Published 12 October 2026
A manufacturer whose product is taxed at 5 per cent, but whose raw materials and packing are taxed at 12 or 18 per cent, collects less tax on its sales than it paid on its purchases. The difference collects in the credit ledger. The law refunds some of it, but not all. Credit on services and on capital goods does not count towards the refund, which surprises many claimants. The formula was changed in 2022, and the courts have since decided whether the change applies to earlier periods. Some goods are excluded altogether. And the September 2025 rate changes have created a new kind of accumulation, one that the refund does not cover.
This guide covers the inverted duty refund under section 54(3)(ii): what qualifies, the formula in rule 89(5), the cases on it, the notified exclusions, and the 2025-26 position. The general procedure (RFD-01, the time limit, processing and re-credit on rejection) is in Refund of Unutilised Credit: Who Can Claim and How.
What qualifies
Clause (ii) of the first proviso to section 54(3) allows a refund “where the credit has accumulated on account of rate of tax on inputs being higher than the rate of tax on output supplies (other than nil rated or fully exempt supplies)”. The Government may notify supplies to which it does not apply.
Four limits follow from the words and from the circulars:
- “Inputs” means goods. Section 2(59) defines inputs as goods other than capital goods. Circular No. 125/44/2019-GST para 53 states that “the law and the related rules clearly prevent the refund of tax paid on input services and capital goods” under this clause.
- The output must be taxable. Credit used for nil-rated or fully exempt supplies is excluded. RFD-01 carries a declaration to that effect.
- The same goods at two rates over time do not qualify. Circular No. 135/05/2020-GST para 3.2, as substituted by Circular No. 173/05/2022-GST, states that where “the input and output being the same … though attracting different tax rates at different points in time”, the refund is not available. An example is stock bought at 18 per cent and sold after a rate cut at 12 per cent. The substituted para 3.3 allows the refund where the same goods are sold at a lower rate under a concessional notification “at the same point of time”.
- The comparison uses all inputs. Where inputs carry different rates, Net ITC “covers the ITC availed on all inputs in the relevant period, irrespective of their rate of tax” (Circular No. 125/44/2019-GST para 54). An input taxed at the same rate as the output, or lower, is not left out.
The Supreme Court on input services: VKC Footsteps
Union of India v VKC Footsteps India Pvt Ltd (Supreme Court, Civil Appeal No. 4810 of 2021 and connected matters, 13 September 2021; D.Y. Chandrachud and M.R. Shah JJ.) decided a split between two High Courts:
- The Gujarat High Court had held that Explanation (a) to rule 89(5) was ultra vires section 54(3), because it confined “Net ITC” to credit on inputs and left out input services. The petitioners were footwear makers paying 5 per cent on output.
- The Madras High Court, in Transtonnelstroy Afcons Joint Venture (2020), had upheld the rule.
The Supreme Court affirmed the Madras view and allowed the Union’s appeals from Gujarat. It held that section 54(3)(ii) itself limits the refund to accumulation caused by inputs (goods), and that the rule is consistent with it. On the formula, it said it would not “recraft” it: “the formula is not ambiguous in nature or unworkable”. “However, given the anomalies pointed out by the assessees, we strongly urge the GST Council to reconsider the formula.” The Council’s response was the 2022 amendment described below.
The practical result is that a service provider whose output is taxed below its inputs can claim only on goods credit. A works contractor is one example. Credit on input services stays in the ledger for use against output tax.
The formula in rule 89(5)
Rule 89(5), as amended by Notification No. 14/2022-Central Tax with effect from 5 July 2022, reads:
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 x (Net ITC ÷ ITC availed on inputs and input services)}
- Net ITC is “input tax credit availed on inputs during the relevant period”. Under Explanation (a), this means goods only.
- Adjusted Total Turnover and relevant period have the meanings in rule 89(4) (Explanation (b)). Adjusted Total Turnover is the State turnover under section 2(112), excluding services, plus zero-rated and other services. It excludes the value of exempt supplies other than zero-rated supplies, as reworded from 8 October 2024 by Notification No. 20/2024-Central Tax. The relevant period is the period of the claim.
What the 2022 change did. Before 5 July 2022, the whole of the tax payable on inverted rated supplies was deducted from the goods credit. Tax is in fact paid out of all credit, including credit on services. The amended second term deducts only the share of output tax that corresponds to goods credit, in the ratio of Net ITC to total credit on inputs and input services.
The 2024 amendments to the rule were limited to the words “other than the input tax credit availed for which refund is claimed under sub-rules (4A) or (4B)”. Notification No. 20/2024-Central Tax omitted them when it omitted those sub-rules. CBIC’s text of the rule records no amendment in 2025 or 2026.
An example. In a quarter, a manufacturer has these figures:
- It sells goods taxed at 5 per cent for Rs 10,00,000. Tax payable is Rs 50,000, and it has no other supplies.
- Credit on inputs (goods, mostly at 18 per cent) is Rs 1,00,000.
