Policy Update
Ritobrata Purkayastha
Background
The rollout of the Goods and Services Tax (GST) in July 2017 marked the most extensive structural overhaul of India’s fiscal federalism, subsuming 17 distinct central and state levies along with 13 cesses into a single indirect taxation architecture. Designed to eliminate the cascading tax-on-tax effect, establish a unified national market, and accelerate economic formalization, the original GST regime was constructed around a four-tier rate structure comprising 5%, 12%, 18%, and 28% tax slabs, supplemented by special reduced rates for precious metals and an additional Compensation Cess on select luxury and sin goods. While this multi-tiered framework was politically essential at inception to achieve revenue neutrality and protect low-income consumption, over time it introduced operational frictions, tax classification disputes, and severe structural distortions.
To address these systemic vulnerabilities, the GST Council, during its 56th meeting, approved a comprehensive rate rationalization framework transitioning the country toward a simplified, citizen-friendly tax structure. Effective September 22, 2025, the framework collapsed the traditional four-slab structure into a streamlined two-rate architecture consisting of a Merit Rate of 5% for mass-consumption essentials and a Standard Rate of 18% covering the majority of industrial and commercial goods. A specialized De-Merit Rate of 40% was preserved strictly for a restricted list of luxury and sin items, including pan masala, tobacco products, and aerated beverages.
This rationalization directly targets two long-standing structural weaknesses within India’s indirect tax system: the systemic accumulation of unutilized tax credits caused by Inverted Duty Structures (IDS), and widespread revenue leakage resulting from fraudulent Input Tax Credit (ITC) networks. By aligning input and output tax rates across major domestic value chains and deploying enhanced digital intelligence tools, the reform framework aims to improve tax compliance, relieve working capital blockages for domestic manufacturers, and maximize structural revenue efficiency.
Functioning
The operational mechanics of the rationalized GST framework depend on the structural alignment of value-chain tax rates, automated credit matching, and intelligence-led enforcement. The primary structural defect of the legacy framework was the Inverted Duty Structure (IDS), a situation where raw materials and intermediate inputs were taxed at higher rates than finished final products. Under Section 54(3) of the Central Goods and Services Tax (CGST) Act, 2017, businesses operating under an inverted structure are legally entitled to claim cash refunds for unutilized accumulated credit. However, this credit buildup created persistent working capital blockages for micro, small, and medium enterprises (MSMEs), burdened tax authorities with audit verifications, and created avenues for fake refund claims.
Under the revised framework, rate inversions have been systematically corrected across critical manufacturing sectors by reducing input tax rates to match or fall below output rates. In the man-made textile sector, the tax rate on Man-Made Fibre (MMF) was reduced from 18% to 5%, and Man-Made Yarn (MMY) was lowered from 12% to 5%, aligning raw material taxation directly with the 5% slab applied to readymade apparel priced up to ₹2,500. Similar structural rate alignments were implemented across the agriculture and renewable energy sectors, where GST on intermediate chemical inputs—including sulphuric acid, nitric acid, and ammonia—was cut from 18% to 5%.
Concurrently, the administrative mechanism for safeguarding the ITC ecosystem relies on coordinated intelligence operations led by the Directorate General of GST Intelligence (DGGI) and state enforcement divisions. Tax authorities employ the Business Intelligence and Fraud Analytics (BIFA) platform, an enterprise data engine that processes billions of GSTN transaction points to uncover suspicious billing clusters, circular trading loops, and high-risk taxpayer profiles.
To counter fake billing rackets—where dummy entities issue tax invoices without actual movement of goods to pass on inadmissible credit—the system automatically cross-matches GSTR-1 outward supply filings, GSTR-3B monthly summary returns, and real-time E-Way Bill generation data. For high-risk transactions, automated risk engines flag discrepancies between physical transit records and electronic tax invoices. Gatekeeping at entry has been fortified by mandating biometric Aadhaar authentication at GST Seva Kendras for new applicants, combined with mandatory physical site verifications of declared business premises within 30 days of registration. Legally, fake invoice issuance or fraudulent ITC utilization exceeding ₹5 crore is classified under Section 132(1)(b) and (c) of the CGST Act as a cognizable and non-bailable offence, carrying statutory penalties of up to five years imprisonment alongside monetary fines.
