This article is written by Pramil Kant, pursuing Diploma in Advanced Contract Drafting, Negotiation, and Dispute Resolution from LawSikho. The article has been edited by Ruchika Mohapatra (Associate, LawSikho).


“The Old India was economically fragmented, the new India will create one tax, one market and for one nation”. – Late Sh. Arun Jaitley, Former Finance Minister of India.

“In reality, it’s a ‘Good and Simple Tax”– Sh. Narender Modi, Current and serving Prime Minister of India. The entire scheme of the Goods and the Services Act (GST), 2017 was based on the principle that it shall allow seamless flow of credit. It simply means that any tax(es) paid on the inputs shall be adjusted in the payment of the output tax liability. As a result, there will be a downfall in the net output tax liability for the businesses which will result in a reduction of inflation and will make the Indian Economy and businesses more competitive globally. 

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Before the introduction of the Goods and Services Tax in 2017, the Central Government used to levy Excise Duty, Service Tax and Customs Duty over the manufacture of goods, provisions of services and export-import of goods. The state government used to levy sales tax, value-added tax over the sale and purchase of goods. The credit of taxes paid to the central government in the form of excise duty and service tax could not be utilized in the payment of taxes that were to be paid to the state government in the form of sales tax, value-added tax. Therefore, it resulted in an undesirable situation for both the businesses and consumer; for businesses, it meant that there was always unutilized credit available with them and for consumers, it meant that the prices of goods and services were high as the output tax liability for manufacturers and service providers was high. 

One of the objectives of the Goods and Services Tax, 2017 was to solve this problem and make the flow of credit seamless. Seamless flow of credit was also believed to moderate the inflationary pressures, The former Revenue Secretary, Hasmukh Adhia, as reported in a leading national news daily, said in an interview that the introduction of GST will result in a fall of inflation by 2 per cent. 

Refund under the current GST Law

As per the GST law as it stands today, refund is allowed under Section 54(3) in only two situations;

  1. In the transactions involving exports and;
  2. In the transactions involving inverted duty structure.

Inverted duty structure means that the taxes paid on input goods and services are higher than the taxes paid on the final product. In other words, if a manufacturer procures raw material on which GST is levied at the rate of 18% and the output is taxed at the rate of 5%, then the manufacturer is entitled to get a refund on account of inverted duty structure. But according to the law, as it stands today in Section 54(3) of the CGST Act, a taxpayer is liable to get a refund of taxes paid on input goods and not on input services. This restriction was imposed by an amendment and was given a retrospective effect from 1st July 2017. This restriction of not allowing input tax credit paid on the input services became a bone of contention between the taxpayers and the Revenue Department and resulted in writ petitions before the High Court. 

In 2019, the Division Bench of the Gujarat High Court in the matter of VKC Footsteps India Private Limited upheld the challenge to Rule 89(5) which created a classification between the input services and input goods and held that it is ultra vires the  Section 54(3) of the CGST Act, 2017 which allows the taxpayer to take credit of tax paid on input goods but does not give the same treatment to input services. On the other hand, a division bench of the Madras High Court in the case of Tvl. Transtonnelstroy Afcons Joint Venture Vs Others upheld the classification contained in Rule 89(5) of the CGST Rules and restricted the refund of input tax credit only on the input goods. 

With contradictory judgments coming from the Madras High Court and the Gujarat High Court, the matter reached the Supreme Court for finality. On 13th September 2021, the Supreme Court accepted the view taken by the Madras High Court and rejected the view taken by the Gujarat High Court.  

Reasons due to which controversy was created

Rule 89(5) of the CGST Rules 2017 reads as follows;

“In the case of refund on account of inverted duty structure, refund of the input tax credit shall be granted as per the following formula:- 

Maximum Refund Amount = {(Turnover of inverted rated supply of goods and services) x Net ITC÷ Adjusted Total Turnover} – tax payable on such inverted rated supply of goods and services.

Explanation: – For the purposes of this sub-rule, the expressions – (a) ―Net ITC shall mean input tax credit availed on inputs during the relevant period other than the input tax credit availed for which refund is claimed under sub-rules (4A) or (4B) or both”

In the Explanation of Net ITC, it is clearly mentioned that net ITC shall mean the input tax credit availed on inputs. As per Section 2(59) of the CGST Act 2017, input is hereby defined as;

“Input” means any goods other than the capital goods used or intended to be used by a supplier in the course or furtherance of business.

