GST hurdles in the fertiliser sector: The subsidy conundrum

Unlike most commodities, fertilizers are not sold at free market prices, which means that the Maximum Retail Price (MRP) is fixed by the Government of India.
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indiaphotos

The fertilizer sector forms the backbone of India’s agricultural economy, ensuring food security and farmer support. In its 56th Meeting, the GST Council has taken significant steps to ease long-standing concerns in the industry. The recommendations included rationalizing rates on inputs like ammonia and nitric acid which are used to manufacture fertilizers. This was expected to resolve the inverted duty structure (“IDS”) that previously burdened manufacturers.

This is a welcome reform, as it aligns the input tax rates with those on finished fertilizers, both now taxed at five per cent GST. This will also curb the issue of the accumulation of unutilised input tax credit (ITC). However, while the rationale behind this was noble and for support to the industry, it has had some unintended consequences, which the Government will need to step in for.

Fixing the price of fertilizers

Unlike most commodities, fertilizers are not sold at free market prices, which means that the Maximum Retail Price (MRP) is fixed by the Government of India. This is done under the Fertilizer Control Order, 1985. For instance, MRP of a 45 kg bag of urea is mandated to be sold at ₹242 per bag, whereas the actual cost of production/import is much higher. The practice followed by the government is that the difference between the actual cost and the notified MRP is reimbursed to manufacturers/importers by the government as a subsidy. Percentage-wise, there is no mandate imposed on the manufacturers regarding how much subsidy they must absorb. Instead, the government is simply fixing the MRP and subsequently reimbursing the manufacturers for their actual cost incurred.

Point of sale mechanism

This reimbursement is routed through the Point of Sale (PoS) devices installed at each retailer shop and the beneficiaries are identified through Aadhaar Card, KCC, Voter Identity Card etc. This mechanism is explained below:

· The manufacturer sells to the retailer at the notified MRP. Thereafter, at the retailer’s outlet, the farmer purchases fertilizer at the fixed MRP. Aadhaar authentication details are captured on the PoS device.

· Once the transaction is verified, the PoS automatically generates the subsidy claim. Accordingly, the Department of Fertilizers verifies and credits the subsidy directly into the manufacturer’s bank account. The catch here is that the manufacturer does not raise an invoice on the Government for subsidy. The PoS record itself acts as the basis of reimbursement.

Subsidy as an exempt supply

The Central Goods and Services Tax Act, 2017 (CGST Act), classifies these subsidies as exempt supplies. Section 2(31), CGST Act defines “consideration” and it explicitly excludes subsidies given by the Central and State Governments. Similarly, under Section 15, value of taxable supply includes subsidies directly linked to the price but excludes government subsidies.

The challenge lies with Section 17(2), CGST Act as it blocks ITC on exempt supplies. And since subsidy is treated as an exempt supply, ITC attributable to it is blocked. Additionally, Section 54(3), CGST Act which deals with refunds provides that refund of unutilized ITC is allowed only for zero-rated supplies or inverted duty cases and not for exempt supplies. With ITC blocked, large sums remain locked in the system. Manufacturers are unable to offset their tax liabilities effectively, despite paying GST on inputs.

The policy paradox

What emerges is a paradox that the subsidy mechanism designed to support farmers ends up straining the manufacturers who supply them. Since under the current GST framework, no input tax credit is available on the subsidy component of the supply, the manufacturers face financial woes as their working capital gets blocked. The main problem lies not in the grant of the subsidy on fertilizers by the government, but the issue of accumulation of ITC due to subsidy. Even the government by rationalizing both the input and output tax on fertilizers has not been able to address the issue. The lack of clarity by the government on the aspect of claiming of ITC on fertilizer subsidies has left the manufacturers in a lurch.

The way forward

This issue of accumulation of ITC due to subsidies can be solved by subjecting the fertilizer subsidies to a special treatment. One of the possible solutions being that the government could consider excluding fertilizer subsidies from the definition of exempt supplies under Section 17, by which manufacturers would be able to claim input tax credit even on the subsidy component of the final supply which otherwise is currently not available.

Another possible solution could be to provide an alternative relief to claim ITC on blocked subsidy component which is similar to claiming ITC in zero rated supplies. In this way manufacturers would be able to claim ITC even while the classification of subsidy remains the same. The government should issue a clarification in this regard so as to clear the confusion surrounding fertilizer subsidy so that working capital of manufactures isn’t blocked.

Only by resolving the current blockage of ITC on the subsidy component of supply, various objectives like improved financial health of fertilizer manufacturers, strengthening of supply chains and eventually, fertilizer distribution at affordable prices to farmers can be fully achieved.

Mathews is Partner and Yashika Soni is Associate of CMS IndusLaw

Published on September 27, 2025