What is Inverted Duty Structure under GST?
Inverted duty structure is an anomaly under Indian Indirect Tax i.e., Goods and Service Tax ("the GST") where the Input Tax on Raw Material used to produce Finished Goods is higher than the Output Tax for Sale of such Finished Goods. The Rate of GST applied on the Raw Material is more than the Rate of GST applied to the Finished Goods. In other words, the Output Tax payable on the output of the Finished Goods is less than the Input Tax Payable of the Raw Material used to produce such Finished Goods.
Taxpayers who face an inverted duty structure will always have Input Tax Credit (ITC) in their GST electronic credit ledger even after paying off the output tax liability. Hence, working capital issues arises for the taxpayers, as crucial resources remain blocked in the form of ITC.
Refund of ITC Under GST
As per Section 54(3) of Central Goods and Services Tax Act, 2017 ("the CGST Act"), A Registered Person under GST Act may claim a refund of Unutilized ITC available on the Electronic Credit Ledger at the end of the Tax period. For Claiming Refund of this ITC, a Registered person must furnish the Return of Relevant Tax period.
Refund of Unutilized ITC is allowed in two cases:
1. Zero Rated Supply made without Payment of Tax: As per Section 16(3) of Integrated Goods and Service Act, 2017 ("IGST Act"), if a person is making Nil Rated Supply (0%) then he is eligible to claim refund of ITC in the following ways:
· Supply of Goods under Letter of Undertaking (LUT): A LUT is a prescribed form GST RFD 11 under Rule 96 A of Central Goods and Services Tax Rules, 2017 (the "CGST Rules"), where the Exporter shall declare that he/she will fulfil all the requirements that are prescribed under GST while exporting without paying IGST. In the above case Supplier should claim refund of Unutilized Input tax credit.
· Supply of Goods on which GST is paid and claim refund of such tax paid.
The Person should claim refund of Unutilized ITC as per Section 54(3) read with Rule 86 and 96 as the case may be.
2. Inverted Duty Structure: Where the credit accumulates on the account of input rate being higher than the output rate (other than Nil rated supply or fully Exempt Supply), Except the following:
· Output Supplies as notified by the Government on the recommendation of the Council.
· Goods Exported are subject to Export Duties.
· Refund of Supplies claimed under IGST Act of Output Tax paid.
· If Supplier avails the refund of IGST or CGST and SGST.
· Circular No. 135/05/2020-GST dated 31.03.2020 - Refund on account of inverted duty structure would not be admissible in cases where the input and output supply are same, refund of ITC cannot be claim on the account of above-mentioned supplies. In any other case the ITC can be claimed.
Circular No. 173/05/2022-GST dated 06.07.2022 - "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.”
Therefore, Circular No. 173/05/2022-GST clarifies the intent of legislation and states that refund on account of Inverted Duty Structure caused due to Government's concession schemes would certainly be admissible.
Refund of ITC in case of Inverted Duty Structure:
As per clause (ii) of the first proviso of section 54(3) of CGST Act, 2017, refund of accumulated ITC shall be allowed where the credit accumulation takes place on the accounts of Inverted Duty Structure. In respect of Goods the central government has issued Notification No. 05/2017 – Central Tax (Rate) dated 26.06.2017 amended vide Notification No. 44/2017 – Central Tax (Rate) dated 14.11.2017 over and above that the Government has notified certain goods in respect of which unutilized ITC is not allowed as refund.
Forms to be filed:
A person claiming a refund must apply in Form GST RFD – 01. GSTR-1 and GSTR-3B have to be filed for the relevant tax period for which you want to file a refund application for the accumulated ITC.
Time limit to file:
RFD-01 has to be filed within two years from the end of the financial year in which such a claim for refund arises.
Maximum Amount of Refund:
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)}
As per Section54(7) provides that the final refund/claim shall be issued within 60 Days from the date of receipt of application, complete in all respects.
The refund and/or interest sanctioned, if any, will be directly credited to the bank account of the applicant.
Landmark Case Law regarding Inverted Duty Structure: -
Union of India Vs VKC Footsteps India (P) Ltd.
In 2019, The Division Bench of Gujarat High Court in the matter of VKC Footsteps India (P) Ltd. which passed a judgement which allows taxpayer to avail the unutilized ITC on the input of Goods and not allowed in case of inputs of Services.
On the other hand, a Division Bench of Madras High Court in the case of Tvl. Transtonnelstroy Afcons Joint Venture V/S UOI passed a judgement which restricts the availment of Refund of ITC in case of inputs of Goods. Due the Contradictory Judgement passed by the Gujarat high court and Madras High Court; Supreme Court has passed a Judgement which is applicable to all the cases having similar Facts.