Therefore, by using the word input in the definition of net ITC in the Explanation, the refund under inverted duty structure was restricted only to the input goods and it completely excluded the input services. 

Legal issues in front of the Supreme Court

The Revenue Department along with the Union of India contended that;

  1. The distinction between the Goods and Services is reasonable and not arbitrary. Goods and services are distinct at the constitutional level as well,  and therefore different treatment can be given to the refund on tax paid on goods and services.
  2. If the legislature intended to allow refund of unutilised ITC on input services and capital goods, then the same must have been conveyed by the legislature which is missing. 
  3. “Unutilized input tax credit” includes the input tax credit available on any supply of goods or services or both. The term input tax credit has been used in Section 54(3) because the legislature, in its wisdom, has decided to give a complete refund of taxes paid on input goods and input services on zero-rated supplies. But the legislature has, in its wisdom, decided not to extend the same benefit in the case of an inverted duty structure. 

The taxpayer, on the other hand, argued that;

  1. The intention and the objective of the GST was to allow seamless flow of input tax credit. Section 54(3) allows for the refund of unutilized input tax credit and input tax, as defined under the CGST Act, including taxes paid on input services and input goods. Therefore, by introducing an explanation in Rule 89(5) of the CGST Rules 2017, the executive has unnecessarily narrowed down the refund to only the tax(es) paid on input goods. 
  2. The assessee further argued that in Section 54(3) of the CGST Act, 2017, the legislature has used the words “any unutilised input tax credit”. “Any” means unutilized input tax paid on both the input goods and input services. Therefore, the explanation (a) to Rule 89(5) narrows down the meaning of “any unutilised input tax credit” to only tax paid on input goods and excludes the tax paid on input services. 
  3. The intention behind Rule 89(5) is to provide a procedure for claiming a refund in accordance with Section 54(3) of the CGST Act. By introducing restrictions on the claiming of a refund under Rule 89(5) of the CGST Rules 2017, Rule 89(5) is against the mandate given by Section 54(3) of the act.
  4. The challenge to Rule 89(5) exists only because of the explanation in which net input tax credit has been restricted only to the inputs and therefore, the expression “on inputs” needs to be struck down. 
  5. There is no difference in the manner of availing or utilizing input tax credit on goods or services. Therefore, if the legislature has not differentiated between the goods and services at the time of availing or utilizing input tax credit, it could not have been the intention of the legislature to differentiate between the goods and services at the time of giving refund under the inverted duty structure. 

Observations made by the Supreme Court

The Supreme Court, after going through the arguments put forth by both the Parties, upheld the reasoning of the Madras High Court. The Supreme Court held that;

  1. Refund is not a constitutional right but a statutory right and therefore, the legislature, in its wisdom, and through statute, can decide how the refund is to be granted.
  2. Under proviso (ii) to Section 54(3) of the CGST Act, 2017, the legislature has used the word “inputs” which, as defined in the act, means only input goods. Therefore, there is no disharmony between Rule 89(5) of the CGST Rules and Section 54(3) of the CGST Act. If the legislature had any intention of giving the credit of tax paid on input goods and input services, the legislature would not have restricted the scope of refund in inverted duty structure to only “inputs”.
  3. Rule 89(5) was framed under Section 164 of the CGST Act and therefore, Rule 89(5) is not without jurisdiction.
  4. An inequitable and discriminatory provision in tax legislation does not make it discriminatory per se. The court observed that input goods and input services constitute two different classes and therefore, the argument that equals are being treated unequally does not hold water. 

The Supreme Court did acknowledge that the formula in Rule 89(5) of the CGST Rules 2017 is inequitable and therefore, urged the GST Council to take the necessary corrective action.


After this ruling of the Supreme Court, the confusion which arose because of contradictory rulings from the Madras and Gujarat High Court has been resolved. It is clear that in an inverted duty structure, the taxpayer shall be allowed a refund of only the input goods and not of input services. 

This judgment of the Supreme Court will have an adverse sectoral impact on the e-commerce sector, construction, fertilizers, textiles and other industries where the taxes on input is higher than the tax liability on the output. 

The Court in this judgment also held that if a provision in the taxation law fails to achieve certain ideals, it does not make it invalid and ultra vires of the act. 

The only silver lining in this judgement is that the Supreme Court has acknowledged certain anomalies in the Goods and Services Act, 2017. Further, while the Supreme Court was conscious not to overstep the powers and responsibilities of the legislature, the apex court did ask the GST council to reconsider the formula. 



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