[By Shrushti Taori & Tatva Damania]
The authors are students of Maharashtra National Law University, Nagpur and Maharashtra National Law University, Mumbai respectively.
Introduction
Recently, in Union of India v. Tata Steel Ltd. , the Hon’ble Supreme Court decided on the prospective nature of the Explanation to Rule 89(4) of the Central Goods and Services Rules, 2017 (‘the Rules’) (‘the Explanation’) added vide Notification No. 19/2022 (‘the Notification’). The appeal was against Jharkhand High Court’s judgement in Tata Steel Ltd. v. Union of India , wherein the petitioner challenged the validity of Paragraph 47 of the Circular No. 125/44/2019-GST (‘the Circular’). Paragraph 47 of the Circular directs the authorities to examine the value declared in both the GST invoice and the shipping bill while processing refund claims of unutilised Input Tax Credit (‘ITC’). It further clarifies that the lower of the two values must be considered to compute the eligible refund amount. This was later vis-à-vis incorporated as the Explanation vide the Notification. The very objective of the Explanation is to avoid over-invoicing by the assessee.
In Tata Steel, the Hon’ble Supreme Court decided on the prospective application of the Notification. However, it remanded the matter back to the Jharkhand High Court to decide on the merits of the Paragraph 47 the Circular, and hence that of the Explanation. The petition is pending in the Jharkhand High Court. The authors contend that the Explanation to Rule 89(4) of the Rules is ultra vires the Central Goods and Services Act, 2017 (‘CGST Act’), as it imposes a substantive cap on availment of refund on ITC, despite having no such cap in the parent statute. This article frames three arguments to justify the ultra vires nature of the Explanation: (i) the statutory scheme of the CGST Act bases refund of ITC entirely on the invoice only, and shipping bill serves an entirely different purpose; (ii) The CGST Act employs the intention of ‘full refund’, and basing refund on shipping bill does not ascertain ‘full refund’, especially in cases of CIF Contracts; and (iii) Principles laid down in Tanbo Imaging affirms that exports are ‘zero-rated’ and hence, must be tax neutral.
Refund on Export in GST Laws
Exports are zero-rated supplies under Section 16(1) of the Integrated Goods and Services Tax Act, 2017 (‘the IGST Act’). In cases of zero‐rated supplies under a Bond/Letter of Undertaking (‘LUT’), according to Rule 96A of the Rules, the export is made without the payment of IGST. In such arrangement, the refund of unutilised ITC is later claimed by the exporter under Section 54(3) of the CGST Act. Rule 89(4) of the Rules lays down the formula to calculate the refund of unutilised ITC for that export. It is :
Refund = (Export turnover) × (Net ITC) / (Adjusted Total Turnover).
Here, Export turnover means turnover of zero‐rated supplies of goods and services, and Net ITC is the input credit availed during the period. The Adjusted Total Turnover is essentially the exporter’s overall turnover (taxable supplies plus zero‐rated services) in a State, excluding exempt supplies and any supplies already refunded under Rules 89(4A)/(4B). Hence, the formula essentially prorates the total ITC based on the share of exports in the total (taxable) business, so that only the portion of credit attributable to exports is refunded.
While this mathematical equation precisely gives the amount of refund for that specific export turnover, an important legal issue that arose is the cap on export turnover in this formula. Oftentimes, the transactional value on tax invoice is different than that on the shipping bill for the same product. Hence, vide Paragraph 47 of the Circular, and then vide the Explanation, the Department inserted an explanation to Rule 89(4): it expressly provides that the “value of goods exported” shall be taken as the lower of (i) the Free On Board (‘FOB’) value in the shipping bill; or (ii) the invoice value. According to the Circular No. 197/09/2023- GST (‘2023 Circular’), this ‘lower’ value must be considered in both numerator and denominator in ‘export turnover’ and ‘adjusted total turnover’ while calculating the refund according to the Rule 89(4) of the Rules.
The explanation to Rule 89(4) is ultra vires the CGST Act
This consideration of the ‘lesser’ value of the invoice or the shipping bill has been challenged in the Tata Steel. It is pertinent to note that the Jharkhand High Court did not decide on the validity of the Explanation yet, nor consider the issue in the judgement. Hence, the Supreme Court remanded the matter back to the Jharkhand High Court to decide on the validity of the Explanation of considering the ‘lesser’ value out of either FOB value of the value on the tax invoice for the purpose of refund of the unutilised ITC.
