The government is actively considering a major reform in the Goods and Services Tax (GST) regime by allowing refunds of unutilized Input Tax Credit (ITC) on capital goods in cases of inverted duty structure (IDS). At present, such refunds are restricted only to input goods, excluding input services and capital goods, which has led to significant accumulation of credit and working capital blockage for capital-intensive industries.
This proposed move aims to provide relief to manufacturers and sectors facing input-output tax rate mismatches, improve liquidity, and make the GST framework more business-friendly. The Ministry of Finance and the GST Council are reportedly exploring the legal and procedural mechanisms to operationalize such refunds, marking a potentially significant shift in the existing refund structure under Section 54 of the CGST Act, 2017.
Background: Inverted Duty Structure & the current refund regime
- An “inverted duty structure (IDS)” occurs when the tax rate on inputs (goods or services) is higher than on the output (final goods). That causes accumulation of unutilised Input Tax Credit (ITC).
- Under Section 54(3)(ii) of the CGST Act, 2017, a registered person can claim a refund of unutilised ITC arising because tax on inputs exceeds tax on outputs, subject to conditions (for example, the output should not be nil‐rated or fully exempt, etc.)
- The mechanism for such refunds is governed by Rule 89 of the CGST Rules. The formula in Rule 89(5) determines the “maximum refund” amount.
- However, under prevailing interpretation and practice, refund under IDS is restricted only to ITC on “inputs” (i.e. raw materials, intermediate goods), excluding ITC on capital goods and input services. This is a key limitation.
- E.g., in legal commentary, it is noted: “A crucial restriction is that IDS refunds are limited only to ITC on input goods. ITC on input services and capital goods is excluded.”
- The CBIC (Board) and Circulars have also reiterated that, under current law / rules, refunds for ITC on capital goods or input services are not allowed under IDS claims.
- In the 2022 Circular No. 173, the CBIC clarified that para 3.2 of the earlier Circular 135/2020 (which disallowed refund if input = output) was not intended to override the statute, but still the restrictive reading is applied.
- Because of this restriction, many industry players (especially in capital‐intensive sectors) have for years complained that the existing refund regime does not fully address working capital blockages caused by IDS, especially for machinery, plant, equipment, etc.
What’s new: Government exploring refunds on capital goods
Recent media reports and statements indicate that the government is actively examining the possibility of relaxing the restriction and permitting refunds on unutilised ITC for capital goods in IDS cases.
Key pointers from the reports:
- The business media says the Centre “has the appetite and is examining how a refund of [ITC on capital goods] could be allowed under inverted duty structure”.
- Industry experts are advocating that this reform should also consider input services (not just capital goods) to make the relief more comprehensive.
- The government is also working on process reforms to expedite IDS refunds generally, which would support any expansion of the refund base.
- As a related development, the CBIC has instructed its field formations (as of October 2025) to provisional sanction 90% of the refund claims in IDS cases filed on or after October 1, 2025, in order to provide quicker liquidity.
- Note: this provisional refund still applies to the existing eligible base (i.e. inputs), not capital goods (as per existing law).
- In the 56th GST Council meeting’s press FAQs, it was reiterated that refund of accumulated ITC under IDS is available to manufacturers, and process reform is being recommended.
- Some analysts flag that unless capital goods and services are also included, the benefits of rate rationalisation may not fully “flow through” to manufacturers, because a part of their blocked credit (on machines etc.) would remain stuck.
So, the proposal is not yet law; it’s under consideration. But it signals intent, and if adopted, it would be a significant relief to capital-intensive industry sectors.
Challenges and constraints in making this change
Permitting refunds on capital goods (and input services) under IDS is not as simple as tweaking a circular. Here are the legal and policy challenges:
- Statutory vs. rule interpretation
- The current legal scheme (Section 54 + Rule 89) (and subsequent judicial interpretations) has drawn a line excluding capital goods / services in refunds under IDS. Changing that would likely require legislative or rule change (or clarificatory amendment).
- There is litigation risk — tax authorities may resist or interpret narrowly unless the change is very explicit.
- Revenue loss and fiscal impact
- Allowing refunds of capital goods credits may lead to substantial outflows. Policymakers would have to assess fiscal cost vs. industrial support.
- The risk of misuse (fraud, inflated claims) is higher in capital goods (expensive machinery), so safeguards will be needed (audit, caps, vetting, etc.).
- Timing and retrospective effect
- Will the change apply prospectively or allow retrospective claims? This is a key issue for manufacturers who have accumulated credits in prior periods.
- The government may limit effectiveness to claims filed after a certain date or allow only going forward.
- Formula and apportionment complexities
- The existing refund formula in Rule 89(5) would likely need revision to appropriately apportion “net ITC” including capital goods.
- Apportionment between capital and non-capital components, useful life, depreciation, etc., complicate fair allocation.
- Interaction with other provisions / ineligible goods
- Some goods or sectors are already excluded from refund under IDS by notification (e.g. notification No. 5/2017) — the new rule may need to revise those.
- The change must reconcile with the law’s exclusion clauses (e.g., exempt supplies, nil‐rated, etc.).
- Administrative burden and verification protocols
- Efficient verification, risk management, audit trails, etc., must be put in place to prevent abuse.
- Systems (GST portal, refund modules) would need upgrade to handle capital goods claims distinctly.
What to watch for / expected time frame & outlook
- Because media reports are recent, it is too early to confirm when (or whether) the change will be legislated or notified. Business Standard’s “likely soon” headline suggests it may be part of near-term GST reforms.
- The 56th GST Council has already flagged process reforms and the need for expedited refunds, which may pave the way for such structural changes.
- If adopted, the change might first come via amendment to Rule 89 or via a new notification under the CGST Act, possibly in the next GST Council / Budget cycle.
- Watch for draft exposure, consultations, stakeholder comments, and circulars from the CBIC.
- In the interim, the 90% provisional refund rule (effective Oct 2025) improves liquidity for existing eligible refunds (though still limited to inputs).
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Also monitor how the government handles retrospective eligibility — whether past capital goods credits (held over) will be allowed as claims or not.