does not exceed the amount calculated at the aggregate level (IGST+CGST+SGST) in the table “Balance in Electronic Credit Ledger at the end of the tax period for which refund is claimed.”
5. Document Submission: Relevant documents as specified in Rule 89(2) of the CGST Rules must be attached with the application.

Step-by-Step Guide to Filing Refund on GST Portal

The actual process of filing for a refund on the GST portal involves several specific steps:

1. Login to the GST portal and navigate to the refund section.
2. Select the appropriate refund type (Refund of Excess Balance in Electronic Cash Ledger).
3. Choose the relevant ARN of GSTR-3B or GSTR-4 return.
4. Select the checkbox for ‘Refund of ITC accumulated due to inverted tax structure’.
5. Enter the details of the refund to be claimed under each tax head (CGST, SGST, IGST).
6. Upload the required documents.
7. Submit the application and note down the ARN generated for future reference.

Post-Submission Process

After the refund application is submitted, the following process ensues:

1. Acknowledgment: The proper officer shall issue an acknowledgment in Form GST RFD-02 within 15 days of filing the application.
2. Scrutiny: The application is scrutinized for any deficiencies. If found, these are communicated to the applicant in Form GST RFD-03.
3. Provisional Refund: In eligible cases, the proper officer may grant a provisional refund of 90% of the claimed amount within 7 days of issuing the acknowledgment.
4. Final Order: The proper officer shall pass an order in Form GST RFD-06 within 60 days of receipt of the application, either sanctioning or rejecting the refund claim.
5. Payment: If sanctioned, the refund amount is credited to the bank account of the applicant.

Restrictions on Refund under Inverted Duty Structure

While the GST law provides for refund of accumulated ITC due to Inverted Duty Structure, certain restrictions have been placed on this provision through various notifications. These restrictions are primarily based on the Harmonized System of Nomenclature (HSN) of the outward supply of goods or services.

Key Notifications

Several notifications have been issued restricting the eligibility of certain goods and services for refund under the Inverted Duty Structure:

1. Notification No. 5/2017 – Central Tax dated 19/06/2017
2. Notification No. 15/2017 – Central Tax dated 01/07/2017
3. Notification No. 29/2017 – Central Tax dated 22/09/2017
4. Notification No. 44/2017 – Central Tax (Rate) dated 14/11/2017
5. Notification No. 20/2018 – Central Tax dated 26/07/2018
6. Notification No. 9/2022 – Central Tax dated 13/07/2022

These notifications specify certain goods and services for which refund under Inverted Duty Structure is not allowed. Businesses must carefully review these notifications before applying for a refund to ensure their supplies are not restricted.

Implications of Restrictions

The restrictions on refund eligibility have significant implications for businesses operating in the affected sectors:

1. Accumulated ITC: Businesses dealing in restricted goods or services may face issues of accumulated ITC that cannot be refunded.
2. Cash Flow Impact: The inability to claim refunds can lead to cash flow problems, especially for businesses with significant input costs.
3. Pricing Strategies: Businesses may need to adjust their pricing strategies to account for the non-refundable accumulated ITC.
4. Sector-specific Challenges: Certain sectors may be disproportionately affected by these restrictions, potentially impacting their competitiveness.

Key Notifications and Circulars

The Central Board of Indirect Taxes and Customs (CBIC) has issued several notifications and circulars to clarify various aspects of refunds under the Inverted Duty Structure. Understanding these is crucial for businesses seeking to navigate the refund process effectively.

Important Notifications

1. Notification No. 26/2018 – Central Tax (13th June, 2018): This notification made changes to Rule 89(5) with retrospective effect from 1st July 2017, allowing refund only for the inputs of goods. It clarified that ‘input’ doesn’t include input services and capital goods for this purpose.
2. Notification No. 13/2022 – Central Tax (5th July 2022): This notification excluded the period from 01/03/2020 to 28/02/2022 for computation of the period of limitation for filing refund applications under section 54 of the CGST Act.
3. Notification No. 14/2022 – Central Tax (5th July, 2022): This notification amended the formula under Rule 89(5) for calculating the refund amount.