Performance
An evaluation of tax performance over recent financial years demonstrates sustained growth in gross revenue collections alongside an increase in administrative detections of illicit credit networks. In Financial Year 2024-25, gross annual GST collections reached an all-time peak of ₹22.08 lakh crore, marking a year-on-year growth of 9.4% and an average monthly collection of ₹1.84 lakh crore. Monthly revenue highlights included a record single-month collection of ₹2.36 lakh crore in April 2025. Following the rollout of the rationalized two-rate structure in late September 2025, gross monthly GST revenue for October 2025 reached ₹1,95,936 crore, representing a 4.6% increase over the corresponding period in the previous year.
Major industrial and consumption states—specifically Maharashtra, Karnataka, Gujarat, Tamil Nadu, and Haryana—generated over 40% of national domestic collections, reflecting strong tax buoyancy across manufacturing and service hubs. The table below outlines key structural rate rationalization adjustments across major economic sectors.
| Sector / Product Category | Legacy GST Rate | Rationalized GST Rate | Structural Objective / Rationale |
| Man-Made Fibres (MMF) | 18% | 5% | Eliminates Inverted Duty Structure; aligns raw fibre with apparel rates |
| Man-Made Yarns (MMY) | 12% | 5% | Resolves credit blockage for synthetic textile SMEs |
| Readymade Garments (up to ₹2,500) | 5% (up to ₹1,000) | 5% (limit raised) | Expands affordable apparel threshold; boosts domestic consumption |
| Fertilizer Inputs (Ammonia, Acids) | 18% | 5% | Corrects input rate inversion; lowers agricultural production costs |
| Commercial Goods Vehicles / Trucks | 28% | 18% | Lowers logistics costs across 65-70% of national freight movement |
| Cement & Construction Materials | 28% | 18% | Lowers residential construction costs; accelerates housing investment |
| Small Cars & Motorcycles (≤350cc) | 28% | 18% | Enhances middle-class mobility; supports automotive manufacturing |
| Life-Saving & Cancer Medicines | 5% / 12% | Nil / 5% | Enhances healthcare affordability across 33 critical drug types |
| Educational Supplies (Pencils, Books) | 5% / 12% | Nil | Eliminates taxation on essential learning materials for students |
Parallel to overall revenue expansion, administrative detection of Input Tax Credit fraud rose significantly. Data presented in Parliament indicates that CGST enforcement formations detected 30,162 cases of fake ITC claims in FY 2025-26, involving fraudulent credit valuations totaling ₹74,782 crore. This represents a near-doubling of detected case volumes compared to FY 2024-25. The trajectory of fake ITC fraud detection over the past three financial years is summarized below.
| Enforcement Metric / Financial Year | FY 2023-24 | FY 2024-25 | FY 2025-26 |
| Total ITC Fraud Cases Detected | 9,190 cases | 15,283 cases | 30,162 cases |
| Quantum of Fraudulent ITC Detected | ₹36,373 crore | ₹58,773 crore | ₹74,782 crore |
| Growth in Detected Case Volume (YoY) | Baseline | +66.3% | +97.4% |
| Growth in Fraud Value Detected (YoY) | Baseline | +61.6% | +27.2% |
| Primary Enforcement Vector | Paper Invoice Audits | BIFA Network Analytics | Algorithmic Chain Tracing |
This empirical trend indicates that the growth rate of detected case volumes (+97.4% in FY26) outpaced the growth rate of overall fraud value (+27.2%). Rather than catching only large-scale illicit syndicates, enforcement teams are increasingly utilizing automated analytics to identify smaller links, intermediary shell nodes, and downstream beneficiaries within complex, multi-tiered supply chains.
Impact
The rationalization of tax rates and enforcement of credit integrity exert compounding effects across macroeconomic stability, sectoral production, and consumer demand.
From a macroeconomic and compliance perspective, collapsing the rate structure into a standard 18% slab and a merit 5% slab significantly reduces compliance complexity and classification litigation. Taxpayers previously navigated ambiguous legal distinctions between closely related tariff headings—such as varying rates applied to different classes of processed food items, health services, or auto components—which led to litigious classification disputes. Standardizing taxation across entire product categories minimizes administrative litigation, simplifies invoice generation for traders, and streamlines automated audit matching.
