GST on Normal Production Loss: Can ITC Be Reversed?

Under the GST framework, the treatment of Normal Production Loss (scientifically referred to as Inherent Inevitable Loss or Invisible Loss) highlights a fundamental tension between the taxpayer’s right to claim seamless Input Tax Credit (ITC) under Section 16(1) and the Department's attempt to restrict credit under Section 17(5).

We will discuss a robust statutory and judicial defense regarding normal production losses, which can be understood individually and as a blueprint for defending other Asset and Expense Specific ITC categories.

Inherent inevitable loss vs. normal production loss

The sources define Inherent Inevitable Loss as the natural, ordinary, and predictable shrinkage of inputs that is scientifically and mechanically unavoidable during manufacturing.

Scientific reality

This loss manifests in physical and chemical forms such as evaporation, melting, burning, chemical reactions, spillage, screening, trimming, or the generation of scrap.

The "invisible" standard

As ruled by the Madras High Court in Rupa & Co. Ltd. and Eastman Exports, expecting the physical weight of a finished product to precisely match the sum of its raw inputs is theoretically and commercially flawed. "Invisible loss" is an intrinsic part of the manufacturing process; therefore, the total quantity of inputs introduced represents the final product in its entirety.

The statutory defense: Section 16(1) vs. Section 17(5)(h)

The Department frequently issues Show Cause Notices demanding a proportional reversal of ITC on the raw materials lost during production, citing Section 17(5)(h) of the CGST Act (which blocks credit on goods "lost, stolen, destroyed, written off, or disposed of"). The defense is built on two core principles:

Identifiable vs. process loss

The term "goods lost" in Section 17(5)(h) must be interpreted restrictively. It refers exclusively to identifiable, quantifiable, and exceptional external losses caused by independent, unforeseen events (such as theft, fire, or accidental destruction). It does not encompass ordinary, predictable process consumption.

Consumption is "use", not loss

Once raw materials are introduced into the production line, they are "consumed and transformed". They lose their independent identity as individual goods and are converted into finished products. Such consumption satisfies the "use" criteria under Section 16(1) in the course or furtherance of business.

Key judicial authority

In ARS Steels & Alloy International (P) Ltd. v. STO, the Madras High Court categorically ruled that reversing ITC for normal manufacturing loss is entirely misconceived, as process-related consumption is not contemplated under Section 17(5)(h).

The larger context: asset and expense specific ITC

The legal distinction between actual physical loss/disposal and inherent business/operational use forms the foundation of defenses against ITC disallowance for several specific assets and expenses:

A. Written-off inputs and capital goods

The dispute

The Department often demands ITC reversal under Section 17(5)(h) when a taxpayer writes off or writes down inventory/assets in their books.

The defense

Replicating the logic of production loss, the sources argue that a ledger write-down or revaluation (to comply with Ind AS-2 or Ind AS-16) is a purely notional accounting adjustment and does not constitute physical destruction, disposal, or loss. As affirmed by the Gujarat High Court in Ingersoll Rand, as long as the goods remain physically present in the factory and capable of future use, the ITC remains an accrued, vested right.

B. Repairs and maintenance of immovable property

The dispute

Routine repairs (replacing broken tiles, sanitary fittings, or plumbing) are blocked by the Department under Section 17(5)(c)/(d) on the grounds that they relate to the "construction of an immovable property".

The defense

Under Section 17(5), the restriction is limited "to the extent of capitalisation". Routine, recurring operational repairs that are expensed in the P&L Account do not create a new asset or permanently enhance land value; they preserve existing functionality and are fully eligible for ITC under Section 16(1).

C. Movable furniture and prefabricated structures

The dispute

Detachable fit-outs, modular cabins, partitions, and pre-fabricated sheds are denied ITC on the presumption that they constitute "immovable property".

The defense

Citing the Supreme Court in Solid & Correct Engineering, the defense applies the twin tests of extent of annexation and object of annexation. Items fixed temporarily with nuts and bolts for functional stability (rather than the permanent beneficial enjoyment of the land) are legally "goods/movable property". Because they are designed to be dismantled, relocated, and sold without structural damage, the immovable property restrictions do not apply.

D. Solar power plants for captive consumption

The dispute

ITC on solar power plants is blocked under Section 17(5)(d) as a civil structure, or under Section 17(2) because excess electricity is temporarily routed to the grid.

The defense

Solar power plants are mechanical and electrical systems capitalised as "Plant and Machinery," which is explicitly excepted from the immovable property restriction in Section 17(5). Furthermore, net-metering is a grid-balancing transmission mechanism, not an exempt outward sale of electricity.

