Impact of Rate Rationalization in GST 2.0 Regime on Textile Sector

> Background:

When Goods and Services Tax (GST) was introduced in 2017, the textile sector was expected to benefit from a streamlined tax system, removal of multiple levies, and smoother credit flow. However, in practice, the sector became one of the most litigation-prone industries due to complex rate structures, an inverted duty structure (IDS), and classification disputes. The GST Council attempted multiple times to correct these anomalies, but reforms were often postponed because of strong pushback from industry bodies and state governments, particularly those from textile-dominant states like Gujarat, Tamil Nadu, and West Bengal.

Recognising these issues, the Group of Ministers (GoM) on Rate Rationalisation was constituted. Its mandate was clear: simplify GST rate slabs, eliminate IDS, and ensure revenue neutrality without compromising industry growth. The final report was considered in the 56th GST Council Meeting held on 3rd September 2025, where several far-reaching changes were accepted for the textile value chain. Let us discuss them in greater detail and understand the key impact and challenges way forward.

> Existing Law

Prior to the rationalisation exercise, the textile sector was caught in a maze of differential tax rates:

1. Fibre & Yarn – Cotton and natural fibres enjoyed exemption or 5% GST, whereas man-made fibres (MMF) and their yarns attracted 12% or 18%. This created a cost disadvantage for synthetic textiles compared to cotton.

2. Fabrics – Most woven, knitted, or non-woven fabrics were taxed at 5%, but with a key restriction, refunds of accumulated ITC were not permitted under Section 54(3) CGST Act, leading to blocked credits.

3. Garments –The sector followed a dual slab: garments up to INR 1,000 per piece were taxed at 5%, and those above INR 1,000 at 12%. This threshold-based taxation encouraged “value-splitting” and disputes on classification.

4. Made-ups and Carpets – Major textile made-ups were at 12%, while handmade carpets and handloom items enjoyed concessional rates, but confusion persisted due to varying HSN codes and classification to be adopted for the same.

5. Footwear – Similar to garments, footwear also followed a threshold-based slab. Footwear with a sale value up to INR 1,000 per pair was taxed at 5%, while footwear above INR 1,000 attracted 12%. Given that India’s footwear industry is closely linked with textiles (canvas shoes, chappals, and leather-textile combinations), this bifurcation added another layer of complexity for manufacturers and retailers.

6. Cotton and Raw Inputs – Cotton, one of the most important raw materials for India’s textile industry, attracted GST under reverse charge mechanism (RCM) when procured from unregistered agriculturists. This meant that ginners and textile mills purchasing cotton had to discharge GST liability themselves and could claim ITC thereafter.

This structure created distortions in the value chain. For instance, a polyester shirt manufacturer paid 18% GST on fibre, 12% on yarn, 5% on fabric, and 12% on garment output. The mismatch between input and output rates not only blocked ITC but also made man-made fibre-based apparel 10-15% costlier than cotton-based apparel, reducing India’s competitiveness in global synthetic textiles, a segment where China and Vietnam dominate.

> GST 2.0 – Change

The 56th Council meeting approved a comprehensive restructuring of GST rates in line with the GoM’s report with respect to Textile industry –

1. Fibre and Yarn – All synthetic fibres, filament yarns, and staple fibres, earlier attracting 12% or 18%, have now been brought down to 5%. This ensures parity with cotton and removes the cost distortion between natural and man-made textiles.

2. Fabrics and Intermediates – Nonwoven fabrics, terry towelling, tulles, embroidery, labels, coated fabrics, metallised yarn, and technical fabrics (HSN 5601–5911) have been standardised at 5%, replacing earlier 12% rates. This eliminates inversion at the fabric stage.

3. Garments and Apparel – A major policy change was the revision of garment slabs:

a) Garments and apparel with a sale value up to INR 2,500 per piece will attract 5% GST (earlier threshold INR 1,000).

b)  Apparel above INR 2,500 per piece will now be taxed at 18% (up from 12%).

4. Carpets, Rugs, and Shawls – Handmade carpets, mats, and hand-embroidered shawls have been reduced to 5%, benefitting the traditional and cottage sector.

5. Footwear – To maintain parity, footwear with a sale value up to INR 2,500 per pair is taxed at 5% instead of the earlier INR 1,000 threshold. Above this threshold would be charged at 18%

6. Cotton and Raw Inputs – Raw cotton continues to be taxed under reverse charge (RCM), ensuring credit chain continuity. The GST Council in its recent meeting clarified in its FAQ that taxing cotton avoids breakage of ITC and benefits the sector in the long run.