Case Brief: -
Issue & Brief Background -
Questioning the validity of Rule 89(5) of the CGST Rules, in furtherance of Section 54(3) of CGST Act 2017 which deals with the refund of unutilized Input Tax Credit that gets accumulated due to Inverted duty structure. The issue raised is on the formula provided in Rule 89(5) with the term ‘Net ITC’ that includes only input goods and not input services for the purpose of calculation of maximum refund amount.
Writ petition under Article 226 were instituted in Hon’ble High Court of Gujarat and High Court of Judicature Madras. It was submitted by petitioners that while Sec.54(3) allows refund of ITC that gets accumulated due to invert duty structure, on the other hand the Rule 89(5) restricts the refund of input service and allows only the refund of input goods.
The High Court of Gujarat gave a ruling in support of the assessees directing the Union Government to allow the refund with respect to ITC accumulated due to both input goods and input services. The High Court of Judicature Madras on the contrary stated in its judgment that it does not infringe Art.14 and the right of refund is a statutory right and making exceptions or limiting the ambit of refund is part of legislation.
The difference between the judgments of High Court of Gujarat and High Court of Judicature Madras makes the subject matter of these appeals.
Pleadings of Union of India : -
Ø Senior Counsel Mr.Venkataraman representing UOI questioned the validity of Gujarat High Court judgment and contended that goods and services are both separate terms and the Constitution and statute have both maintained a distinction between the two. They remain distinct for prescription, treatment and interpretation. The need to integrate both taxes on input goods and input services is for creating a common pool of credit for cross utilization on both goods and services.
Ø Interpreting Sec.54(3) he stated that the proviso of the section have to be read as restrictions and not as qualifications. The word ‘allowed’ is used in all three provisos of this section, he contended that if the parliament has not used statutory language to include input services than it is wrong to do so via judicial interpretation.
Ø He further contended that refund is not constitutional right, it is a statutory right which is subject to limitations and cited case law named Mafatlal Industries Ltd. V UOI which entails that burden of proof is on the claimant to avail the refund. Also, doctrine of reading down shall not be employed to increase the ambit of refund or rewriting the legislation.
Ø He further stated that levy of taxes has to be in consonance with Art.14 and Art 19 and equality amongst inequals and inequality amongst equals is invalid other than that the latitude for legislation to make limitations is totally valid.
Ø He also submitted that refund is a form of exemption and when it comes to provisions regarding exemptions from tax the interpretation has to be strict.
Pleadings of Assessees : -
Ø Senior Counsel Mr. Sridharan appearing on behalf of assesses submitted that Rule 89(5) originally enacted allowed for refund of input goods as well as input services and hence was in line with Sec.54(3) of CGST Act, 2017. The rule was revised by the notification 21/2018 CT and input services were excluded from the ambit of refunds. He further added that the revenue department is allowing accumulation of ITC of input goods and input services both, but the refund is being denied and the refund already given has been recovered.
He further added that GST is destination-based consumption tax and the seamless transfer of burden of tax is its main component which results in the final consumer bearing the burden of tax without any ‘sticking’ or unabsorbed ITC, with the refund being denied it defeats the very purpose of GST as the seamless flow of burden in supply chain is hindered. The refund of unutilized ITC ensures elimination of cascading effect (tax on tax effect).
While interpreting the concerned section he added that the provisos of Sec.54 (3) entail the cases or situations where the refund is allowed. Even erstwhile State Value Added Tax had the concept of refund of ITC even before GST came into existence. The submission of Revenue department shall not be accepted as there is no ‘to the extent of’ expression in the clause (ii) of statutory provision.
That since Rule 89(5) is curtailing the ambit of Section 54(3) it is ultra vires and since it is delegated legislation because the rules are made by the suggestion of GST council and that does not elevate them to the status of legislated statute and hence by the doctrine of severability the ultra vires portion of Rule 89(5) must be struck down.
Ø Learned Counsel Sujit Ghosh submitted that the provisos of Section 54(3) are not restrictions but merely threshold conditions. He stated that intent of legislature must be borne in mind, the legislators do not want the tax payers to suffer cascading effect of tax. The purpose of provision is to give effect to doctrine of equivalence and neutrality which is the basic objective of GST.
Section 54(3) does not cover the situations where inverted duty structure is because of assessees own decisions i.e. discount/distress/non supply which is distinguished from rate structure created by the state. At the contextual interpretation of Sec.54(3) one can find that the provisos merely describe the conditions to be qualified and not the quantum of refund. The convergence of the ITC happens at the stage of availing and not at utilization stage.
The reliance placed on Mafatlal case by the Revenue Department is out of context as what is being claimed is not out of statutory ambit, but the claim is being sought through appropriate statute.
