Concept of Inverted Duty Structure

Under GST law there are different types of GST rates like 5%, 12%, 18% & 28% etc. The applicable rate of tax on specific goods would depend upon the description of the goods/products. Similarly there are different rates of tax which are applicable of services depending upon the services. Since there are different type of rates, hence sometime the situation arises where the rate of tax on purchases of inputs are higher than the applicable rate of tax on final product/output. In said situation the input tax credit paid on the purchases are not completely utilised for payment of output tax and some inputs are remain unutilised every month. Such type of situation where the rate of tax on inputs are higher than the tax rate on output are called inverted duty structure. In this article we are going to discuss in detail about the provisions related to inverted duty structure and refund of such unutilised ITC due to inverted duty structure.

Before going into detailed discussion, let us discuss some of the examples where inverted duty structure applies;
1. Mr. A who is a manufacturer of goods has procured the input at the rate of 18%. Mr. A has manufactured the final product out of such input purchased. The applicable rate of tax on the said final product is 12%. Accordingly there is accumulation of ITC due to inverted duty structure.

2. Mr. XYZ is a manufacturer and procured goods @ 18% GST and Sold the final product to Merchant Exporter @ 0.1% as per Notification No 41/2017-Integrated Tax (Rate) dated 23.10.2017. In such situation also, there is accumulation of ITC due to inverted duty structure.

Accordingly, due to inverted duty structure the taxpayers has always huge amount of ITC available in his electronic credit ledger. Hence the taxpayer can claim the refund of such inverted duty structure. The provisions relating to refund are contained in section 54 of CGST Act 2017. Sub section 3 of section 54 of CGST Act 2017 talks about the refund of any unutilised input tax credit at the end of any tax period. The said section 54(3) also contains provisos in it which are as follows;

“Provided that no refund of unutilised input tax credit shall be allowed in cases other than
(i) zero rated supplies made without payment of tax;
(ii) where the credit has accumulated on account of rate of tax on inputs being higher than the rate of tax on output supplies (other than nil rated or fully exempt supplies), except supplies of goods or services or both as may be notified by the Government on the recommendations of the Council:

Provided further that no refund of unutilised input tax credit shall be allowed in cases where the goods exported out of India are subjected to export duty:

Provided also that no refund of input tax credit shall be allowed, if the supplier of goods or services or both avails of drawback in respect of central tax or claims refund of the integrated tax paid on such supplies”

Further sub section (4) of section 54 of CGST Act 2017 states that the application of refund should be accompanied by prescribed documentary evidence to establish that a refund is due to the applicant; and such documentary or other evidence (including the documents referred to in section 33) as the applicant may furnish to establish that the amount of tax and interest, if any, paid on such tax or any other amount paid in relation to which such refund is claimed was collected from, or paid by, him and the incidence of such tax and interest had not been passed on to any other person.

Provided that where the amount claimed as refund is less than two lakh rupees, it shall not be necessary for the applicant to furnish any documentary and other evidences but he may file a declaration, based on the documentary or other evidences available with him, certifying that the incidence of such tax and interest had not been passed on to any other person.

Procedure for filing refund and calculation of refund of inverted duty structure:
Rule 89(1) of CGST Rules 2017 specifies the Form for filing refund of inverted duty structure in FORM GST RFD-01. The said form is available online on the GSTN portal and it should be filed online.

Further Rule 89 (5) states that the refund of input tax credit shall be granted for inverted duty cases as per the following formula:

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)}]

Explanation: – For the purposes of this sub-rule, the expressions –
(a)  “Net ITC” shall mean input tax credit availed on inputs during the relevant period other than the input tax credit availed for which refund is claimed under sub-rules (4A) or (4B) or both; and

(b) [“Adjusted Total turnover” and “relevant period” shall have the same meaning as assigned to them in sub-rule (4).

