GST Rate Rationalization 2025: How Lower Output Tax Rates Are Trapping Manufacturers in an Inverted Duty Spiral

The Paradox Hidden Inside a Rate Cut

When the government reduces GST rates, the natural assumption is that everyone in the supply chain benefits. Consumers pay less. Demand rises. Business improves. But for a specific and sizeable group of manufacturers across India, the September 2025 rate rationalization has produced the opposite outcome — lower output rates have created a structural mismatch with unchanged input tax rates, resulting in accumulating credit that cannot be utilized and working capital that sits frozen inside an electronic ledger.

Consider the situation of Mr. Sharma, who operates a corrugated packaging unit on the outskirts of a Tier-2 industrial town. His business spans over two decades, handles clients ranging from food processors to pharmaceutical packaging companies, and generates an annual turnover of approximately ₹8.5 crore. He files returns on time and has a clean compliance record.

On 22 September 2025, the revised GST rates took effect. The output rate on corrugated boxes under HSN 4819 fell from 12% to 5%. His buyers were delighted. Fresh purchase orders followed almost immediately. What Mr. Sharma had not fully anticipated, however, was that the kraft paper he procures — HSN 4804 — remained taxed at 18%. Within two months of the rate change, his electronic credit ledger had accumulated over ₹15 lakh in unutilised Input Tax Credit (ITC). By the end of the December quarter, the figure had crossed ₹27 lakh.

This is the structural reality now confronting thousands of manufacturers across pharmaceuticals, food processing, packaging, electric vehicles, handicrafts, and agricultural equipment. The customer received the benefit of rationalization. The manufacturer received the invoice.

The 56th GST Council and What Changed on 22 September 2025

Background to the Restructuring

The 56th GST Council Meeting, held on 3 September 2025, approved a significant restructuring of the GST rate framework. The existing four-tier structure — comprising slabs of 5%, 12%, 18%, and 28% — was compressed into a leaner two-rate system of 5% and 18%, with a retained 40% slab applicable to luxury and demerit goods.

The changes were formally operationalized through:

• Notification No. 09/2025-Central Tax (Rate) dated 17 September 2025 — governing goods
• Notification No. 13/2025-Central Tax (Rate) dated 17 September 2025 — governing handicrafts

Both notifications came into force on 22 September 2025.

The Three Stated Objectives

The Council articulated three principal goals behind the restructuring:

1. Correcting long-standing inverted duty structures inherited from the original GST framework
2. Resolving classification disputes arising from the proliferation of rate slabs
3. Providing greater rate predictability for businesses and consumers

Where the Reform Delivered

In several sectors, the rationalization achieved precisely what was intended:

• Man-made fibres and yarns (HSN 5402, 5503, 5509): Rates reduced from 12–18% to 5%, ending a multi-year inversion that had plagued the synthetic textile chain since GST's inception in 2017
• Fertiliser inputs including ammonia, sulphuric acid, and nitric acid: Reduced from 18% to 5%, resolving one of the most persistent IDS grievances in the agricultural inputs sector
• Consumer goods including soaps, shampoos, packaged foods, two-wheelers, medicines, cement, and dairy products: All moved to the 5% slab, delivering immediate price relief to end consumers

These corrections represent genuine policy wins and must be acknowledged alongside the new complications the restructuring has introduced.

Where New Inversions Were Created

However, wherever the Council aggressively cut output rates without simultaneously reducing the entire upstream input chain, new inverted duty structures have emerged or existing ones have been intensified. The arithmetic is straightforward: if an assessee pays 18% GST on inputs but collects only 5% GST on outputs, the tax paid exceeds the tax collected. The resulting credit accumulates in the electronic credit ledger and cannot be discharged against output liability — because the output liability itself is insufficient to absorb it.

Sectors Affected by Inverted Duty Structure Post-22 September 2025

The following sectors now face structurally inverted tax chains under Notifications 09/2025-CTR and 13/2025-CTR: