New Rates, Old Woes: Piled Up ITC After GST Rate Cuts

The 56th Goods and Services Tax (GST) Council Meeting¹ promised a historic reset, simpler slabs, rationalised rates, and long-awaited correction of the inverted duty structure (IDS). On paper, it looks like a long-awaited relief. However, behind the celebration lies a stubborn reality, the problem of input tax credit (ITC) accumulation.

Instead of upholding the promise of seamless credit flow, the new structure threatens to widen the existing inversions, create fresh inversions, and pile the stranded credit even higher. What was meant to simplify may, in practice, complicate. One common concern for businesses across industries is: what is the fate of the growing heap of accumulated ITC?

Market behaviour in the coming two weeks

In the run-up to the new GST rates kicking in from 22-9-2025, market behaviour has already begun to shift. Distributors, wholesalers, and retailers across key sectors have deliberately stopped stocking up inventory, anticipating lower tax incidence post the change. This supply chain pause means that, over the next two weeks, India is set to witness a sharp and temporary dip in market activity, before the demand surge.

While rationalisation promises long-term relief, this transition period could strain both sales momentum and cash flow. This tactical pause, while rational from a business perspective, creates a peculiar ripple effect on ITC. Purchases made at the earlier higher rate are now locked as accumulated credit, with no immediate output liability to absorb them, especially in sectors such as the pharmaceutical sector and food sector, already plagued by IDS. As a result, the next two weeks are likely to witness a sharp dip in transactions, further swelling the ITC pool without corresponding utilisation.

The inverted duty structure: From hope to disappointment

An IDS arises when inputs are taxed at a higher rate than the finished output. This imbalance leads to the accumulation of ITC, leaving businesses with working capital locked in their ledgers. While refunds are allowed in theory, in practice, it is a long haul considering the disputes and delays involved in obtaining the same.

Sectors like textiles, fertilisers, and renewable energy have long borne the brunt of this problem, with credit piling up month after month. For years, businesses have consistently argued that IDS undermines the principle of GST as a seamless value-added tax, since credits remain stranded and working capital is locked up.

Against this backdrop, the industry placed great hopes on the 56th GST Council Meeting, expecting GST 2.0 to finally address the issue. The Council has introduced a new mechanism for allowing a 90% refund upfront on a provisional basis, mirroring the refund mechanism in case of zero-rated exports. It also promised that ITC will be available on the tax paid against the receipt of supplies prior to 22-9-2025, based on the rates applicable then, and the same shall remain utilised against output tax liabilities for supplies made after 22-9-2025. On paper, this looks like progress. Yet, the core question of what relief would be provided for ITC accumulation remains unanswered.

Fresh inversions due to rate cuts

Consider the scenario where companies that procured inputs before 22-9-2025 at higher tax rates will now sell outputs taxed at lower slabs. The mismatch immediately triggers fresh IDS. The question that arises here is whether the taxpayer will be able to claim a refund on this new accumulation of credit?

The Council, while upholding the Circular No. 135/05/2020-GST dated 31-3-2020 (Circular 135)² (as amended), has stated that the refund of accumulated ITC is not available on account of inputs attracting different tax rates at different points in time. This position persists even after various High Court rulings cast serious doubt on the validity of the said Circular.³

For industries where inversion was already a reality, such as textiles, fertilisers, the new rates have only widened the gap between heavily taxed inputs and lower taxed outputs. Instead of relief, rationalisation threatens to deepen credit blockages. It remains to be seen whether, in practice, the much-touted 90% provisional refund mechanism will be robust enough to keep pace with this new surge.

The exclusion of input services and impact of nil-rated outputs

The problem becomes sharper when services enter the equation. The Council has upheld Circular 135 (as amended), reiterating that refunds will continue to be limited only to “inputs”.

The issue of excluding “input services” from the definition of “Net ITC” under Rule 89(5) of the Central Goods and Services Tax Rules, 2017 (CGST Rules)⁴ was decided in favour of taxpayers by the Gujarat High Court in VKC Footsteps India (P) Ltd. v. Union of India⁵, wherein the High Court read down Rule 89(5) of the CGST Rules to the extent it excluded ITC on “input services” from the purview of refund. However, the Supreme Court in Union of India v. VKC Footsteps India (P) Ltd.⁶ upheld the validity of Rule 89(5) of the CGST Rules, including the distinction created between “inputs” and “input services” therein. However, in disposing of the petition, the Supreme Court took note of the problems caused to the industry as a result of the exclusion of “input services” from the definition of “Net ITC” and urged the GST Council to take appropriate measures.

Despite the above, the GST Council, however, has not yet taken any substantive steps to address this concern. Instead, it has continued to uphold the restrictive interpretation through circulars and amendments.

There might be cases where input goods may now attract 5%, but input services have been pushed up to 18% from 12% such as residuary job work services and goods transport agency (GTA) services. Since no refunds are allowed on input services under law, the ITC accumulation will effectively be increased with the increase in the GST rate of the input service, becoming a cost to the business.

Last but not the least, with several goods and services shifted into the nil-rated category, ITC on associated inputs and services would become a cost.

These situations converge into one central dilemma, will the growing pile of unusable ITC be factored into costs, inviting higher consumer prices, or will anti-profiteering provisions force companies to absorb the hit?

Fate of accumulated cess

With cess being discontinued for most sectors from 22-9-2025, businesses now face a pressing concern, what will be the fate of the accumulated cess balances lying in their electronic credit ledgers? This is a matter of grave concern in industries where compensation cess was payable, such as automobiles, aerated drinks and coal, where the accumulation of such credit is significant.

Under the GST framework, cess credit can only be utilised for payment of outward cess liability. Once the levy itself is withdrawn, this credit risks becoming unusable. The Council is yet to clarify whether such accumulated cess will be refunded in cash or allowed to be cross-utilised against GST liabilities. As the provision for refund stands today, there does not appear to be any mechanism to seek a refund of compensation cess. The silence on this issue leaves taxpayers in a state of uncertainty, raising the fundamental question: will the cess lapse in entirety or will the Government step in with a transitional mechanism to the rescue of the businesses?

Till the Government provides any clarity, there would be an accumulation of cess credit, which would amount to a substantial working capital hit for industries like automobiles, coal, and aerated beverages.

Conclusion

While the 56th GST Council Meeting has delivered much-needed clarity on several fronts, such as rate rationalisation and the treatment of intermediaries, it has left one of the most fundamental concerns of the industry tying all these together, unresolved i.e. the fate of accumulated credit. However, the exclusion of input services and the lack of clarity around cess and refunds due to rate changes continue to pose challenges. As things stand, the industry must now wait for detailed clarifications and procedural guidance from the Government to understand how these changes will be implemented and whether further relief will be extended. With continued engagement between stakeholders and policymakers, there is cautious optimism that future meetings will bring more definitive resolutions and pave the way for a more streamlined and equitable GST regime.