GST Inverted Duty Structure Refund: Section 54(3), Rule 89(5) Formula and Filing Guide (2026)

Key Takeaways

• An inverted duty structure arises when GST on inputs (raw materials) exceeds GST on output supplies (finished goods), causing unused ITC to accumulate
• Section 54(3)(ii) of the CGST Act allows refund of this accumulated ITC; Rule 89(5) prescribes the maximum refund formula
• Refund applies only to ITC on inputs (goods): input services and capital goods are excluded from the refund computation (Supreme Court, VKC Footsteps, September 2021)
• From 1 October 2025, low-risk refund applications receive 90% provisional refund under CGST Instruction 6/2025
• Refund must be claimed within 2 years from the end of the financial year in which the claim arises
• Supplies of edible oils (Chapter 15) and coal (Chapter 27) are excluded from IDS refund by Notification 9/2022-Central Tax (Rate)

What is an inverted duty structure in GST? An inverted duty structure (IDS) exists when the GST rate on inputs used in manufacturing or processing is higher than the GST rate charged on the finished output supply. The excess input tax credit (ITC) that accumulates because of this rate differential cannot be fully utilized against the lower output tax liability, locking up working capital unless a refund is claimed under Section 54(3) of the CGST Act, 2017.

Why Inverted Duty Structure Matters for Your Business

When you buy raw materials at 18% GST and sell finished goods at 5% GST, you pay more tax on purchases than you collect on sales. Every month, the gap widens. Your Electronic Credit Ledger swells with unusable ITC while your cash goes to suppliers and the government.

Without claiming a refund, this ITC sits idle indefinitely. For a manufacturer with Rs 50 lakh in monthly purchases taxed at 18% and Rs 60 lakh in sales taxed at 5%, the monthly ITC accumulation is roughly Rs 6 lakh (Rs 9 lakh input tax minus Rs 3 lakh output tax). Over a year, that is Rs 72 lakh locked up.

Section 54(3)(ii) of the CGST Act provides the mechanism to unlock this amount.

Which Industries Face Inverted Duty Structure

Inverted duty structure is most common in manufacturing sectors where raw materials attract higher GST than finished products.

Comparison

Industries with Inverted Duty Structure Under GST

Parameter	Sector	Rate Mismatch
Footwear (up to Rs 1,000/pair)	Output: 12% GST (increased from 5% in 2022)	Inputs (leather, rubber, adhesives): 18% GST. IDS partially corrected but still exists for certain inputs.
Textiles and Garments	Output: 5-12% GST depending on value	Inputs (yarn, dyes, chemicals): 12-18% GST. IDS partially corrected for MMF textiles after September 2025.
Fertilizers	Output: 5% GST	Inputs (sulphuric acid, ammonia): reduced from 18% to 5%. IDS largely corrected.
Pharmaceuticals	Output: 5-12% GST on most formulations	Inputs (APIs, chemicals, packaging): 18% GST. Significant IDS persists.
Plastics and Packaging	Output: 18% on some finished goods	Inputs (polymer granules, additives): 18% GST. IDS arises in specific product categories with lower output rates.
Electric Vehicles	Output: 5% GST	Inputs (batteries, motors, steel): 18-28% GST. Deliberate policy to keep EV prices low.
Corrugated Boxes	Output: 12% or 18% depending on use	Inputs (kraft paper, starch, chemicals): 12-18% GST. IDS arises when output is at 12%.

Source: GST Rate Schedule as amended by 55th GST Council recommendations; Notification 1/2017-Central Tax (Rate) and amendments

If your raw material GST rate is higher than your finished goods rate, check whether you are eligible for the refund.

Legal Framework: Section 54(3) and Rule 89(5)

Section 54(3)(ii), CGST Act, 2017

This is the statutory provision that creates the refund right. It states that a registered person may claim refund of any unutilised input tax credit at the end of any tax period where the credit has accumulated on account of rate of tax on inputs being higher than rate of tax on output supplies. Two important exclusions apply:

1. No refund if the output supply is nil-rated or fully exempt
2. No refund on goods or services notified by the government as excluded

Rule 89(5), CGST Rules, 2017

This rule prescribes the formula to calculate the maximum refund amount. The formula was amended by Notification 14/2022-Central Tax dated 5 July 2022.

The Refund Formula (Rule 89(5))

The maximum refund amount is computed as:

Maximum Refund = (Turnover of Inverted Rated Supply x Net ITC / Adjusted Total Turnover) minus Tax Payable on Such Inverted Rated Supply x (Net ITC / ITC Availed on Inputs and Input Services)

Variable Definitions

Turnover of Inverted Rated Supply: Value of supplies (goods and services) where the input tax rate exceeds the output tax rate, during the relevant period.

Net ITC: Input tax credit availed on inputs (goods only) during the relevant period. ITC on input services and capital goods is excluded.

Adjusted Total Turnover: Turnover in a State/UT during the relevant period, excluding exempt supplies other than zero-rated supplies. For goods suppliers, the value of zero-rated and non-zero-rated supply of services is excluded.

