An inverted duty structure occurs when the tax you pay on your purchases is higher than the tax you charge on your sales. This creates a problem because you can't fully use the tax credit you've accumulated, leaving you with a recurring tax refund claim.
Section 54(3) of the CGST Act allows businesses to claim a refund for accumulated Input Tax Credit (ITC) caused by an inverted duty structure. However, this is subject to conditions, and certain goods, input services, and capital goods are excluded as per official notifications.
How does IDS block working capital?
When Input Tax Credit (ITC) accumulates, it essentially becomes working capital that is locked away with the government, interest-free. This creates a particularly acute burden for high-input, low-margin industries such as textiles and footwear. These businesses pay significant GST on inputs each month but cannot fully utilize the credit because their output tax liability is too low.
Key working-capital impacts include:
- Increased Borrowing: Companies are forced to use more of their bank limits or expensive informal credit to finance procurement, as their own capital is stuck as unutilized ITC.
- Operational Constraints: With lower internal cash, they cannot afford to hold sufficient inventory, lose bargaining power with suppliers, and must restrict credit offerings to their own customers.
Mechanism of refund and delays
The procedural mechanism for refunds under an inverted duty structure is governed by Rule 89(5) of the CGST Rules, which specifies a calculation based on turnover and net ITC, to be claimed via Form RFD-01. In practice, the scope of this refund is restricted. Following CBIC clarifications and judicial precedent (e.g., VKC Footsteps), eligibility is confined to ITC on input goods, thereby excluding input services and capital goods and constraining the total refund value.
The refund process has traditionally been plagued by manual checks and disputes over product classification, creating significant delays and uncertainty for businesses. Compounding this problem, the interest provided on delayed refunds fails to compensate for the real cost of capital, meaning companies still bear a substantial financial burden despite eventually receiving their funds.
How refund delays worsen working capital strain?
Refund delays prolong the lock-up of Input Tax Credit (ITC), directly extending a company's cash conversion cycle. This forces businesses to take corrective measures, such as:
- Increasing working capital limits or securing short-term loans, which raises interest costs and bank charges.
- Postponing critical investments in capital expenditure, marketing, or inventory due to a lack of accessible funds.
Uncertainty around eligibility-such as the classification of goods, treatment of services, or retrospective law changes-often leads businesses to under-claim their Input Tax Credit (ITC). This under-claiming permanently turns potential tax credits into a cost, eroding profit margins. This is especially damaging for exporters and price-controlled sectors, who cannot easily pass these additional costs onto their customers.
Recent measures to ease working capital impact
Recent policy changes have aimed to alleviate the working capital strain of an inverted duty structure (IDS) by tackling its root cause. Through rate rationalization, the GST Council has narrowed the tax gap between inputs and outputs. This strategy, often part of "GST 2.0" reforms, directly minimizes future ITC accumulation, while targeted, sector-specific rate corrections address existing imbalances.
To accelerate liquidity, an automated regime has been introduced that targets the swift release of a 90% provisional refund for IDS claims. This system aims to free up working capital faster and improve cash flow predictability for manufacturers, with the remaining balance settled after final verification.
FAQs
How to calculate refund amount under inverted duty structure?
To calculate the refund amount under the inverted duty structure in GST, use the latest amended formula as per Rule 89(5) of the CGST Rules.
Refund Calculation Formula
The maximum refund amount is calculated as:
Where:
- Net ITC means input tax credit availed on inputs and input services during the relevant period
- Adjusted Total Turnover includes total turnover of goods/services in India excluding exempt supplies
- Turnover of inverted rated supply means turnover of supplies where input tax rate is higher than output tax rate
Documents required to claim IDS refund and timeline for RFD 01
For Form RFD-01 (Inverted Duty Structure), the main documents are:
- GSTR-1 and GSTR-3B for the relevant tax period (month/quarter) for which refund is claimed.
- Statement 1A (auto-populated from the GST portal).
- Declaration under Rule 89(2)(l) - that incidence of tax has not been passed on to any other person.
- Declaration under Rule 89(2)(m) - that no refund of the same ITC is claimed under any other provision (like export, deemed export, SEZ, etc.).
- Undertaking under Section 54(3) that the supplies are not nil-rated or fully exempt.
- If refund amount > ₹2 lakh, a certificate from a CA/CMA that there is no unjust enrichment.
- Invoices (inward and outward) and ITC reconciliation with GSTR-2B (may be asked by officer).
If refund is ≤ ₹2 lakh, a self-declaration in lieu of CA certificate is sufficient.
Circumstances when IDS refund claims are restricted or denied
IDS refund claims are restricted or denied in these cases:
- Output supplies are nil-rated, fully exempt, or subject to a lower rate of tax under a specific government notification.
- When the supplier claims refund of IGST paid on exports or supplies to SEZ under other categories.
- If the inputs used are not covered under GST or blocked under Section 17(5) (e.g., motor vehicles, membership of a club).
- Refund is not allowed on capital goods or for services, only on ITC of inputs under IDS.
CAclubindia
