ITC Refund on Zero-Rated Supplies Under GST: A Guide

Exempt Yet Refundable: ITC Refund on Zero-Rated Supplies Under GST

Page Contents

Under GST, exporters and suppliers to SEZs are often surprised to learn that they can claim a refund of unutilised Input Tax Credit (ITC) even when their outward supplies are exempt in the domestic market. This benefit flows from the special treatment given to zero-rated supplies under the IGST Act, read with section 54 of the CGST Act, and has been clarified through law, departmental guidance and case-based illustrations.

Understanding Zero-Rated vs Exempt Supplies

What is a zero-rated supply?

Section 16 of the IGST Act defines zero-rated supplies to include:

Export of goods
Export of services
Supplies to SEZ units or developers for authorised operations

In the case of zero-rated supplies, the output is taxed at a rate of 0%, but the supplier is still entitled to take ITC of eligible input and input service taxes and claim refund of such unutilised ITC under section 54(3) of the CGST Act, subject to the prescribed conditions and formula.[1][2][3][4][7]

How are exempt supplies different?

Exempt supplies are those on which no GST is charged and for which ITC relating to inputs and input services used exclusively for such exempt supplies is not available. Further, common credits attributable to exempt supplies must be reversed under Rule 42/43 of the CGST Rules.

However, there is a crucial distinction: while ITC is generally restricted for exempt supplies, zero-rated supplies are not treated as exempt for ITC purposes. Therefore, exports and SEZ supplies may still allow refund of accumulated ITC even if the same goods or services are exempt when supplied within India.[1][2]

Legal Framework for ITC Refund on Zero-Rated Supplies

Key statutory provisions

Section 16 of the IGST Act: Treats exports and supplies to SEZ as zero-rated and allows ITC on inputs and input services used in making such supplies, notwithstanding that such supplies may otherwise be exempt, subject only to blocked credit provisions under section 17(5) of the CGST Act.[1][2][7]
Section 54(3) of the CGST Act: Permits refund of unutilised ITC in two broad cases: (a) zero-rated supplies made without payment of tax and (b) inverted duty structure, subject to certain restrictions (such as no refund where exported goods are subjected to export duty).[3][4]
Rule 89(4) of the CGST Rules: Prescribes the formula for refund of unutilised ITC on account of zero-rated supplies without payment of tax.[3][4]

Formula for refund of unutilised ITC

Where zero-rated supplies are made without payment of IGST under a Bond or Letter of Undertaking (LUT), the maximum refund of unutilised ITC is computed as:[2][3][4]

Refund Amount = (Turnover of zero-rated supply of goods + Turnover of zero-rated supply of services) × Net ITC ÷ Adjusted Total Turnover

Turnover of zero-rated supply: Value of exports and supplies to SEZ made without payment of tax during the relevant period.
Net ITC: Input tax credit availed on inputs and input services during the relevant period, excluding blocked credits.
Adjusted Total Turnover: As defined in the rules, broadly including all taxable and zero-rated turnover, with specified exclusions.

Blocked credits and restrictions

Even in the context of zero-rated supplies, ITC is not available on items blocked under section 17(5) of the CGST Act (such as motor vehicles for personal use, certain works contract services, etc.). Only eligible ITC, after excluding blocked credits and reversals related to domestic exempt supplies, can be refunded.[1][2]

Exempt Yet Refundable: Practical Illustrations

Illustration 1 – Export of domestically exempt goods (e.g., fresh fruits)

Consider an exporter engaged in supply of fresh fruits. Domestically, these fruits are exempt from GST by a rate notification, so if sold within India, no output tax is charged and ITC attributable to exempt domestic supplies would have to be reversed.

Now assume the same fresh fruits are exported without payment of IGST under LUT. For such exports:

The outward supply qualifies as a zero-rated export, not as an exempt supply, for ITC purposes.
ITC related to inputs and input services used in exported fruits is fully eligible, subject to section 17(5).
Common ITC attributable to domestic exempt turnover is reversed under Rule 42, but ITC relatable to export turnover remains in the electronic credit ledger as eligible.
Refund of unutilised eligible ITC is allowed under the proviso to section 54(3), computed using the zero-rated formula, even though the underlying goods are exempt for domestic transactions.[1]

The article illustrates this with figures, where only the portion of ITC qualifying as eligible (after excluding blocked credits) is refunded, while blocked credits remain permanently ineligible for both credit and refund.[1]

Illustration 2 – Zero-rated supplies to SEZ where similar domestic supplies are exempt

Now consider a supplier making exempt supplies in the domestic tariff area and also supplying the same goods to an SEZ unit for authorised operations, without payment of tax under LUT.

Supplies to SEZ qualify as zero-rated supplies, even if the same goods are exempt when supplied domestically.[1][7]
ITC exclusively attributable to SEZ supplies is eligible and can form part of Net ITC for refund.
Common ITC is apportioned: the portion relatable to domestic exempt turnover is reversed; the portion relatable to SEZ zero-rated turnover is retained and can be refunded as unutilised ITC.[1]
The supplier can thus enjoy a refund of unutilised ITC linked to SEZ supplies, effectively making such supplies tax-free in the value chain.

Why zero-rated exports are not treated as exempt for ITC purposes

The combined reading of section 16(2) of the IGST Act and section 54(3) of the CGST Act makes it clear that Parliament intended to give a full ITC and refund benefit to zero-rated supplies, notwithstanding any exemption status of such goods/services in the domestic market.[1][2][7]

Accordingly:

Export turnover is treated as zero-rated, not exempt, in the Rule 42/43 computation.
ITC relating to zero-rated exports/SEZ supplies is not hit by the bar on credits for exempt supplies.
The only substantive restrictions are blocked credit under section 17(5) and specific prohibitions such as no refund where the exported goods are subjected to export duty.[3][4][7]

Compliance, Documentation and Practical Tips

Choosing the refund route

A registered person making zero-rated supplies has two broad options:[2][3][4][6][7]

Export / supply to SEZ with payment of IGST and claim refund of the tax so paid.
Export / supply to SEZ without payment of IGST under Bond/LUT and claim refund of unutilised ITC.

Where domestic outward supplies are largely exempt and significant ITC accumulation occurs on inputs and input services used for exports/SEZ supplies, the LUT route with ITC refund often gives better cash-flow efficiency.

Key procedural points

File refund application in FORM GST RFD-01 on the GST portal for refund of unutilised ITC on zero-rated supplies without payment of tax.[3][4][5]
Provide details of turnover of zero-rated supplies and adjusted total turnover for the relevant period, and ensure consistency with GSTR-1 and GSTR-3B.[3][4][5]
Maintain documentary evidence such as tax invoices, shipping bills, LUT/Bond, SEZ endorsements and declarations that the incidence of tax has not been passed on to any other person (unjust enrichment).[3][4][5]
Segregate and track eligible vs blocked credits and ensure proper reversal for domestic exempt supplies to avoid disputes during refund scrutiny.

For businesses dealing in goods or services that are exempt domestically but exported or supplied to SEZs, this nuanced distinction between exempt and zero-rated supplies can unlock substantial cash-flow benefits through ITC refunds, provided the legal conditions, documentation and computations are correctly handled.