Tax Payable on Such Inverted Rated Supply: Output tax liability on the inverted rated supply during the relevant period.

ITC Availed on Inputs and Input Services: Total ITC availed on both inputs and input services during the relevant period (used as the denominator for proportioning).

Practical Calculation Example

A footwear manufacturer in Agra reports the following for July 2026:

• Total sales (all inverted rated, 12% GST): Rs 40 lakh, output tax Rs 4.80 lakh
• Purchases of inputs (leather, rubber at 18% GST): Rs 30 lakh, ITC on inputs Rs 5.40 lakh
• Input services (rent, logistics at 18% GST): Rs 5 lakh, ITC on services Rs 0.90 lakh
• Capital goods purchased: nil
• No exempt or zero-rated supplies

Step-by-step:

1. Turnover of Inverted Rated Supply = Rs 40 lakh
2. Net ITC (inputs only) = Rs 5.40 lakh
3. Adjusted Total Turnover = Rs 40 lakh (no exempt/zero-rated)
4. Tax Payable = Rs 4.80 lakh
5. ITC on Inputs and Input Services = Rs 5.40 + Rs 0.90 = Rs 6.30 lakh

Maximum Refund = (40,00,000 x 5,40,000 / 40,00,000) minus (4,80,000 x 5,40,000 / 6,30,000)

= 5,40,000 minus 4,11,429

= Rs 1,28,571

The refund reflects the real cash differential: you paid Rs 5.40 lakh on inputs, utilized Rs 4.80 lakh against output tax, and the formula accounts for the proportional service credit adjustment. Over 12 months, this manufacturer would recover approximately Rs 15.4 lakh of otherwise locked-up working capital.

What Is Not Eligible for IDS Refund

Input Services (Supreme Court Ruling)

In Union of India v. VKC Footsteps India Pvt. Ltd. (Civil Appeal No. 4810 of 2021, decided 13 September 2021), the Supreme Court held that Rule 89(5) is constitutionally valid and refund of ITC accumulated on input services under inverted duty structure is not permissible. The Gujarat High Court had earlier allowed it, but the Supreme Court overruled that decision, siding with the Madras High Court's view.

The Court observed that the formula in Rule 89(5) deliberately restricts "Net ITC" to inputs (goods) only, and this is a conscious legislative choice, not a drafting error.

Capital Goods

ITC on capital goods (machinery, equipment, furniture used in business) is excluded from the refund computation. Capital goods ITC can be utilized against output tax but cannot be refunded under the IDS route.

Excluded Goods by Notification

The government has notified specific goods where IDS refund is blocked:

• Edible oils (Chapter 15 of Customs Tariff Act): Notification 9/2022-Central Tax (Rate) dated 13 July 2022, effective from 18 July 2022, blocks IDS refund for supplies of goods falling under Chapter 15
• Coal (Chapter 27): Same notification blocks IDS refund for Chapter 27 supplies
• Tobacco and pan masala: Separately notified under various rate amendments

These restrictions apply prospectively to refund applications filed on or after 18 July 2022 (Circular 181/13/2022-GST dated 10 November 2022).

Nil-Rated and Exempt Supplies

If your output supply is nil-rated or fully exempt from GST, Section 54(3) itself bars the refund claim. The provision applies only where there is an actual rate differential between taxable inputs and taxable (but lower-rated) outputs.

90% Provisional Refund: CGST Instruction 6/2025

From 1 October 2025, CBIC Instruction 6/2025 dated 3 October 2025 extends the 90% provisional refund mechanism to inverted duty structure claims. Previously, this facility was available only for zero-rated supply (export) refunds under Section 54(6).

How It Works

1. You file Form RFD-01 for IDS refund
2. The GST portal's system categorizes your application as "low-risk" or otherwise, based on automated risk parameters
3. If categorized as low-risk, 90% of the claimed refund amount is provisionally sanctioned and credited to your bank account
4. The remaining 10% is released after the proper officer completes verification

Who Qualifies as Low-Risk

The risk assessment is system-driven. Factors include filing history, return compliance, past refund claim accuracy, and flagged discrepancies. Taxpayers with clean compliance records and consistent filing history are more likely to be categorized as low-risk.

This instruction is a trade-facilitation measure ahead of a formal legislative amendment to Section 54.

How to File IDS Refund: Form RFD-01

Step-by-Step Guide

File Inverted Duty Structure Refund on GST Portal

Form GST RFD-01, Section 54(3)(ii) read with Rule 89(5)

1

File GSTR-1 and GSTR-3B

Ensure GSTR-1 and GSTR-3B for the relevant tax period (the period you are claiming refund for) are filed. The portal will not allow RFD-01 filing without these returns.

Pre-requisite

2

Login and Navigate to Refund

Login at gst.gov.in. Go to Services > Refunds > Application for Refund. Select 'Refund of ITC on account of Inverted Tax Structure' as the refund type.

Portal

3

Select the Period

Choose the tax period (month/quarter) for which you are claiming the refund. A single application covers one tax period. You can file for multiple periods separately.