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Purpose of invoice and shipping bill, and the scheme of CGST Act for refund of ITC
For the purpose of tax, the invoice and the shipping bill serve different purposes. The invoice is issued under Section 31 of the CGST Act r/w Rule 46 of the CGST Rules, whereas the Shipping Bill is issued under Section 50 of the Customs Act, 1962. Even though, according to Rule 96 of the CGST Rules, the Shipping Bill is deemed as a refund application of integrated tax paid on the goods, it is merely a proof of the fact that the good has been exported and the assessee has utilised zero-rated policy, and hence is eligible for the refund. According to the Shipping Bill and Bill of Export (Forms) Regulations, 2017, Form SB I / SB II mandates to list the quantity, description, and declared values (including INCOTERM-based breakdown of FOB, freight, insurance, etc.). However, the valuation of refund as per the Explanation is based on the FOB component only.
The invoice, on the other hand, contains total value of supply of goods or services, taxable value of supply of goods or services, rate of tax, and amount of tax charged. For the purpose of valuation, especially that of ITC, the authorities rely on the invoice. According to the clear scheme of the CGST Act, tax invoice and not the shipping bill is the document to claim ITC. While the shipping bill is a deemed application for refund and CGST Act, the CGST Act considers the valuation based on the invoice to calculate the refund for claiming unutilised ITC. Here are the particulars that make reliance on tax invoice only to calculate the refund of unutilised ITC –
Section 31 of the CGST Act mandates that every registered supplier “shall, before or at the time of removal of goods… issue a tax invoice showing description, quantity, value and tax charged”. More critically, Section 16(2) of the CGST Act spells out the conditions of eligibility for a recipient to claim ITC: it requires that “he is in possession of a tax invoice… issued by the supplier” and that the details of that invoice have been furnished by the supplier in his outward-supply statement (GSTR-1 Form) to the recipient under Section 37 of the CGST Act. This means that ITC is explicitly allowed only on the basis of tax invoices issued under Section 31 of the CGST Act. Rule 36 of the Rules reinforces this: credit can be availed “on the basis of any of the following documents, namely – (a) an invoice issued by the supplier… in accordance with the provisions of section 31”. However, Rule 36 of the CGST Rules does not list ‘shipping bill’ as a requisite document to avail ITC.
Section 16 of the CGST Act thus makes a tax invoice (and its return-reporting) the gateway to credit. Section 16(3) of the IGST Act then provides that a LUT-based exporter is entitled to refund of unutilized ITC on exports without payment of tax, “in accordance with the provisions of section 54” of the CGST Act. Meanwhile, Section 54(3) of the CGST Act expressly permits refund of accumulated ITC only in the case of zero-rated supplies made without payment of tax. CBIC’s refund master circulars also rely on invoices only to calculate the amount of ITC the assess can rightfully avail. For example, the Master Refund Circular (Circular No.125/44/2019-GST) recognized that ITC refunds must be tied to invoices reflected in the tax returns. Furthermore, Circular 147/03/2021-GST (Mar 2021) further bases the refund of ITC based on invoice only. Deeming export suppliers or recipients, it requires an undertaking that “refund has been claimed only for those invoices which have been detailed in statement 5B for the tax period for which refund is being claimed…”. This again ties the refund to the particular invoice numbers listed in the return.
Thus, by design, the parent act, i.e, the CGST Act channels export refunds through the ITC already recorded on supplier invoices, and not through the shipping bill. Hence, such refund valuation must be based only on the value from the invoice, and not that of the sole component of the shipping bill, i.e, FOB. Hence, in practice, the shipping bill triggers the refund process, but it does not record input credits.
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The case of Cost, Insurance, Freight (‘CIF’) Contracts and the intention of ‘full refund’
In CIF contracts, the invoice includes freight and insurance up to the buyer’s port. However, according to the Explanation, the refund would be calculated on the ‘lesser’ of a FOB value in the shipping bill or the value in the tax invoice. Now, in cases where the CIF Contract is present, invoice is generally greater than the FOB. This means an exporter on CIF terms, whose IGST paid was on the higher invoice price, might get a refund only on the lower FOB amount. This effectively forfeits the refund on the taxes paid against the CIF services, despite these services also being in furtherance of the export only.
However, under CGST Act, such incidental charges are part of the transaction value. Section 15(1) of the CGST Act defines value as the price “actually paid or payable,” and Section 15(2)(c) explicitly includes “incidental expenses charged by the supplier… before delivery” (such as freight and insurance). Also, considering the fact that the CIF contract is a composite supply, an invoice in a CIF export includes freight and insurance, and the seller pays input tax on the entire CIF value also.
