Library / Goods and Services Tax: The Professional's Master Guide

8. Classification and Rates

Once it is clear that there is a taxable supply, the rate depends on classification. For goods, the rate notifications follow the Harmonised System of Nomenclature (HSN) as used in the Customs Tariff. For services, CBIC adopted a Services Accounting Code (SAC) scheme based on the UN Central Product Classification. A wrong classification can cost a business the difference in rate on years of turnover, so this is one of the areas most exposed to audit.

8.1 HSN and SAC on invoices

Invoices and GSTR-1 must show the HSN or SAC code. From 1 April 2021, a registered person with aggregate turnover in the previous year up to Rs. 5 crore must show at least 4 digits on B2B invoices (optional on B2C), and a person with turnover above Rs. 5 crore must show 6 digits on all invoices. GSTR-1 Table 12 carries an HSN-wise summary.

Illustration 41: HSN digits required

Joshi Fabrics had aggregate turnover of Rs. 4,80,00,000 in 2024-25. Its group company Joshi Garments had Rs. 6,20,00,000.

Step 1: Joshi Fabrics (up to Rs. 5 crore): 4-digit HSN on B2B invoices in 2025-26, for example 5208 for cotton fabric.

Step 2: Joshi Garments (above Rs. 5 crore): 6-digit HSN on all invoices, for example 620520 for men's cotton shirts.

Result: The two companies have different PANs, so each is tested on its own turnover.

8.2 Principles of classification

The rate notifications say that "tariff item", "heading", "sub-heading" and "chapter" have the meaning in the First Schedule to the Customs Tariff Act, 1975, and that the rules for interpretation of that Schedule, including Section and Chapter Notes and the General Explanatory Notes, apply. GST classification of goods therefore follows customs classification.

Rule	What it says in brief
Rule 1	Titles of Sections and Chapters are for reference only. Classification is by the terms of the headings and the Section and Chapter Notes.
Rule 2(a)	An incomplete or unassembled article is classified as the complete article if it has its essential character.
Rule 2(b)	A reference to a material includes mixtures and combinations of it with other materials.
Rule 3(a)	The heading with the most specific description is preferred over a general one.
Rule 3(b)	Mixtures, composite goods and retail sets are classified by the component that gives them their essential character.
Rule 3(c)	If still undecided, the heading that occurs last in numerical order.
Rule 4	Goods not covered by any heading go under the heading for goods most akin to them.
Rule 5	Cases and packing normally sold with goods are classified with them.
Rule 6	The same principles apply at sub-heading level.

Alongside these rules, courts apply the common parlance or trade parlance test: how the product is understood by those who deal in it and use it, unless the tariff uses a technical or scientific term. A residuary entry is used only when no specific entry fits.

Judicial view: Common parlance and burden of proof

Dunlop India Ltd. v. Union of India (Supreme Court, 1976): When an article has, by all standards, a reasonable claim to be classified under a specific entry, it should not be pushed into a residuary entry. Meaning in common commercial usage is relevant in reading tariff entries.

HPL Chemicals Ltd. v. Commissioner of Central Excise (Supreme Court, 2006): Classification is a matter of evidence, and the burden of proving that goods fall under the heading claimed by the department is on the revenue. Resort to a residuary heading is a last option.

Practical relevance under GST: In a classification dispute, the department must bring evidence (technical literature, trade enquiries, test reports) for its heading. The taxpayer should build its own file of product literature, trade usage and customs classification of the same goods.

Illustration 42: What a classification dispute costs

Bhavani Foods Ltd. classifies a snack product under a heading taxed at 5%. The department claims it falls under a heading taxed at 18%. Turnover of the product over the period under audit is Rs. 3,00,00,000.

Step 1: Rate difference = 18% minus 5% = 13%.

Step 2: Tax in dispute = 13% of Rs. 3,00,00,000 = Rs. 39,00,000, plus interest at 18% a year under section 50 and penalty.

Result: With this exposure, an advance ruling (which covers classification under section 97(2)(a)) or at least a reasoned opinion supported by evidence is worth obtaining before the dispute arises. Advance rulings bind only the applicant, and rulings in different States have differed on similar products.

8.3 The rate structure after GST 2.0

The table gives the structure in force from 22 September 2025. A few items may still carry old rates or special conditions, so the current notification must always be checked.

