Introduction
Nine years into GST, the most persistent cash-flow grievance of Indian manufacturers is finally being addressed: credit that piles up because inputs are taxed at higher rates than the finished product. The 57th GST Council, which met in New Delhi on 8 October 2026, has recommended that the refund of such accumulated credit be widened to cover input services and capital goods, and not merely input goods.
The timing is no accident. The rate rationalization of September 2025 collapsed the slab structure and moved a large number of consumer goods to the lower rate. Prices fell, but the cost of that relief has been borne partly by producers whose purchases continue to attract 18%. For many of them, the electronic credit ledger has become a balance that only grows.
This note examines where the law stands today, why the present restriction has outlived its logic, what the Council has now proposed, and what still remains to be done.
The law as it stands
Section 54(3) of the CGST Act, 2017 permits refund of unutilized input tax credit in only two situations, set out in the first proviso: zero-rated supplies made without payment of tax (clause (i)), and credit that has accumulated because the rate of tax on inputs is higher than the rate on output supplies (clause (ii)). Every other accumulation must simply be carried forward.
The restriction to goods begins in the statute itself. Clause (ii) speaks of the rate of tax on "inputs", and "input" is defined in Section 2(59) to mean goods other than capital goods. Rule 89(5) of the CGST Rules, 2017 then gives effect to this by defining "Net ITC" in the refund formula as credit availed on inputs alone. The result is that GST paid on input services and on capital goods, even when it sits in the same ledger and arises from the same manufacturing activity, is left out of the refund computation.
It is worth noting that capital goods are excluded even for exporters. For zero-rated supplies under bond or LUT, Rule 89(4) counts credit on inputs and input services, but not on capital goods.
Why the restriction no longer holds up
A modern factory does not run on raw material alone. Design and engineering, research and testing, software, logistics, maintenance, job work and professional services all go into the finished product, as does expensive plant and machinery. GST on each of these is part of the same value chain, yet only the tax on goods consumed is eligible for refund.
Take a manufacturer whose product is taxed at 5% while its principal raw materials, its service vendors and its machinery suppliers all charge 18%. Because the raw materials alone carry a higher rate, the case is one of inverted duty and a refund is admissible. But the refund is computed only on the credit for those raw materials. The credit on services and machinery, often a substantial share of the total, stays in the ledger with no realistic way of being used. Year after year, a tax meant to be neutral becomes a fixed cost.
Industry has been saying as much. In Deloitte India's GST@9 survey, released on 23 June 2026 and based on about 1,100 responses, 67% of respondents placed working-capital optimisation among the key challenges and 77% pointed to refund delays and the need for stricter timelines. Deloitte's own commentary on the survey singled out the widening of the inverted duty formula to input services and capital goods as the top policy ask, particularly in sectors such as pharmaceuticals, food processing and electric vehicles where recent rate cuts had deepened the inversion.
The Council itself has, on earlier occasions, recognised that inverted rate structures distort investment decisions, breed litigation and can leave domestic producers at a disadvantage to importers.
The judicial backdrop
The exclusion of input services was tested before two High Courts with opposite results. The Gujarat High Court in VKC Footsteps India Pvt. Ltd. v. Union of India read down Rule 89(5) and allowed refund of credit on input services. The Madras High Court in Tvl. Transtonnelstroy Afcons Joint Venture v. Union of India (W.P. No. 8596 of 2019, decided 21 September 2020) upheld the rule.
The Supreme Court settled the conflict in Union of India v. VKC Footsteps India Pvt. Ltd., Civil Appeal No. 4810 of 2021, decided on 13 September 2021, reported as 2021-TIOL-237-SC-GST and 2021 SCC OnLine SC 706. Speaking through Dr. D.Y. Chandrachud J., the Court reversed the Gujarat High Court and affirmed the Madras view. It held that refund is a matter of statutory prescription, that Parliament was entitled to confine the clause (ii) refund to credit on inputs, and that Section 54(3) and Rule 89(5) were valid. It declined to rewrite the formula itself, since doing so would trespass into the domain of the legislature and the executive.