Sectorally, the structural correction of the Inverted Duty Structure delivers immediate liquidity relief to labor-intensive manufacturing industries. In the synthetic textile sector, lowering input tax rates on man-made fibres and yarns from 18% and 12% to 5% removes working capital blockages. Manufacturers are no longer forced to deploy capital to absorb unrefunded input taxes or await government refund processing cycles. This improves corporate cash flow, lowers short-term borrowing costs, and enhances export price competitiveness against international peers.
In logistics and transport, cutting GST on commercial goods vehicles from 28% to 18% reduces capital expenditure costs for fleet operators. Because road transport handles 65% to 70% of national freight volume, lower vehicle procurement costs cascade through supply chains, lowering freight rates and overall distribution expenses for industrial goods.
For final consumers, complete tax exemptions on staple foods (UHT milk, paneer, chapati/paratha) combined with the reduction of GST to 5% on everyday household goods (soaps, toothbrushes, bicycles, packaged foods) directly lower cost-of-living pressures. This price moderation supports real disposable income, particularly among rural and middle-income households, sustaining aggregate domestic consumption.
Emerging Issues
Despite the operational improvements driven by tax rationalization, sophisticated tax evasion schemes continue to present systemic challenges to indirect tax administration. Organized fraud syndicates have evolved beyond basic non-supply paper invoicing into multi-layered shell company networks. Layer-1 “generator” entities are established using stolen or borrowed identity documents (KYC) from low-income individuals. Invoices are passed through Layer-2 “intermediary” entities to obscure the audit trail before ultimate utilization by Layer-3 beneficiary companies to offset outward tax liabilities or claim cash refunds on zero-rated export claims under Letter of Undertaking (LUT). Operational investigations have revealed masterminds orchestrating multi-hundred-crore frauds using centralized remote cloud servers, dummy management personnel, and temporary co-working spaces lacking physical business infrastructure.
A major enforcement case in Gurugram uncovered a nexus of 93 non-existent shell entities operated via remote cloud storage, which passed on ₹491 crore in inadmissible ITC without any underlying supply of goods. Similarly, an investigation by the DGGI Ahmedabad Zonal Unit apprehended the mastermind behind an ₹1,825 crore refund fraud scheme centered in Kandla Special Economic Zone (KASEZ). The operators set up dummy firms using borrowed KYCs, generated fake purchase invoices for high-value tobacco products to accumulate artificial ITC, and procured low-grade local tobacco at nominal prices. Misdeclaring the goods as high-value Kimam/Jarda, they executed fictitious zero-rated exports under LUT to siphon accumulated ITC refunds directly from the exchequer.
This sophisticated evasion ecosystem creates legal and operational risks for bona fide taxpayers. Under Section 16(2)(aa) of the CGST Act, a registered taxpayer can only claim ITC if the underlying supplier has validly reported the invoice in their outward supply returns (GSTR-1) and communicated it via GSTR-2B. When upper-tier suppliers commit invoice fraud or collapse after issuing billing documents, enforcement authorities frequently initiate recovery proceedings against honest downstream buyers who paid tax in good faith. This exposes legitimate businesses—particularly MSMEs lacking sophisticated vendor-auditing infrastructure—to retroactive credit denials, legal notices, and working capital disruption.
Furthermore, tax authorities face an operational trade-off between speed and risk control when administering provisional refunds. While Section 54 mandates the grant of 90% provisional refunds within tight timelines to prevent working capital blockages for inverted duty sectors and exporters, automated risk engines must continuously adapt to prevent synthetic export claims from draining public funds prior to physical audit verifications.
Way Forward
To convert rate rationalization into sustained revenue efficiency while protecting compliant businesses, strategic policy interventions are necessary across technology, enforcement, and statutory frameworks.
The GST Network (GSTN) should incorporate real-time dynamic risk flags directly into the GSTR-2B credit auto-population statement. By analyzing parameters such as sudden spikes in turnover, recent updates to bank details, high ratios of credit to cash tax payments, and irregular filing histories, the system can alert purchasing taxpayers to high-risk vendors before payments are settled. This preemptive intelligence framework shifts the compliance burden from post-audit enforcement to real-time preventive detection.
