The case of VKC Footsteps – Refund of input services under inverted duty structure

The historic judgement of Honorable Gujarat High Court in the case of VKC Footsteps India Pvt Ltd with respect to refund of input services, which otherwise was restricted by the rule. In this case the petitioner is engaged in the business of manufacture and supply of footwear which attracts GST @ 5% and majority of the inputs and input services procured by them attract GST @12% or 18%. So naturally there is an accumulation of unutilized credit lying the electronic credit ledger. This unutilized credit includes credits accumulated from inputs & input services.

As per the provisions of Section 54(3) of the CGST Act:

Subject to the provisions of sub section (10), a registered person may claim refund of any unutilized input tax credit at the end of any tax period:

Provided that no refund of unutilized input tax credit shall be allowed in cases other than


(ii) where the credit has accumulated on account of rate of tax on inputs being higher that the rate of tax on output supplies (other than nil rated or fully exempt supplies), except supplies of goods or services or both as may be notified by the Government on the recommendations of the Council

Rule 89(5) of the CGST rules restricts the scope of refund by defining Net ITC which can be refunded as per the formula:

“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 rule (4A) or (4B) or both

Section 2(63) of the CGST Act defines input tax credit as “credit of input tax”

Section 2(62) of the CGST Act defines input tax as “input tax in relation to registered person means the central tax, state tax, integrated tax or Union territory tax charged on any supply of goods or services or both made to him”.

Section 54(3)(ii) of the CGST Act lays down condition for the registered person to claim refund of unutilized input tax credit. This clause (ii) lays down the eligibility for the grant of refund and the sub section 54 (3) heading lays down the quantum of the refund, where it clearly says refund of any unutilized input tax credit.

Original rule 89(5) of the CGST Rules provided an explanation that “for the purposes of this sub rule, the expression “Net ITC” and “Adjusted Total turnover” shall have the same meanings as assigned to them in sub rule (4)” which says Net ITC means input tax credit availed on input and input services during the relevant period. Notification 21/2018 substituted the way the Net ITC was calculated for the purposes of sub rule 5 and which was given retrospective effect vide Notification no.26/2018 dated 13.06.2018. The amendment vide the notification deleted input services from its calculation with retrospective effect. The amendment of rule 89(5) violates Article 14 of our Constitution of India which deprives the petitioner of the vested right of the refund. The mischief of the Government taking away the right of the person that also retrospectively by amending rule 89(5) is ultra vires and not tenable.

GST has multiple rates of taxes and this creates a situation wherein the output taxes collected may be at lower rate than the taxes paid on inputs. Intention of the legislature while drafting section 54(3) was to give benefit to the registered person to get the refund for any accumulation of credits which may arise because of the situation of inverted duty structure. Introduction of GST brought the end to the cascading effect of taxes and all the taxes paid by the businesses were allowed to be set off by the tax collected from their customers and the final burden of the tax was supposed to be borne by the end consumer and hence it was termed as an destination based consumption tax. GST. Flyer No. 19 dated 1.1.2018 issued by the CBEC explaining the input tax credit mechanism in GST reads thus: “Uninterrupted and seamless chain of input tax credit hereinafter referred to as “ITC” is one of the key features of Goods and Services Tax. ITC is a mechanism to avoid cascading of taxes. Cascading of taxes, in simple language, is ‘tax on tax’. Under the present system of taxation, credit of taxes being levied by Central Government is not available as set-off for payment of taxes levied by State Governments, and vice versa. One of the most important features of the GST system is that the entire supply chain would be subject to GST to be levied by Central and State Government concurrently. As the tax charged by the Central or the State Governments would be part of the same tax regime, credit of tax paid at every stage would be available as set-off for payment of tax at every subsequent stage.”

The electronic credit ledger is like a bank account, credits in the credit ledger will be a composition of credits from inputs, input services and capital goods. Once the credits from these sources gets merged in the electronic credit ledger, it is difficult in the later stage to bifurcate the nature of the credits and it becomes input tax credit which loses its color of its source. Section 54(3) provides registered person an option to claim refund of the unutilized input tax credit and nowhere in sub section does it restrict the refund to only inputs. When the section does not limit the refund, the rule which is only procedural to follow the Act cannot bring its own limitations and is ultra vires. The Act which was passed by both the houses, cannot be altered at the whims and fancies of the Government. Section 164(1) of the CGST Act confers a general rule “The Government may, on the recommendation of the Council, by notification, make rules for carrying out the provisions of the Act.” Therefore, the powers given to the Government to make rules are purely to carry out the provisions of the Act only and cannot go beyond the scope of the Act. When section 54(3) provides the refund of any unutilized input tax credit, it does not give power to the Government to restrict the quantum of input tax credit by bringing artificial restrictions provided in rule 89(5). In the case of Lohara Steel Industries Ltd. v. State of AP. Reported in (1997) 2 SCC 37 it is well settled that if a provision is ultra vires, the court in an appropriate case can strike down the offending portion keeping intact the valid portions of the provision.

One more point raised by the petitioner in the case was refund of input tax credit with respect to zero rated supply as per rule 89(4) allows refund of input & as well as input services, different treatment under rule 89(5) for inverted duty structure is discriminatory. Discrimination is also made between industries who supply goods or services whose inverted duty structure is basically because of more of inputs than the input services compared to the industries whose input services may be higher than inputs and they are at the disadvantage and there is no equality between the tax payers. The industries with inverted duty structure scenario with more inputs can get the refund whereas industries with more of input services are denied the refund.

The Honorable High court verdict that the intent of the Government by framing the rule restricting the statutory provision cannot be the intent of law, which denies the refund of “unutilized input tax” paid on “input services” as part of “input tax credit” accumulated on account of inverted duty structure is ultra vires the provision of Section 54(3) of the CGST Act, 2017.

The department will definitely knock the door of the Supreme Court, but denying the benefit given by the Act by making retrospective amendments in the rules should be avoided.

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  1. Mukundan says:

    “The amendment of rule 89(5) violates Article 14 of our Constitution of India which deprives the petitioner of the vested right of the refund.”

    Article 14 deals with fundamental right (Right to equality). It is nothing to do with vested rights. Vested right is the right which arises by operation of law. The legislator by its wisdom can withdraw those vested rights. In this caselaw the argument was placed on right to equality (Article 14) basis the refund on export vs refund on inverted duty structure. But this argument may not sustain since the discrimination on refund for exporter vs refund on inverted duty structure has reasonable classification. In former case there is inflow of foreign reserves which is not there in later case.

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May 2021