Zero-Rated Supply: Bond/LUT or IGST-What's Right for You?

Exports are the lifeblood of any growing economy and India’s GST regime gives them a major boost through zero-rating. Whether you're shipping goods overseas or providing services to foreign clients, GST ensures that taxes don't eat into your margins. That’s where Section 16 of the IGST Act steps in.

But here’s the catch: exporters have to choose between two refund routes-and the choice isn’t always obvious. Should you go the Bond/LUT route and claim back unutilized ITC? Or is the IGST refund route a better fit?

This article breaks it down-step by step-to help you understand zero-rated supplies and decide the refund mechanism that aligns with your business needs.

What is Zero-Rated Supply?

Under Section 16(1) of the IGST Act, certain supplies are classified as zero-rated, which means that the output supply is subject to a zero rate of tax, but the supplier is still entitled to claim unutilized input tax credit (ITC) used in making such supplies.

The following are treated as zero-rated supplies:

☑Export of goods

☑Export of services

☑Supply of goods or services to a Special Economic Zone (SEZ) developer or unit for authorised operations.

Note: The phrase "for authorised operations" was inserted by the Finance Act, 2021 (13 of 2021) and notified via Notification No. 27/2023–Central Tax, dated 31.07.2023, effective from 01.10.2023. Until 30.09.2023, all supplies to SEZ units or developers were treated as zero-rated supplies (ZRD) by default. However, with effect from 01.10.2023, only those supplies made for authorised operations are eligible to be treated as zero-rated.

Zero-Rated Supply vs Exempt Supply

While Section 16(1) of the IGST Act clearly spells out what qualifies as a zero-rated supply, it’s important not to confuse it with an exempt supply-a term frequently used in GST but fundamentally different. Although both may appear tax-relieved at first glance, they operate on very different principles and have vastly different implications for input tax credit and refunds. Here's a quick comparison to set the record straight:

Can I Claim ITC on Zero-Rated Supplies?

Yes-you absolutely can. Section 16(2) of the IGST Act makes it clear that input tax credit (ITC) is available even when your zero-rated supplies are treated as exempt.

However, there’s one important caveat: you can’t claim ITC on blocked credits listed under Section 17(5) of the CGST Act. As long as you stay clear of those, you're entitled to claim the ITC and get your refund.

Refund Mechanisms: IGST vs ITC Route

Exporters have two lanes to get their refunds under GST. But choosing the right one and being eligible is key.

Route 1: Bond/LUT Route

(Section 16(3) of IGST Act)

Export your goods or services without paying IGST, by furnishing a Bond or Letter of Undertaking (LUT), and then claim a refund of your unutilized ITC.

☠ One condition: If your foreign buyer doesn’t pay up within the time allowed under FEMA, you’ll need to return the refund with interest u/s 50 (Rule 96B) -within 30 days of that period ending.

Route 2: IGST Payment Route

(Section 16(4) of IGST Act)

This is the "pay now, claim later" route. You pay IGST on your exports, and then claim a refund of the tax paid. But after Notification No. 01/2023 – Integrated Tax (31.07.2023) as amended from time to time, this option is no longer open to everyone.

❖ What the Law Says: Section 16(4) allows the Government to limit the IGST refund route by notifying:

(i) Class of persons (i.e., who can export with IGST refund).

(ii) Class of goods or services (i.e., what can be exported with IGST refund);

❖ What the Notification Restricts: The notification puts two filters in place:

(i) Class of Goods/Services: All goods or services except goods specified in column (3) of the table (25 items are blocked/restricted, including tobacco, pan masala, aerated waters, etc.); and

(ii) Class of Persons: All suppliers making supply to SEZ units/developers (for authorised operations) can claim IGST refund - unless they supply restricted goods.

The conditions are disjunctive, not cumulative - meaning you can be disqualified based on either who you are or what you supply.

❖ Thus, if you're supplying any of the 25 restricted goods listed in Table 3, the IGST refund route is completely blocked for you - even for direct exports or supplies to SEZs.

Speedy Relief: Provisional Refunds

To keep cash flowing for exporters, Section 54(6) read with Rule 91 offers provisional refunds.

✓ 90% of your refund must be released within 7 days from the date your refund application is acknowledged.

✓ Eligibility Check: You’re in the clear if you haven’t been prosecuted for any offence under the Act or under an existing law for tax evasion of over Rs.2.5 crore in the last 5 years.

The Red Line: No Refund on Export Duty Goods

Here’s the big update that came into effect from 1st November 2024:

📢 Section 16(5) (inserted via Finance Act, 2024 and Notification No. 17/2024 – Central Tax, effective from 01.11.2024) says:

"If you’re exporting goods that attract export duty, you can’t claim any refund-neither of IGST paid nor of unutilized ITC."

Refund Process under ITC Route (LUT/Bond): Legal Framework & Procedure

When a registered person makes zero-rated supplies without payment of tax under a Letter of Undertaking (LUT) or Bond, they are eligible to claim a refund of unutilised Input Tax Credit (ITC) as per Section 54(3) of the CGST Act.

Let’s break down both the legal basis and the practical steps for claiming such refunds:

Legal Provisions at a Glance

• Section 54(1) read with Rule 89(1): Refund application must be filed within 2 years from the relevant date.

• Section 54(3): Refund of unutilised ITC allowed only in:

(i) Zero-rated supplies made without payment of tax;

(ii) Accumulation of credit due to inverted duty structure (not relevant here).

• Section 54(8)(b): Refund of unutilised ITC (under Section 54(3)) shall be paid directly to the applicant, not credited to the Consumer Welfare Fund.

