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Inverted Tax Structure Under GST: A Comprehensive Overview

By Yogesh Verma (CS/LLB) / 5 min read / GST Article

The Goods and Services Tax (GST) system, implemented in India in 2017, was designed to streamline the country's indirect tax structure, making it more efficient and transparent. One of the concepts that have gained attention under GST is the Inverted Tax Structure (ITS). This article explores the term "Inverted Tax Structure," the rules around claiming a refund on unutilized Input Tax Credit (ITC) under this structure, and the process that taxpayers need to follow to claim such refunds.

What is an Inverted Tax Structure?

The term Inverted Tax Structure refers to a situation where the rate of tax on inputs (goods or services used for production or provision of goods/services) is higher than the rate of tax on output supplies (the goods or services that are sold to the customers). In simple terms, the business has paid a higher tax on its purchases (inputs) than it collects from its sales (outputs). This leads to an accumulation of unutilized Input Tax Credit (ITC) that cannot be set off against output tax liabilities because the output tax rate is lower than the input tax rate.

To clarify this further, an example would be a scenario where a company manufacturing a product pays a higher tax on the raw materials (inputs) than what it collects when selling the final product (output). This discrepancy leads to the accumulation of excess credit, and the company may seek a refund for the unutilized ITC.

However, the law also allows certain exceptions. Goods or services that are exempt or nil-rated do not qualify for a refund under this structure, as these are not subject to tax, and hence no credit is accumulated. The government may notify certain goods or services on the recommendation of the GST Council, which may be exempt from the refund provision.

Section 54(3)(ii) of the GST Act: Refund on Inverted Tax Structure

As per Section 54(3)(ii) of the GST Act, a registered person can claim a refund of unutilized ITC if the credit has accumulated due to the rate of tax on inputs being higher than that on the output supplies (other than nil-rated or fully exempt supplies). This provision essentially ensures that businesses that face an inverted tax structure do not lose out on the credit accumulated during their business activities.

The refund is available at the end of any tax period, and the taxpayer can claim this refund by following the procedure laid down in the GST Rules.

Procedure for Claiming Refund

The manner for determining the refund amount and the procedure for claiming the refund is provided in Rule 89 of the GST Rules. To claim the refund under the inverted tax structure, the taxpayer must ensure they meet several conditions:

Pre-Conditions for Claiming Refund:

1.     Registration under GST: The taxpayer must be registered with the GST Department and hold an active GSTIN (Goods and Services Tax Identification Number) during the period for which the refund is being applied.

2.     Filing of Returns: The taxpayer must have filed their Form GSTR-1 (details of outward supplies) and Form GSTR-3B (summary of outward and inward supplies along with payment of tax) for the relevant tax period. Failure to file returns will lead to the rejection of the refund claim.

3.     Rate of Tax Condition: As per Section 54(3)(a), two conditions must be fulfilled:

o    The rate of tax on inputs must be higher than the rate of tax on output supplies.

o    The output supplies (goods/services) must have a lower tax rate.

4.     Compliance with GST Provisions: The taxpayer must comply with all conditions and restrictions mentioned in Section 16 and Section 17 of the GST Act for claiming input tax credit. Specifically, credit blocked under Section 17(5) cannot be claimed.

Formula for Calculating Refund

Refund of ITC due to an inverted tax structure is calculated using the formula provided in Rule 89(5) of the GST Rules. The formula is designed to ensure that businesses are refunded the appropriate amount of ITC based on their turnover and the taxes paid.

Formula for Maximum Refund Amount:

Maximum Refund Amount = [Turnover of inverted rated supply of goods & services * Net ITC / Adjusted Total Turnover] – [Tax payable on such inverted rated supply of goods & services * Net ITC / ITC availed on inputs and input services]

Where:

• Turnover of inverted rated supply of goods & services refers to the turnover of supplies that attract a lower tax rate.
• Net ITC represents the unutilized Input Tax Credit, which includes the credit remaining after adjusting for output tax liabilities.
• Adjusted Total Turnover is the total turnover of the taxpayer for the period, adjusted for the supply of goods or services that are not eligible for a refund.

Net ITC Explained

The term Net ITC refers to the Input Tax Credit that remains unutilized after the taxpayer has set off the available credit for the payment of output tax. If the business has multiple inputs with different rates of tax, the formula takes into account all the ITC availed on those inputs for the relevant period, regardless of their respective tax rates.

For example, if a business purchases raw materials taxed at 18% and finished goods taxed at 12%, the ITC on both these inputs will be considered in calculating the Net ITC, even though they attract different tax rates.

Required Documents for Refund Application

To apply for the refund of unutilized ITC under the inverted tax structure, the taxpayer must file Form RFD-01 (Refund Application) along with the following documents:

1.     GSTR-2B: A copy of the GSTR-2B (auto-populated ITC statement) for the relevant period.

2.     Annexure-B: A statement of invoices (Annexure-B) detailing the ITC claimed during the period.

3.     Invoices not in GSTR-2B: Self-certified copies of invoices entered in Annexure-B whose details are not found in GSTR-2B.

Online Declarations and Statements

Additionally, the taxpayer must submit the following online declarations or undertakings:

1.     Declaration under Second and Third Proviso to Section 54(3): This declaration certifies that the taxpayer is eligible to claim the refund under the inverted tax structure provisions.

2.     Declaration under Section 54(3)(ii): This declaration ensures that the refund claim is based on accumulated ITC due to the inverted tax structure.

3.     Undertaking under Sections 16(2)(c) and 42(2): This confirms the taxpayer's compliance with the conditions for claiming ITC under the GST Act.

4.     Statement 1A under Rule 89(2)(h): A statement regarding the details of the ITC claimed.

5.     Self Declaration under Rule 89(2)(i): This is required if the amount claimed does not exceed INR 2 lakh.

Conclusion

The concept of Inverted Tax Structure is an essential provision under the GST Act, ensuring that businesses are not burdened by an accumulation of unutilized Input Tax Credit when the tax rate on inputs exceeds the rate on output supplies. By offering a refund mechanism, the GST law provides relief to businesses that face this situation, ensuring smooth cash flow and a level playing field.

Understanding the conditions and procedures for claiming refunds, such as filing the necessary documents and declarations, is crucial for businesses to ensure timely and accurate refunds. By following the rules outlined in the GST Act and the relevant GST Rules, taxpayers can benefit from the refund mechanism provided for under the inverted tax structure.

Disclaimer: All the Information is based on the notification, circular and order issued by the Govt. authority and judgement delivered by the court or the authority information is strictly for educational purposes and on the basis of our best understanding of laws & not binding on anyone.