Period

4

Portal Auto-Populates Data

The portal auto-fills turnover and ITC values from your filed GSTR-1 and GSTR-3B. Verify these figures against your books. Correct any discrepancy in the returns before proceeding.

Verification

5

Enter Statement 1 Details

Statement 1 captures the refund computation. Enter turnover of inverted rated supply, net ITC on inputs, adjusted total turnover, and tax payable. The portal computes the maximum refund using Rule 89(5) formula.

Computation

6

Upload Supporting Documents

Attach a declaration (no unjust enrichment) and any supporting documents. A CA certificate in Form GSTR-9C is not required for IDS refunds, but maintain reconciliation records.

Documents

7

Sign and Submit

Sign with DSC (for companies and LLPs) or EVC (for proprietors, partnerships, individuals). An ARN is generated on submission. Track status under Services > Refunds > Track Application Status.

Filing

Source: Rule 89(5), CGST Rules 2017; Section 54(3)(ii), CGST Act 2017; GST Portal (gst.gov.in)

Filing Frequency

You can file IDS refund for each tax period separately. Monthly filers can claim every month; quarterly filers can claim every quarter. There is no restriction on claiming for consecutive periods.

Time Limit

File within 2 years from the last date of the financial year in which the tax period falls. For the July 2026 period, the deadline is 31 March 2029. Missing this deadline means the refund claim is time-barred (though the Gujarat High Court has held in July 2025 that circulars cannot override the statutory time limit).

Documents to Keep Ready

While the portal auto-fills most data from returns, keep these records for the proper officer's verification:

1. Purchase register with HSN codes showing input GST rate for each line item
2. Sales register showing output GST rate and value for inverted rated supplies
3. GSTR-2B reconciliation confirming ITC claimed matches supplier filings
4. Stock statement (if requested) to demonstrate that inputs were consumed in manufacturing the inverted rated output
5. CA certificate (if refund exceeds Rs 2 lakh per application, the proper officer may request one)
6. Declaration that refund claim does not include ITC on input services or capital goods
7. No unjust enrichment declaration confirming the tax burden was not passed on to buyers

Common Reasons for Refund Rejection

Knowing why IDS refund claims get rejected helps you file correctly the first time.

Mismatch between GSTR-1 and GSTR-3B: If the turnover or tax figures in GSTR-1 do not match GSTR-3B, the officer will issue a deficiency memo (Form RFD-03). Reconcile returns before filing.

Including input services in Net ITC: The most common computational error. Net ITC in the formula includes only inputs (goods). If you include service ITC, the computed refund will exceed the eligible amount and get scaled down or rejected.

ITC not reflected in GSTR-2B: ITC on inputs must be confirmed by the supplier's GSTR-1 filing. If your supplier has not filed or reported the invoice incorrectly, the ITC will not appear in your GSTR-2B, and the refund may be reduced.

Filing after the 2-year window: The statutory time limit under Section 54(1) is two years from the relevant date. Late applications are rejected.

Claiming for excluded goods: If your output falls under Chapter 15 (edible oils) or Chapter 27 (coal), IDS refund is blocked by Notification 9/2022.

IDS Refund vs Export Refund: Key Differences

Both use Form RFD-01 but the rules differ significantly.

Comparison

IDS Refund vs Export Refund Under GST

Parameter	Parameter	Export Refund (Zero-Rated)
Legal Basis	Section 54(3)(ii), Rule 89(5)	Section 54(3)(i) for ITC refund; Rule 96 for IGST refund
What Gets Refunded	Excess ITC on inputs (goods only) due to rate differential	Entire unutilised ITC on inputs and input services (no exclusion)
Input Services Included	No (VKC Footsteps ruling)	Yes, included in Net ITC computation
Capital Goods Included	No	No
Formula	Rule 89(5): proportional computation with service ITC adjustment	Rule 89(4): (Zero-rated turnover x Net ITC / Adjusted Total Turnover)
90% Provisional Refund	Available from 1 October 2025 (Instruction 6/2025)	Available since 2019 for zero-rated supplies (Section 54(6))
Excluded Goods	Chapter 15 (edible oils), Chapter 27 (coal) blocked	No specific exclusions for exported goods

Source: CGST Act 2017, Sections 54(3) and 54(6); Rules 89(4), 89(5), 96; Notification 9/2022-CT(Rate)

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Source attribution: Section 54, CGST Act 2017 (cbic-gst.gov.in); Rules 89(4) and 89(5), CGST Rules 2017; Notification 14/2022-Central Tax dated 5 July 2022 (formula amendment); Notification 9/2022-Central Tax (Rate) dated 13 July 2022 (edible oil and coal exclusion); Circular 181/13/2022-GST dated 10 November 2022 (prospective application clarification); CGST Instruction 6/2025 dated 3 October 2025 (90% provisional refund); Union of India v. VKC Footsteps India Pvt. Ltd., Civil Appeal No. 4810 of 2021 (Supreme Court, 13 September 2021).