Key Circulars

1. Circular No. 79/53/2018 (31st December, 2018): This circular clarified that ‘Net ITC’ includes ITC of all inputs, whether or not directly consumed in the manufacturing process.
2. Circular No. 125/44/2019 (18th November, 2019): This circular confirmed that supplies at concessional rates are also eligible for refund on account of inverted tax structure.
3. Circular No. 135/05/2020 (31st March, 2020): This circular clarified that the restriction on bunching of refund claims across financial years shall not apply.
4. Circular No. 173/05/2022 (6th July, 2022): This circular provided clarification on the issue of claiming refund under inverted duty structure where the supplier is supplying goods under some concessional notification.
5. Circular No. 181/13/2022 (10th November, 2022): This circular clarified that Notification No. 14/2022-Central Tax dated 05/07/2022 is applicable prospectively with effect from 05/07/2022.

Implications of Notifications and Circulars

These notifications and circulars have significant implications for businesses:

1. Clarity on Refund Calculations: They provide clear guidelines on how to calculate refund amounts, reducing ambiguity and potential disputes.
2. Temporal Considerations: Some notifications have retrospective effects, while others are prospective, affecting the applicability of refund provisions for different periods.
3. Scope of Refund: The clarifications on what constitutes ‘inputs’ for refund purposes help businesses understand the scope of their refund claims.
4. Procedural Guidance: These documents offer procedural clarity, helping businesses navigate the refund process more effectively.

Landmark Case Laws

Several landmark court decisions have shaped the interpretation and application of the Inverted Duty Structure refund provisions. These judgments provide valuable insights into the legal perspective on various aspects of the refund mechanism.

VKC Footsteps India Pvt Ltd vs. Union of India & Others (Gujarat High Court, 2020)

In this case, the Gujarat High Court held that the explanation to Rule 89(5), which denies refund of unutilized input tax paid on input services as part of ITC accumulated due to inverted duty structure, was ultra vires Section 54(3) of the CGST Act, 2017. The court directed the government to allow refund claims considering unutilized ITC on input services as part of “Net ITC” for calculating refunds under Rule 89(5).

Tvl. Transtonnelstroy Afcons Joint Venture vs Union of India (Madras High Court, 2020)

Contrary to the Gujarat High Court’s decision, the Madras High Court upheld the validity of Rule 89(5). The court concluded that Section 54(3)(ii) does not infringe Article 14 of the Constitution and that the exclusion of unutilized ITC accumulated on account of input services from refund is a valid classification and exercise of legislative power.

Union of India & Others vs. VKC Footsteps India Pvt Ltd (Supreme Court)

The Supreme Court, in this landmark judgment, overturned the Gujarat High Court’s ruling and affirmed the Madras High Court’s decision. The apex court held that if the legislature had intended to give credit for tax paid on both input goods and input services, it would not have restricted the scope of refund in inverted duty structure to only inputs. However, the court acknowledged the anomaly in the formula under Rule 89(5) and directed the GST Council to take corrective action.

Indian Oil Corporation Limited Vs. Commissioner of Central Goods And Services Tax & Ors (Delhi High Court, 2023)

In this recent case, the Delhi High Court dealt with the applicability of refund under Inverted Duty Structure for LPG supplies. The court directed the relevant authority to process the applicant’s refund application, including applicable interest, within six weeks. This judgment highlighted the importance of timely processing of refund applications and the applicability of Inverted Duty Structure refunds in specific sectors.

Implications of Case Laws

These judicial pronouncements have significant implications for businesses and tax authorities:

1. Scope of Refund: The Supreme Court’s decision in the VKC Footsteps case clarified that refunds under Inverted Duty Structure are limited to inputs and do not include input services.
2. Constitutional Validity: The judgments affirm the constitutional validity of the current refund mechanism under Inverted Duty Structure.
3. Need for Legislative Action: The Supreme Court’s acknowledgment of anomalies in the refund formula highlights the need for potential legislative or policy changes.
4. Sector-Specific Considerations: The Indian Oil Corporation case underscores the importance of considering sector-specific nuances in applying Inverted Duty Structure refund provisions.
5. Timely Processing: The courts have emphasized the need for timely processing of refund applications, putting pressure on tax authorities to adhere to prescribed timelines.

Challenges and Future Outlook

While the provision for refund under Inverted Duty Structure aims to address the issue of accumulated ITC, several challenges persist, and the future outlook of this mechanism remains a topic of discussion among stakeholders.

