Experts flag tax credit blockage for FMCG distributors despite GST relief

The government's recent circular has brought clarity on trade discounts and credit notes under the GST regime, but has shifted compliance obligation and cash-flow pressure onto FMCG distributors, experts said. 

Indirect Tax Expert at LexVed Vedika Agrawal said the GST circular 251 makes it clear that financial or commercial credit notes - those issued without GST - do not require distributors to reverse their input tax credit (ITC). 

Input tax credit is the tax a business unit pays on its purchases, which it can claim back to lower the tax it owes when it sells products or services. 

“For manufacturers, this (the circular) ensures that past tax payments remain untouched. For distributors, however, the downside is clear: they continue to hold excess ITC (input tax credit) balances, which often cannot be fully utilised, effectively locking up working capital,” she told PTI. 

Another taxation expert Vivek Jalan pointed out that there is currently no refund mechanism for such accumulated input tax credit. 

“The industry may push for a new refund mechanism, but this would be difficult for the government to allow, given the high risk of misuse,” he told PTI. 

Jalan, Partner at Tax Connect Advisory Services, however, noted that the problem of input tax credit accumulation at the recipient's end due to financial credit notes by suppliers may ease once the proposed amendment to Section 15 of the CGST Act—discussed in the 56th GST Council meeting—is notified. 

“After the amendment, GST credit notes can be issued even without a pre-sale agreement or invoice linkage. This will ensure that accumulated input tax credit doesn't remain blocked at the recipients' end, since ITC reversal at the recipient's end would be required once the supplier adjusts the output tax. The problemwill persist for about a year until this amendment takes effect,” he said. 

The circular also clarified the treatment of trade discounts, Agrawal said. 

"Where manufacturers only support dealer pricing, no extra GST arises. But if they directly promise a lower price to consumers, dealers must add such support to their taxable value and pay GST on the combined amount. Routine dealer promotions, however, are not treated as taxable services unless backed by a separate agreement and fee," she said. 

Trade discount is basically the price reduction that a manufacturer offers either to dealers (distributors) or directly to customers.

Meanwhile, the All India Consumer Products Distributors Federation (AICPDF) has written to the Central Board of Indirect Taxes and Customs (CBIC), seeking urgent clarifications on the implementation of the recent GST rate cuts. 

The industry association represents 4.5 lakh distributors and serves over 1.3 crore kirana stores across the country. 

In its recent memorandum, the federation flagged concerns over excess input tax credit that may build up following the rate reductions, and urged the government to specify how such credits will be treated to avoid disputes during audits. 

The Goods and Services Tax (GST) Council recently decided to rationalise the tax rates and have a two-rate structure of 5 per cent and 18 per cent. The revision, which was made effective from September 22, was expected to reduce the prices of a large number of products and services. 

The federation also pointed out an anomaly in the detergent segment, noting that while GST on detergent cakes has been cut to 5 per cent, washing powders remain at 18 per cent. 

“This distortion will adversely impact consumers. We urge that powders also be brought under the 5 per cent slab,” it said.

AICPDF National President Dhairyashil H Patil said, “While we welcome the landmark reforms, urgent clarifications on input tax credit treatment and anomalies like detergents are essential to ensure benefits flow smoothly to consumers and avoid disruptions in retail trade.” Patil said they have also flagged the issue of input tax credit with Union Finance Minister Nirmala Sitharaman and will continue to engage with the ministry. 

Industry experts said that the dual concerns raised by distributors and tax specialists underline the challenges of implementing GST reforms—while "manufacturers gain certainty, distributors remain exposed to cash flow pressures until legislative changes and clarifications take full effect". 

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