E. Employee welfare: canteen facilities and transport

The dispute

ITC on employee catering, food services, and commute vehicles is blocked under Section 17(5)(b)(i).

The defense

The proviso to Section 17(5)(b) overrides the block wherever the employer is under a legal obligation to provide the facility. For instance, if a factory employs more than 250 workers, providing a canteen is a statutory mandate under Section 46 of the Factories Act, 1948, making the expense a mandatory compliance cost rather than a discretionary benefit.

Formal grounds of appeal template: normal production loss / process loss

BEFORE THE HON’BLE APPELLATE AUTHORITY OF GOODS AND SERVICES TAX
 AT: [LOCATION OF APPELLATE OFFICE]

APPEAL NO: [TO BE FILLED]
 (Under Section 107 of the Central Goods and Services Tax Act, 2017 / [State] GST Act, 2017)

IN THE MATTER OF:
 M/S [APPELLANT'S BUSINESS NAME]
 [Appellant's Full Registered Address]
 GSTIN: [Appellant's GSTIN]
 ... APPELLANT

VERSUS

THE ASSISTANT / DEPUTY COMMISSIONER OF STATE TAX / CENTRAL TAX
 [Name of the Jurisdictional Adjudicating Circle/Ward]
 ... RESPONDENT / ADJUDICATING AUTHORITY

I. Statement of facts

1. The Appellant is a registered taxable person under the GST regime, engaged in the business of manufacturing [Name of finished goods, e.g., Steel Billets, Textiles, Chemicals, etc.] classifiable under HSN [HSN Code].
2. The Appellant utilises various raw materials and inputs, primarily [Name of primary inputs, e.g., Iron Ore, Coal, Cotton Yarn, Chemicals] classifiable under HSN [Input HSN Code], which are essential for its manufacturing operations. The Appellant has duly availed of Input Tax Credit (ITC) on these inputs in terms of Section 16(1) of the CGST Act, 2017.
3. During the course of manufacture, a natural, inherent, and technically unavoidable loss of weight/quantity occurs. This loss is caused by physical and chemical processes such as [Specify process: e.g., evaporation, melting, combustion, trimming, spillage, or generation of scrap], which is scientific and inevitable.
4. The Respondent/Adjudicating Authority conducted a [GST Audit under Section 65 / Scrutiny of Returns under Section 61 / Investigation] for the Financial Year(s) [FY, e.g., 2018-19, 2019-20] and subsequently issued a Show Cause Notice (SCN) dated [Date of SCN] under Section [73 or 74] of the CGST Act, 2017.
5. In the SCN, the Respondent proposed to disallow and recover ITC amounting to Rs. [Amount of Disputed ITC] along with applicable interest under Section 50 and equal penalty under Section [73(9) or 74], on the ground that a portion of the inputs was "lost" during the manufacturing process, thereby triggering the blocked credit restriction under Section 17(5)(h) of the CGST Act, 2017.
6. The Appellant filed a detailed, written submission dated [Date of Submission] before the Respondent, demonstrating that the process-related loss is an inherent part of the manufacturing process, and does not represent "goods lost or destroyed" under Section 17(5)(h).
7. Without appreciating the physical, scientific, and legal distinction between "process consumption" and "accidental loss," and ignoring binding judicial precedents, the Learned Respondent passed the Impugned Order-in-Original No. [Order Number] dated [Date of Order] confirming the entire demand of ITC, interest, and penalty.
8. Aggrieved by the Impugned Order, the Appellant prefers this Appeal before this Hon'ble Appellate Authority.

II. Grounds of appeal

The Appellant respectfully submits the following Grounds of Appeal, each of which is independent and without prejudice to the other:

Ground no. 1: The learned adjudicating authority has misinterpreted and extended the scope of Section 17(5)(h) of the CGST Act, 2017

1.1 The Learned Adjudicating Authority has erred in law by invoking the blocked credit provisions of Section 17(5)(h) of the CGST Act to demand reversal of ITC on normal, inevitable process-related losses. Section 17(5)(h) stipulates that input tax credit is blocked in respect of:

“goods lost, stolen, destroyed, written off or disposed of by way of gift or free samples.”

1.2 The Appellant submits that the terms used in Section 17(5)(h)—namely, "lost, stolen, destroyed, written off or disposed of"—must be interpreted restrictively and in accordance with the rule of ejusdem generis. All these terms contemplate identifiable, quantifiable, and exceptional external events where the goods physically cease to exist or are removed from the business cycle due to unforeseen accidents, theft, or deliberate acts of disposal/destruction (such as fire, natural disasters, or write-offs).

