Ajit Ranade: India’s budget should sort out GST’s input tax credit system to perk up private investment

Subscribe to enjoy similar stories. India faces a paradox today. Its GDP growth is among the fastest in the world, public capital expenditure has surged and corporate balance sheets are healthier than they have been in years.

Yet, private investment, especially in manufacturing capacity, machinery and factory expansion, has not responded with comparable vigour. There are several reasons for this, including the cost of capital and still-muted animal spirits. But one underappreciated reason lies in the design of the goods and services tax (GST), particularly its treatment of capital goods.

One powerful reform in the forthcoming budget to revive private investment would be to place capital goods squarely and cleanly within the GST framework, with full, immediate and usable input tax credit (ITC). GST is a destination-based value-added tax on final consumption. It is not meant to be a tax on production or investment.

Its logic rests on seamless input tax credit. Taxes paid on inputs—whether consumption goods, services or capital equipment—should flow through the value chain and never become a cost to business. But in practice, due to ITC delays and the near-impossibility of monetizing ITC on capital goods, India’s neutral consumption tax has become something like a tax on production and investment.

Capital goods—machines, plant, equipment and construction inputs—often generate large GST credits that remain trapped for years, sometimes indefinitely. This raises the cost of capital. To be sure, ITC on capital goods exists under the GST rules, but only on paper.