Rate	Coverage
Nil	Essential goods and exempt services, including UHT milk, paneer, Indian breads, 33 life-saving drugs, individual life and health insurance
0.1%	Supplies to merchant exporters (with conditions)
0.25%	Rough precious and semi-precious stones
1.5%	Cut and polished diamonds
3%	Gold, silver and jewellery
1% and 5%	Residential real estate (affordable and other), without ITC
5%	Merit rate: most food items, toiletries, bicycles, tractors, solar devices, textiles; hotel rooms up to Rs. 7,500, restaurants, beauty services (without ITC)
18%	Standard rate: most goods and services, cement, ACs, TVs, small cars, two-wheelers up to 350cc, works contracts
40%	Demerit and luxury: larger cars, motorcycles above 350cc, aerated sugary drinks, tobacco and pan masala (from 1 February 2026), casinos, betting, lottery, online money gaming

How to find the rate

Identify the correct HSN (goods) or SAC (services) using the tariff, Section and Chapter Notes and the rules above.
For goods, find the entry in the Schedules of the goods rate notification, which group goods by rate. Check the description as well as the HSN; many entries apply only to part of a heading or subject to a condition.
For services, find the entry in the services rate notification, which lists services by heading with the rate and conditions (for example, "without ITC").
Check the exemption notification for goods or services, and whether it is absolute or conditional.
Check any amendment, corrigendum or clarification issued after GST 2.0 for that item.

8.4 Effect of a change in rate

Section 14 of the CGST Act decides whether the old or new rate applies when the date of supply, the invoice and the payment fall on different sides of the date of change. The outline is shown below; the time of supply chapter covers it in detail.

Supply	Invoice	Payment	Rate
Before change	After	After	New (earlier of invoice or payment)
Before change	Before	After	Old (date of invoice)
Before change	After	Before	Old (date of payment)
After change	Before	After	New (date of payment)
After change	Before	Before	Old (earlier of invoice or payment)
After change	After	Before	New (date of invoice)

For this purpose, the date of receipt of payment is the date of credit in the bank account where that is more than four working days after the date of change.

8.5 Inverted duty structure

An inverted duty structure arises when the rate on inputs is higher than the rate on the output, so ITC keeps piling up. GST 2.0 corrected some inversions (for example, man-made fibre and yarn were brought to 5% along with fabric) but created others where finished goods fell to 5% while their parts stayed at 18%. Section 54(3)(ii) allows refund of unused ITC arising from inversion, using the formula in rule 89(5). The formula refunds ITC on inputs only, not on input services or capital goods.

Judicial view: Input services excluded from inverted duty refund

Union of India v. VKC Footsteps India (P) Ltd. (Supreme Court, 2021): The Court upheld rule 89(5) and the restriction of inverted duty refund to ITC on inputs (goods), excluding input services. Refund is a statutory right that exists only to the extent the law provides. The Court suggested that the Council reconsider the formula, but did not strike it down.

Practical relevance: Businesses with large input service costs in an inverted structure will carry forward that part of the credit. The formula was amended in 2022, and the Finance Act, 2026 has provided for 90% provisional refunds of inverted duty claims (enacted but not yet notified).

Illustration 43: Refund for a bicycle manufacturer

Speed Cycles Pvt. Ltd. makes bicycles, taxed at 5% after GST 2.0. In a tax period its turnover is Rs. 1,20,00,000 (all inverted rated supply; no other supplies). ITC on inputs (steel tubes, paint and other inputs taxed at 18%) is Rs. 14,40,000 and on input services Rs. 1,00,000.

Step 1: Output tax = 5% of Rs. 1,20,00,000 = Rs. 6,00,000. Total ITC = Rs. 15,40,000. Unused ITC = Rs. 9,40,000.

Step 2: Rule 89(5): Maximum refund = (turnover of inverted rated supply x Net ITC / adjusted total turnover) minus (tax payable on inverted rated supply x Net ITC / ITC on inputs and input services).

Step 3: First part = Rs. 1,20,00,000 x Rs. 14,40,000 / Rs. 1,20,00,000 = Rs. 14,40,000.

Step 4: Second part = Rs. 6,00,000 x Rs. 14,40,000 / Rs. 15,40,000 = Rs. 5,61,039.

Result: Refund = Rs. 14,40,000 minus Rs. 5,61,039 = Rs. 8,78,961. The balance of Rs. 61,039, broadly the input services share, stays in the ledger.

Chapter summary

• Goods follow HSN as in the Customs Tariff; services follow SAC. Invoices need 4-digit HSN up to Rs. 5 crore turnover and 6 digits above.

• The General Rules for Interpretation, Section and Chapter Notes and Explanatory Notes apply to GST classification.

• Specific entries prevail over general ones; common parlance applies unless the tariff uses a technical term; the residuary entry is the last resort.

• The burden of proving the department's classification is on the revenue (HPL Chemicals).

• After GST 2.0 the main rates are 5%, 18% and 40%, with special rates for precious metals, diamonds, real estate and merchant exports.

• Section 14 decides the rate when a change falls between supply, invoice and payment; inverted duty refunds cover inputs only (VKC Footsteps).