The Court did, however, accept that the formula produced anomalies and urged the GST Council to reconsider it as a matter of policy. That led, at the 47th Council meeting, to an amendment of Rule 89(5) by Notification No. 14/2022-Central Tax dated 5 July 2022. The amended formula apportions the reduction for output tax in the ratio of credit on inputs to credit on inputs and input services, which corrected the arithmetical distortion. CBIC later clarified that the change applies prospectively, to refund applications filed on or after 5 July 2022. What the amendment did not do was make credit on input services or capital goods refundable. That gap is what the 57th Council has now taken up.
What the 57th Council has recommended
The Council has proposed bringing input services and capital goods into the refund computation, with separate start dates and, for capital goods, a phased recognition of credit.
| Credit | Refund route | Credit availed on or after |
|---|
| Input services | Inverted duty structure | 1 November 2026 |
| Capital goods | Inverted duty structure | 1 April 2027 |
| Capital goods | Zero-rated supplies under bond or LUT | 1 April 2027 |
Three features of the proposal deserve emphasis.
First, the trigger for an inverted duty refund does not change. The Finance Ministry's clarification after the meeting makes it plain that inversion must still arise from the rate on input goods exceeding the rate on output supplies. A higher rate on services alone will not qualify. What expands is the quantum of credit that enters the formula once the case qualifies.
Second, the 60-month spread for capital goods mirrors the five-year life that Rule 43 already assumes for such assets. Blocked credit under Section 17(5) stays out, and reversals required under Rule 43 must be deducted.
Third, these are recommendations. They need amendments to the Act and Rules, notifications and changes to the GST portal before they take effect. Until then, the existing position continues to govern refund claims.
The gain is likely to be most visible in capital-intensive and inversion-prone sectors such as pharmaceuticals, textiles, footwear, renewable energy and electric vehicles, where heavy GST is paid at the investment stage while output tax accrues slowly.
What still needs attention
Legacy balances. The relief is prospective. Credit on input services availed before 1 November 2026, and on capital goods before 1 April 2027, gets no refund route. Businesses that have carried large balances since 2017 gain nothing on that stock, and some transitional mechanism for historical credit remains a fair claim on the next round of policy.
Speed of payment. A wider refund is of limited value if it arrives late. Here there is movement on two fronts. The Finance Act, 2026 amended Section 54(6) so that provisional refund is no longer confined to zero-rated supplies and now extends to inverted duty claims under clause (ii). The 57th Council has gone further and proposed an automated 90% provisional refund for eligible low-risk zero-rated and inverted duty claims, to be issued within three working days of acknowledgement, along with a shorter 10-day window for acknowledgement or deficiency memo.
Drafting and implementation. The real benefit will turn on the text of the amendments, the revised Rule 89(5) formula, how mixed-use services and capital goods are apportioned, and how the portal's risk engine treats lumpy capital-goods claims. Poor drafting here could simply shift disputes from eligibility to computation.
Practical steps for businesses now. Pending notification, it would be prudent to:
- track credit on input services separately from 1 November 2026;
- maintain a capital goods register from 1 April 2027 showing date of availment, Rule 43 apportionment and Section 17(5) status;
- confirm that each output line is genuinely inverted on the basis of input goods, since services alone will not qualify.
Conclusion
The 57th Council's proposal marks a change in outlook. Refunds of accumulated credit are no longer being viewed only through a narrow statutory formula, but as a question of working capital, investment and competitiveness. Five years after the Supreme Court left the matter to the Council, the policy response has arrived.
The reform is incomplete. Historical balances stay locked, the trigger for inversion remains tied to goods, and much will depend on the fine print still to be notified. Even so, the direction is right. A GST system should be judged not only by what it collects, but by how freely legitimate credit moves through it. If the amendments are drafted with care and refunds are paid on time, input tax credit can go back to being what it was meant to be: a business asset, not a sunk cost.
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