Refunds in the case of an inverted duty structure for service providers under GST

Author’s note

My colleague asked me a doubt, “Can a supplier of services who is in principle capacity, claim a refund of unutilised input tax credit on account of an inverted duty structure? Can that refund include the ITC accumulated from input services like the marketplace commission charged by Flipkart at 18%? What if in that case your outward service is taxed at 5% subject to a no-ITC condition?”

This doubt made me curious as I had never come across such a situation, hence I researched on it deeply, making me switch from CBIC notifications to judicial judgements, which made me write this article. Happy Reading

Introduction and sections involved

Section 54(3) of CGST Act, 2017 permits refund of unutilised ITC in two situations, first one is when zero-rated supplies are made without payment of tax, and the second one is where the credit has accumulated on account of the rate of tax on inputs being higher than the rate of tax on output supplies (also called the inverted duty structure). The provision applies when the output supplies can be goods or services, but critically, the point for applicability of inverted duty structure is when the rate of GST is higher inputs (as per the act “input goods”).

Also, the first proviso of this section gives the power to the Government to notify supplies (goods or services) on which no IDS refund is allowed.

Note: I am using IDS as a short form of inverted duty structure throughout the article.

Notifications restricting refunds under IDS

In the case of goods, Various goods have been notified over time in Chapter 15 and 27 items in 2022 as not eligible for IDS refunds, while in the case of services, by Notification No. 15/2017 (Tax (Rate), issued on the same subject matter across CT(R)/UTGST/ST(R)), construction services deemed as supplies under Para 5(b) of Schedule II are not eligible for refunds as per IDS. So, the developers supplying such a service cannot seek IDS refunds.

Hence, except for construction services, if the output is a service, it will be eligible for IDS. Thus, the eligibility turns on the inputs (goods) being taxed at a higher rate than the outward service and the absence of other restrictions.

Rule 89(5) of CGST Rule

Refund under IDS is computed as per the formula given under Rule 89(5). The present bare act talks about the turnover of inverted-rated goods and services also it defines “Net ITC” to mean ITC availed on inputs (goods) only (excluding capital goods and input services).

The amendment in 2022 also introduced a proportionate subtraction term linked to the ratio of Net ITC to total ITC on inputs and input services, but Net ITC itself continues to exclude input services.

This amendment was introduced vide Notification 14/2022-CT (05.07.2022), where the formula in Rule 89(5) was changed. Later, CBIC Circular 181/13/2022-GST (10.11.2022)clarified that this amended formula was prospective and applicable only to refund applications filed on or after 05.07.2022.

Judicial rulings

You might be thinking, why input services don’t get refunded, let’s see what courts said in this matter

Supreme Court judgement in the case of Union of India & Ors. Versus VKC Footsteps India Pvt Ltd. - 2021 (9) TMI 626 - Supreme Court in which the honourable supreme court upheld the validity of Rule 89(5), holding that restricting IDS refunds to input goods (excluding input services) is consistent with Section 54(3). While the Court acknowledged anomalies in the formula, it held that such policy matters are for the executive/legislature. In effect, refund of input-service ITC under IDS is not available.

Viewpoint of The High Court before and after the above Supreme Court judgement

Madras High Court in the case of Tvl. Transtonnelstroy Afcons Joint venture, Tvl. Essa Garments Private Limited, India Dyeing Mills (P) Limited, M/s. Veekesy Footcare (India) Pvt. Ltd., Kaleesuwari Refinery Pvt Ltd., Victur Dyeings Versus Union of India, The Goods and Services Tax Council, Assistant Commissioner ST And Others - 2020 (9) TMI 931 - MADRAS HIGH COURT, had earlier sustained Rule 89(5), and the Supreme Court approved that view while overruling the contrary Gujarat HC judgment in the case of VKC Footsteps India Pvt. Ltd. Versus Union of India & 2 Other (s) - 2020 (7) TMI 726 - GUJARAT HIGH COURT

After the amendment that was made in 2022, CBIC’s Circular 181said the new formula is prospective. However, the Gujarat High Court in Ascent Meditech Ltd Versus Union of India & Ors. - 2024 (12) TMI 511 - GUJARAT HIGH COURT held that this amendment to Rule 89(5) is clarificatory and retrospective in nature, and quashed the contrary portion of Circular 181.

In Union Of India & Ors. Versus M/s. Tirth Agro Technology Pvt. Ltd. & Ors. - 2025 (7) TMI 1824 - SC Order, the Supreme Court dismissed the union’s SLP against the Gujarat high court decision which had held the amendment to Rule 89(5) (via Notification No. 14/2022) to be clarificatory and retrospective; while the dismissal was a non-speaking order and thus not a binding precedent under Article 141 (as per Kunhayammed And Others Versus State Of Kerala And Another - 2000 (7) TMI 67 - Supreme Court (LB), it effectively let the Gujarat view stand in that matter, thereby strengthening the taxpayer’s position that the amended refund formula applies retrospectively.

Hence, no IDS refund for input services remains the law. The changes made in the formula in 2022 has been largely about apportionment mechanics and the Gujarat HC judgement, left undisturbed by the SLP dismissal in Tirth agro, hence it can be applied retrospectively for pending/old claims. The substantive bar on input-service refunds persists.

Eligibility of service providers for IDS refunds

They are eligible, subject to the condition that output supplies may be services, and the Rule 89(5) formula itself speaks of “turnover of inverted rated supply of goods and services.” Hence, a service provider is not precluded merely because their output is a service. What matters is that there must be a higher rate on input goods and a lower rate on the outward service. Secondly, the output service is not notified for exclusion, and ITC on inputs is actually admissible.

What about concessional 5% service rates without ITC?

A number of service entries, like the restaurant industry as per Notification 11/2017-CT(R), carry concessional rates restricting ITC either on goods or on both goods and services. In this case, if your outward service is taxed at 5% “without ITC”, you cannot avail any ITC or are not allowed to utilise it, and, therefore, no IDS refund can arise.

Computation of refund

The brief mechanics is that the Net ITC (numerator) is the ITC on input goods only for the relevant period, the turnover of inverted rated supplies is the turnover of those outward supplies (goods or services) where inversion exists and adjusted total turnover shall be calculated as per rules.

From this, we need to subtract (the subtraction term introduced in 2022) the tax payable on such inverted supplies × (Net ITC ÷ ITC on inputs + ITC on input services). This prevents over-refund where input-service ITC was used to pay output tax.

Consequences

If your cost basket is dominated by input services (like commissions, SaaS, consultancy, logistics), the refund quantum shrinks materially, often to nil, hence only where you procure input goods like raw materials, packing materials, spares, consumables, etc shall be taxed higher than the rate on your outward service, will a meaningful IDS refund arise.

Conclusion

Service providers are not barred from claiming IDS refunds merely because their outputs are services. The enduring constraint that is settled by the Supreme Court in the case of VKC is that refund is limited to ITC on input goods, not on input services. Therefore, marketplace commissions and other input-service credits do not convert into IDS refunds, also where the 5% rate on services is conditional upon non-availment of ITC, no ITC may be availed, naturally, no IDS refund lies.

The 2022 reshaping of Rule 89(5) changed the computation (introducing a subtraction term), not the core exclusion of input-service ITC, its temporal reach has been litigated, with the Gujarat HC taking a retrospective view and the SLP against that position being dismissed in July 2025. Keep this strand in mind for past/pending claims.

***

The author can be contacted at [email protected]