In this regard it is important to know that the meaning of Net ITC as per the explanation given above is  ITC availed on inputs only.  Accordingly the ITC of input services and ITC of capital goods would not be eligible in case of refund of inverted duty structure.

The CBIC has also issued a clarification in this regard by issuing a Circular No. 125/44/2019-GST. In the said circular various issues pertaining to refund of GST were discussed. In para 53 & 54 of said circular the clarification given on calculation of refund amount for claims of refund of accumulated ITC on account of inverted tax structure. The said para 53 & 54 are laid down as follows;

“53. Sub-section (3) of section 54 of the CGST Act provides that refund of any unutilized ITC may be claimed where the credit has accumulated on account of rate of tax on inputs being higher than the rate of tax on output supplies (other than nil rated or fully exempt supplies). Further, sub section (59) of section 2 of the CGST Act defines inputs as any goods other than capital goods used or intended to be used by a supplier in the course or furtherance of business. Thus, inputs do not include services or capital goods. Therefore, clearly, the intent of the law is not to allow refund of tax paid on input services or capital goods as part of refund of unutilized input tax credit. It is clarified that both the law and the related rules clearly prevent the refund of tax paid on input services and capital goods as part of refund of input tax credit accumulated on account of inverted tax structure.

54. There have been instances where while processing the refund of unutilized ITC on account of inverted tax structure, some of the tax authorities denied the refund of ITC of GST paid on those inputs which are procured at equal or lower rate of GST than the rate of GST on outward supply, by not including the amount of such ITC while calculating the maximum refund amount as specified in rule 89(5) of the CGST Rules. The matter has been examined and the following issues are clarified:

a) Refund of unutilized ITC in case of inverted tax structure, as provided in section 54(3) of the CGST Act, is available where ITC remains unutilized even after setting off of available ITC for the payment of output tax liability. Where there are multiple inputs attracting different rates of tax, in the formula provided in rule 89(5) of the CGST Rules, the term “Net ITC” covers the ITC availed on all inputs in the relevant period, irrespective of their rate of tax.

b) The calculation of refund of accumulated ITC on account of inverted tax structure, in cases where several inputs are used in supplying the final product/output, can be clearly understood with the help of following example:

i. Suppose a manufacturing process involves the use of an input A (attracting 5 per cent GST) and input B (attracting 18 per cent GST) to manufacture output Y (attracting 12 per cent GST).

ii. The refund of accumulated ITC in the situation at (i) above, will be available under section 54(3) of the CGST Act read with rule 89(5) of the CGST Rules, which prescribes the formula for the maximum refund amount permissible in such situations.

iii. Further assume that the applicant supplies the output Y having value of Rs. 3,000/- during the relevant period for which the refund is being claimed. Therefore, the turnover of inverted rated supply of goods and services will be Rs. 3,000/-. Since the applicant has no other outward supplies, his adjusted total turnover will also be Rs. 3,000/-.

iv. If we assume that Input A, having value of Rs. 500/- and Input B, having value of Rs. 2,000/-, have been purchased in the relevant period for the manufacture of Y, then Net ITC shall be equal to Rs. 385/- (Rs. 25/- and Rs. 360/- on Input A and Input B respectively).

v. Therefore, multiplying Net ITC by the ratio of turnover of inverted rated supply of goods and services to the adjusted total turnover will give the figure of Rs. 385/-.

vi. From this, if we deduct the tax payable on such inverted rated supply of goods or services, which is Rs. 360/-, we get the maximum refund amount, as per rule 89(5) of the CGST Rules which is Rs. 25/-.