• Rule 89(4): Prescribes the formula and documentation for refund claim.

What is the Relevant Date? (Explanation 2 to Section 54)

Refund must be claimed within 2 years from the relevant date:

Refund Formula [Rule 89(4)]

Refund Amount =(Turnover of zero-rated supply of goods + Turnover of zero-rated supply of services) × Net ITC ÷ Adjusted Total Turnover

Where:

• Net ITC = ITC availed on inputs and input services (capital goods excluded) during the relevant period

• Turnover of zero-rated supply of goods =lower of the following two values:

Value of zero-rated supply of goods (i.e., actual export value* during the relevant period, without IGST) under LUT/ Bond;

OR

1.5 times the value of similar goods sold within India by you or another supplier in a comparable position - as declared by you.

*Value of goods exported out of India= The lower of: (a) FOB Value – i.e., the Free on Board value declared in the Shipping Bill or Bill of Export OR (b) The value declared in the tax invoice or bill of supply.

• Turnover of zero-rated supply of services =☑ Payments received during the relevant period for zero-rated services + ☑ Zero-rated services completed during the relevant period for which payment was received in advance (in earlier period) -- ✘ Advances received during the relevant period for which services have not yet been completed.

• Adjusted Total Turnover =

(a) The value of turnover within a State or Union territory (as defined under Section 2(112) of the CGST Act),👉excluding the turnover of services,

PLUS

(b) The turnover of:

• Zero-rated supply of services (calculated above), and

• Non-zero-rated (i.e., domestic taxable) services,

MINUS

The value of exempt supplies (excluding zero-rated supplies) during the relevant period.

• Relevant period =the period for which the claim has been filed.

Step-by-Step Refund Process (Rule 89)

1. Ensure Filing of LUT/Bond: Submit Form GST RFD-11 before making exports without tax.

2. File Refund Application (GST RFD-01) via GST Portal

3. Attach Mandatory Documents (Annexure 1): Depending on the supply type:

4. Acknowledgement & ARN Generation: Once documents are complete, portal generates an Acknowledgement Reference Number (ARN).

5. Provisional Refund (Section 54(6) + Rule 91): 90% refund processed within 7 days, if no prosecution > Rs.2.5 crore in the last 5 years.

6. Final Order (GST RFD-06): Refund is finalized after scrutiny. Any rejection is communicated via Form RFD-08, with a chance to respond in Form RFD-09.

7. Refund Disbursal: Amount is directly credited to your bank account registered on the GST portal.

Key Restrictions to Keep in Mind

• No ITC refund on capital goods under Rule 89(4).

• Refund claims are subject to the provisions of Rule 10B of the CGST Rules, 2017 (i.e. Aadhaar authentication).

• Refund not allowed for goods liable to export duty (Section 16(5), IGST Act).

• Claim must be made within 2 years from the relevant date (Section 54(1)).

When Should You Choose ITC Refund Route and IGST Refund Route?

Now that you understand the two refund options available under GST for zero-rated supplies - IGST refund and ITC refund under LUT - the next question is: Which route is right for you? Here’s when each route is generally preferred:

☑ Choose IGST Refund Route when:

• You have sufficient working capital to pay IGST at the time of export.

• You're looking for a faster and more automated refund process (especially through ICEGATE for goods).

• You have substantial ITC on capital goods - since refund of ITC on capital goods is not allowed under the ITC refund route, going via IGST allows indirect recovery of that credit.

• You want to avoid the more documentation-intensive ITC refund process.

☑ Choose ITC Refund Route when:

• You prefer not to block working capital by paying IGST upfront.

• Your major input credits are from inputs and input services, and not capital goods.

• You are making zero-rated supplies of goods listed in column (3) of the Table of Notification No. 01/2023 – Integrated Tax (dated 31.07.2023), for which the IGST refund route is specifically restricted. In such cases, the ITC refund route is the only available option.

Note: Refund of unutilized ITC on capital goods is not available under the ITC refund route (as per Rule 89(5) of the CGST Rules). Therefore, if you have significant ITC on capital goods, opting for the IGST refund route is usually more beneficial.

Important: You must choose only one refund route per supply - dual benefits are not allowed.

Conclusion: Make the Right Move for Your Exports

Navigating zero-rated supplies under GST isn't just about compliance - it’s about smart financial planning. The choice between the IGST refund route and the ITC refund route under LUT/Bond can significantly impact your cash flow, refund timelines, and eligibility.

The IGST route may be ideal if you’re looking for speed and simplicity, and especially if your ITC includes capital goods, which are not refundable under the ITC route. On the other hand, the ITC refund route is your go-to if you prefer not to pay tax upfront, or if you're dealing with restricted goods under column (3) of the Table of Notification No. 01/2023 - in which case the IGST option is completely off the table.

Recent legal changes - like the restriction of IGST refunds for certain goods and the bar on refund for export duty goods - mean it’s more important than ever to understand the nuances of Section 16 of the IGST Act and the rules that flow from it.

☑ Bottom line:

Always evaluate:

• The nature of your inputs (capital vs non-capital),

• The type of goods or services you export,

• Whether any restrictions under recent notifications apply, and

• Your working capital position.

Choosing the right route isn’t just about claiming a refund - it’s about optimizing your GST strategy to match your business model.

"Let the law work for you - not against you"

Disclaimer: The information given in this article is solely for purpose of understanding the law. It is completely based on the interpretation of the author and cannot be constituted as a legal advise, the author of this article and Lawcrux team is not responsible for any legal issues if arises on the basis of the interpretation given above.