Introduction – What is “Inverted Tax Structure”?

Inverted Tax Structure is a situation where the supplier pays higher rate of tax on its input supplies, and discharges comparatively lower rate of tax while making its output supply. Consequently, a large pool of credit of tax paid on input supplies is accumulated. This would result in cascading effect of taxes in the form of unabsorbed excess tax on inputs with consequent increase in the cost of product which is against the very tenet of GST being a consumption tax. In order to address the said anomaly, GST law provides for refund of accumulated unutilised input tax credit (“ITC”) under Section 54(3)(ii) of the GST Act.

Section 54(3)(ii) of the GST Act allows a refund of unutilized ITC accumulated on account of the GST rate on inputs being higher than the GST rate on output supplies.

Inverted duty structure refund has been subject matter of numerous interpretational issues since introduction of this concept in GST law.

The word “inputs” is not defined under GST, however, “input” is defined under Section 2(59) to mean any goods other than capital goods. Here, two School of thoughts come into the picture viz.;

First School of thoughts: – The refund of unutilized ITC would be restricted to the ITC of input goods; and

Second School of thoughts: – The refund of ITC availed on input services would be eligible.

At the time of implementation of GST, as per the formulae prescribed under Rule 89(5), the refund was eligible for both viz. ITC w.r.t. input goods and input services. Accordingly, the output tax was deductible w.r.t. GST paid by utilization of ITC of input goods and ITC of input services.

Maximum Refund Amount = {(Turnover of inverted rated supply of goods) x Net ITC / Adjusted Total Turnover} – tax payable on such inverted rated supply of goods
Explanation.- For the purposes of this sub rule, the expressions “Net ITC” and “Adjusted Total turnover” shall have the same meanings as assigned to them in sub-rule (4) wherein "Net ITC" means input tax credit availed on inputs and input services during the relevant period; and "Adjusted Total turnover" means the turnover in a State or a Union territory, as defined under 1[clause] (112) of section 2, excluding the value of exempt supplies other than zero-rated supplies, during the relevant period;

Thus, there was a balance in refund amount vis a vis output tax deduction.

However, vide Notification No. 21/2018-CT dated 18 April 2018, the definition of Net ITC was amended retrospectively to include only ITC of input goods whereas the deduction of output tax was for tax paid through input goods and input services. Thus, after the retrospective amendment, there was an anomaly created which created an imbalance in the favour of revenue.

In effect, the amended Rule 89(5) by employing the expression “input tax credit availed on inputs’, has the effect of granting refund of tax paid only on ‘inputs’ and denying the same on ‘input services’.

Said amendment was challenged in multiple proceedings by contending that amended Rule 89(5) by restricting the refund to ‘inputs’ only, runs contrary to the substantive provision i.e. Section 54(3), and is ultra vires to this extent.

The Gujarat High Court in VKC Footsteps India Private Limited v. UOI, had read down the explanation (a) to Rule 89(5) of Central Goods & Services Tax Rules, 2017 (“Rules”), and had allowed refund of tax paid on input services as well.

The Court observed that Section 54(3) employs the expression ‘any unutilised input tax credit’, and ITC is defined under Section 2(63) to mean credit of input, and ‘input tax’ as defined in Section 2(62) means central tax, state tax, integrated tax or union territory tax charged on any supply of goods and / or services. Hence, Section 54(3) must be read to include tax paid on input services as well. Accordingly, upon conjoint reading of Act and Rules, Court held the explanation (a) to Rule 89(5) ultra vires the provision of Section 54(3), and observed that by prescribing formula under the Rules, the Executive cannot restrict the substantive provision enacted by the Legislature. Accordingly, Revenue was directed to process the refund of unutilised ITC by including the tax paid on ‘input services’ as well.

Whereas In a recent judgment of Madras High Court in the case of TVL Transtonnelstroy Afcons Joint Venture v. UOI, the Court denied refund of tax paid on input services on account of inverted tax structure. This marked a significant blow to taxpayers who operate under ‘inverted duty structure’, and have been claiming refund on account of paying higher rate of tax on input supply. 

Madras HC did not subscribe to the view taken by the Gujarat HC in VKC Footsteps India Private Limited v. UOI by observing that the import of proviso to Section 54(3) was not discussed in VKC (supra). It was observed that Section 54(3) undoubtedly enables a registered person to claim refund of any unutilised ITC. However, the principal of the said enacting clause is qualified by the proviso which states that "provided that no refund of unutilised input tax credit shall be allowed in cases other than". It was observed that unless a registered person meets the requirements of clause (i) or (ii) of Sub-section 3, no refund would be allowed. Under clause (ii), the expression used is ‘inputs’, which must mean to include goods only and not input services. Hence, Explanation to Rule 89(5) by prescribing the formula, thereby limiting the ambit of ‘Net ITC’ to mean tax paid on ‘inputs’ only, is valid and vires to Section 54(3).