Also the Circular No. 125/44/2019 consist two types of Annexures. In Annexure A there is a list of all statements/declarations/undertakings/certificates and other supporting documents are given which are to be provided along with the refund application. For claiming the various types of refund like Refund of unutilized ITC on account of exports without payment of tax, Refund of tax paid on export of services made with payment of tax, Refund of ITC unutilized on account of accumulation due to inverted tax structure and many other types of refund. As per serial number 5 of Annexure A, there is a list of documents to be attached while filing refund of ITC unutilized on account of accumulation due to inverted tax structure.  The followings documents/declarations are given for refund of inverted duty structure;
(i) Declaration under second and third proviso to section 54(3)
(ii) Declaration under section 54(3)(ii)
(iii) Undertaking in relation to sections 16(2)(c)
(iv) Statement 1 under rule 89(5)
(v) Statement 1A under rule 89(2)(h)
(vi) Self-declaration under rule 89(2)(l) if amount claimed does not exceed two lakh rupees, certification under rule 89(2)(m) otherwise.

In addition to the above, in the Annexure-B of the said circular, a statement of invoices to be submitted with application for refund of unutilized ITC. The Format of said statement is also given in Annexure-B of Circular No. 125/44/2019.

Sometimes the ITC also accumulated due to reduction in GST rates of output supply. Whether in such situation, the refund of utilised ITC can be claimed as inverted duty structure. This is the common doubt among the taxpayers. The CBIC has also issued a Circular No.135/05/2020-GST to clarify such situation. The para 3 of said of circular covers such situation. The said para after the amendment incorporated by Circular No.173/05/2022-GST dt. 06.07.2022 is laid down as follows;

“3. Refund of accumulated input tax credit (ITC) on account of reduction in GST Rate

3.1 It has been brought to the notice of the Board that some of the applicants are seeking refund of unutilized ITC on account of inverted duty structure where the inversion is due to change in the GST rate on the same goods. This can be explained through an illustration. An applicant trading in goods has purchased, say goods "X" attracting 18% GST. However, subsequently, the rate of GST on "X" has been reduced to, say 12%. It is being claimed that accumulation of ITC in such a case is also covered as accumulation on account of inverted duty structure and such applicants have sought refund of accumulated ITC under clause (ii) of sub-section (3) of section 54 of the CGST Act.

3.2 It may be noted that refund of accumulated ITC in terms of clause (ii) of first proviso to sub-section (3) of section 54 of the CGST Act is available where the credit has accumulated on account of rate of tax on inputs being higher than the rate of tax on output supplies. It is noteworthy that, the input and output being the same in such cases, though attracting different tax rates at different points in time, do not get covered under the provisions of clause (ii) of the first proviso to sub-section (3) of section 54 of the CGST Act.

3.3 There may however, be cases where though inputs and output goods are same but the output supplies are made under a concessional notification due to which the rate of tax on output supplies is less than the rate of tax on inputs. In such cases, as the rate of tax of output supply is less than the rate of tax on inputs at the same point of time due to supply of goods by the supplier under such concessional notification, the credit accumulated on account of the same is admissible for refund under the provisions of clause (ii) of the first proviso to sub-section (3) of section 54 of the CGST Act, other than the cases where output supply is either Nil rated or fully exempted, and also provided that supply of such goods or services are not notified by the Government for their exclusion from refund of accumulated ITC under the said clause.”

Thus from the above circular it was clarified that where the input and output are same but attracting different tax rates of tax at different points in time, would not covered under the provisions of clause (ii) of the first proviso to section 54(3) of the CGST Act and accordingly no refund would be eligible under inverted duty structure in this case. However, where the input and output are same but the output supplies are made under a concessional notification (NN 41/2017 Integrated Tax Rate) due to which the rate of tax on output supplies is less than the rate of tax on inputs, in said situation the credit accumulated is admissible for refund under the provisions of clause (ii) of the first proviso to section 54 (3) of CGST Act.

Conclusion: The refund of unutilised ITC due to inverted duty structure would be eligible as per the provisions of clause (ii) of the first proviso to section 54 (3) of CGST Act. The amount of refund shall be calculated as per the formula given under Rule 89(5) of CGST Rules 2017 and no refund would be eligible for tax paid on input services or capital goods under inverted duty structure.

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.