Rule 89(5) Explained: Unlocking Blocked Working Capital for Manufacturers.

Understand Rule 89(5) GST refund for inverted duty structure and how manufacturers can unlock blocked working capital

For manufacturing and trading units in the Delhi NCR region—especially those operating in Okhla, Noida, and Manesar—managing working capital is a daily battle. One significant choke point often goes unnoticed: Accumulated Input Tax Credit (ITC) due to an Inverted Duty Structure (IDS), particularly for units operating under the MOOWR (Manufacturing and Other Operations in Warehouse Rules) scheme.

If your business imports raw materials at a high GST rate (e.g., 18% or 28%) but sells finished goods in the Domestic Tariff Area (DTA) at a lower rate (e.g., 5% or 12%), you are essentially lending money to the government.

The good news? You can claim it back.

In this post, we break down the legal provisions, the refund formula under Rule 89(5), and the latest judicial trends that every CFO and business owner must know.

What is the Core Issue?

Many businesses in the NCR region utilize the MOOWR scheme to defer custom duties. However, when these units clear goods into the domestic market (DTA), they face a tax anomaly:

• Input Side: You import components/spares paying IGST at 18%.
• Output Side: You sell the refurbished or manufactured product in DTA at 5% or 12%.

This creates an Inverted Duty Structure. The result? Your electronic credit ledger swells with unutilized ITC that you cannot use to pay output liability. Instead of letting this capital sit idle, Section 54(3)(ii) of the CGST Act allows you to claim a cash refund.

Key Legal Provisions & Case Laws

1. The “Goods Only” Rule (VKC Footsteps)

The Supreme Court, in the landmark Union of India v. VKC Footsteps case, settled a major debate. It ruled that refunds under IDS are limited only to ITC on Input Goods.

• Allowed: ITC on raw materials, components, consumables.
• Disallowed: ITC on Input Services (e.g., job work, professional fees) and Capital Goods (machinery).
• Takeaway: Your accounting must strictly segregate ITC into Goods, Services, and Capital Goods to ensure accurate claims.

2. “Same Goods” Refund (Malabar Fuel Corp)

Can you claim a refund if the input and output goods are the same but tax rates differ? The Kerala High Court (and others) have clarified that yes, if an inversion in tax rate exists, a refund is permissible. Circulars trying to restrict this have been challenged successfully.

The Refund Process & Formula

To claim this refund, you must file Form GST RFD-01 on the GST Portal under the category “Refund on account of ITC accumulated due to Inverted Tax Structure.”

The eligible refund amount is calculated using the formula under Rule 89(5):

Maximum Refund =

$[(\text{Turnover of Inverted Rated Supply} \times \text{Net ITC}) \div \text{Adjusted Total Turnover}] – \text{Tax Payable on Inverted Supply}$

Critical Compliance Points:

• Net ITC: Must include only “Inputs”. Exclude services and capital goods.
• Timelines: The limitation period is 2 years from the relevant date.
• Provisional Refund: Following the 56th GST Council meeting recommendations, a 90% provisional refund mechanism is being streamlined to provide immediate liquidity relief.

Implications for Delhi NCR Businesses

The NCR region is a hub for electronics, auto components, and assembly units that heavily rely on imports.

1. Audit Your Ledger: Review your Electronic Credit Ledger. If the balance is increasing despite regular sales, check for IDS.
2. MOOWR Strategy: While MOOWR saves customs duty interest, the GST accumulation must be managed via monthly/quarterly refund claims to ensure cash flow efficiency.
3. Documentation: Maintain robust “Movement Files” (Bill of Entry + Sales Invoices) to substantiate the claim during departmental verification.

FAQs: Common Concerns

Q: Can I claim a refund on the GST paid for Capital Goods (Machinery)?

A: No. Under the current law (affirmed by the SC), IDS refunds are strictly for “Inputs” (raw materials/goods). ITC on machinery cannot be encashed; it can only be carried forward.

Q: What if I have both export (Zero-rated) and domestic (Inverted) sales?

A: You can claim refunds under both categories separately. You will need to apportion the ITC based on turnover to ensure no double dipping.

Q: Is a CA certificate mandatory?

A: Yes, for refund claims exceeding ₹2 Lakhs, a certificate from a Chartered Accountant or Cost Accountant is required to certify the computation and non-passing of unjust enrichment.

Conclusion

The Inverted Duty Structure refund is a powerful provision to recover blocked working capital. However, the calculation is technical, and the Department scrutinizes “Net ITC” categorizations closely. A simple classification error (treating a service as a good) can lead to rejection and penalties.

Don’t let your working capital sleep in the government ledger.

At Kunal Kapoor & Associates, we specialize in identifying refundable credits and managing the end-to-end refund process for MOOWR and manufacturing units.