GST 2.0 revived demand. Now industry wants its tax credit unstuck

GST Council is scheduled to meet next week after a one-year hiatus. One assumes the reform process initiated through GST 2.0 at its last meeting in September 2025 should be taken further. Rate compression and rationalisation — by which the number of GST rates were reduced to 5% and 18% slabs, and for almost all items of common consumption dropped to 5% — rejuvenated aggregate economic demand. This has been endorsed in two separate KPMG and Deloitte surveys earlier this year.

GoI’s assessment that the growth in demand would more than compensate for immediate fall in revenues seems to have played out. After an initial slump in growth rates of monthly GST collections in Q3 FY26 (except for May 2026), growth rates have been above 7.5%, touching 15.8% in July. Net revenue collections (cumulative Centre and states) from GST grew at 9.2% during April-July 2026 compared to the same period of FY26.

Most respondents in the two surveys stressed the need for further structural and procedural reform. An important one is the review of input tax credit (ITC) scheme, in order to remove legal, procedural and administrative bottlenecks in its flow across the value chain. In an ideal VAT system, taxes paid on supplies at the previous stage of the value chain are allowed to be set off against liability at each successive stage, so that the burden of tax falls only on the end consumer, and not businesses constituting the chain that are only pass-through entities.


If there are blockages in this flow, stranded credit becomes a cost to business, resulting in ‘cascading’. The current GST system has several blockages, some enshrined in law (e.g., restrictions on type of input goods or services for which credit is available); others structural (e.g., non-availability of ITC on some petro products since they fall outside GST’s purview; rate inversions between input services and output goods), or operational (e.g., non-transferability of ITC from one state to another within the same business entity).

The combined impact of these on the cost structure of businesses is significant. Absorbing these costs for some time may be possible. But, if sustained, businesses will be compelled to pass them on to end-consumers by increasing prices. Also, such blockages place domestically-supplied goods and services at a disadvantage vis-à-vis imports that enter the country after full neutralisation of embedded indirect taxes in their country of origin.

As a result, accumulation of ITC in their ledgers is a serious challenge that a sizeable section of industry faces, particularly post-GST 2.0. Accumulation occurs owing to rate inversion with some input goods, input services and capital goods being at the standard rate of 18%, while output supplies (say, food products) are at the merit rate of 5%. This differential, of 13 percentage points, is very sharp, and would take an unrealistically high level of value addition for ITC to be fully absorbed.

Of these three sources of accumulation, relief by way of refund of accumulated ITC is available for inversion in rates between input and output supplies of goods alone, and in a very limited and oblique way for services. Recently, a digitalised process for fast-tracking these refunds (with automatic disbursal of 90% of the claimed amount in risk-free cases) has also been launched. But it’s not possible to assess its efficacy, as data on the proportion of cases cleared under it isn’t in public domain.

Remedy of ITC refund accumulated on account of inversion in rates between input services and capital goods as output supplies is simply unavailable. In certain lines of business, the proportion of ITC accumulation from these sources could be as high as 30-40%. To make matters worse, on some input supplies such as imported services, these businesses may be required to pay tax in cash on a reverse-charge basis while saddled with a large pool of unutilised ITC.

The one permanent solution is to move to a single-rate structure. In its absence, several VAT jurisdictions grant refund of any accumulated ITC at the end of a tax period to businesses. It may be unrealistic to expect that the GST Council would be able to provide such a complete solution immediately. But given its healthy tradition of responding to serious and urgent concerns, it must make a beginning by broadening the scope of inversion duty structure (IDS) refunds to cover capital goods and services. At least partially, with a glide path for its future expansion.

The writer is former chairman, Central Board of Indirect Taxes and Customs (CBIC), GoI