When the GST rate on what you buy is higher than the rate on what you sell, input tax credit piles up in the electronic credit ledger. The law allows an inverted duty refund of this accumulated credit under section 54(3), subject to conditions. With the GST 2.0 rate changes from 22 September 2025 moving many finished goods to 5% while some inputs remain at 18%, more businesses now find themselves in an inverted position.
This guide explains who is eligible, how the rule 89(5) formula works, what the application needs, and the most common reasons claims are reduced or rejected.
Key takeaways
- Refund is available where credit accumulates because the tax rate on inputs is higher than the rate on output supplies.
- Only ITC on inputs (goods) counts as Net ITC; input services and capital goods are excluded from the refund computation.
- The formula in rule 89(5), as amended in July 2022, deducts the output tax proportionate to input credit, not total credit.
- Claims must be filed in RFD-01 within two years from the due date of the return for the period.
- Refund is not allowed for goods notified as ineligible, or where inversion arises only from input services.
Who is eligible for an inverted duty refund
Three conditions must generally be met:
- Accumulated ITC arises because the rate on inputs exceeds the rate on outward supplies.
- The outward supplies are taxable, not nil-rated or fully exempt.
- The goods or services supplied are not in the list notified as ineligible for this refund.
Typical situations include textile and garment makers, footwear, food processing, fertiliser, and many manufacturers of items moved to 5% under GST 2.0, where key raw materials, packaging or components still attract 12% or 18%.
Inversion caused only by input services, such as high-rate freight or professional services, does not qualify. The Supreme Court in 2021 upheld this restriction in the formula, so it is settled for now.
The rule 89(5) formula
Maximum refund = (Turnover of inverted rated supply x Net ITC / Adjusted total turnover) – (Tax payable on inverted rated supply x Net ITC / ITC availed on inputs and input services)
Where:
- Net ITC = ITC availed on inputs during the period, excluding blocked credits and ITC used for other refunds
- Turnover of inverted rated supply = value of supplies made at the lower rate that cause the inversion
- Adjusted total turnover = total turnover in the state, excluding exempt supplies
The second part of the formula was amended in 2022 so that only the share of output tax attributable to input goods is deducted, which is fairer than the earlier version.
Worked example
A manufacturer of a product taxed at 5% has these figures for a quarter:
| Item | Amount (₹) |
|---|---|
| Turnover of 5% product (inverted rated supply) | 1,00,00,000 |
| Adjusted total turnover | 1,00,00,000 |
| Output tax on the 5% product | 5,00,000 |
| ITC on inputs (Net ITC) | 12,00,000 |
| ITC on input services | 2,00,000 |
| ITC on inputs and input services | 14,00,000 |
Step 1: 1,00,00,000 x 12,00,000 / 1,00,00,000 = ₹12,00,000
Step 2: 5,00,000 x 12,00,000 / 14,00,000 = ₹4,28,571
Maximum refund = ₹12,00,000 – ₹4,28,571 = ₹7,71,429
The refund is also capped by the balance in the electronic credit ledger at the end of the period and at the time of filing. The ₹2 lakh of input service credit stays in the ledger for use against output tax.
Filing the claim in RFD-01
- Select ‘Refund on account of ITC accumulated due to inverted tax structure’ and the period (a month or a quarter, or consecutive periods).
- Upload the statement of turnover and invoice-wise inward supply details as prescribed.
- Ensure GSTR-1 and GSTR-3B for the period are filed and consistent.
- Debit the eligible amount from the electronic credit ledger through the form.
- Track the acknowledgment (or any deficiency memo) and respond to any show cause notice promptly.
The CBIC has, since October 2025, applied a system-based risk assessment for provisional refunds and extended the facility to inverted duty claims as an interim measure, with a legislative change to section 54(6) proposed to make it permanent. Check the current position when filing, since it can speed up cash flow significantly.
Common reasons for rejection or reduction
| Issue | What goes wrong | How to avoid it |
|---|---|---|
| Input services included in Net ITC | Refund overstated | Separate goods and services credit in books |
| Capital goods credit included | Refund overstated | Tag capital goods at booking stage |
| Wrong turnover figures | Formula mismatch with returns | Reconcile with GSTR-1 and GSTR-3B |
| Same-rate inputs and outputs | No real inversion | Check product-wise rates before filing |
| Blocked credits in Net ITC | Disallowed under section 17(5) | Review blocked items first |
| Invoices not in GSTR-2B | Credit questioned | Claim only credit backed by supplier filings |
| Time-barred period | Claim rejected | File within two years of the return due date |
Our guide on blocked credit under section 17(5) helps with the review step, and our note on GST refunds for exporters covers the zero-rated side if you also export.
Practical tips for manufacturers after GST 2.0
- Map product-wise output rates and input rates after the September 2025 changes to see where inversion now exists
- Maintain separate ledgers for ITC on inputs, input services and capital goods
- File claims regularly, quarterly for example, rather than letting balances build up for years
- Keep a reconciliation of the credit ledger balance to the refund working
- Where the refund is partly rejected, review the order carefully; an appeal may be worthwhile if the issue is about computation rather than eligibility
Frequently asked questions
What is an inverted duty structure under GST?
It is a situation where the tax rate on inputs is higher than the tax rate on the outward supply, causing input tax credit to accumulate.
Can I claim refund of ITC on input services?
No. For inverted duty refunds, Net ITC includes only ITC on inputs (goods). Input services and capital goods are excluded.
What is the time limit for an inverted duty refund?
Two years from the relevant date, which for this refund is the due date for furnishing the GSTR-3B for the period in which the claim arises.
Can refund be claimed for several months together?
Yes, a claim can cover a tax period or consecutive tax periods, provided each is within the two-year limit and the financial year boundaries are respected as required.
If input tax credit is piling up in your ledger, our GST team will be glad to check eligibility, compute the refund and prepare a clean RFD-01 claim.
This article is general information based on the law as of September 2026, and is not legal or tax advice. Please check the facts of your own case with a professional before acting.