Court also observed that refund is a statutory right, and the Parliament is within its legislative competence to impose a source-based restriction in order for a supplier to be eligible for refund of unutilized ITC.

The matter reached the Hon’ble Supreme Court and the ruling of the Hon’ble Madras High Court was affirmed while the appeals against the judgement of the Gujarat High Court by the Union of India was allowed.

The Supreme Court upheld the validity of Rule 89(5) of the Central GST Rules, 2017 which prescribes a formula excluding the refund of ‘unutilised input tax’ paid on ‘input services’ as part of ‘input tax credit’ (ITC).

However, in this ruling, the Hon’ble Supreme Court noted that the formulae prescribed for the calculation of a refund suffer from an anomaly and strongly urged the GST Council to reconsider the formula and take a policy decision 

regarding the same.

In this regard, the Hon’ble Supreme Court noted that the GST Council should ascertain whether the deduction of output tax in the formulae could be allowed to be made in the proportion of ITC on input goods and input services.

Respecting the remarks made by the Hon’ble Supreme Court, the GST Council, in its 47th GST Council Meeting, proposed the following change which was incorporated in Rule 89(5) w.e.f. 05 July 2022 vide Notification No. 14/2022-CT;

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)}.

Accordingly, as per the revised formulae, the deduction of output tax would be in proportion to the ITC availed on goods.

Let us analyse the application of the amendments made in the formulae prescribed for the calculation of refund of unutilized ITC accumulated due to an inverted rate structure.

Application of formulae of calculation of refund amount

Rule 89(5) of the GST Rules prescribes a formula for the calculation of refund of unutilized ITC on account of an inverted rate structure. The formula as it stood before July 2022 is as follows:

Maximum Refund Amount = {(Turnover of inverted rated supply) x Net ITC / Adjusted Total Turnover} – tax payable on such inverted rated supply of goods and services.

Applying the legal principle pronounced by the Apex Court, “Net ITC” was to include only such ITC attributable to “inputs” i.e. input goods. With this understanding, let us understand the application of the formulae with an example.

On a perusal of the above formulae, it transpires that refund was allowed only of the ITC availed on input goods (A) whereas the output tax deducted (F) was the output tax paid by utilizing both viz. ITC of input goods as well as ITC of input services. This anomaly resulted in the sanction of reduced refund claims or denial of claim in some cases, hence, the formulae created an imbalance against applicants.

Application of amendment in the formulae

Accordingly, as per the revised formulae, the deduction of output tax would be in proportion to the ITC availed on goods. Thus, a revised calculation of the refund amount in the above example per the amended formulae is as follows:

From the above, It is clear that earlier, the taxpayer was entitled to a refund of INR 0.50 lac and after the change, the taxpayer would be entitled to a refund of INR 1.125 lac. Accordingly, with the above amendment, the anomaly that existed before has been rectified to certain extent.

Whether the benefit of the amendment could be taken for the past period?

We need to analyse if the benefit of the amendment could be taken for the refunds pertaining to past periods. The application of the above amendment for past period refunds is as summarised below:

Why Retrospective application of the formulae ?

It could be construed that the instant amendment is done to resolve the anomaly created after the retrospective amendment in 2018 and to rectify or to restore the intention of the Government not to allow refund of unutilised credit of input services.

It is worth to note that amendments made to rectify or to restore the position which existed before the creation of anomalies are only corrective and clarificatory in nature and have a retrospective effect as discussed in the case WPIL Ltd, Ghaziabad vs CCE Meerut SCC, Ralson (India) Ltd. vs CCE Chandigarh I SCC.

Applying the above legal principle in the instant case, it could be construed that the amendment in the formulae is nothing but a rectification or restoration of the provision that existed earlier with an intent to restrict the benefit of refund on input goods. Thus, the amendment would have a retrospective effect. Accordingly, the new formulae could be applicable for refund of credits accumulated in the past period.

Further, as Rule 89(5) prescribes a method to calculate the amount of refund eligible under the inverted duty structure, it could be construed that the revised method would apply to all the refunds claims after the amendment as the refund claims filed after the amendment would be governed by the procedure prescribed under Rule 89(5) as on the date of refund application.

Moreover, it is a settled legal principle that where a law is enacted for the benefit of community as a whole, even in the absence of a provision the statute may be held to be retrospective in nature as discussed in the case Vatika Township Pvt. Ltd. In Supreme Court.

Comments:

The amendment has been a welcome step by the GST Council to consider the impact of ITC accumulation on account of services when allowed a refund of unutilized ITC accumulated on account of the GST rate on inputs being higher than the GST rate on output supplies.