How the recent GST reforms have added to the burden of MSMEs by creating an inverted duty structure in some segments

Tarun Goyal Manufactures aluminium cookware in Jagadhri, Haryana. He has mixed views about the recent changes to the Goods and Services Tax (GST). A lower tax on utensils under GST 2.0 is expected to result in an increase in sales during this festive season. The GST rate on utensils has been lowered to 5% from 12%. However, he will now have to contend with the new problem of inverted duty, which has already begun choking the working capital pipeline. “So, the raw material for my product continues to be taxed at 18% while the finished product has been brought to the 5% slab. If I buy aluminium scrap at Rs 200 per kg, I must pay Rs 36 per kg as GST. But if I sell utensils at Rs 280 per kg, I can only charge 5% GST, which comes to Rs 14. This leaves me short by Rs 12 per kg, an amount I then have to claim as a tax refund. This refund takes a long time,” says Goyal. At its 56th meeting, the GST Council reduced rates on 453 goods, with nearly 295 items shifting from the 12% tax slab to the 5% or 0% categories. Additionally, several products that were previously taxed at 28% are now subject to an 18% rate. There are now two main slabs, 5% and 18%, along with a higher rate of 40%. The 12% and 28% slabs, as well as the compensation cess, which was levied to compensate states for the loss of revenue after GST subsumed value-added taxes that states levied, will go away. The 0% rate and marginal tax rates for several items continue. Goyal estimates that about 10% working capital will be held up every month due to the inverted duty structure, and he would have to take on more debt, which would be expensive (anywhere between 9-12% rate of interest). As per a survey by SIDBI in May 2025, the MSME sector has an addressable credit gap of about 24% or Rs 30 lakh crore. “The gap is higher in the services sector at 27%; it is estimated to be also higher at 35% for women-owned MSMEs, indicating a need for targeted policy actions.” The survey also said that timely and adequate credit access was one of the key challenges despite the comprehensive policy initiatives in that regard. While borrowings from informal sources are minimal for small and medium enterprises at 3% and 2%, respectively, they are relatively significant at 12% for micro enterprises. Raj Kamal Jindal, Proprietor, Cargo International PackagingsGoyal is reluctant to divulge his annual turnover but says if he produces 100 tonnes of finished material in a month, at Rs 1,200 per tonne, the refund amount is Rs 12 lakh, which could be held up with the government. Sonepat-based Raj Kamal Jindal faces a similar predicament. His company, Cargo International Packagings, has been supplying corrugated boxes used in packaging to Amazon, PepsiCo and Britannia Industries. Jindal says raw materials, including kraft paper and corrugated paper boards, were at the 12% rate earlier but have been moved to the 18% slab. Simultaneously, the finished product has been moved from 12% to 5%, thereby creating a 13% differential which has to be claimed as a refund, blocking precious working capital. Goyal and Jindal are just two examples of the pain GST 2.0 has unleashed for India’s micro, small and medium enterprises (MSMEs). Makers of bells and gongs, steel products, tractors and their parts and even sewing machines are facing similar problems due to inverted duties after the government decided to scrap the 12% and 28% slabs under GST 2.0. Many daily-use items and some aspirational products have moved to lower tax slabs, thus making them cheaper for the end consumer. This is widely expected to lead to an overall consumption boom and boost the economy. Finance Minister Nirmala Sitharaman has said that GST rate rationalisation will lead to a consumption boost of Rs 2 lakh crore. But manufacturers say that for items where the input is now taxed more than the finished product, another reform is required. The problem of such MSMEs may be partially addressed if they get refunds of excess tax paid within seven to ten days. In the earlier GST regime, refunds sometimes took nearly 90 days, with another MSME sector representative pointing out that the delays were greater at the state government level. A provision in GST 2.0 may help cut down refund delays, says Vivek Jalan, Partner at Tax Connect Advisory Services. “Under GST 2.0, there is a new amendment for sanctioning 90% of the refund amount within one week. This rule was always there but was rarely followed, with concerned officers taking their own sweet time, and sometimes refunds took 60 days to be processed. But now, the government has mandated that if the provisional refund is not issued within seven days, the officers must give a reason. This means lots of working capital for MSMEs will not remain stuck,” Jalan says. Whether the provision is actually practised remains to be seen. The Chairman of the Banking and Finance Committee of the Federation of Indian Micro &amp; Small &amp; Medium Enterprises (FISME), Neeraj Kedia, has written to Sitharaman on ways to address the inverted duty structure. He has suggested a mechanism to make refunds time-bound and automatic (he has drawn a parallel with personal income tax refunds, which are now processed within days) and a new grievance redressal mechanism for small businesses. Further, Kedia has suggested that input items at 18% used in manufacturing of items in the 5% rate bracket be moved to a new concessional rate of 8%. He has given the example of a mechanism currently available to exporters, wherein they are “permitted to source goods at 0.1% GST against specified formalities.” The inverted duty structure may be riling up MSMEs, but some other provisions under the new regime have brought them cheer. One relates to easing the process of registration of small units under the GST regime. MSMEs usually look for a tie-up with the big e-commerce players, such as Flipkart and Amazon, among others, to expand their geographical reach. It was tough to do so earlier, since getting small units registered under GST could take anywhere up to 100 days. Under the new regime, the registration can be done in just three days, as long as the GST value of goods sold is up to Rs 2.5 lakh per month. While this excludes medium enterprises (since their turnover is higher), those classified as micro and small stand to benefit. The Co-Chairman of CII’s National MSME Council, M Ponnuswami, welcomes this provision, saying it will encourage greater participation of MSMEs in the formal economy. Many household consumption items like paneer (cottage cheese), pizza bread, khakhra, ultra-heat-treated milk, have been totally exempted from GST. This will help units selling only exempted items—many of them dealing in agricultural products—since they no longer need to be registered under the GST mechanism. Ajay Srivastava, Founder, Global Trade Research Initiative (GRTI)GST 2.0 is a mixed bag for MSMEs, with an inverted duty structure making working capital scarce, but some other provisions easing compliance for these small units. To make the MSME sector growth more robust, Ajay Srivastava, founder of the Global Trade Research Initiative (GRTI), suggests that 99% of small businesses should be freed from all compliance burden whatsoever by raising the exemption limit to Rs 1.5 crore. “The GST data shows that of the total 14 million registrations, firms with less than Rs 1.5 crore annual turnover account for 84% of total registrations but contribute less than 7% of the tax collected,” Srivastava says. Currently, registration for GST is optional for firms with an annual turnover of less than Rs 40 lakh for goods and Rs 20 lakh for services. According to him, if the exemption limit is increased to Rs 1.5 crore for goods and services, it would amount to Rs 12-13 lakh monthly turnover, which at 10% of profit margin would translate to just Rs 1.2 lakh. “Only a fraction of this money will remain with the business owner after payment of working capital and fixed expenses,” he says.

How the recent GST reforms have added to the burden of MSMEs by creating an inverted duty structure in some segments

The recent GST reforms have been a mixed bag for India's MSMEs, easing some compliances but also adding to their burden by creating an inverted duty structure in some segments