When the Main Input Was Not the Real Problem
The Madras High Court’s decision in M/s Vindhya Spinning Mills Private Limited v. The Assistant Commissioner of CGST and Central Excise, Sivakasi Division, Thiruthangal, 2026-VIL-731-MAD, Neutral Citation: 2026:MHC:2893, W.P.(MD) Nos.16757 and 16758 of 2025, dated 14.07.2026, is a useful and practical ruling on the refund of unutilised input tax credit under Section 54(3) of the CGST Act, 2017. The judgment addresses an issue frequently faced by manufacturing taxpayers: whether a refund under the inverted duty structure can be denied merely because the principal input and the final output attract the same GST rate.
The petitioner was engaged in manufacturing combed cotton yarn. The principal input, raw cotton yarn, was subject to a 5% tax. The final product, combed cotton yarn, was also taxable at 5%. On this basis, the Department rejected the refund claims. However, the manufacturing process also involved chemicals, consumables, packing materials and other ancillary inputs taxable at 12% and 18%. These higher-rated inputs led to the accumulation of ITC because the final output was taxable only at 5%. The core question, therefore, was not whether the principal input and output had the same rate. The real question was whether higher-rated inputs used in the supply chain had caused the accumulation of unutilised ITC.
Section 54(3) Speaks of Inputs, Not Principal Inputs
Section 54(3) of the CGST Act, 2017 permits a registered person to claim a refund of unutilised ITC at the end of any tax period, subject to the restrictions in the provision. Clause (ii) allows a refund where credit has accumulated because the rate of tax on inputs exceeds the rate on output supplies, except in excluded cases such as nil-rated or fully exempt supplies and notified exclusions.
The language of the provision is significant. It uses the word “inputs”. It does not use the expressions “principal input”, “main input”, “major input” or “dominant input”. Therefore, the statutory test cannot be narrowed to ask only whether the main raw material is taxed at a higher rate than the output. If any eligible input bears a higher GST rate than the output supply and credit accumulates on that account, the claim must be examined under Section 54(3)(ii) and Rule 89(5).
This was the decisive point in favour of the petitioner. Raw cotton yarn and combed cotton yarn may both have been taxable at 5%, but other inputs used in the process attracted 12% and 18%. Once those higher-rated inputs contributed to credit accumulation, the refund claim could not be rejected by applying a principal-input filter that does not exist in the statute.
Ancillary Inputs Cannot Be Treated as Legally Invisible
In manufacturing, the final product is not created solely from the main raw material. Chemicals, consumables, packaging materials and process-related inputs may be necessary for production, preservation, handling, sale or delivery. They may not be the dominant raw material, but they are still inputs. GST law does not make refund entitlement dependent on the commercial dominance of an input.
The Department’s approach effectively treated ancillary inputs as legally irrelevant because the principal input and output carried the same rate. The High Court rejected that approach. Section 54(3)(ii) does not ask whether the higher-rated input is the largest cost component. It asks whether credit has accumulated because the input tax rate is higher than the output tax rate.
This interpretation is commercially realistic and legally sound. Many industries use multiple inputs at different GST rates. If refunds were restricted only to cases where the principal input is higher-rated, genuine accumulated credit arising from other essential inputs would remain blocked without statutory basis. The Court’s ruling avoids that artificial restriction.
Finished Goods Value Is Not the Statutory Test
The Department also argued that the value of outward supplies exceeded that of inputs and that the cost of packing materials and other ancillary inputs was absorbed into the value of the finished goods. This argument may be relevant to costing, pricing or margin analysis, but it does not determine refund entitlement under Section 54(3)(ii).
The inverted duty refund provision is based on rate comparison, not value comparison. Finished goods often have a higher value than inputs because value addition, labour, processing, overheads and profit are built into the final price. That does not answer the statutory question. The relevant inquiry is whether ITC was accumulated because the rate of tax on inputs was higher than the rate of tax on output supplies.
Therefore, the Department’s valuation-based objection had no independent statutory bearing on the refund claim. If the statute had wanted value comparison to be a condition for refund, it would have said so. In the absence of such language, the authority must apply the statutory rate-based test and then compute the refund under Rule 89(5).
Circulars Cannot Add a Restriction to the Act
The Department relied on Circular No.135/05/2020-GST, dated 31.03.2020 to support the rejection. The broad departmental understanding was that when the tax rate on the principal input and the output supply is the same, a refund under the inverted duty structure should not be granted. The difficulty with this approach is that circulars cannot override the Act.
An administrative circular can clarify the law, guide departmental officers, and promote uniform administration. But it cannot impose a restriction that Section 54(3)(ii) itself does not contain. If the statute does not distinguish between principal and ancillary inputs, an administrative circular cannot introduce that distinction.
Rule 89(5) Converts Entitlement Into Computation
The petitioner also relied on Circular No. 125/44/2019-GST dated 18.11.2019, particularly the clarification that where multiple inputs attract different rates, the formula under Rule 89(5) must be applied irrespective of the individual rates applicable to the different inputs. This approach is closer to the statutory scheme because Rule 89(5) is the prescribed method for computing the eligible refund once the claim falls within the inverted duty structure.
