New Delhi, May 14: India’s small businesses are facing a compounding crisis. While global markets reel from West Asia disruptions and the Prime Minister calls on the nation to practise economic prudence, a structural flaw in the Goods and Services Tax (GST) framework is quietly draining the working capital of millions of small sellers and manufacturers across the country.
The Inverted Duty Structure (IDS) – a condition where the tax rate on inputs is higher than the tax rate on finished goods – is systematically trapping billions of rupees in unrefunded Input Tax Credits (ITC), creating a liquidity crisis that no amount of operational efficiency can overcome. Empower India, a public policy think tank, is urging the GST Council to act at the earliest opportunity to correct this structural distortion.
The Numbers: What the Data Shows
The financial toll is no longer theoretical. Data from multiple independent sources points to a systemic crisis:
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13% of working capital locked for months: Manufacturers purchasing raw materials at 18% GST and selling finished goods at 5% face a persistent tax gap recoverable only through government refunds – refunds that routinely take months despite the promised 30-day timeline.
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₹30 lakh crore MSME credit gap: India’s MSME sector, contributing 30% of GDP and employing over 110 million people, faces an estimated ₹30 lakh crore credit gap, compounded by blocked ITC and delayed refunds.
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GST 2.0 deepened the problem: The September 2025 rate rationalisation, while simplifying slabs, has intensified inverted duty structures in food processing, FMCG, and pharmaceuticals, creating fresh backlogs of unusable credits.
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Billions trapped in unrefunded ITC: Across sectors, the IDS forces SMEs to absorb costs or pass them on to consumers, creating a systemic liquidity crisis that undermines competitiveness.
Speaking on this, Mr. K. Giri, Director General, Empower India, said,
“India’s small businesses are the backbone of our economy – and they are being slowly asphyxiated by a tax structure that punishes production. In a world already destabilised by the West Asia crisis, with supply chains under pressure and input costs rising, the burden of trapped ITC is not a bureaucratic inconvenience: it is an existential threat. The Prime Minister himself has asked the nation to be prudent with every rupee. Fixing the Inverted Duty Structure is exactly that kind of prudence – it returns capital to the hands of those who create jobs and drive growth. Every month of inaction is a month stolen from India’s small sellers.”
Where the Inversion is Most Acute
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Food Processing: Finished products taxed at 5%; packaging, cold storage, and logistics services attract 18% GST. The 2025 rate rationalisation has shifted more products to the 5% slab, deepening the inversion.
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E-Commerce Sellers: Over 1.4 million small sellers on marketplace platforms bear 18% GST on platform fees, logistics and packaging, while many product categories (garments, food, handicrafts) are taxed at 5%. The asymmetry is structurally embedded in the e-commerce cost model.
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Renewable Energy: Solar and wind components carry a 5% output rate while steel, glass, and engineering services remain at 18%, directly adding to the cost of India’s energy transition.
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Pharmaceuticals & FMCG: Pharmexcil (May 2026) has warned of reduced manufacturing capacity, supply disruptions, and employment instability following post-GST 2.0 inversions in the sector.
The Structural Flaw
Under Section 54(3) of the CGST Act, ITC refunds are permissible only where inversion is attributable to inputs (goods). Input services and capital goods – which form a growing share of costs in services-intensive industries, particularly e-commerce and food processing – are excluded from the refund scope. This exclusion significantly limits the efficacy of the relief mechanism.
A small seller on an e-commerce marketplace paying 18% GST on platform fees, logistics, and packaging while selling garments or food items at 5% faces a permanent 13-percentage-point cost disadvantage. No amount of operational efficiency bridges this gap.
Empower India’s Recommendations to the GST Council
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Broaden ITC refund scope to include input services and capital goods, not only inputs (goods).
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Redefine ‘Net ITC’ to reflect the full spectrum of input costs, delivering meaningful and complete relief rather than partial mitigation.
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Rationalise GST rates to correct structural inversions deepened by the September 2025 reforms, particularly in food processing, FMCG, and pharmaceuticals.
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Streamline and expedite refunds for MSMEs through automated processing and reduced procedural burdens to improve working capital access.
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Establish an IDS monitoring mechanism to identify and flag emerging inversions before they accumulate into systemic crises.
The Urgency
This is not a policy inconvenience. It is an economic emergency. Every month of inaction means more working capital trapped, more small factories shutting down, more sellers exiting the formal economy. In manufacturing clusters across Punjab, Maharashtra, and Gujarat, small units are forced to halt operations periodically because working capital is tied up in unrefunded ITC claims.
India cannot build a $5 trillion economy on the backs of broken small businesses. The GST was designed to liberate commerce, not strangle it. The Inverted Duty Structure represents an unfinished reform that demands urgent completion.
Empower India urges the GST Council to take corrective action at its next meeting. The cost of delay is measured not in policy papers – but in shuttered factories and lost livelihoods.
