GST Reforms Add Burden to MSMEs by Creating Inverted Duty Structure

GST Reforms Add Burden to MSMEs by Creating Inverted Duty Structure

Issue: To explain how the recent Goods and Services Tax (GST) rate rationalization, despite its overall intention to simplify taxes, has inadvertently led to the creation of a detrimental Inverted Duty Structure (IDS) in certain segments, disproportionately affecting Micro, Small, and Medium Enterprises (MSMEs).

Facts:

• The GST reforms introduced simplified tax slabs and cut rates on numerous final products (outputs) to boost consumer affordability and demand.
• However, in some manufacturing supply chains, the tax rate on inputs (raw materials, components, and services) utilized by MSMEs remained at the higher original rate (e.g., 12% or 18%).
• This disparity created a situation where the tax paid on inputs is higher than the tax charged on the output, leading to the accumulation of unutilized Input Tax Credit (ITC).

Decision:

The GST reforms have inadvertently imposed a cash flow and compliance burden on MSMEs in the affected segments due to the newly created Inverted Duty Structure.

Key TakeDowns:

• Creation of Inverted Duty Structure (IDS): The rate cuts on final products (outputs) were not synchronized with corresponding cuts on manufacturing inputs. This resulted in the tax rate on the final product being lower than the tax rate on the materials used to make it.
• Cash Flow Blockage: The primary impact is the accumulation of unutilized Input Tax Credit (ITC). This traps the MSMEs’ working capital, which remains locked with the government until a refund is processed. For cash-sensitive MSMEs, this blockage severely impacts their liquidity and operational capacity.
• Refund Complexity and Delays: MSMEs are forced to go through the complex and time-consuming process of filing for an IDS refund. The cumbersome procedure often leads to delays, further straining the enterprise’s finances.
• Demand for Policy Correction: The situation necessitates targeted policy corrections by the GST Council, either by allowing refunds on capital goods ITC (currently restricted under IDS) or by achieving complete rate synchronization across the value chain to eliminate the inversion entirely.
• Impact on Competitiveness: The cost of carrying this unrefunded ITC reduces the MSMEs’ ability to price their products competitively, especially against larger firms or imports.