Your GST Refund Is Stuck, Your Money Shouldn’t Be

Imagine running a manufacturing business where you pay more GST on the materials and services you buy than you collect on the products you sell. Every month, the difference adds up. Your input tax credit keeps growing, but you cannot use all of it to pay your GST liability. Meanwhile, salaries, suppliers and other business expenses still need to be paid. You may even have to borrow money from a bank while a substantial amount of your own money remains locked in the GST system.

 This is not an unusual situation for businesses operating under an inverted duty structure. For many of them, it has been a long-standing challenge.

A recent case handled by our firm illustrates the problem. A mid-sized footwear manufacturer in the NCR had accumulated nearly ₹4 crore in input tax credit over the years. Its products attracted GST at 5%, while several materials and services used in manufacturing attracted rates of 12% or 18%.

 The result? Around ₹8–10 lakh of additional input tax credit accumulated every month, even as the company continued to incur borrowing costs to manage its working capital. The problem was not simply the accumulation of credit. It was the difficulty of getting that money back. Recent recommendations of the 56th and 57th GST Councils could bring significant changes to this situation. To understand why they matter, it is worth looking at how the problem developed and what businesses should do next.

What exactly is an inverted duty structure?

The concept is straightforward.

A business buys goods or services on which it pays GST at a higher rate than the rate applicable to the finished product it sells. For example, a footwear manufacturer may sell shoes attracting 5% GST while paying 12% or 18% GST on certain materials and business services.

The GST paid on purchases becomes input tax credit (ITC). However, because the GST collected on sales is relatively low, the business may be unable to utilise the entire credit against its output tax liability.

Over time, unused credit accumulates

Section 54(3) of the CGST Act provides for refunds of unutilised input tax credit in specified circumstances, including cases involving an inverted duty structure, subject to applicable conditions and restrictions.

But there was a catch: the refund formula did not allow every category of credit to be included.

The rule that left businesses with a refund problem

Under Rule 89(5) of the CGST Rules, the definition of “Net ITC” for inverted duty structure refunds was restricted to credit on inputs, meaning goods. Credit on input services was excluded. For our footwear manufacturer, this distinction had a substantial financial impact.

GST paid on materials such as soles and adhesives could be considered under the applicable refund formula. But credit relating to services such as job-work, freight, factory rent and professional fees could not be included in the inverted duty refund calculation under the rule then in force.

In other words, a business could be paying GST on essential manufacturing and operating costs without being able to recover the resulting accumulated credit through this refund mechanism.

The issue eventually reached the courts.

In 2020, the Gujarat High Court took a taxpayer-friendly view in VKC Footsteps India Pvt. Ltd. The Madras High Court took a different position in Tvl. Transtonnelstroy Afcons Joint Venture.

The Supreme Court settled the issue in September 2021 in Union of India v. VKC Footsteps India Pvt. Ltd.

The Court upheld the validity of the refund formula and ruled that the exclusion of input services was legally permissible. This was a setback for businesses hoping to recover that portion of their accumulated credit.

However, the judgment also acknowledged the difficulties and inequities that could arise from the formula’s operation and urged the GST Council to reconsider the issue. For businesses, the practical problem remained: credit continued to accumulate, but the refund mechanism did not cover it all.

What happened after the Supreme Court judgment?

The years that followed brought further disputes over the calculation of refunds, the application of revised formulas to earlier periods and restrictions affecting particular categories of goods. Changes to the refund formula in July 2022 were intended to improve the calculation. However, questions arose over whether the revised method could apply to earlier periods. Businesses also faced disputes over refunds involving goods purchased at one rate and sold at a lower concessional rate, along with exclusions notified for specified goods.

There was another practical difficulty. Refund claims often involved detailed documentation, departmental queries and repeated follow-ups. Deficiency memos and limitation periods added to the pressure.

For a business already facing a working-capital shortage, a delayed refund could mean additional borrowing, interest costs and money unavailable for expansion.

The lesson was clear: a refund provision on paper does not necessarily translate into timely cash in a business’s bank account.

The 56th GST Council: addressing the problem through tax rates.

The September 2025 GST rate rationalisation sought to simplify the tax structure and reduce rate differences across several sectors.

In some cases, reducing the GST rate on inputs helped align the tax rates across the supply chain. For example, changes affecting man-made fibre and yarn, as well as certain fertiliser inputs, were intended to address rate differences in those areas. Where the rates on purchases and sales become better aligned, less excess input tax credit may accumulate in the first place. That is an important improvement. Preventing credit from getting stuck is better than having to claim a refund later.

However, rate changes alone cannot resolve every inverted duty problem. A product may attract a lower GST rate while the services, factory rent or machinery used to produce it continue to carry higher tax rates. Businesses could therefore continue to face accumulated credit even after rate rationalisation.

 The next step needed to address the refund mechanism itself.

The 57th GST Council: a potential change in the refund framework

According to the recommendations of the 57th GST Council meeting held on 8 October 2026, the refund framework is proposed to change in three important ways.

1. Input services could become eligible for refunds

The Council recommended extending inverted duty structure refunds to accumulated credit on input services for credit availed on or after 1 November 2026. This could make a meaningful difference to manufacturers whose GST costs include job-work, freight, rent and professional services.

