Denial Of Refund Of Input Tax Credit On Inverted Duty Structure

Inverted duty structure simply refers to a condition where the tax rate on inputs used is higher than the tax rate on the outputs for sale. The condition may not be prevalent for all industries. In the pre-GST regime, a situation of an inverted duty structure arose in cases where import duty on raw materials that were used in the production of finished goods was higher than the import duty on finished goods itself. Inverted duty structure has implied a stream of revenue outflow for the government prompting the government to relook the duty structure.

Problems

The inverted duty structure is causing several administrative problems in the GST system. Taxpayers will have accumulated credits in the form of refund claims with the tax Department.The inverted duty structure is a revenue loss for the government as it has to refund the tax already paid (in inputs). Under GST, the inverted duty structure is identified for goods and not for services.

One of the major issues with respect to Inverted Tax Structure is that a manufacturing industry can have multiple inputs with variable tax rates. While some are likely to fall under the nature of inverted duty structure, some can have lower or same rate as the output. So, it is very difficult to co-relate with the output and the computation of refund amount is difficult and, in some cases, inaccurate. Here, ‘input’ means any goods other than capital goods used by a supplier for running the business. So, the definition of ‘input’ does not include input services. Hence, refund of input tax credit (‘ITC’ for short) on input services is not available. As per Rule 89(5) of CGST Rules unused ITC on services is not considered while calculating ‘Net ITC’. GST Refund of ITC on capital goods is also not available.

Refund

A registered person may claim a refund of unutilized ITC. The ITC on account of inverted tax structure can be claimed at the end of any tax period where the credit has accumulated on account of the rate of tax on inputs being higher than the rate of tax on output supplies. A tax period is a period for which a return is required to be furnished.

Section 54(3) of the Central Goods and Services Tax Act, 2017 (‘Act’ for short) provides that subject to the provisions of sub-section (10), a registered person may claim refund of any unutilized ITC at the end of any tax period. No refund no refund of unutilized ITC shall be allowed in cases other than–

1. zero rated supplies made without payment of tax;
2. 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.

No refund of unutilized input tax credit shall be allowed in cases where the goods exported out of India are subjected to export duty. 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.

Withholding of refund

Section 54 (10) provides that where any refund is due to a registered person who has defaulted in furnishing any return or who is required to pay any tax, interest or penalty, which has not been stayed by any court, Tribunal or Appellate Authority by the specified date, the proper officer may withhold payment of refund due until the said person has furnished the return or paid the tax, interest or penalty, as the case may be deduct from the refund due, any tax, interest, penalty, fee or any other amount which the taxable person is liable to pay but which remains unpaid under this Act or under the existing law.

The expression ‘specified date’ shall mean the last date for filing an appeal under this Act.

When refund cannot be claimed?

In the following cases refund of ITC cannot be claimed-

If output supplies are ‘nil’ rated or fully exempt supplies except for supplies of goods or services or both as may be notified by the Government on the recommendations of the GST Council.

If the goods exported out of India are subject to export duty.

If supplier claims refund of output tax paid under IGST Act.

If the supplier avails duty drawback or refund of IGST on such supplies.

GSTR-1 and GSTR-3B have to be filed for the relevant tax period for which a registered person wants to file a refund application of the accumulated ITC.

Purpose of refund

The primary purpose of the refund of inverted duty is to provide relief to businesses facing an inverted tax structure; enhance cash flow and improve business competitiveness; promote investment and production in specific sectors.

Refund formula

Rule 89(5) provides the formula for the refund of inverted duty structure. The formula is as below-

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)}

The expression ‘Net ITC is defined as 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. The expression ‘The Adjusted Turnover’ is defined as the sum total of the value of the turnover in a State or a Union territory, as defined under clause (112) of section 2, excluding the turnover of services; and the turnover of zero-rated supply of services determined in terms of clause (D) above and non-zero-rated supply of services, excluding the value of exempt supplies other than zero-rated supplies; and the turnover of supplies in respect of which refund is claimed under sub-rule (4A) or sub-rule (4B) or both, if any, during the relevant period. The expression ‘relevant period’ is defined as the period for which the claim has been filed.

Restrictions

Circular No. 135/05/2020-GST dated 31.03.2020 restricts refund of Inverted Duty Structure in cases, where Inputs and Outputs Supplies are same. It was clarified that the refund of accumulated ITC under Section 54(3)(ii) would not be applicable in cases where the input and output supplies are the same. This condition has been modified through the Circular dated 06.07.2022. Though the restrictions are imposed based on the circular dated 31.03.2020, the circular dated 06.07.2022 allowed the 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 section 54 (3) of the 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.

In ‘Empire Foundation v. Union of India and others’ – 2024 (11) TMI 39 -Gujarat High Court, the High Court held that section 54(3)(ii) of the Act provides that the refund of the input tax credit could not be payable even when the credit has accumulated on account of credit of tax or inputs being higher than the rate of tax on output supplies other than fully exempt supplies. Admittedly, the education service provided by the petitioner and other educational institution falls in category of fully exempt supply and therefore, the petitioner would not be entitled to the input tax credit. Sub-clause (ii) of section (3) applies to the inverted rate structure only whereas, in the ‘zero-rated supply’, ‘Nil’ Rated supply or exempted supply, the same would not be applicable as the very basis of inverted rate structure would not be applicable as the entire GST paid on the inputs would be liable to be refunded in such cases.

The Delhi High Court allowed to get refund of ITC in which the input supply and output supply are the same in ‘Indian Oil Corporation Limited v. Commissioner of Central Goods and Services Tax Act, 2017 – WP 10222/2023, Delhi High Court – decided on 05.12.2023.

