Whalesbook
The Service Tax Refund Bottleneck
The current GST system creates a major hurdle for Indian manufacturers by not allowing refunds for tax paid on services under an inverted duty structure. This setup, where companies pay more tax on their inputs than they collect on their sales, traps essential working capital.
How Trapped Tax on Services Hurts Manufacturers
While refunds are allowed for tax on input goods, the tax paid on services such as IT, logistics, consulting, and marketing becomes a permanent cost. This situation limits cash flow and flexibility. It's especially tough for sectors like Fast-Moving Consumer Goods (FMCG) and pharmaceuticals, which depend on high sales volumes and thin profit margins. Recent GST rate cuts on many FMCG products to 5% have widened this gap, as tax on services often stays at 18%. The manufacturing sector's contribution to India's economy (GVA) has also lagged, staying flat at about 17%.
India's GST Differs from Global Systems
India's rule differs from many global VAT and GST systems. Countries in the European Union and the UK typically allow tax credits for goods and services, promoting fairer tax treatment. Though India's GST law covers refunds, the exclusion of services in inverted duty structure cases has been debated. The Supreme Court has recognized these issues and urged the GST Council to revisit the rules.
This topic is frequently raised by industry groups and is expected to be discussed at the GST Council meeting in May-June 2026. Experts note this policy gap creates a disadvantage, as unrecoverable 18% GST on services like marketing hurts FMCG and pharma firms. Recent manufacturing data, like the HSBC India Manufacturing PMI falling to its lowest since September 2021, highlights the need for lower costs.
Competitiveness at Risk from Policy Gaps
Keeping input services out of inverted duty structure refunds poses a major risk to Indian manufacturing's global standing. This limitation weakens government initiatives like 'Make in India' and PLI schemes, meant to boost local production and exports. Unlike other major economies that allow broad refund of accumulated tax credits, India's strict rules raise effective production costs. This raises operating expenses and makes Indian goods less competitive than imports.
Small and medium businesses (MSMEs) are especially vulnerable. Trapped capital can disrupt production, delay payments, and create financial hardship. It may also lead to more legal disputes as companies try to reclaim owed tax credits.
GST Council Meeting: A Crucial Decision Point
All eyes are now on the upcoming GST Council meeting in May-June 2026, which could be a turning point for resolving the service tax refund issue. Industry groups have repeatedly raised this concern, and the Supreme Court's past comments lend support to the call for change. The Council usually handles procedural and rate changes, but the ongoing problem of blocked working capital due to untaxed services needs a firm policy decision. This is crucial for improving India's manufacturing cost-competitiveness and future growth.