With the introduction of GST 2.0 and rate rationalisation, many businesses are encountering a new and unexpected challenge. While GST rates on finished goods were reduced to improve affordability for consumers, GST on inputs and services has largely remained unchanged. This mismatch has resulted in a growing accumulation of Input Tax Credit (ITC), particularly for businesses operating at GST rates of 5% or lower.
For such businesses, GST refunds are no longer merely a compliance requirement. They have become a crucial cash-flow management tool that directly affects daily operations.
An inverted duty structure, in simple terms, means a business pays more GST on its purchases than it collects on its sales. For instance, goods may be sold at 5% GST, while raw materials, packaging, rent, transport, and marketing expenses attract GST at 12% or 18%. This difference leads to continuous accumulation of ITC each month, with insufficient output tax available for utilisation.
GST law allows a refund of such accumulated ITC, but the refund is neither complete nor automatic. Only a portion of the accumulated credit is eligible, which often surprises many MSMEs.
This issue has become more widespread after the introduction of GST 2.0. While the government reduced GST rates on many consumer and daily-use products to boost demand, GST rates on services and several inputs remained unchanged. As a result, output tax liabilities declined, while input taxes stayed high, leading to greater ITC accumulation than earlier. This is why many MSMEs are now witnessing unusually large balances in their electronic credit ledger.
A simple real-life example illustrates this clearly. Consider a small ice-cream manufacturer. Ice cream is taxed at 5% GST, resulting in a low output tax liability. However, the business pays 12% GST on inputs such as milk powder, flavours, and packaging materials. In addition, expenses like advertising, branding, cold-storage rent, transportation, logistics, and professional services attract GST at 18%.
At the end of the month, the business has a low GST liability on sales but a high amount of ITC from purchases, resulting in a large balance that is difficult to utilise.
This raises the most critical question—can a business obtain a full refund of the accumulated ITC? The answer is no. Under GST law, refunds are permitted only for ITC related to inputs (goods). ITC on services is not refundable, even though it continues to accumulate in the electronic credit ledger.
In the ice-cream example, GST paid on milk, flavours, and packaging can be claimed as a refund. But the GST paid on advertising, rent, transport, and professional services is a dead end – non-refundable. This is where many MSMEs hit a reality check, realising that a significant portion of their ITC is locked away, offering no immediate cash relief.
Refund planning for MSMEs does not have to be complicated. The first step is to clearly understand the split of ITC between goods and services, which helps set realistic expectations and prevent incorrect refund claims. Refunds should be filed regularly rather than waiting until year-end, as smaller, timely claims are processed faster and generally face less scrutiny.
Spotless compliance isn’t optional; it’s your fastest route to smooth refunds. Ensure GSTR-1, GSTR-3B, and GSTR-2B match your books, because even small mismatches can block cash. Treat non-refundable ITC as a cost, not future cash, to plan smarter.
Navigating refunds under an inverted duty structure requires caution, as the GST department scrutinizes them closely. Proper documentation and accurate returns make refunds achievable, but aggressive or incorrect claims often trigger notices and lengthy follow-ups. Courts have largely upheld the existing refund framework, reinforcing that a careful, compliant approach is the safest way forward.
Ultimately, GST 2.0 has made products more affordable for customers, but for MSMEs operating at low GST rates, it has introduced new challenges around ITC and cash flow. Accumulated ITC is not inherently a problem, its impact depends on understanding what is refundable, what is not, and planning accordingly. By performing simple analysis, filing timely refunds, and maintaining clean compliance, MSMEs can navigate inverted duty structure issues smoothly, without stress or disputes. Leveraging the guidance of expert GST advisors can make this process even more efficient, ensuring maximum refunds and optimal cash-flow management.