1.3 A normal production/process loss is fundamentally different. It is a predictable, natural, and scientifically inevitable operational shrinkage that occurs after the inputs are put into the manufacturing process. It does not represent an independent event of loss. Once the raw materials are fed into the manufacturing line, they are "consumed and transformed" and lose their separate identity. Therefore, they cannot be categorized as "goods lost" under the statute.

Ground no. 2: The entire quantity of inputs is "used" in the course or furtherance of business as mandated under Section 16(1)

2.1 The Learned Adjudicating Authority failed to appreciate that the entitlement to ITC is governed by Section 16(1) of the CGST Act, which states:

“Every registered person shall, subject to such conditions and restrictions as may be prescribed... be entitled to take credit of input tax charged on any supply of goods or services or both to him which are used or intended to be used in the course or furtherance of his business...”

2.2 The primary statutory requirement is that the inputs must be used or intended to be used in the course or furtherance of business. In the instant case, the Appellant purchased [Quantity] of inputs and physically introduced 100% of these inputs into the production plant to manufacture the finished product. The entirety of the input has been actively utilized and consumed for business operations.

2.3 The physical weight or volume of the final output is commercially and scientifically irrelevant to the eligibility of ITC. The statute requires the "use" of inputs, not their physical presence or retention in the final finished product. To deny ITC on a portion of inputs simply because it has evaporated or shrunk during production violates the basic mandate of Section 16(1) and introduces an extra-legal condition that is completely absent from the Act.

Ground no. 3: Process loss cannot be equated to "goods lost" - binding jurisprudence of the Hon’ble High Court of Madras 

3.1 The issue involved in the present appeal is squarely settled by the landmark judgment of the Hon'ble High Court of Madras in the case of ARS Steels & Alloy International (P) Ltd. v. State Tax Officer [2021] 127 taxmann.com 787 / 52 GSTL 402 (Mad.).

3.2 In this case, the Revenue had demanded reversal of ITC under Section 17(5)(h) on the invisible loss of steel inputs during the melting process. Quashing the demand, the Hon'ble High Court drew a clear legal distinction between goods "lost" and goods "consumed," holding as under:

“Reversal of input tax credit, involving Section 17(5)(h) ibid, by Revenue, in cases of loss by consumption of input which is inherent to manufacturing loss is misconceived, as such loss is not contemplated or covered by situations adumbrated under Section 17(5)(h) of the Central Goods and Services Tax Act, 2017.” “The raw materials are put into a process of manufacture and a portion is consumed or lost. This is consumption, not loss. The term ‘lost’ refers to a situation where the goods are no longer available due to external causes, whereas ‘consumption’ represents intended business use.”

3.3 This principle was further reaffirmed in R.K. Ganapathy Chettiar v. Assistant Commissioner (ST), Kangeyam [2022] 133 taxmann.com 259 / 56 G.S.T.L. 129 (Mad.), wherein the Court held that the assessee is fully entitled to ITC on the invisible loss of inputs during the manufacturing process.

3.4 Similarly, in the case of Eastman Exports Global Clothing Pvt. Ltd. v. Assistant Commissioner (CT), Tirupur [2025] 7 taxmann.com 1936 / [2023] 7 Centax 210 (Mad.), the Court held:

“Manufacturing or invisible loss, being admittedly an inevitable/inherent part of manufacturing, would fall within the scope of the expressions ‘used in manufacturing or process of goods’, and could not be stated to be either damaged or destroyed; the same would be entitled to input tax credit.”

3.5 The facts of the Appellant's case are identical to the above-cited rulings. The process loss suffered by the Appellant is an unavoidable manufacturing reality. By ignoring these binding judicial pronouncements, the Learned Respondent has committed a grave error of law, rendering the Impugned Order illegal and liable to be set aside.

Ground no. 4: Established principles under erstwhile CENVAT & Excise regimes prevent reversal on process loss 

4.1 The Appellant submits that the scheme of credit under GST is a continuation of the CENVAT credit system. Under the erstwhile Central Excise and Service Tax laws, it was a settled position that CENVAT credit is admissible on the entire quantity of inputs introduced into the manufacturing process, and no reversal is required on process-related losses.

4.2 In Rupa & Co. Ltd. v. CESTAT, Chennai 2015 (324) ELT 295 (Mad.), the Hon'ble High Court of Madras eloquently explained the commercial and scientific reality of manufacturing:

“To say that what is contained in finished product is only a quantity of all the inputs of the same weight as that of the finished product would presuppose that all manufacturing processes would never have an inherent loss in the process of manufacture... If there is no dispute about the fact that every manufacturing process would automatically result in some kind of a loss such as evaporation, creation of by-products, etc., the total quantity of inputs that went into the making of the finished product represents the inputs of such products in entirety.”

