GST 2.0: Blocking ITC in Healthcare & Insurance – A Retrograde Step? Does it reintroduce cascading taxes like the excise era

GST 2.0: Blocking ITC in Healthcare & Insurance – A Retrograde Step?

Does it reintroduce cascading taxes like the excise era?

1. GST’s Core Principle

The Goods and Services Tax (GST) was introduced to eliminate the cascading effect of taxes through a seamless input tax credit (ITC) chain. In this model, only the value added at each stage should be taxed, ensuring neutrality and efficiency.

However, recent changes under GST 2.0 have exempted or nil-rated critical sectors like healthcare products and insurance. By blocking ITC in these areas, the government has effectively reintroduced embedded taxes into the supply chain.

GST was designed to eliminate cascading by allowing seamless input tax credit (ITC) across goods and services to ensure that tax applies only on value addition at each stage. By exempting goods/services (e.g., life-saving drugs, insurance) and blocking ITC, the government is partly returning to a pre-GST excise/VAT pattern where taxes get embedded in costs.

• With ITC: Only the value added at each stage is taxed.
• Without ITC (exemption/NIL-rated): Inputs suffer tax, outputs do not. That tax becomes cost, reviving tax on tax.

2. Policy Shift in GST 2.0 - What Has Changed?

• Healthcare products: Many life-saving drugs/devices brought down to NIL or 5% ? ITC blocked if output is NIL.
• Insurance services: Life/health insurance premiums moved to exempt ? insurers must reverse/block ITC on inputs (IT, rent, marketing, outsourcing).
• Effect / Result:: ITC chain broken, input taxes embedded. Suppliers can no longer claim credits, so input taxes turn into embedded costs.

3. Retrograde from GST’s Philosophy

GST’s founding principle: “Seamless credit chain, no cascading of taxes.”

• With ITC: Only value addition is taxed.
• Without ITC: Inputs suffer tax, outputs are exempt, causing tax on tax—exactly what GST was designed to eliminate.
• This makes the step retrograde, pulling India back towards the fragmented excise/VAT model.

4. Why It Is Called Retrograde

1. Reintroduces Cascading: Inputs taxed at 18%+ with no credit, raising effective costs. When ITC is blocked, businesses pay GST on inputs but cannot claim it back. This inflates costs and reintroduces the tax-on-tax problem.
2. Breaks Neutrality: Businesses may change sourcing/structuring to avoid blocked ITC rather than focus on efficiency.
3. Transparency Lost: Consumer sees “0%” or “5%” GST, but final price carries hidden embedded tax.
4. Pricing Transparency: Even if invoices show NIL or 5%, consumers indirectly pay hidden embedded taxes.
5. Litigation Triggered:
   • ITC reversal disputes (Rule 42/43 apportionment).
   • Classification conflicts (drug vs. wellness product, exempt vs taxable).
   • Anti-profiteering inquiries (did firms pass on rate cut?).
6. Administrative Burden: ITC apportionment rules (42/43) and disputes around classification/valuation increase compliance complexity.
7. Global Competitiveness Eroded: Exports carry non-rebatable taxes, unlike zero-rated supply chains elsewhere. Exempt sectors exporting products/services face non-rebated taxes in their cost base.

5. Comparison with Excise/VAT Era

1. Pre-GST: Excise duty and VAT had multiple exemptions, leading to cascading. For example, exempt life-saving drugs still had excise on inputs, raising their actual cost.

1. Now under GST 2.0: Exemptions for insurance and healthcare reintroduce the same structural flaw—input taxes are costs, not credits.

5. Does It Reintroduce Cascading?

Yes, clearly:

• Healthcare Example: A hospital buys equipment (18% GST) but outputs (treatment/insurance) are exempt. The 18% becomes a cost, built into final charges.
• Insurance Example: Insurer pays GST on outsourced IT, marketing, office rent, but cannot claim ITC—those costs are passed into the premium indirectly.
• This reintroduces cascading, just like the old excise service-tax mix where multiple levies accumulated in price.

6.  Government’s Rationale

• Affordability & Optics: Lower premiums and medicine prices upfront are visible relief. Lower headline tax rates on insurance and medicines are politically/socially appealing, reducing immediate consumer costs.
• Refund Management: Blocking ITC reduces refund outgo (otherwise inverted duty refunds rise). Avoids large refund outflows that would occur if these sectors were zero-rated with ITC.
• Consumer Simplicity: A “NIL or 5% GST” label is easy for end-users to understand. For retail consumers, seeing 0% or 5% is clearer than paying 18% and relying on ITC to flow through.
• Policy Targeting: Relief in socially sensitive sectors like healthcare and insurance.