Current Challenges

1. Complexity in Calculation: The formula for calculating the refund amount under Rule 89(5) is complex and can be challenging for businesses to apply accurately. This complexity can lead to errors in refund claims and potential disputes with tax authorities.
2. Exclusion of Input Services: The current refund mechanism excludes ITC accumulated on input services, which can lead to significant accumulation of credits for service-intensive industries.
3. Sector-Specific Issues: Certain sectors, particularly those with long production cycles or those dealing with seasonal goods, face unique challenges in managing ITC accumulation and claiming refunds.
4. Procedural Delays: Despite prescribed timelines, businesses often face delays in the processing of refund applications, leading to working capital issues.
5. Frequent Changes in Regulations: The frequent amendments to rules and issuance of clarifications, while intended to improve the system, can create confusion and increase compliance burdens for businesses.
6. Restricted Goods and Services: The list of goods and services restricted from claiming refunds under Inverted Duty Structure creates challenges for businesses operating in these sectors.

Future Outlook

1. Potential Policy Changes: Following the Supreme Court’s acknowledgment of anomalies in the refund formula, there is anticipation of potential changes to the refund mechanism to address these issues.
2. Automation and Digitization: The GST Council is likely to focus on further automating and digitizing the refund process to reduce manual intervention and expedite refund disbursements.
3. Expansion of Refund Scope: There is ongoing discussion about potentially expanding the scope of refunds to include input services, which could provide relief to service-intensive industries.
4. Harmonization of Tax Rates: To address the root cause of Inverted Duty Structure, there may be efforts to harmonize tax rates across the supply chain for various goods and services.
5. Enhanced Compliance Measures: To prevent misuse of the refund mechanism, stricter compliance measures and scrutiny processes may be implemented.
6. Sector-Specific Solutions: Recognizing the unique challenges faced by certain sectors, there might be a move towards developing sector-specific solutions or exemptions.
7. Simplification of Refund Formula: There is a possibility of simplifying the refund calculation formula to make it more accessible and less prone to errors.

Conclusion

The Inverted Duty Structure and the associated refund mechanism for accumulated Input Tax Credit represent a complex yet crucial aspect of India’s GST regime. While the system aims to provide relief to businesses facing tax rate disparities in their supply chain, it also presents several challenges in its implementation and execution. The evolution of this mechanism, as evidenced by numerous notifications, circulars, and judicial pronouncements, reflects the government’s ongoing efforts to address the concerns of businesses while maintaining the integrity of the tax system. The landmark judgments, particularly the Supreme Court’s decision in the VKC Footsteps case, have provided clarity on certain aspects of the refund mechanism while also highlighting areas that require further attention. As the GST regime continues to mature, it is likely that the Inverted Duty Structure refund mechanism will undergo further refinements. These changes are expected to address the current challenges, simplify the process for businesses, and potentially expand the scope of refunds to provide more comprehensive relief to affected sectors. For businesses operating in sectors affected by Inverted Duty Structure, it is crucial to stay informed about the latest developments in this area. This includes keeping abreast of new notifications, circulars, and judicial decisions that may impact their eligibility for refunds or the process of claiming them.

Moreover, businesses should focus on:

1. Accurate Record-Keeping: Maintaining detailed and accurate records of all transactions, inputs, and tax payments to support refund claims.
2. Regular Review of ITC Accumulation: Conducting regular reviews of ITC accumulation to identify potential refund opportunities and manage working capital effectively.
3. Compliance with Procedural Requirements: Ensuring strict adherence to all procedural requirements for filing refund applications to avoid delays or rejections.
4. Seeking Expert Advice: Consulting with tax experts or professionals to navigate the complexities of the refund process and stay updated on regulatory changes.
5. Proactive Engagement: Actively engaging with industry associations and regulatory bodies to voice concerns and contribute to discussions on potential improvements to the refund mechanism.

The future of the Inverted Duty Structure refund mechanism in India’s GST regime will likely be shaped by a balance between providing relief to businesses and maintaining the fiscal integrity of the tax system. As the economy evolves and new sectors emerge, the mechanism may need to adapt to address new challenges and scenarios. Ultimately, the goal of the Inverted Duty Structure refund mechanism is to ensure that businesses are not unduly burdened by tax rate disparities and can operate efficiently within the GST framework. While challenges persist, the ongoing dialogue between businesses, tax authorities, and policymakers provides hope for a more streamlined and effective refund system in the future. As India continues its journey towards becoming a more integrated and efficient economy, the evolution of the Inverted Duty Structure refund mechanism will play a crucial role in supporting businesses and promoting economic growth. By addressing current challenges and adapting to changing economic realities, this mechanism can contribute significantly to the success of the GST regime and the overall ease of doing business in India.