India is preparing for its most ambitious tax reform since the launch of GST in 2017. Known as GST 2.0, this update, effective 22 September 2025, reduces the number of GST slabs, revises Input Tax Credit (ITC) rules, and adjusts tax burdens across sectors. The reform intends to make GST simpler, encourage compliance, and boost consumption.
While essentials get cheaper, luxury and harmful goods cost more, and businesses must adapt to new compliance demands. A closer look at the ITC framework reveals both opportunities and challenges, shaping how companies balance costs and cash flow in the new era.
Understanding Input Tax Credit (ITC)
Input Tax Credit (ITC) is a mechanism that allows businesses to deduct the GST already paid on inputs (raw materials, services, or capital goods) from the GST payable on final sales. This ensures that tax is collected only on the value added at each stage, preventing cascading taxation.
Example:
A manufacturer buys inputs worth ₹1,00,000 with 18% GST (₹18,000). He sells the finished product for ₹1,50,000 with 18% GST (₹27,000). Instead of paying ₹27,000, he offsets the ₹18,000 ITC and pays only ₹9,000 as net GST.
This principle is retained in GST 2.0, with refinements that affect sectors differently.
How ITC Works Under GST 2.0
- Transition Benefits: Businesses can continue using ITC accumulated under the older slabs to offset liabilities under new rates.
- Exemptions Impact: Goods or services that shift to exempt categories require businesses to reverse ITC on related inputs.
- Refunds for Inverted Duty: Industries where input tax exceeds output tax can claim refunds, preventing cost accumulation.
- No ITC in Some Sectors: Restaurants, salons, yoga studios, and budget hotels enjoy reduced GST but are barred from ITC claims.
- Insurance ITC Debate: While health and life insurance are GST-free, insurers cannot claim ITC, raising operational cost concerns.
Advantages of ITC in GST 2.0
- Prevents Double Taxation by allowing tax offsets at every stage of supply.
- Supports Smooth Transition as businesses can use past ITC balances during the shift to new slabs.
- Boosts Liquidity since refund mechanisms for inverted duty structures help cash flows.
- Improves Compliance & Transparency as ITC incentivizes proper invoicing and filing.
- Assists in Litigation with ITC usable for pre-deposits in GST appeals, reducing immediate cash strain.
Challenges and Limitations of ITC
- Stricter Compliance: Enhanced return-matching requirements make filing more complex.
- Exemption-Driven Losses: When goods and services become exempt, businesses lose ITC benefits.
- Sectoral Disadvantages: Service sectors like wellness and hospitality cannot claim ITC despite reduced GST rates.
- Delayed Refunds: Slow ITC refunds may create working capital issues for smaller businesses.
- Revenue Concerns: States expect heavy revenue loss, sparking debates on fiscal sustainability.
Summary Table of GST 2.0 & ITC
| Aspect | Old GST System | GST 2.0 (2025 Update) | Impact |
|---|---|---|---|
| Tax Slabs | 5%, 12%, 18%, 28% | 5%, 18%, 40% | Fewer slabs, simpler system |
| Essentials | 5% or 12% | 0% or 5% | Cheaper medicines and daily goods |
| Luxury Goods | 28% + cess | 40% | Higher cost for cars, tobacco, sugary drinks |
| ITC Usage | Allowed with conditions | Allowed + carry-forward | Smoother transition for businesses |
| Exempt Items | Limited scope | Wider scope (insurance, wellness) | ITC reversal required |
| Refunds | Inverted duty refunds | Continued | Cash relief for manufacturers |
| Services | Most allowed ITC | Several barred (restaurants, salons, budget hotels) | Margins reduced in some sectors |
| Compliance | Errors tolerated | Stricter matching rules | Higher compliance burden |
Frequently Asked Questions
1. What is Input Tax Credit (ITC)?
Input Tax Credit allows businesses to claim credit on GST paid for inputs like raw materials and services, reducing their overall tax liability.
2. Can old ITC balances still be used?
Yes, ITC from older slabs remains valid and can offset GST liabilities under GST 2.0, ensuring a smooth transition.
3. What happens when goods become exempt?
If a good or service becomes exempt under GST 2.0, any ITC accumulated on related inputs must be reversed, impacting business cash flows.
4. Are inverted duty refunds available?
Yes, refunds are available if the input tax is higher than the output tax, preventing businesses from bearing additional costs.
5. Why are restaurants and salons denied ITC?
Restaurants, salons, and wellness services now enjoy lower GST rates, but ITC is barred to prevent revenue leakage and simplify administration.
6. Why are insurers worried about ITC?
Although insurance premiums are exempted from GST, insurers cannot claim ITC on input costs, increasing operational expenses and reducing margins.
7. Can ITC be used in legal disputes?
Yes, taxpayers may now use ITC for mandatory pre-deposits during GST appeals, improving liquidity during litigation.
8. Is ITC claiming tougher now?
Yes, GST 2.0 introduces stricter compliance measures. Businesses must ensure invoices match across GSTR-1, GSTR-3B, and other filings.
9. Does GST 2.0 simplify compliance overall?
The tax rate structure is simpler with fewer slabs, but ITC eligibility rules remain complex, requiring detailed understanding and compliance.
10. What’s the revenue impact of GST 2.0?
The central government projects revenue loss around ₹48,000 crore, though some experts suggest the shortfall could reach ₹1 lakh crore, raising state-level fiscal concerns.
Conclusion
GST 2.0 is designed to simplify India’s tax system, making essentials cheaper, streamlining ITC, and reducing slab complexity. While businesses benefit from smoother ITC transitions and refund provisions, exemptions and ITC restrictions in service sectors raise concerns.
The ultimate success of GST 2.0 depends on how well the government addresses compliance hurdles, ensures timely ITC refunds, and balances state revenue concerns. If executed effectively, this reform could set the stage for a more transparent, growth-friendly tax regime.
Report by Toofan Express