New Delhi, April 2: A structural flaw in India’s Goods and Services Tax (GST) framework is creating a mounting crisis for small and medium enterprises, as the Inverted Duty Structure (IDS) continues to trap billions of rupees in unutilized input tax credits, choking working capital and undermining the competitiveness of businesses that form the backbone of India’s economy.
While GST was designed to ensure tax neutrality and eliminate the cascading effect of taxes, the current framework has inadvertently created a situation where input tax rates exceed output tax rates in several sectors leaving businesses unable to recover legitimate tax credits on input services and capital goods. The result: mounting financial pressures, increased cost of doing business, and a credit chain riddled with inefficiencies that disproportionately impact smaller players with limited access to capital.
For MSMEs operating on thin margins, the accumulation of blocked credits translates directly into working capital shortages, forcing many to either absorb the costs—eroding profitability—or pass them on to consumers, weakening their competitive position. The exclusion of input services and capital goods from the refund mechanism has compounded the challenge, creating a structural disadvantage that threatens the viability of businesses across manufacturing, exports, and services sectors.
Industry voices have grown increasingly urgent in calling for policy clarity and structural reforms to address this anomaly, with concerns now resonating across multiple stakeholder groups. The issue strikes at the heart of India’s ease of doing business agenda and its ambitions to build a globally competitive MSME sector—making resolution not just a matter of tax policy, but of economic imperative.
According to Empower India, these structural limitations continue to dilute the intended benefits of the GST framework. “A predictable and efficient input tax credit framework is central to the success of GST,” said K. Giri, Director General, Empower India.
He further added,
“While recent revisions to the refund formula are a step forward, the continued exclusion of input services and capital goods constrains liquidity and creates cost pressures across sectors. Addressing these gaps will be important to ensure tax neutrality and support industry competitiveness.”
The impact of the inverted duty structure is visible across sectors such as pharmaceuticals, FMCG, insurance, ecommerce, edible oils, and packaged foods, where input and service tax rates are often higher than output rates.
In addition, interpretational ambiguities arising from GST circulars related to inverted duty refunds have led to inconsistent practices and increased litigation, particularly in cases involving rate changes over time. This has added to compliance complexity and uncertainty for businesses.
By expanding the scope of the refund mechanism to cover input services and capital goods, amending Section 54(3) of the CGST Act to enable broader refunds, revising the definition of Net ITC, simplifying procedures, and issuing clear guidance shall address ambiguities and ensure consistent implementation.
