GST Council Meeting Ushers in Major Tax Reforms with Unintended Consequences
The 56th GST Council Meeting represented a watershed moment for India's indirect taxation framework, implementing comprehensive reforms designed to streamline the system and alleviate burdens on both enterprises and consumers. Among the most impactful decisions was the substantial reduction in GST rates across multiple categories, a strategic initiative intended to boost demand, mitigate cost pressures, and strengthen domestic market competitiveness.
Rate Rationalization Benefits Key Sectors
Industries poised to gain significantly from these rate adjustments include fast-moving consumer goods (FMCG), automobile manufacturing, healthcare services, and consumer durables such as electronics. The lowered rates were expected to stimulate consumption and enhance affordability across these vital economic segments.
The Emerging Challenge of Inverted Duty Structures
However, a deeper examination reveals a complex paradox emerging from these GST revisions. While the rate reductions have successfully lowered final consumer prices by decreasing output GST rates, numerous industries now confront an unexpected dilemma. This predicament originates from structural complications, specifically the inverted duty structure phenomenon where input services and capital goods attract higher GST rates than finished products.
This structural imbalance has become particularly pronounced following recent GST rationalization efforts. Many products manufactured by food processing companies have transitioned from previous 12% or 18% tax slabs to a mere 5% rate. Although this shift aimed to make essential consumer goods more accessible, it simultaneously widened the disparity between input and output tax rates.
Food Processing Industry Faces Acute Disparity
Food processing enterprises continue to pay 18% GST on crucial input services including transportation, warehousing, job work, and consultancy, plus capital goods acquisitions, while their finished products now attract only 5% GST. This significant misalignment results in disproportionate accumulation of input tax credit that cannot be fully utilized, leaving companies with blocked working capital and severe liquidity constraints.
For an industry traditionally operating on narrow profit margins and depending on high-volume turnover, the inability to effectively utilize accumulated credits undermines the intended relief of the rate cuts and creates a structural imbalance that threatens financial sustainability.
Refund Eligibility Limitations Compound the Problem
The situation gains additional complexity because credits accumulated in companies' electronic credit ledgers under these circumstances cannot be claimed as refunds, since input services and capital goods are excluded from refund eligibility provisions. A detailed interpretation of Section 54(3) read with Rule 89(5) indicates that while refunds are permitted in cases where input tax rates exceed output tax rates, this benefit does not extend to situations where tax rates on input services and capital goods are higher than GST on finished products.
Consequently, credits associated with input services and capital goods remain perpetually trapped in credit ledgers, with businesses having no practical means of utilizing these credits as their outward supplies attract substantially lower GST rates.
Contradiction with GST Foundational Principles
This widespread credit accumulation contradicts the fundamental premise of the GST framework, which was conceived as a destination-based tax system designed to ensure seamless credit flow throughout the value chain. The core promise of GST was that taxes paid at any production or distribution stage could be completely offset against subsequent liabilities, thereby eliminating cascading effects and promoting economic efficiency.
By excluding input services and capital goods from refund eligibility in inverted duty structure scenarios, the current mechanism disrupts this foundational principle. This approach not only compromises the neutrality that GST was designed to maintain but also distorts working capital cycles, particularly for sectors with substantial dependence on service inputs and capital-intensive operations.
Global Comparisons Highlight Restrictive Framework
Internationally, jurisdictions including the European Union and several other nations permit refunds of accumulated input tax credit where it exceeds output tax liability, without distinguishing between inputs, input services, or capital goods. Against this global backdrop, India's current framework appears restrictive, as it denies refund eligibility for credits arising from input services and capital goods in inverted duty structure situations.
This limitation not only undermines GST regime efficiency but also imposes undue financial strain on industries that rely heavily on service inputs and capital investments.
Call for Structural Reforms
Revisiting this framework has therefore become imperative. The forthcoming Union Budget presents a timely opportunity for policymakers to address structural inefficiencies within the GST framework. Accordingly, rationalization of inversion-related provisions should be prioritized as a key budget recommendation to support a more balanced, growth-oriented tax regime.
By expanding refund eligibility or rationalizing input tax rates, India could create a genuine win-win scenario, ensuring that intended GST 2.0 benefits are fully transmitted to end consumers through lower prices while simultaneously safeguarding business liquidity and financial health.
Conclusion: Toward Balanced Reform
Addressing this well-recognized problem would help restore balance in the credit chain, improve working capital efficiency, and enable suppliers to pass on the complete benefit of rate rationalization to end consumers. Timely reform would not only strengthen sectoral competitiveness but also advance the broader GST objective of making essential goods and services more affordable, thereby reinforcing the system's credibility as a driver of inclusive economic growth.
Such reforms would strengthen GST system credibility, align India with global best practices, and enhance industry competitiveness in both domestic and international markets.
