GST 2.0 cut tax clutter. Now comes the harder fix

The Goods and Services Tax (GST) Council is set to convene next week, in the wake of a year-long break. It is anticipated that the reform efforts initiated through GST 2.0, which reduced the number of GST rates to 5% and 18% slabs, and nearly all items of common consumption to a 5% slab, will be further pursued. This has led to a boost in aggregate economic demand, as supported by surveys conducted by KPMG and Deloitte.

Initial concerns regarding revenue loss due to the drop in demand have apparently been alleviated. Following a dip in growth rates of monthly GST collections in Q3 FY26 (except for May 2026), growth rates have since been above 7.5%, peaking at 15.8% in July. Net revenue collections (cumulatively from the Centre and states) from GST grew by 9.2% during April-July 2026, compared to the same period in FY26.

Experts involved in the surveys emphasized the need for additional structural and procedural reforms, particularly in the area of input tax credit (ITC). In an ideal VAT system, taxes paid on supplies at the previous stage of the value chain can be set off against liability at each successive stage, minimizing tax burden to the end consumer.

However, blockages in the flow of ITC result in 'cascading' costs for businesses, causing an increase in prices and disadvantaging domestically-supplied goods and services against imports.

Accumulation of ITC stems from rate inversions in input goods, input services, and capital goods, with output supplies such as food products taxed at the lower rate of 5%, while input goods and services are taxed at the standard rate of 18%. This sharp 13 percentage point differential makes it challenging for ITC to be fully absorbed through value addition.

While refund of accumulated ITC is available for rate inversion between input and output supplies of goods, it's not applicable to services, and there is no solution for accumulated ITC resulting from inversions in rates between input services and capital goods as output supplies.

A permanent solution could involve transitioning to a single-rate structure, although implementing such a change immediately may be unrealistic. In the interim, the GST Council should broaden the scope of inversion duty structure (IDS) refunds to include capital goods and services, with a gradual expansion of this relief mechanism.