For our client, approximately ₹3.5 lakh out of the ₹10 lakh accumulating each month related to input services. Under the proposed framework, eligible credit availed from the specified date could potentially be included in the refund mechanism, subject to the final legal provisions.

2. Capital goods credit could also become refundable, over 60 months

The Council recommended extending refunds to eligible credit on capital goods for inverted duty and zero-rated supplies, with the benefit spread over 60 months for credit availed on or after 1 April 2027. This could be relevant for businesses investing in machinery, production lines and other capital equipment.

For example, our client was planning a machinery investment of ₹2 crore. At an assumed GST rate of 18%, the tax component would be ₹36 lakh. Under the proposed framework, eligible credit on such capital goods could potentially become refundable over the prescribed period, subject to the final rules. This is not an immediate or one-time refund of the entire amount. The proposed 60-month mechanism needs to be understood carefully when planning capital expenditure.

3. Refund processing could become faster

The Council also recommended a more technology-driven refund process. The proposals include provisional sanction of 90% of eligible inverted duty and zero-rated refund claims through a risk-based system, shorter acknowledgment timelines and system-readable refund applications. If implemented as proposed, these measures could reduce documentation burdens and delays.

For businesses, the potential benefit goes beyond receiving a refund. Faster access to eligible funds could reduce working-capital pressure and dependence on bank finance.

What could this mean for our client?

The potential financial impact is significant.

The footwear manufacturer in our case study had been accumulating around ₹10 lakh of input tax credit each month. Approximately ₹3.5 lakh related to input services.

The proposed changes could open up a refund route for eligible input service credit availed from November 2026. The planned machinery investment could also benefit from the proposed capital goods mechanism from April 2027. The recommendations may also help eligible existing input-side refund claims move through a more streamlined provisional refund process.

Based on the assumptions in this case study, the additional cash potentially released through the proposed changes could be around ₹50–60 lakh annually. These figures are illustrative, not a guaranteed refund entitlement. The actual benefit will depend on the final amendments, the applicable refund formula, eligibility conditions, the period of credit and the business’s individual facts.

The broader point is that money previously tied up in accumulated credit could, in eligible cases, become available to support day-to-day operations and future investment.

What should businesses do now?

Businesses operating under an inverted duty structure should not wait until the new framework is fully implemented before reviewing their position. Start by separating accumulated credit into three categories:

* Inputs: Raw materials and other goods used in the business.

* Input services: Freight, job-work, rent, professional fees and other eligible services.

* Capital goods: Machinery and other qualifying capital assets.

Each category may be governed by a different refund treatment or effective date under the proposed changes. Review pending refund claims. Check the relevant periods, supporting documents and applicable limitation deadlines. The proposed reforms should not be assumed to revive claims that have already become time-barred.

Plan significant purchases and contracts carefully. Businesses considering major machinery investments or service contracts should examine the proposed effective dates and the date on which the relevant credit is actually availed. The final legal provisions will determine whether the credit qualifies.

Watch for the final notifications and amendments. GST Council recommendations do not, by themselves, complete the legal process. The amended rules, notifications and any prescribed formulas will determine the actual scope and calculation of the refund. Above all, businesses should quantify the financial impact instead of treating accumulated ITC as merely an accounting entry. Credit that cannot be used or recovered when needed has a real cost.

The bigger lesson: tax credit should not become a working capital burden.

The inverted duty structure refund issue shows how a relatively narrow provision in a tax rule can have a substantial impact on business finances.

For years, businesses faced the consequences of a refund formula that excluded input services, even where those services were an essential part of manufacturing. The Supreme Court upheld the earlier rule, while also drawing attention to the problems caused by its operation.

The latest GST Council recommendations represent a proposed shift towards a broader refund framework and more technology-driven processing.

For businesses, the real test will be how these recommendations are translated into law and implemented in practice.

Until then, reviewing accumulated credit, protecting pending claims and understanding the effective dates are sensible steps. Because money tied up in tax credit is still your money and for a growing business, access to that money can make a real difference.

Frequently asked questions

1. What is an inverted duty structure under GST?

It occurs when the GST rate on a business’s purchases is higher than the rate on its sales, resulting in an accumulation of input tax credit that the business cannot fully utilise. Refunds may be available under Section 54(3) of the CGST Act, subject to the applicable conditions and exclusions.

2. Can businesses claim refunds of GST paid on services and machinery?

The 57th GST Council recommended extending inverted duty refunds to eligible input service credit availed on or after 1 November 2026. It also recommended a refund mechanism for eligible capital goods credit, spread over 60 months, for credit availed on or after 1 April 2027. The final amendments and notifications will determine the operative rules.

3. Does the Supreme Court’s VKC Footsteps judgment still apply?

Yes. The judgment upheld the earlier Rule 89(5) formula, including the exclusion of input services. The latest recommendations contemplate prospective changes; they should not be treated as automatically changing the legal position for earlier periods.

4. Is there a time limit for claiming an inverted duty structure refund?

Generally, the relevant limitation period is two years from the due date of the return for the period in which the refund claim arises, subject to the applicable statutory provisions. Businesses should review pending periods promptly rather than assume accumulated credit can be claimed indefinitely.

About DSRV & Co. LLP

DSRV & Co. LLP is a chartered accountancy firm based in Gurugram, advising businesses on GST, indirect tax litigation, refund matters and tax compliance. This case study draws on matters handled by the firm, with figures rounded and identifying details changed.