Rule 89(5) Refund Formula Under GST: From Litigation to Resolution?

The Goods and Services Tax (GST) framework in India is designed to avoid cascading taxes and enable smooth flow of input tax credit (ITC). However, refund mechanisms particularly under inverted duty structures have witnessed considerable litigation. At the centre of this controversy lies Rule 89(5) of the CGST Rules and its retrospective amendments, raising critical questions about fairness, legislative intent, and taxpayer rights.

Rule 89(5) prescribes the formula for refund of unutilised ITC in cases of an inverted duty structure where the tax rate on inputs exceeds that on output supplies.

“Input tax credit availed on inputs and input services during the relevant period.”

[(Turnover of inverted rated supply of goods) × Net ITC ÷ Adjusted Total Turnover]

{(Turnover of inverted rated supply of goods and services) x (Net ITC/Adjusted Total Turnover}

1. Gujarat High Court in VKC Footsteps India Pvt. Ltd.[2020(07)LCX0022] held Rule 89(5) ultra vires, stating it contradicted Section 54(3) by excluding input services.

2. Madras High Court in Tvl. Transtonnelstroy Afcons Joint Venture[2020(09)LCX0058] upheld the Rule.

The Supreme Court upheld the validity of Rule 89(5) and rejected the argument that it arbitrarily excludes input services.

➢ The petitioners contended that Rule 89(5) draws an arbitrary distinction between input goods and input services and results in denial of refund of unutilised ITC on input services under the inverted duty structure. However, the Supreme Court held that this exclusion is in line with Section 54(3)(ii), which allows refund only where the accumulation of credit is on account of the rate of tax on input goods being higher than that on output supplies. The relevant excerpt of the ruling:

“104 We now turn to the submissions of the counsel for the assessees regarding the anomalies in the formula. In our view, the submission of Mr Sujit Ghosh, that the formula creates a distinction between suppliers having a higher component of input goods than those having a higher component of input services, and must be read down accordingly, must be rejected. The purpose of the formula in Rule 89(5) is to give effect to Section 54(3)(ii) which makes a distinction between input goods and input services for grant of refund. Once the principle behind Section 54(3)(ii) of the CGST Act is upheld, the formula cannot be struck down merely for giving effect to the same.”

➢ At the same time, the Court acknowledged practical inequities arising from the formula. It pointed out that Rule 89(5) presumes that output tax is discharged entirely from ITC on input goods, ignoring the reality that ITC from both goods and services is pooled and used interchangeably. The relevant excerpt of the ruling:

“105 The aberrations which have been pointed out by the MrSridharan and Mr G Natarajan certainly indicate that the formula is not perfect. The formula makes a presumption that the output tax payable on supplies has been entirely discharged from the ITC accumulated on account of input goods and there has been no utilisation of the ITC on input services. While a similar formula is provided in Rule 89(4) with regard to zero rated supplies, in that case, the ‘Net ITC’ includes input goods and input services and thus, there is no imbalance between the different components of the formula. The formula prescribed in Rule 89(5) however, seeks to deduct the total output tax from only one component of the ITC, namely ITC on input goods. This in our view is at odds with reality, where the ITC on both input goods and input services is accumulated in the electronic ledger and is then utilised for the payment of output tax. In making such an assumption, the formula tilts the balance in favour of the Revenue by reducing the refund granted. We are equally cognizant of the fact that the proposed solution, that is prescribing an order of utilisation of the ITC accumulated on input services and input goods, may tilt the balance entirely in favour of the assessee as that would make a contrary assumption that the output tax is discharged by the ITC accumulated on account of input services entirely. Another possible solution could be that the Rule itself provides for a statutory assumption or a deeming fiction of utilisation of a certain percentage of ITC on input services towards the payment of output tax for the purpose of calculation of refund.”