Ø Senior Counsel Mr. Arvind Datar urged that CGST and SGST Act treats goods as services for example transfer of rights in goods without transfer of title is deemed as ‘supply of services’ and hence meaning of input in Section 54(3) cannot be restricted to goods only, services has to be included as well.
Ø Appearing on behalf of intervenor Learned Counsel Mr. G Natranjan submitted that since the formula does not allow refund of ITC accumulated by input services than the assessees should be allowed to first use credit on account of input service from electronic credit ledger which is otherwise not eligible for refund.
Ø Appearing for another intervenor Learned Counsel Mr. Vinay Shraff added that the inequality arises because small businesses (SMEs) will get lesser refund while large businesses will get refund that will infringe Art.19(1)(G).
Ø Learned Counsel Mr. Uchit Sheth contended that it is not possible to find the source of ITC once it enters the electronic ledger, thus the presumed hierarchy for usage against output tax of ITC on account of input goods and thereafter the ITC of input services is baseless.
Ø Learned Counsel Dr. Arvind Poddar contended that in the formulae the turnover of inverted services and tax payable on such inverted supply has been included while the ITC of input services has been excluded from ‘net ITC’, he called it Paradoxical.
"It is paradoxical that while on the one hand the definition of net ITC has been amended to exclude ITC availed on input services, on the other hand, turnover of inverted supply of services and tax payable on such inverted rated supply of services has been included in the formula for calculating the maximum amount of refund."
Pleading of UOI in Rejoinder : -
Ø If the submissions of assessees is accepted it would render Art.279A (4) which deals with GST council useless because goods and services are treated as two different aspects and there can be no harmony or parity among the two in the sense submitted by assessees.
Prior to the enactment of GST, MODVAT/CENVAT Rules contained formulae to determine the quantum of eligibility of credit. Similarly, to legally dissect the homogenous unutilized ITC, a formula may be resorted to determine eligibility, restrictions, or refunds.
Ratio decidendi: - Court turning to Sujit Ghosh’s submission regarding the anomalies in the formula in Rule 89(5) rejected it because the Rule89(5) is to give effect to Sec.54(3) for making distinction between the input goods and services and thus the principle behind the section is uheld by the rule and hence it cannot be struck down.
That as per judicial precedents cited by counsels for assessees i.e. Lakshmi Machines Works case, Arun Kumar & ors v UOI and Commissioner of Income Tax v HCL Ltd. the court has only intervened to read down or to interpret a formula if the formula is unworkable and gives absurd results ,in the present case however the formula is working and it is in consonance with the intent of legislation.
Crux of Supreme Court Judgement: - The Taxpayer can only get ITC Refund of Inputs of Goods and not for Inputs of Services. The court also held that if Laws fails to create certain ideals, it does not make it invalid and ultra vires the act.
The reading down of the formula as prescribed by Mr. Natranjan and Mr. Sridharan will take this court to a path of recrafting the formula that is impermissible. But the court indicated that the formula is not perfect. The court hence refrained from replacing the legislation and walking in the shoes of executive or legislative bodies. However, the court strongly urged the GST council to reconsider the anomalies in the formula and take a policy decision about the same.
The Change in Formula: -
The GST Council’s 47th meeting was held in Chandigarh on June 28th and 29th, 2022 under the chairmanship of the Union Finance & Corporate Affairs Minister Smt. Nirmala Sitharaman. The GST Council has inter-alia made recommended amendment in formula to calculate refund of unutilised ITC in case of inverted duty structure:
Change in formula for calculation of refund under Rule 89(5) of the CGST Rules to take into account utilization of ITC on account of inputs and input services for payment of output tax on inverted rated supplies in the same ratio in which ITC has been availed on inputs and input services during the said tax period.
Conclusion: -
The 47th GST Council meeting considered making changes to the Formula which was hitherto flawed when the aforementioned case was sub judice. The Hon'ble Supreme Court affirmed the view of Madras High Court and rejected the view of Gujarat High Court, however asked the GST council to reconsider the formula and pay heed towards promulgating a new policy regarding the same, Therefore the contentions of Counsels for Assessees that brought forth the anomaly did not win the case but indeed pointing out the unfair discrimination of the formula in Rule 89(5) in the Apex court perhaps caused the GST Council to reconsider the Formula to include Input services for calculating maximum refund.
Of course, recrafting the formula would have been going too far and that too without ample reason to do so, nevertheless, the Apex Court’s judgment is laudable and has contributed to change in Formula, and it maybe anticipated that the question of law raised in this case will bring more changes and provide fairness to the Taxpayers in the forthcoming days and resolve the conundrum with regard to Cascading effect and Inverted Duty Structure.
Well articulated