> Analysis of the Change

• Structural Impact – The most significant achievement is the elimination of IDS in the man-made fibre value chain. By aligning inputs (fibres, yarns) and intermediates (fabrics) at 5%, the cascading impact has been neutralised. Manufacturers will now face smoother ITC flow and lower working capital blockage. However, critical inputs such as dyes, chemicals, zippers, buttons, elastics, labels, and embellishments continue at 12% or 18%. Since fabrics and most apparel up to ₹2,500 are taxed at 5%, this creates a new inversion.
• Industry Relief vs. Revenue Protection – By raising the threshold for concessional rate garments from INR 1,000 to INR 2,500, the Council has provided relief to the mass-market segment which constitutes over 70% of India’s apparel consumption. However, by raising GST above ₹2,500 from 12% to 18%, the Council has inadvertently squeezed the mid-market and branded segment. This may push consumption towards informal or unbranded players, creating an uneven playing field.
• Cotton and Raw Inputs – The Council retained reverse charge mechanism (RCM) on cotton procurement from unregistered farmers. Cotton farmers remain outside the GST net, but the imposition of RCM discourages small ginners from buying from unregistered farmers due to compliance hassle. If the goal was to simplify compliance and reduce paperwork, the Council could have considered exempting cotton entirely. Instead, the RCM system continues, adding friction to the supply chain.
• Khadi and Handloom Products Exemption – The handloom/khadi sector has consistently demanded full exemption from GST (similar to pre-GST excise exemption). Currently, these products are taxed at 5%. The Council has not considered exemption or zero-rating for khadi, even though it is promoted as a national heritage sector.
• Composite Supply vs. Mixed Supply – Garment retailers increasingly sell bundled products (shirt & tie, saree & blouse or kurta & dupatta). GST Act requires classification of bundles as composite supply (principal item rate) or mixed supply (highest rate). With different rate bands (5% on garment, 18% on accessory), disputes could arise whether the bundle is to be taxed at 5% or 18%.
• Technical Textiles – Technical textiles (industrial fabrics, medical textiles, filtration materials) are a declared “sunrise sector” under the National Technical Textiles Mission. Yet, only a few HSNs (like coated fabrics) have been rationalised to 5%. Many technical textile products still attract 12% or 18%, creating disparity within the same sector. Exporters of these goods face disadvantage compared to cotton/MMF apparel.

> Recommendations for trade/ business

• Strengthen SKU–HSN Mapping – Textile and footwear businesses must immediately revalidate their SKU master data with correct 6-digit HSN codes and map them to GST rates in their ERP or billing systems. The recent rationalisation has reset rates for yarns, fabrics, and garments, but accessories and bundled items remain at higher slabs. Misclassification at the billing stage can lead to incorrect GST charging, refund denials, and audit disputes. This is particularly important for large retailers and exporters who deal with thousands of SKUs and dynamic pricing structures.
• Develop an “Core Inputs” for Refunds – Given that dyes, chemicals, zippers, trims, and packaging materials are taxed at 12–18%, while outputs like fabrics and low-value garments are at 5%, businesses face ITC accumulation and refund challenges. Refunds on these items are often disputed under Rule 89(5). To defend claims, businesses should maintain a dedicated “Core Inputs” containing invoices, purchase orders, utilization records (linking trims to exported garments), job work challans, and even physical samples or lab reports.
• Pricing Strategies around GST Slabs – With garments and footwear above ₹2,500 taxed at 18%, businesses in the mid-premium segment face pricing pressures. To manage this, companies should re-engineer product designs and SKUs to strategically align price points. For instance, marginal adjustments in fabric choice, trims, or packaging can bring products under the 5% slab, while premium ranges can be clearly positioned with the 18% tax factored into pricing. Additionally, Apparel and footwear are highly seasonal products, where prices fluctuate sharply between festive peaks and off-season clearance. A kurta sold at ₹2,800 in peak season (18% GST) may later be discounted to ₹1,900 (5% GST). Businesses must adopt seasonal pricing policies that document MRP, discount logic, and GST rate treatment at each stage.
• Minimise RCM Burden – Cotton procurement from unregistered farmers continues under RCM, disproportionately affecting MSME ginners and spinning mills. To mitigate compliance and liquidity pressures, textile clusters (e.g., in Gujarat, Maharashtra, Telangana) should form registered farmer-procurement pools or cooperatives. Such pools can issue GST invoices, thereby shifting farmers into the formal net and sparing individual spinners from RCM obligations.
• Advocate for Textile-Specific GST Clarifications – Trade bodies in textiles should collectively advocate for:

a. Explicit inclusion of accessories in refund eligibility under Rule 89(5).

b. Binding CBIC circulars clarifying classification of blended and technical textiles.

c. Transitional ITC guidelines for pre-rationalisation stock.

d. Harmonisation between GST refunds and FTP benefits to avoid double-benefit disputes.

> Conclusion

The GoM’s final report on rate rationalisation marks a watershed moment for India’s textile industry. By addressing long-pending structural issues like inverted duty structures and aligning natural and man-made fibres, the Council has paved the way for a more balanced, competitive, and less litigious GST regime. While challenges remain in terms of high-end garment taxation and unresolved anomalies in accessories, the broader direction is clear – GST 2.0 is about simplification, equity, and future-proofing India’s indirect tax framework.

Views expressed are strictly personal and cannot be considered as a legal opinion in case of any query. For feedback or queries email us yash@hnaindia.com.