Rule 89(5): The Inverted Duty Formula and the Services Gap

Rule 89 explained: this guide covers what it means, who it applies to, the step-by-step process, documents required, fees, due dates and penalties in India — so you can stay compliant with confidence and avoid costly mistakes.

The inverted duty refund is the one that never quite gives back what accumulated. The reason is a single asymmetry in the formula, and it survived a Supreme Court challenge.

Maximum Refund Amount = {(Turnover of inverted rated supply of goods and services) × Net ITC ÷ Adjusted Total Turnover} − {tax payable on such inverted rated supply of goods and services × (Net ITC ÷ ITC availed on inputs and input services)}. Net ITC means input tax credit availed on inputs during the relevant period other than that availed for which refund is claimed under sub-rules (4A) or (4B). So input services are in the divisor of the second limb but not in Net ITC — and the credit attributable to them is not refunded.

The two limbs

First limb — the proportionate credit. Turnover of inverted rated supply × Net ITC ÷ Adjusted Total Turnover. This is the credit attributable to the inverted-rated turnover.

Second limb — the tax already recovered. Tax payable on such inverted rated supply × (Net ITC ÷ ITC availed on inputs and input services). This removes the portion of credit already used against the output tax on those supplies.

The subtraction leaves the accumulated credit attributable to the inversion.

Where the asymmetry sits

Net ITC = credit on inputs only.

The second limb's divisor = credit on inputs and input services.

So the same expression Net ITC appears in both limbs, but in the second it is divided by a larger number — inputs plus input services. That makes the fraction smaller, which makes the deduction smaller, which increases the refund.

The October 2024 change, made by Notification No. 14/2022-CT and refined subsequently, added input services to the divisor of the second limb. Before that, the divisor was ITC availed on inputs alone, and the fraction was 1 — so the second limb deducted the whole of the tax payable.

The effect of the change: a business with substantial input services now deducts less in the second limb, and its refund rises. It still does not get the credit on input services into Net ITC, so it does not recover that credit — but the tax on the output is no longer set off entirely against a base that excluded it.

Worked example

A manufacturer with:

• Turnover of inverted rated supply — ₹1,00,00,000
• Adjusted Total Turnover — ₹1,20,00,000
• ITC on inputs (Net ITC) — ₹15,00,000
• ITC on input services — ₹5,00,000
• Total ITC on inputs and input services — ₹20,00,000
• Tax payable on inverted rated supply at 5% — ₹5,00,000

First limb = 1,00,00,000 × 15,00,000 ÷ 1,20,00,000 = ₹12,50,000

Second limb = 5,00,000 × (15,00,000 ÷ 20,00,000) = 5,00,000 × 0.75 = ₹3,75,000

Maximum refund = 12,50,000 − 3,75,000 = ₹8,75,000

Under the pre-amendment divisor (inputs only, so the fraction is 1), the second limb would have been ₹5,00,000 and the refund ₹7,50,000. The amendment is worth ₹1,25,000 in this example.

But note what is still missing. The business accumulated credit on ₹5,00,000 of input services that Net ITC never captures. That credit stays in the ledger.

Why the asymmetry survived

In Union of India v. VKC Footsteps India Pvt Ltd, the Supreme Court upheld the validity of Rule 89(5) and the exclusion of input services from Net ITC.

The reasoning: s.54(3) is not a right to refund of all accumulated credit. The proviso permits refund only in the two specified circumstances, and clause (ii) refers to a rate on inputs being higher than the rate on output supplies. The legislature was entitled to confine the refund to the credit on inputs, and the courts would not read the word "inputs" as including "input services" where the Act distinguishes them in s.2(59) and s.2(60).

The Court did observe the anomalies in the formula and suggested the Council reconsider — which is what produced the 2022 and 2024 refinements to the second limb, not a change to Net ITC.

What is excluded from the refund entirely

Capital goods credit. Not in Net ITC. Accumulated capital goods credit in an inverted period has no refund route at all.

Notified supplies. Section 54(3) proviso clause (ii) excludes supplies the Government notifies. Construction services and specified fabrics have historically been on that list — check the current notification before building a claim.

Nil-rated and fully exempt output. Outside clause (ii) altogether; the credit is reversed under Rule 42, not refunded. Rule 42 worked →

The provisional refund position

Rule 91(2), substituted with effect from 01.10.2025, makes the provisional refund order in RFD-04 a system-risk-based decision within seven days.

Section 54(6) currently permits provisional refund only for zero-rated supplies. The Finance Act, 2026 extends it to inverted duty — but that amendment awaits notification. Provisional refund for inverted duty →

Key takeaways

• Net ITC in the first limb is inputs only; the second limb's divisor is inputs and input services.
• The 2022 and 2024 amendments added input services to the divisor, increasing the refund.
• Credit on input services is still not recovered through the formula.
• Capital goods are excluded entirely.
• VKC Footsteps upheld the exclusion of input services from Net ITC.
• Notified supplies are excluded from clause (ii) altogether.

Read next

• Inverted Duty Refund Formula: Calculation and Examples
• Rule 89(4): The Zero-Rated Refund Formula
• ITC Accumulation After GST 2.0 Rate Cuts
• Provisional Refund for Inverted Duty Structure

Disclaimer: Positions stated as on 5 September 2026, based on the CGST Rules as amended to 31 March 2026 (ICAI Bare Law, 12th edition) and the ICAI Handbook on Refunds under GST (January 2026).