- Credit on input services is Rs 25,000, so total credit is Rs 1,25,000.
The first term is 10,00,000 x 1,00,000 ÷ 10,00,000 = Rs 1,00,000. The second term is 50,000 x (1,00,000 ÷ 1,25,000) = Rs 40,000. The maximum refund is Rs 60,000.
Under the pre-2022 formula it would have been 1,00,000 − 50,000 = Rs 50,000. The Rs 10,000 difference is the part of the output tax treated as paid from services credit. After the refund, Rs 15,000 of services credit remains in the ledger. The portal then applies its own limits: the claim cannot exceed the ledger balance at the end of the period or on the day of filing (Circular No. 125/44/2019-GST para 37).
Does the 2022 formula apply to earlier periods?
Circular No. 181/13/2022-GST of 10 November 2022 (para 2(1)) said the amendment was “not clarificatory” and applied only to applications filed on or after 5 July 2022.
The Gujarat High Court struck down that paragraph in Ascent Meditech Ltd v Union of India (Special Civil Application No. 18317 of 2023, 17 October 2024). It held that Notification No. 14/2022 “is curative and clarificatory in nature” and applies “retrospectively to the refund or rectification applications filed within two years as per the time period prescribed under section 54(1)”. The Supreme Court dismissed the Union’s special leave petition on 28 March 2025 (SLP © No. 8134 of 2025), and its review petition on 2 December 2025. Two further special leave petitions against Gujarat judgments following Ascent were dismissed in July 2025 (Tirth Agro Technology).
The Bombay High Court applied the same rule in CHEC-TPL Line 4 Joint Venture v Union of India (Writ Petition No. 2583 of 2025, 23 April 2026). The petitioner was a metro rail works contractor paying 12 per cent on its output, with inputs at 18 and 28 per cent. Its refund claims for November 2018 to March 2021 had been rejected because they were filed before 5 July 2022. The Court quashed the rejection and held the joint venture entitled to refund under the amended formula. The text of Ascent Meditech was read here as it is quoted in the Bombay judgment.
No contrary High Court decision was found. Circular No. 181/13/2022-GST has not been withdrawn on CBIC’s circular list.
Goods and services for which no refund is allowed
| Notified exclusion | Instrument |
|---|---|
| Railway locomotives, rolling stock and parts, and track fixtures (headings 8601 to 8608) | Notification No. 5/2017-Central Tax (Rate) |
| Woven and knitted fabrics (chapters 50 to 55 headings listed, and chapter 60): the bar does not apply to credit on supplies received from 1 August 2018. Credit accumulated on earlier supplies lapsed | Notification No. 5/2017, as amended by No. 20/2018-Central Tax (Rate) |
| Edible oils (headings 1507 to 1518) and coal, lignite and peat (2701 to 2703), from 18 July 2022 | Notification No. 9/2022-Central Tax (Rate) |
| Imitation zari thread made of metallised polyester or plastic film (5605), for credit on that film only, from 20 October 2023 | Notification No. 20/2023-Central Tax (Rate) |
| Construction of a complex or building intended for sale, where consideration is received before completion or first occupation | Notification No. 15/2017-Central Tax (Rate), as amended by No. 15/2023 |
Circular No. 181/13/2022-GST para 2(2) said the 2022 exclusion of edible oils and coal applied to all applications filed from 18 July 2022, even for earlier periods. The courts have struck that paragraph down:
- the Andhra Pradesh High Court in Priyanka Refineries and Gemini Edibles
- the Gujarat High Court in Patanjali Foods Ltd v Union of India (Special Civil Application No. 17298 of 2024, 12 February 2025), where a refund for February to March 2021, filed in December 2023 and granted, had been withdrawn by a section 73 order; the Court quashed the order
- the Rajasthan High Court in Shree Arihant Oil and General Mills (8 September 2025)
- the Allahabad High Court in Vaibhav Edibles (13 November 2025)
The Rajasthan judgment records that the Supreme Court rejected the special leave petition against the Andhra Pradesh decisions on 9 May 2025. On these decisions, the exclusion governs credit accumulated from 18 July 2022. A claim for an earlier period, filed within two years, is not barred by it.
The 2025-26 position
No new exclusions, and no change to the formula. The CBIC list of Central Tax (Rate) notifications shows no amendment to Notification No. 5/2017 or No. 15/2017 after 2023. Notification No. 9/2025-Central Tax (Rate), which reset goods rates from 22 September 2025, contains no refund restriction. Rule 89(5) was not amended in 2025 or 2026.
But the rate changes matter in two ways. First, from 22 September 2025, a business may have moved into or out of inversion, and each period’s claim uses the rates actually charged in that period. Second, credit on stock bought before 22 September 2025 at a higher rate, and sold afterwards at a reduced rate, is accumulation from a change of rate on the same goods. Circular No. 135/05/2020-GST para 3.2, as substituted, says that is not refundable under clause (ii).