7. Comparison with Pre-GST Excise System

• Earlier (Excise/VAT): Multiple exemptions led to cumulative taxation. E.g., an excise-exempt medicine still bore excise on its inputs.
• Now (GST 2.0 without ITC): Exact replay—input tax not creditable, cascades into cost.
• Thus, it undoes GST’s original reform and mirrors excise-era inefficiencies.

8. Pros vs Cons

Pros (Government’s View)

• Cheaper sticker prices for consumers.
• Affordability: Makes premiums and medicines appear cheaper upfront (political & social optics).
• Social-policy support for healthcare & insurance.
• Administrative savings by reducing refund outgo.
• Simplicity for Consumers: Bills show NIL or low rates; no ITC mechanism for retail buyers.
• Reduced Refund Outflows: Prevents large refund claims from pharma/insurance companies

Cons (Economic/Business View)

• Cascading taxes permanently reintroduced - Revives hidden taxes, hurting efficiency.
• Loss of Neutrality: Firms may restructure business models to minimize blocked ITC rather than optimize operations.
• Global Competitiveness Hit: Exporters carry embedded costs, unlike zero-rated supply chains.
• Compliance and litigation burden rises- Litigation Risk: Apportionment (Rule 42/43), classification disputes, anti-profiteering investigations likely.
• Business distortions (vertical integration, sourcing decisions).
• Weakens GST’s credibility as a true value-added tax.- Breaks GST Credibility: Undermines the “one nation, one tax” principle.

9. Author’s Opinion:

Yes—removing ITC for healthcare and insurance is a retrograde step.

Yes—it reintroduces cascading, the very flaw GST was meant to cure.

While short-term optics favour consumers, in the long run this move leads to higher embedded costs, disputes, inefficiency, and erosion of India’s GST credibility.

10. Potential Risk in  Long run: The risk of future disputes arises because when ITC is denied (by making outputs exempt or nil-rated), the law forces businesses to apply allocation, reversals, and apportionment rules—which are inherently subjective and open to challenge. Let me explain the main drivers:

1. Apportionment of Common Inputs

• Companies (e.g., hospitals, insurers) usually procure goods/services that serve both taxable and exempt outputs.
• GST Rules (42/43) require pro-rata reversal of ITC for exempt supplies.
• Disputes arise over:
  • Whether a service is “exclusively” for taxable or exempt output.
  • How turnover is calculated for the denominator (esp. mixed-use services like IT systems, rents, or overheads).
• Different interpretations ? litigation.

2. Classification Issues

• Once exemptions come in, the question of classification becomes critical.
• Example: Is a healthcare product “medicine” (nil-rated) or “wellness item” (taxable at 18%)?
• Insurers may dispute whether a bundled insurance product qualifies under the exempt category.
• This leads to show-cause notices and appeals.

3. Valuation Disputes

• In exempt sectors, GST is not charged, but embedded taxes increase costs.
• Tax officers may argue that part of the supply chain should have been taxable, leading to valuation adjustments.

4. Refund Disputes

• For 5% with ITC cases (like devices), refunds are allowed for inverted duty.
• For NIL/exempt items, refunds are barred.
• Manufacturers often attempt to claim refunds citing zero-rated principles ? rejected by department ? appeals.

5. Anti-profiteering Investigations

• Where the government announces a rate cut or exemption, authorities may investigate whether companies passed on the benefit.
• If insurers or pharma firms keep prices the same (to cover embedded tax losses), disputes arise under anti-profiteering provisions.

6. Contractual Disputes

• Long-term contracts with tax clauses (say, hospital tie-ups or insurance brokerage agreements) often state “GST extra as applicable.”
• When the rate becomes NIL/exempt, questions arise on whether prices should drop or whether embedded tax should be reimbursed.
• These often spill over into litigation between businesses, not just with tax officers.

Conclusion

In the short run, exemptions give a price-relief headline.

In the long run, because exemptions force ITC reversals, blurred classification, refund denials, and anti-profiteering challenges, litigation is inevitable—bringing us back to the pre-GST era of interpretation-heavy tax disputes.