Inverted duty structure and accumulated unutilised ITC refunds when input equals output: Section 54(3)(ii) bar rejected

Refund of accumulated unutilised ITC due to an inverted duty structure was denied on the premise that refund under Section 54(3)(ii) of the CGST Act is barred where input and output are the same and that the rate comparison must be confined to "principal input" versus "principal output supply." Relying on its earlier decision in an identical fact situation, the HC held that Section 54(3)(ii) does not prohibit refund merely because input and output are the same, and the proviso does not mandate a principal input/principal output rate comparison or any further restrictive test beyond inverted rate incidence. The impugned orders were set aside and the refund claim was allowed.

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1. ISSUES PRESENTED AND CONSIDERED

(i) Whether refund of accumulated and unutilised input tax credit (ITC) under Section 54(3)(ii) of the CGST Act is admissible on an inverted duty structure where the taxpayer's principal input and output supplies fall under the same HSN and attract the same GST rate, but other inputs suffer higher GST resulting in accumulation of ITC.

(ii) Whether rejection of refund by relying on paragraph 3.2 of Circular No.135/05/2020-GST dated 31.03.2020 was legally sustainable on the facts, and whether the subsequent substitution/deletion in Circular No.173/05/2022-GST dated 06.07.2022 required the refund to be granted.

(iii) Whether the taxpayer is entitled to statutory interest on the refund under Section 56 of the CGST Act, and the consequential directions required upon quashing of the refund rejection orders.

2. ISSUE-WISE DETAILED ANALYSIS

Issue (i): Refund entitlement under Section 54(3)(ii) where principal input and output are the same

Legal framework: The Court considered Section 54(3)(ii) of the CGST Act governing refund of unutilised ITC where "credit has accumulated on account of rate of tax on inputs being higher than the rate of tax on output supplies".

Interpretation and reasoning: The Court examined that the taxpayer procured edible oils taxable at 5%, packed them into smaller retail packs and supplied the packed oils also at 5% under the same HSN. ITC accumulated because certain inputs attracted a higher tax rate than the output supply. The Court applied the principle that Section 54(3)(ii) does not impose a bar merely because the principal input and output supply are the same or attract the same rate; what is material is whether accumulation is due to higher tax on "inputs" vis-à-vis "output supplies".

Conclusion: The Court held the taxpayer's accumulated ITC refund claim was admissible and the denial on the premise that input and output are the same was unsustainable; the refund claim therefore had to be allowed.

Issue (ii): Validity and applicability of Circular No.135/05/2020-GST and effect of Circular No.173/05/2022-GST

Legal framework: The Court considered paragraph 3.2 of Circular No.135/05/2020-GST dated 31.03.2020 and its substitution by Circular No.173/05/2022-GST dated 06.07.2022, as discussed and applied in the Court's earlier decision relied upon.

Interpretation and reasoning: The Court held that reliance on paragraph 3.2 of Circular No.135/05/2020-GST to reject refund was erroneous because that circular was treated as addressing cases where ITC accumulation arose due to different GST rates at different points in time on the same goods, which was not the factual basis here. Further, the Court accepted that the later substitution/deletion removed the restriction that denied refund where input and output supplies are the same, thereby reinforcing eligibility. The Court treated the substituted circular as beneficial/clarificatory and applied it to support granting the refund.

Conclusion: The Court concluded that the impugned refund rejection orders, founded on the inapplicable circular restriction, were illegal and liable to be quashed, and the department was required to grant the refund.

Issue (iii): Statutory interest on refund and consequential relief

Legal framework: The Court considered Section 56 of the CGST Act providing for interest where refund is not made within 60 days from receipt of a complete application.

Interpretation and reasoning: Since the refund rejection orders were set aside and the taxpayer was held entitled to refund, the Court held that interest follows as a statutory consequence. The Court directed payment of "applicable interest" along with the refund, within the time fixed by the Court.

Conclusion: The Court directed the respondents to refund the amounts claimed in the refund applications together with applicable interest, and quashed the impugned orders/notices that had denied the refund.

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