Section 54(3)(ii) creates the substantive entitlement to a refund in an inverted duty situation. Rule 89(5) provides the method of calculation. The formula does not require the officer to first identify a principal input and then deny the claim if that input carries the same rate as the output. Instead, it provides a structured method for computing the refund based on turnover of inverted-rated supply, net ITC, adjusted total turnover, and tax payable on such inverted-rated supply.
This is why Rule 89(5) is important. It avoids subjective disputes about whether an input is major or minor. Once higher-rated inputs have caused accumulation, the authority must apply the formula. The formula ensures discipline and prevents excessive or arbitrary refunds by calculating the amount through the statutory mechanism.
The High Court therefore directed the Department to process and sanction the refund in accordance with Rule 89(5). The ruling makes it clear that refund authorities should not reject the claim at the threshold by applying a principal-input test. Their role is to verify the facts and apply the statutory formula.
Indian Oil Case Law Reinforced the Supremacy of the Statute
The petitioner relied on Indian Oil Corporation Ltd. v. Assistant Commissioner of Central Tax, (2025) 174 taxmann.com 1 (Kar.) = 2025-VIL-318-KAR. In that case, the Karnataka High Court considered Circular No. 135/05/2020-GST and held that the CBIC cannot issue circulars contrary to the provisions of the statute. The Court also recognised that Section 54(3) concerns the accumulation of unutilised ITC and does not impose an additional principal-input condition.
The underlying principle is straightforward. Administrative instructions cannot curtail statutory refund rights. If Section 54(3)(ii) permits a refund where credit accumulates because the input tax rate is higher than the output tax rate, the claim must be tested on that basis. Circulars may assist in implementation, but they cannot rewrite eligibility.
This principle was directly relevant in Vindhya Spinning Mills. The Department’s rejection was essentially based on a restrictive reading not found in Section 54(3)(ii). The High Court followed the statutory route and refused to allow executive interpretation to narrow the provision.
MK Agrotech and Nainar Judgments Supported the Wider Input Approach
The petitioner also relied on MK Agrotech Pvt. Ltd. v. Union of India, (2025) 32 Centax 479 (Kar.), where the Karnataka High Court followed the earlier view and held that the refund benefit cannot be restricted solely by looking at the principal input. This decision is important because it recognises the practical reality of multi-input manufacturing. Credit may arise from supporting inputs, and the law does not permit ignoring them merely because they are not the dominant input.
Reliance was also placed on M /s Nainar Industrial Enterprises Limited v. Union of India, 2023 (11) TMI 209 (Rajasthan High Court) = 2023-VIL-790-RAJ. That decision also supported refund entitlement under the inverted duty structure where the statutory conditions were satisfied. The broader thread in these judgments is that refund claims must be tested against the Act and the Rules, not against extra-statutory filters.
The Madras High Court’s earlier decision in M/s Eveready Spinning Mills Private Limited v. The Assistant Commissioner, 2024 (7) TMI 1160 (Madras High Court) = 2024-VIL-723-MAD, further strengthened the petitioner’s case. That decision allowed a refund in similar circumstances after considering the judicial trend and the limits of restrictive circulars.
The Relief Followed the Formula, Not Administrative Assumption
The High Court allowed both writ petitions and quashed the refund rejection orders dated 17.03.2025 and 15.05.2025. The Department was directed to process and sanction refunds of Rs. 10,88,231/- and Rs. 15,50,228/-, respectively, along with interest as per the CGST Act, 2017. The refunds were to be processed in accordance with the Rule 89(5) formula, after granting an opportunity of personal hearing, within three months.
This relief is important because the Court did not merely send the matter back without guidance. It clarified the legal principle and directed the Department to proceed under the statutory formula. The opportunity of hearing preserves procedural fairness, while the direction to apply Rule 89(5) preserves statutory discipline.
For refund authorities, the message is clear. Verify the rate structure, documents, ITC accumulation and computation. But do not reject the claim merely because the principal input and output carry the same rate. That is not the statutory test.
The Practical Message for Taxpayers
For taxpayers, the ruling underscores the need to present an inverted duty refund claim as a clear statutory claim, not merely as a hardship claim. The refund file should show the tax rate on output supplies, the tax rates on all relevant inputs, the accumulation of ITC and the computation under Rule 89(5). Where the principal input and output carry the same rate, the taxpayer should specifically demonstrate how higher-rated ancillary inputs caused the accumulation. Proper invoices, credit ledger details, and rate-wise workings will strengthen the claim and reduce the scope for rejection based on circulars or valuation objections.
Rate Inversion Cannot Be Tested Through Input Labels
Vindhya Spinning Mills lays down a clear rule. An inverted duty refund under Section 54(3)(ii) cannot be denied merely because the principal input and output supplies carry the same GST rate. If other inputs attract a higher GST rate and result in the accumulation of ITC, the claim must be examined under the Rule 89(5) formula.
The judgment restores the statutory focus: compare the tax rate on inputs with that on output supplies, and then apply the prescribed formula. A principal-input filter or a valuation-based objection cannot be read in where the statute does not provide for it.
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