Gujarat High Court Rules Rule 89(5) Ultra Vires: GST ITC Refund on Input Services Allowed Under Inverted Duty Structure
In a significant ruling for businesses operating under an inverted duty structure, the Gujarat High Court in VKC Footsteps India Pvt. Ltd. vs. Union of India held that Explanation (a) to Rule 89(5) of the CGST Rules, 2017 is ultra vires the provisions of Section 54(3) of the CGST Act, 2017. The ruling directly addresses the long-disputed question of whether unutilized Input Tax Credit (ITC) accumulated on input services qualifies for a GST refund under the inverted duty structure and answers it in favor of the taxpayer. Businesses in manufacturing, textiles, footwear, pharmaceuticals, and other sectors where input GST rates exceed output GST rates stand to benefit materially from this decision. For a structured review of your ITC position and refund eligibility, our indirect tax advisory services can assist in assessing the implications for your business.
Understanding the Inverted Duty Structure: Background to the Dispute
An inverted duty structure arises when the GST rate applicable on inward supplies (inputs and input services) is higher than the GST rate on outward supplies (output). This results in an accumulation of unutilized ITC in the taxpayer’s electronic credit ledger that cannot be set off against output tax liability, leading to blocked working capital.
Section 54(3) of the CGST Act, 2017, provides for a refund of unutilized ITC where the tax credit has accumulated on account of the rate of tax on inputs being higher than the rate of tax on output supplies. However, Rule 89(5) of the CGST Rules, 2017, as amended vide Notification No. 26/2018-Central Tax dated 13th June 2018, introduced Explanation (a), which restricted the refund computation to ITC accumulated on inputs (goods) only.
effectively excluding ITC on input services from the refund formula.
This restriction was further reinforced by CBIC Circular No. 79/53/2018-GST dated 31st December 2018, which clarified that the refund of ITC is admissible only to the extent of accumulated ITC on account of rate of tax on inputs being higher than on output supplies and is not admissible for input services per se. Tax authorities across the country relied on this circular to deny refund claims that included the input services component of accumulated ITC.
Facts of the Case: VKC Footsteps India Pvt. Ltd.
The petitioner, VKC Footsteps India Pvt. Ltd., is engaged in the manufacture and supply of footwear, which attracts GST at the rate of 5% on outward supply. The petitioner procures input services, including job work services and goods transport agency services, as well as inputs such as synthetic leather and PU polyol, predominantly at GST rates of 12% or 18%.
This differential created a classic inverted duty structure: GST paid on inward supplies consistently exceeded GST collected on outward supplies, resulting in a growing balance of unutilized ITC. The petitioner challenged the restriction in Explanation (a) to Rule 89(5), contending that it was contrary to the express statutory language of Section 54(3), which references “input tax credit” broadly, a term defined under Section 2(63) of the CGST Act to include both goods and services. Multiple similar petitions were clubbed and disposed of together by the Gujarat HC through this judgment.
Key Finding of the Gujarat High Court
The Gujarat HC held that Explanation (a) to Rule 89(5) of the CGST Rules, 2017 is ultra vires and contrary to Section 54(3) of the CGST Act, 2017. The court’s reasoning rested on the following key observations:
- The terms “Input Tax Credit” and “Input Tax” are broadly defined under Sections 2(63) and 2(62) of the CGST Act to include tax charged on any supply of goods or services made to a registered person. A delegated rule cannot narrow the scope of a statutory provision.
- The refund of unutilized ITC under Section 54(3) cannot be restricted solely to inputs on goods received, as prescribed in Explanation (a) to Rule 89(5). It must extend to input services as well.
- A subordinate rule (Rule 89(5)) cannot override or restrict a statutory provision (Section 54(3)) of the parent Act.
- “Net ITC” as used in the refund formula should mean input tax credit availed on both inputs and input services, as defined under the act.
Accordingly, the court held that the inverted duty structure criterion in Section 54(3) where the rate of tax on inputs is higher than the rate of tax on output supplies, operates as a qualifying condition. Once that condition is met, the refund of unutilized ITC is available irrespective of whether it comprises ITC on inputs or input services.
MBG Advisory Comments: What This Ruling Means for Your Business
This ruling represents a meaningful relief for industries operating under an inverted tax structure particularly in sectors such as footwear, textiles, pharmaceuticals, and job work services, where input service costs form a significant share of total procurement. By striking down the restrictive Explanation (a) to Rule 89(5), the Gujarat HC has restored the broader legislative intent of Section 54(3) and opened the door to refund claims that had previously
been denied by GST authorities.
Businesses that have been suffering from blocked ITC under similar circumstances should evaluate this ruling in detail to determine whether the benefit can be availed in their specific factual context. In cases where refund claims have been previously rejected solely on the ground of input services exclusion, this judgment provides a strong legal basis for re-filing or challenging the rejection. A GST compliance health check can help identify the quantum of eligible ITC and assess the feasibility of a refund claim.
One important practical consideration is that the Government may seek to bring an amendment to Rule 89(5) of the CGST Rules in response to this ruling, which could prospectively reinstate the restriction. Businesses should therefore act with urgency in evaluating and filing claims while the current legal position is favorable.
Additionally, a critical compliance question arises around the time limits for filing GST refund claims for past periods and the restriction on filing refund claims for the same period twice. Companies intending to avail the benefit of this ruling for historical periods must carefully assess whether their claims remain within the limitation window.
Our GST refund advisory team can assist in mapping eligible periods, computing refund quantum, and managing the filing process.
Source: VKC Footsteps India Pvt. Ltd. vs.
Union of India & Others [2020-TIOL-1273-HC-AHM-GST]
Article contributed by:
CA Vaibhav Matta
Assistant Director, Taxation
MBG Corporate Services