4.3 The Hon'ble Supreme Court in Union of India v. Asahi India Safety Glass Ltd. [2015] 58 taxmann.com 237 / (320) ELT 179 (SC) (affirming the Delhi High Court decision) held that defective or waste pieces generated in the course of manufacturing do not require any credit reversal.

4.4 Other key rulings consistently holding that process wastage or shrinkage does not trigger credit disallowance include:

• Real Ispat & Power Ltd. v. CCE, Raipur [2016] 72 taxmann.com 84 / (335) ELT 325 (Tri.) (holding that weight loss of coal due to washing is an inherent process loss and credit is fully allowed).
• Lafarge India Ltd. v. CCE & ST, Bilaspur 2017 (48) STR 466 (Tri.-Del.) (reaffirming that process loss does not restrict credit eligibility).
• Seven Star Steels Ltd. v. CCE, CUS & ST, BBSR-II [2013] 32 taxmann.com 186 / (30) S.T.R. 532 (Tri.-Kolkata) (holding that screening loss of iron ore is a part of manufacturing and cannot result in denial of credit).

Since the legislative design of ITC under GST is identical to CENVAT with respect to the "use" of inputs in business, the ratio of these decisions is fully applicable, and the disallowance of ITC is wholly unjustified.

Ground no. 5: The imposed interest under Section 50 and penalty are completely arbitrary and bad in law 

5.1 The Learned Adjudicating Authority has erred in confirming interest under Section 50 and imposing penalty under Section [73(9) or 74] of the CGST Act.

5.2 Interest under Section 50 is compensatory in nature and is levied only when there is an actual tax liability that was payable but remained unpaid. In the present case, since the Appellant has rightly availed and utilized the ITC in accordance with Section 16(1), there is no "tax due" or wrong availment. Consequently, the question of demanding interest does not arise.

5.3 Penalty under Section 73(9) / 74 is completely untenable. A penalty cannot be imposed automatically or mechanically. The issue in dispute is purely a question of statutory interpretation and classification of process loss under Section 17(5)(h). The Appellant has maintained absolute transparency, recorded all input purchases, production records, and return filings in a bona fide manner in its audited books of accounts. In the absence of any mens rea (guilty mind), fraud, willful misstatement, or deliberate attempt to evade tax, no penal provisions can be triggered.

Ground no. 6: The impugned order is a non-speaking order violating Section 75(6) and the principles of natural justice

6.1 The Learned Adjudicating Authority has confirmed the demand by passing a cryptic, non-reasoned order that completely ignores the detailed submissions and judicial citations placed on record by the Appellant.

6.2 Under Section 75(6) of the CGST Act, 2017, the proper officer is statutorily mandated to issue a speaking order:

“The proper officer shall set out the relevant facts and the basis of his decision in his order.”

6.3 The Hon’ble Supreme Court of India in Kranti Associates Pvt. Ltd. v. Masood Ahmed Khan [2011] 273 E.L.T. 345 (SC) has held that recording of clear, cogent reasons is an indispensable requirement of the principles of natural justice and is the soul of any quasi-judicial or administrative order. A failure to address the taxpayer's legal defenses and mechanical confirmation of demand constitutes a "rubber-stamp" adjudication, rendering the Impugned Order bad in law and liable to be set aside on this ground alone.

III. Prayer

In light of the facts, grounds, and judicial precedents submitted above, the Appellant most humbly prays before your Honour to:

SET ASIDE the Impugned Order-in-Original No. [Order Number] dated [Date of Order] passed by the Respondent in its entirety;

RESTORE the disallowed Input Tax Credit of Rs. [Disputed ITC Amount] to the Appellant's Electronic Credit Ledger;

DROP the proposed demand of interest under Section 50 and penalties;

GRANT an opportunity of personal hearing to the Appellant to represent the case through its Authorised representative; and

Pass such other or further order(s) as this Hon'ble Appellate Authority may deem fit in the interest of justice and equity.

For this act of kindness, the Appellant, as in duty bound, shall ever pray.

For, M/s [APPELLANT'S BUSINESS NAME]

(Authorised Signatory)
 Place: [Location]
 Date: [Date of Filing]

IV. Verification

I, [Name of Authorised Signatory], being the [Designation, e.g., Director / Partner / Proprietor / Authorised Signatory] of M/s [Appellant's Business Name], do hereby verify and declare that the contents of the Statement of Facts and Grounds of Appeal are true, correct, and complete to the best of my knowledge, information, and belief. No part of it is false, and nothing material has been concealed therefrom.

Verified at [Location] on this [Day] of [Month], 2026.

(Authorised Signatory)