At the same time, Section 54 of the CGST Act mandates that tax paid on exported goods must be refunded to the exporter. The whole zero‐rating scheme is premised on exports being tax-neutral, i.e. full refund so that exporter bears no net GST. In particular, Section 54(8)(a) of the CGST Act provides that refund “shall be paid to the applicant” if it relates to “tax paid on export of goods … or inputs or input services used in making such exports”.
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Relying on the principles laid down in Tonbo Imaging
Prior to Notification No. 16/2020 (‘2020 Notification’), the “turnover of zero‐rated supply of goods” meant simply the actual export value under bond/LUT. In March 2020, the 2020 Notification substituted Rule 89(4C) of the Rules to add a cap: turnover would be the lower of (a) the actual export value, or (b) 1.5× the value of “like” goods sold domestically by the supplier (or a similar supplier). This 1.5× restriction was intended to limit over-invoicing. However, this amendment was challenged in M/s Tonbo Imaging India Pvt. Ltd. v. UOI. The Karnataka High Court struck down this amendment. The HC held that tying refunds to a domestic sales cap had no basis in the CGST Act and refund policy for zero-rated supply. The Court noted that Section 16(3) the IGST Act and Section 54 the CGST Act allow full refund of ITC on exports, so the Rule’s arbitrary 1.5× cap was ultra vires to the four-bounds of the parent legislation. Following the Tonbo Imaging, the Delhi High Court in Indian Herbal Store Pvt. Ltd. v. UOI similarly refused to apply the 1.5× rule to past periods, and also quashed its retrospective application.
Applying the principles held in the Tanbo Imaging –
- Intention of the legislature under Section 16 of the CGST Act is evident, as Section 16(1)(a) of the IGST Act export is a “zero-rated service”, and Section 16(2) of the IGST Act says that an input tax credit can be availed on the same. Further, Section 54(3) of the CGST Act provides that a registered person can claim unutilised ITC. The Court held that the very intention to make exports as zero-rated is to make entire supply chain of export as zero-rated by exempting the exporter from both, the input and the output tax.
- The Karnataka High Court held that Rule 89(4C) of the Rules is a machinery provision governing refund procedure, which cannot override substantive rights under Section 54 of the CGST Act and Section 16 of the IGST Act. The Explanation to Rule 89(4) performs the same function. Yet, by capping export turnover to the lower of invoice or FOB value, it effectively reduces the amount of ITC refundable. The Court made clear that procedural rules must facilitate, not subtract from, statutory entitlements.
- The Hon’ble High Court also reaffirmed that exports must be fully tax-neutral. Under that logic, any rule that denies full ITC refund directly contradicts the objective of zero‑rating.
By tying refunds to FOB value, which excludes insurance and freight, the Explanation denies CIF exporters the refund on tax paid for those essential services. This runs counter to Section 54(8)(a) of the CGST Act, which explicitly mandates refund of tax paid on “export of goods or services … or on inputs or input services used in such exports.”
Conclusion
The Explanation to Rule 89(4) of the CGST Rules has implications for exporters, especially those involving in CIF contracts. It creates a difference between the tax actually paid and the refund allowed, burden of whom is borne by the exporter. Exporters may pay input tax on the full invoice value, which includes freight and insurance, but receive refunds limited to the lower FOB value captured in the shipping bill. This leads to under-refunding of eligible input tax credit. This undermines the GST regime’s core objective of tax neutrality on exports. Moreover, it sets a substantive cap, which is nowhere found in the parent legislature, and thus ultra vires the CGST Act.
If the Jharkhand High Court strikes down the Explanation, the change will be industry‐wide. Exporters under CIF contracts would be legally entitled to the claim full refunds on the tax invoice value. For sectors with high freight and insurance components, such as heavy engineering, bulk commodities, and high‐value machinery, this could significantly enhance competitiveness in global markets and further boost exports from India.
To address this inconsistency, a legislative amendment is needed to amend the Explanation clause, and align the same with the CGST Act based on the principles of tax neutrality in export cases. However, till the Jharkhand High Court decides on the issue of ultra vires nature of the provision, the exporters may consider structuring the contracts to minimise the gap between invoice and FOB values, and maintain detailed records linking all incidental export costs to input tax credit cases. This may help to reduce the adverse impact of current regulatory ambiguity.