Provisional refund is now available. The GST Council at its 56th meeting on 3 September 2025 recommended that 90 per cent of inverted duty claims be refunded provisionally, as for zero-rated supplies. Section 155 of the Finance Act, 2026 inserts the words in section 54(6) to cover “unutilised input tax credit allowed under clause (ii) of the first proviso to sub-section (3)”. CBIC’s text records that amendment as not yet in force.
In the meantime, Instruction No. 06/2025-GST of 3 October 2025 (para 5.1) directs that inverted duty claims filed on or after 1 October 2025 “may be sanctioned on provisional basis” at 90 per cent, in the same way as zero-rated claims. That means through the risk-based procedure in rule 91(2), substituted from 1 October 2025 by Notification No. 13/2025-Central Tax. The same exclusions apply:
- persons prosecuted for evasion above Rs 250 lakh (rule 91(1))
- persons without Aadhaar authentication, and suppliers of areca nuts, pan masala, tobacco and essential oils (Notification No. 14/2025-Central Tax)
- cases where an earlier refund issue is pending in appeal or under a show cause notice (Instruction No. 06/2025-GST para 3.2)
The instruction says GSTN has provided the functionality.
What to have ready
| Item | Where it comes from |
|---|---|
| Outward supplies of the period by rate, with tax payable; exempt and nil-rated values | GSTR-1 (and GSTR-1A), books |
| Credit for the period split into inputs, input services and capital goods | Books and table 4 of GSTR-3B |
| Inward invoices of inputs, with HSN, GSTIN of supplier and tax, appearing in GSTR-2B | Purchase register and GSTR-2B |
| HSN of outputs, checked against the notified exclusions | Books |
| Credit ledger balances at the end of the period and on the date of filing | Portal |
| Evidence of any concessional notification under which output is sold | Books and contracts |
The statements and filing
The ground in RFD-01 is “ITC accumulated due to inverted tax structure [clause (ii) of first proviso to section 54(3)]”. Statement 1 gives the rule 89(5) calculation. The copy of RFD-01 on CBIC’s site still prints the pre-2022 computation in Statement 1’s last column.
Statement 1A lists, under rule 89(2)(h), “the number and the date of the invoices received and issued during a tax period”. This covers inward supplies of inputs with supplier GSTIN and tax, and outward supplies with tax. Credit is admitted only on invoices in GSTR-2B for that period or an earlier one, from the period of January 2022 (Circular No. 197/09/2023-GST para 1.3). The applicant also declares under section 54(3)(ii) that the claim excludes credit used for nil-rated or exempt supplies.
The portal’s user manual says that invoices uploaded in Statement 1A are locked once the application is filed. They cannot then be used in another refund application or amended in a return.
The relevant date is the due date of the GSTR-3B for the period in which the claim arises (Explanation 2(e) to section 54). The two years run from there. Claims for successive periods may be clubbed, including across financial years (Circular No. 135/05/2020-GST para 2), but must be filed in order. The application is filed with DSC or EVC by the authorised signatory.
Consequences and what can be put right
- Credit later found ineligible is rejected from the refund and recovered as wrongly availed credit through the same RFD-08 and RFD-06, read with section 73, 74 or 74A. Interest is charged where the credit was utilised (Circular No. 125/44/2019-GST paras 20 to 21).
- A provisional refund found excessive is recovered through RFD-08 (Instruction No. 06/2025-GST para 3.4).
- A claim computed on the old formula, or rejected under Circular No. 181/13/2022-GST paras 2(1) or 2(2), may be pursued under Ascent Meditech and the edible oil cases, if within two years of the relevant date (net of the 1 March 2020 to 28 February 2022 exclusion). In Ascent Meditech the Court accepted “rectification applications” filed within that period.
- Rejection is appealable under section 107 (Appeals and Pre-Deposit). Without an appeal, the undertaking on the portal leads to re-credit by PMT-03 under rule 93(2).
- Errors in GSTR-1 that make Statement 1A fail are corrected first (Correcting Mistakes in Returns).
The procedure in order
- Check that the output is taxable, is not a notified exclusion, and is lower-rated than the inputs at the same time, not only after a rate change.
- Split the period’s credit into inputs, input services and capital goods. Only inputs enter Net ITC.
- Compute the rule 89(5) amount on the 2022 formula, using Adjusted Total Turnover as defined in rule 89(4).
- Confirm every input invoice is in GSTR-2B and every outward supply is in GSTR-1.
- File RFD-01 with Statements 1 and 1A and the section 54(3)(ii) declaration, within two years of the GSTR-3B due date for the period, with DSC or EVC.
- Follow it through RFD-02, the provisional RFD-04 where the system rates it low-risk, and RFD-06. Answer any RFD-08 within fifteen days.
- On rejection, appeal or file the undertaking for re-credit.
This guide completes the set on input tax credit procedure. The conceptual background is in Input Tax Credit: the Conditions in Section 16(2) and The Three Electronic Ledgers.