In the above said case, the petitioner is engaging in the business of bottling and distributing the LPG for domestic as well as industrial use. The principal source of LPG is crude oil. LPG consists of various hydrocarbons such as propylene, butane and butylene. The said hydrocarbons are liquified on compression. Then it is transported in bulk through road and rail to the petitioner’s bottling unit. From these the cylinders are distributed to the customers. These are chargeable to GST @ 5% in terms of Entry No.165 and 165A of Schedule I appended to CGST Notification Ref. No.1/2017 – CT (Rate), dated 28.06.2017. The petitioner also uses various other items in the production of bottled LPG, which includes accessories required for the purpose of safety. The said items are chargeable to varying rates of GST.

The petitioner applied for refund of unaccumulated ITC for various period in Form GST RFD – 01 to the tune of Rs.1.23 crore. The refund applications of the petitioner were duly acknowledged and not processed. The Department issued show cause notices for the said 5 claims of the petitioner. The petitioner duly replied to the show cause notices issued by the Department. But the Department did not satisfy with the reply of the petitioner and issued order against the petitioner. The Adjudicating Authority rejected the applications filed by the petitioner. The Adjudicating Authority denied the refund on the ground that the bulk LPG as well as bottled LPG is the same product chargeable to GST at the rate of 5% and the petitioner’s case is not one of inverted duty structure and therefore, the refund is proscribed in terms of Clause (ii) to Section 54(3) of the Act.

The petitioner filed 5 appeals against the impugned order. The said appeals were rejected. The Appellate Authority found no fault with the orders passed by the Adjudicating Authority and accordingly upheld the denial of refund of accumulated ITC to the petitioner. The Appellate Authority was of the view that the petitioner was not entitled to refund by virtue of the last sentence of paragraph 3.2 of the Circular 135/5/2020, which provided that provisions of Clause (ii) of Subsection (3) of Section 54 was inapplicable, where input and output supplies are the same. Therefore, the petitioner filed the present writ petition before the High Court against the order of Appellate Authority.

The High Court analysed the circular No. 135/5/2020-GST, dated 31.03.2020. The High Court observed that it is apparent from the plain reading of Section 168(1) of the Act that CBIC can issue such orders, instructions, or directions only if it considers it necessary and expedient to do for the purpose of uniformity in implementation of the Act. Plainly, CBIC has no power to issue circulars in derogation of the provisions of the Act. CBIC can neither add to the provisions of the Act nor curtail the import of any part of the enactment. Section 168(1) of the Act confines the powers of CBIC to issue circulars for uniformly implementing the provisions of the Act. It can do nothing further.

The petitioner’s claim for refund is founded on Clause (ii) of the proviso to Section 54(3) of the Act. According to the petitioner, the rate of tax on certain inputs is higher than the tax paid on outputs (bottled LPG). Resultantly, the petitioner has been unable to fully utilize the ITC on its inputs. The petitioner uses various items in production of bottled LPG, which include accessories required for the purposes of safety. Undisputedly, the items and accessories as specified are essential for production of the bottled LPG and making it suitable for retailing. The said items are chargeable to varying rates of GST. The use of the word ‘inputs’ in plural clearly indicates that the refund of accumulated ITC is not confined to ITC accumulated on a singular input. Thus, there may be multiple inputs that may be used or consumed for effecting the output supplies. The use of the words ‘output supplies’ also indicates that the taxpayer’s output supply may not be singular.

It is important to note that Section 54(3)(ii) of the Act does not proscribe the grant of refund where the input and the output are the same. Section 54(3)(ii) of the Act merely restricts the refund of unutilized ITC to cases where there is accumulation of unutilized ITC on account of rate of tax on inputs being higher than the rate of tax on the output supplies. The legislative intent behind grant of refund of unutilized ITC that has accumulated on account of inverted tax structure is to confine the tax to the tax on the output supplies at the rate so fixed. In view of the plain language of proviso to Section 54(3)of the Act, the Revenue’s contention that the petitioner is not entitled to refund of unutilized ITC as the rate of bulk LPG and bottled LPG is the same, is unsustainable. It is impermissible to disregard the rate of tax on other inputs.

The High Court allowed the writ petition. The High Court directed the Department to process the petitioner’s applications for refund along with applicable interest in accordance with law as expeditiously as possible and in any event, within a period of six weeks from date.

Value of services also input tax credit

In ‘VKC Footsteps India Private Limited v. Union of India and 2 other(s)’ – 2020-TIOL-1273-HC-AHMGST, the petitioner is engaged in the business of manufacture and supply of footwear which attracts GST @5%. The majority of the inputs and input services procured by them attract GST @12% or 18% – in spite of utilization of credit for payment of GST on outward supply, there is an accumulation of unutilized credit in electronic credit ledger. The Department allowed the refund to the input tax credit in respect of inputs of the goods but denied the inputs on services.

Therefore, the petitioner challenged the provision of Rule 89(5) to the extent of the denial of refund of input tax credit relatable to Input services. The petitioner contended that the amended rule violates the provisions of Section 54(3) of the Act which entitles any registered person to claim refund of ‘any’ unutilized input tax credit. The Gujarat High Court has held that it is clear from the conjoint reading of the provisions of Act and Rules, that the action of prescribing the formula in Rule 89(5) of the Rules to exclude refund of tax paid on ‘input services’ as part of the refund of unutilized input tax credit is contrary to the provisions of sub-section 3 of section 54 of the Act which provides for claim of refund of ‘any unutilized input tax credit’.

The High Court directed the Department to allow the claim of the refund made by the petitioners considering the unutilized input tax credit of ‘input services’ as part of the ‘net input tax credit’ (Net ITC) for the purpose of calculation of the refund of the claim as per rule 89(5) of the Rules for claiming refund under section 54 (3) of the Act.