To eliminate shell entity creation at entry, mandatory biometric Aadhaar authentication must be expanded nationwide for all high-risk GST registration applications. Physical verification protocols should be strengthened by integrating AI-driven spatial tools, verified site photographs, and geo-tagged address coordinates to confirm that declared premises possess operational infrastructure appropriate for their reported business volume.
System-driven provisional refunds for zero-rated supplies under LUT must be cross-referenced with electronic customs data (ICEGATE), international banking realization receipts (e-BRC), and E-Way Bill transit analytics. Automated algorithms should flag export refund claims where declared export values deviate significantly from industry benchmarks or where transportation logs reveal doubtful vehicle registration numbers, blocking automated disbursement pending physical inspection.
Because tax evasion networks operate across state boundaries to exploit administrative gaps, joint State-Central Enforcement Taskforces should be established under the DGGI umbrella. Unified access to multi-jurisdictional financial intelligence ensures coordinated intervention against inter-state circular trading networks, preventing administrative arbitrage.
Finally, a statutory safe harbour policy should be introduced to protect compliant businesses from immediate credit blocking or penalty proceedings in cases of upstream vendor defaults. Where a taxpayer presents verifiable proof of actual receipt of goods, valid tax invoice issuance, and bank payment evidence, recovery proceedings should target the defaulting vendor rather than the purchasing buyer. This maintains commercial certainty, protects working capital, and upholds equity within the tax administration.
References
- GST Council Secretariat (Ministry of Finance, Government of India):
- Press Release on Recommendations of the 56th GST Council Meeting (September 2025), detailing the adoption of the two-rate architecture (5% Merit Rate, 18% Standard Rate), the 40% De-Merit Rate, and the correction of Inverted Duty Structures across textiles, fertilizers, and manufacturing.
- Press Information Bureau (PIB), Government of India:
- Next-Gen GST Overhaul: Staple Foods Tax-Free, Processed Foods at 5% – Big Relief for Consumers and Small Businesses (Release ID: 2164586, Sept 2025).
- Factsheet: GST Rate Rationalisation across Textiles, Apparel, and Logistics Sectors (Factsheet ID: 150293), covering MMF/MMY rate adjustments, readymade apparel limits, and commercial goods vehicle rationalization.
- Factsheet & Press Note: GST Reforms for a New Generation (Factsheet ID: 150302 & Note ID: 155151), detailing rate revisions for education supplies, life-saving medicines, consumer durables, auto parts, and daily household items.
2. Parliamentary Reports & Official Statistics
- Rajya Sabha Parliamentary Submission:
- Official response placed before the Rajya Sabha by the Minister of State for Finance, Pankaj Chaudhary (July 28, 2026), providing national enforcement statistics on detected fake Input Tax Credit (ITC) fraud cases and valuations for FY 2023-24, FY 2024-25, and FY 2025-26.
- Directorate General of GST Intelligence (DGGI):
- Annual enforcement metrics and reports on nationwide special drives against fake registrations, automated chain-tracing analytics, and high-value shell company networks.
3. Statutory Legal Framework
- Central Goods and Services Tax (CGST) Act, 2017:
- Section 16(2)(aa): Mandates credit eligibility matching through GSTR-2B communications.
- Section 54(3): Regulates refund claims for accumulated unutilized ITC arising from inverted duty structures and zero-rated exports.
- Section 132(1)(b) & (c): Specifies statutory offences, penal liabilities, and non-bailable prosecution thresholds for fake invoicing and illegal ITC utilization exceeding ₹5 crore.
About the Contributor
Ritobrata Purkayastha is a Research & Editorial Intern at the IMPRI Impact and Policy Research Institute, New Delhi. He is currently pursuing a Bachelor of Science (B.Sc.) in Economics (3rd Year) at XIM University, Bhubaneswar. His research interests encompass monetary econometrics, public policy, and the application of data science and quantitative econometric tools to socio-economic challenges.
Disclaimer
All views expressed in the article belong solely to the author and not necessarily to the organisation.
Read more at IMPRI:
