Library / Goods and Services Tax: The Professional's Master Guide
48. Case Study 4: Textile Unit with Inverted Duty Structure after GST 2.0
48.1 Facts
Sanskriti Garments Pvt. Ltd., Surat, Gujarat, makes readymade garments with a sale value of up to Rs. 2,500 per piece, taxed at 5%. After GST 2.0 its man-made fibre fabric is also bought at 5%. Dyes, chemicals, polybags and some trims are bought at 18% (rates as charged by suppliers; the classification has been checked). The figures for April to June 2026 are:
Item | Value (Rs.) | GST (Rs.) |
|---|---|---|
Garments sold (5%) | 2,00,00,000 | 10,00,000 |
Fabric bought (5%) | 96,00,000 | 4,80,000 |
Dyes, chemicals, trims, polybags (18%) | 40,00,000 | 7,20,000 |
ITC on inputs (Net ITC) | 12,00,000 | |
Job work for stitching (5%) | 24,00,000 | 1,20,000 |
Rent, security, testing (18%) | 10,00,000 | 1,80,000 |
ITC on input services | 3,00,000 | |
Sewing machines (capital goods, 18%) | 10,00,000 | 1,80,000 |
48.2 Issues
- Whether the unit has an inverted duty structure under section 54(3)(ii).
- Refund under rule 89(5) as amended in 2022, and why input services are excluded.
- Provisional refund of 90%.
48.3 Analysis and computation
Section 54(3)(ii) allows refund of unutilised credit where it accumulates because the rate on inputs is higher than the rate on output supplies. Before GST 2.0, man-made fibre yarn at 12% and fabric at 5% created large inversion in the chain. After 22 September 2025, fibre and yarn are at 5%, so much of that inversion has gone. It remains for units like this one that buy chemicals and trims at 18% and sell at 5%. The goods must not be ones notified as ineligible for this refund, and inversion caused only by a rate change on the same goods does not qualify.
Rule 89(5), as amended from 5 July 2022, gives:
Maximum refund = (Turnover of inverted rated supply x Net ITC / Adjusted total turnover) less (Tax payable on inverted rated supply x Net ITC / ITC on inputs and input services). Net ITC means credit on inputs only. Capital goods are excluded and input services are excluded.
Turnover of inverted rated supply | Rs. 2,00,00,000 |
Adjusted total turnover | Rs. 2,00,00,000 |
Net ITC (inputs only) | Rs. 12,00,000 |
ITC on inputs and input services | Rs. 15,00,000 |
Part 1: 2,00,00,000 x 12,00,000 / 2,00,00,000 | Rs. 12,00,000 |
Part 2: 10,00,000 x 12,00,000 / 15,00,000 | Rs. 8,00,000 |
Maximum refund | Rs. 4,00,000 |
Illustration 211: Effect of the 2022 amendment and of excluding input services Step 1: Under the formula before July 2022, the whole tax payable was deducted: 12,00,000 less 10,00,000 = Rs. 2,00,000. Step 2: The amended formula deducts only the part of output tax that is treated as paid out of input credit: Rs. 4,00,000. The gain is Rs. 2,00,000. Step 3: If input services were counted in Net ITC, the claim would be 15,00,000 less 10,00,000 = Rs. 5,00,000. The difference of Rs. 1,00,000 is not refundable and stays in the ledger. Step 4: Ledger check: 15,00,000 + 1,80,000 (capital goods) less 10,00,000 output tax = Rs. 6,80,000. The refund of Rs. 4,00,000 is within the balance, leaving Rs. 2,80,000 for later use. Step 5: Provisional refund at 90% = Rs. 3,60,000. |
Judicial view: Refund of accumulated ITC on input services Union of India v. VKC Footsteps India (P) Ltd. (Supreme Court, 2021): The Court upheld rule 89(5) and held that section 54(3)(ii) allows refund only of credit accumulated on inputs, not on input services. It noted the anomalies in the formula but left the remedy to the GST Council. In practice, a unit with large job work or service costs will always carry some credit that cannot be refunded; plan for it by using the credit on any domestic supplies taxed at 18%. |
Provisional refund. The Finance Act, 2026 amended section 54 to allow 90% provisional refund for inverted duty claims as well, but that change awaits notification. In the meantime CBIC grants 90% provisionally on inverted duty claims after risk-based evaluation. The unit should keep its records ready for scrutiny of the balance 10%.
48.4 Compliance and documentation
- RFD-01 under "refund on account of ITC accumulated due to inverted tax structure", for a tax period or a group of tax periods within one financial year.
- Time limit: two years from the due date of the GSTR-3B for the period in which the claim arises.
- Statement 1A with invoice-wise details of inward and outward supplies; declaration that the goods are not notified as barred. No unjust enrichment certificate is needed, because a refund of unutilised credit falls under section 54(8)(b).
- GSTR-2B for each month should support every input invoice claimed.
Key point Lessons Classify each input as input, input service or capital good before the claim. Job work is an input service and never enters Net ITC. GST 2.0 reduced inversion on yarn and fibre; recheck whether a claim is still worth filing each quarter. Credit on input services that cannot be refunded should be planned into pricing. |
Chapter summary • Inversion continues where chemicals and trims at 18% feed garments at 5%. • The amended rule 89(5) formula gives a refund of Rs. 4,00,000, against Rs. 2,00,000 under the old formula. • Credit of Rs. 3,00,000 on input services is outside the formula, as upheld in VKC Footsteps. • Provisional refund of Rs. 3,60,000 is available on risk-based evaluation. |
© Vipin Nair. This guide is for reading online only. Copying, downloading, printing and redistribution are not permitted. For study and general reference; not legal, tax or investment advice.