VKC Footsteps: why input service tax stays stuck in an inverted duty structure

The Supreme Court upheld a formula it described as anomalous, and told the GST Council to fix it. Five years on, the formula still decides your refund.

The structural problem

An inverted duty structure exists where the rate on inputs is higher than the rate on the output supply. Credit accumulates because output tax is insufficient to absorb input tax. Section 54(3) permits a refund of that accumulation in two situations: zero rated supplies, and an inverted duty structure.

Rule 89(5) prescribes the formula for the second category. Net input tax credit in the formula is defined to mean input tax credit availed on inputs. Inputs, under Section 2(59), means goods other than capital goods. Services are therefore outside the numerator.

The result is that a taxpayer paying eighteen percent on services, selling at five percent, accumulates credit on those services permanently. It is not refundable, and there is no output tax large enough to use it.

The split in the High Courts, and how the Court resolved it

The Gujarat High Court in VKC Footsteps held Rule 89(5) ultra vires to the extent it excluded input services, on the reasoning that Section 54(3) speaks of accumulated input tax credit without distinguishing between goods and services.

The Madras High Court in Transtonnelstroy Afcons took the opposite view, holding that the entitlement is a statutory concession whose contours Parliament may define.

The Supreme Court agreed with the Madras view. It held that the proviso to Section 54(3) uses the expression unutilised input tax credit but confines the entitlement in clause (ii) to cases where credit has accumulated on account of the rate on inputs being higher than the rate on output supplies. Reading input as including input services would rewrite the definition in Section 2(59).

The Court also refused to sever or reconstruct the formula, observing that curing the anomaly by judicial surgery would produce a different formula rather than a valid one, and that the remedy lay with the Council and the legislature.

What the Court said about the formula's anomaly

The Court did not pretend the formula was fair. It recorded that the formula assumes output tax is discharged entirely from goods credit, and that this produces distortions where a taxpayer has substantial services credit.

It expressly commended the anomalies to the GST Council for reconsideration.

A partial administrative correction followed in the treatment of the adjusted total turnover, but the core exclusion of input services has not been reversed. Any submission that VKC has been overtaken must be checked against the current text of Rule 89(5).

What is still arguable, and what is not

Not arguable: the exclusion of input services from an inverted duty refund. That is closed by a binding judgment.

Arguable: whether the output supply in question is in fact an inverted duty case at all, or whether it is a zero rated supply, where accumulated credit including services is refundable under the first limb. Many taxpayers file under the wrong limb and then litigate the exclusion.

Arguable: the composition of net input tax credit where a taxpayer has both nil rated and lower rated outputs, and where the department excludes credit on capital goods and services indiscriminately rather than as the formula requires.

Arguable: whether accumulated credit that cannot be refunded and cannot be used may be written off with a corresponding cost consequence, which is an accounting and pricing question rather than a tax dispute — and often the only remaining lever.

Arguable: refund under a different route altogether, such as Section 49(6) refund of a cash ledger balance, or restructuring so that services are procured by an entity whose output rate absorbs them.

Exhibit — Where the accumulation actually goes

Filing under the wrong limb of Section 54(3) is the most common self inflicted refund loss we see.

Authorities relied on

What to do on Monday

1. Split the refund workings by limb of Section 54(3) before filing; a single consolidated application is the most common cause of rejection.

2. Quantify the permanently stuck services credit for each year and take it into pricing, because it is a cost and not an asset.

3. Audit whether the department has excluded any goods credit from net input tax credit that the formula permits; that portion is recoverable.

4. Where accumulation is structural, model the alternatives — procurement restructuring, output rate review, and a cash ledger refund under Section 49(6).

Questions we are asked on this

Has the formula been amended since VKC?

There have been changes in the computation of adjusted total turnover and in administrative guidance, but the exclusion of input services from net input tax credit remains. Always verify against the current text of Rule 89(5) before advising.

We export and also sell domestically at a lower rate. Which limb do we use?

Both, separately. Zero rated exports go under the first limb where services credit is available. Domestic inverted supplies go under the second limb where it is not. Mixing them in one application costs money.

Can we claim the unrefundable services credit as a deduction in income tax?

That is an income tax question turning on whether the credit has become irrecoverable and when. Take it up as a write off question with your auditors, with the GST position documented.

Is a restructuring of procurement legitimate?

Procuring services in an entity whose output rate absorbs them is a commercial arrangement, and legitimate if the arrangement is real. It fails when the services are not actually rendered to that entity.

Does VKC affect refund of credit on capital goods?

Capital goods are excluded from inputs by Section 2(59) and were never within the inverted duty refund. The judgment confirms rather than changes that.

In this cluster

• GST refunds: every category, every form, every deadline
• Export refunds: the LUT route versus the IGST route
• Provisional refund of ninety percent: the mechanism and how to keep it
• Replying to RFD-08: the refund rejection notice
• Deficiency memos in RFD-03 and the limitation reset problem
• Interest on delayed refunds under Section 56
• Unjust enrichment in GST refunds: when it applies, and when it does not
• Section 77: refund where tax was paid under the wrong head
• SEZ supplies and refund: endorsement, authorised operations and the disputes
• Deemed exports and the refund to the recipient

GST Insights is published by AMLEGALS for general information. Law stated as on 3 September 2026. Not advice on any particular set of facts; not an advertisement or a solicitation under Rule 36 of the Bar Council of India Rules. Readers with a question on their own facts may write to the GST practice of their own accord.