➢ Importantly, while refraining from judicial redrafting of the formula, the Court issued a strong recommendation to the GST Council. The relevant excerpt of the ruling:

“111 The above judicial precedents indicate that in the field of taxation, this Court has only intervened to read down or interpret a formula if the formula leads to absurd results or is unworkable. In the present case however, the formula is not ambiguous in nature or unworkable, nor is it opposed to the intent of the legislature in granting limited refund on accumulation of unutilised ITC. It is merely the case that the practical effect of the formula might result in certain inequities. The reading down of the formula as proposed by Mr Natarjan and Mr Sridharan by prescribing an order of utilisation would take this Court down the path of recrafting the formula and walk into the shoes of the executive or the legislature, which is impermissible. Accordingly, we shall refrain from replacing the wisdom of the legislature or its delegate with our own in such a case. However, given the anomalies pointed out by the assessees, we strongly urge the GST Council to reconsider the formula and take a policy decision regarding the same.”

Thus, while the legality of Rule 89(5) was upheld, the Supreme Court made it unequivocally clear that the formula needs policy reconsideration in light of its inequitable practical consequences.

Responding to the Supreme Court’s observations, the GST Council in its 47th Meeting deliberated upon the anomalies in Rule 89(5). In the absence of empirical utilisation data, the Law Committee recommended a proportional approach to allocate ITC based on the ratio of ITC availed on inputs and input services.

{(Turnover of inverted rated supply of goods and services) × Net ITC ÷ Adjusted Total Turnover}

{Tax payable on such inverted rated supply of goods and services × (Net ITC ÷ (ITC availed on inputs and input services))}

This change brought a fairer, rational balance aligning refund calculations with the pooled nature of ITC utilisation.

Particulars	Amount (Rs.)
Turnover of inverted duty supplies	4,50,000
Adjusted Total Turnover	6,00,000
Input Tax Credit (ITC) on Inputs	90,000
Input Tax Credit (ITC) on Input Services	60,000
Total ITC (Inputs + Input Services)	1,50,000
Output Tax Payable (on inverted supply)	30,000

Particulars	Old Rule 89(5)	Amended Rule 89(5)
Refund Formula	(Inverted Turnover × ITC on Inputs ÷ Adj. TO) − Output Tax Payable	(Inverted Turnover × ITC on Inputs ÷ Adj. TO) − Output Tax Attributable to Input ITC
Calculation Step 1	(4,50,000 × 90,000 ÷ 6,00,000) = Rs.67,500	(4,50,000 × 90,000 ÷ 6,00,000) = Rs.67,500
Step 2 – Output Tax Reduction	Less Rs.30,000	Less Rs.18,000 (30,000 × 90,000 ÷ 1,50,000)
Refund Amount	Rs.37,500	Rs.49,500
Difference in Refund	–	↑ Rs.12,000

“The said amendment is not clarificatory in nature and is applicable prospectively with effect from 05.07.2022. Accordingly, it is clarified that the said amended formula... would be applicable in respect of refund applications filed on or after 05.07.2022. The refund applications filed before 05.07.2022 will be dealt as per the formula as it existed prior to the amendment.”

This left taxpayers in the lurch particularly those who had already filed claims but were unfairly denied under the earlier formula.

Gujarat High Court’s Intervention: Ascent Meditech Ltd. v. Union of India[2024(10)LCX0396]

In this significant ruling, the Gujarat High Court struck down this prospective interpretation, holding the amendment to be curative and clarificatory, and hence retrospectively applicable.

“48. In view of the foregoing reasons, the impugned order dated 24.08.2023 is hereby quashed and set aside. The Circular No. 181/22 dated 10.11.2022 so far as it clarifies that the amendment is not clarificatory in nature is quashed and set aside and it is held that the Notification No. 14/2022 is applicable retrospectively as the amendment brought in Rule 89(5) of the Rules is curative and clarificatory in nature and the same would be applicable retrospectively to the refund or rectification applications filed within two years as per the time period prescribed under section 54(1) of the Act. Rule is made absolute to the aforesaid extent.”

This decision affirms that taxpayers with older refund claims are equally entitled to relief under the revised formula, thereby safeguarding substantive justice over procedural technicalities.

The amended Rule 89(5), as endorsed by the GST Council and upheld (retrospectively) by the Gujarat High Court, appears to strike a fairer balance between policy intent and practical reality. It partially addresses the anomalies identified by the Supreme Court while staying within the boundaries of legislative competence.

Until these questions are resolved across jurisdictions or settled by the Supreme Court the refund landscape under inverted duty structures remains cautiously optimistic, but not yet uniformly certain.

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.