Difference between Zero Rated, Nil Rated, Non-GST and exempt supplies

 

Look, if you’ve ever stared at a GSTR-1 form at 11 PM wondering whether to classify that export invoice as “zero-rated” or “exempt,” you’re not alone.

These four terms—zero-rated, nil-rated, exempt, and non-GST supplies—sound like variations of the same thing, but misclassifying them triggers notices, blocks ITC refunds, and creates compliance nightmares that’ll haunt your next three quarters.

Here’s the truth: these aren’t synonyms. They’re distinct legal categories under the CGST Act, each with different tax treatments, ITC eligibility rules, and reporting requirements.

The GST portal doesn’t care about your confusion—it cares about accurate classification. So let’s fix this once and for all.

Quick Comparison: The Four Supply Types

This table is your north star. Everything below unpacks why these differences matter for your returns, your cash flow, and your sanity.

What Makes a Supply “Taxable” in the First Place?

Before we dive into the four categories, let’s establish the baseline: a taxable supply is any supply of goods or services made for consideration in the course of business, where GST applies.

This includes supplies taxed at 0%, 5%, 12%, 18%, or 28%.

The moment you classify something as taxable, you’re saying “GST law applies here”—even if the rate is zero.

This distinction is critical because zero-rated and nil-rated supplies are taxable (GST applies), while exempt and non-GST supplies are not taxable (GST doesn’t apply).

Why does this matter? Because taxable supplies—even at 0%—appear in your GSTR-1. They impact your turnover calculations.

And for zero-rated supplies specifically, they unlock full ITC refunds, which is a game-changer for exporters.

Zero Rated Supplies: The Exporter’s Best Friend

Zero-rated supplies are taxable supplies charged at 0% GST, with full ITC refund eligibility.

Think of them as “taxable but tax-free”—the GST framework applies, you just don’t collect tax from the customer.

Instead, you claim back every rupee of input tax you paid.

GST Treatment & ITC Rules

Under Section 16 of the IGST Act, zero-rated supplies include:

• Exports of goods or services
• Supplies to SEZ developers or SEZ units

Here’s where it gets interesting. Post-Budget 2026, exporters can now claim provisional refunds under Section 54(6)—90% of your ITC upfront, released within days instead of the old 120-day wait.

This extends to Inverted Duty Structure (IDS) cases too, where your input tax exceeds output tax (common for manufacturers buying high-GST raw materials but selling at lower rates).

The refund formula under Rule 89(4) is:

(Turnover of zero-rated supplies / Adjusted total turnover) × Net ITC

For exports, you file using LUT (Letter of Undertaking) on the GSTN Portal 2.0—the bond-free mechanism introduced in 2025 with real-time e-verification.

No bank guarantees, no paperwork hell. Just upload your LUT, get approved, and ship without paying IGST.

Real-World Examples

• Export of IT services: A Bangalore software firm invoices a UK client $50,000 for app development. Zero-rated. Full ITC on their office rent GST, laptop purchases, cloud hosting—everything.
• Supply to SEZ units: A textile manufacturer sells fabric to an SEZ garment exporter. Zero-rated, ITC refund eligible.
• Deemed exports: Domestic supplies to export promotion schemes (like advance authorization holders) get zero-rating treatment for refund purposes.

Compliance Checkpoint

In GSTR-1, zero-rated supplies go in Table 6A (exports with payment of tax) or Table 6B (exports under LUT/bond).

Your turnover includes these supplies. Your ITC-01 must reconcile with shipping bills for exports—GSTN now auto-matches these via ICEGATE integration as of 2026.

One messy reality: post-sale discounts used to trigger ITC disputes because auditors demanded “pre-agreement proof.”

Budget 2026 fixed this—Section 15 and Section 34 amendments now let you issue credit notes for post-sale discounts without prior written agreements.

Just ensure the recipient reverses their proportional ITC. This killed 25% of exporter litigation overnight.

Nil Rated Supplies: The Zero Without the Refund

Nil-rated supplies are taxable supplies charged at 0% GST, but with no ITC eligibility.

Same rate as zero-rated, completely different ITC treatment.

Why the ITC Block?

Schedule I of the CGST Act lists nil-rated goods—mostly essential commodities like unbranded food items, educational materials, and certain agricultural products.

The policy logic: these are necessities, so no tax burden on consumers.

But since there’s no output tax collected, there’s no ITC refund either. It’s a deliberate trade-off.

Examples That Matter

• Unbranded food grains: Rice, wheat, pulses sold loose (not packaged/branded).
• Fresh vegetables and fruits: Sold as-is, no processing.
• Educational books and journals: Printed material for schools.
• Contraceptives and certain drugs: Public health essentials.

If you’re a trader dealing in these, you’re paying GST on your inputs (transport, packaging) but can’t claim it back.

This isn’t a loophole—it’s by design.

The Reporting Quirk

Nil-rated supplies still appear in GSTR-1 under Table 8 (nil-rated, exempt, and non-GST supplies combined).

Your turnover includes them. But unlike zero-rated supplies, there’s no separate ITC reconciliation—because there’s nothing to reconcile.

Exempt Supplies: Outside the Tax Net

Exempt supplies are non-taxable supplies where GST does not apply, and ITC is blocked.

This is the first category where we leave the “taxable supply” universe entirely.

Legal Basis & Examples

Section 11 of the CGST Act and Schedule III define exempt supplies. These include:

• Healthcare services: Hospital treatment, diagnostics (excluding cosmetic surgery).
• Educational services: Pre-school to higher education (excluding coaching centers post-2026 reclassification).
• Public transport: Passenger transport by rail, metro, or non-air-conditioned buses.
• Agricultural services: Services by way of cultivation, harvesting.

The ITC Reversal Trap

Here’s where businesses get burned. If you provide both taxable and exempt supplies (say, a hospital offering paid cosmetic procedures alongside regular treatment), you must reverse ITC proportionally under Section 17(2).

The formula:

(Exempt turnover / Total turnover) × Common ITC

Miss this reversal, and the next GST audit flags it.

I’ve seen small clinics hit with ₹2-3 lakh demands because they claimed full ITC on their electricity bills despite 40% exempt revenue.

Compliance Reality

Exempt supplies go in GSTR-1 Table 8. They inflate your turnover for registration threshold calculations (₹40 lakh for goods, ₹20 lakh for services) but don’t generate output tax liability.

This creates a weird scenario where you might cross the threshold and need to register, but still collect zero tax from customers.

Non-GST Supplies: Completely Outside the Framework

Non-GST supplies fall entirely outside GST law—not taxable, not exempt, just excluded.

These are governed by other laws or constitutional provisions.

What Qualifies as Non-GST?

Schedule III of the CGST Act lists these:

• Alcoholic liquor for human consumption: Governed by state excise laws.
• Petrol, diesel, ATF, natural gas: Until notified by GST Council (still excluded as of 2026).
• Electricity: Covered under the Electricity Act.
• Land and building sales: Real estate (excluding construction services, which are taxable).

The Petroleum Exception

This is the big one. Petroleum products remain under the old VAT/excise regime because states didn’t want to lose that revenue stream.

For businesses, this means:

• No ITC on fuel purchases (except for certain specified uses like in manufacturing).
• Separate accounting for fuel expenses.
• No GST invoicing—you get retail bills instead.

GSTR-1 Treatment

Non-GST supplies appear in Table 8 alongside nil-rated and exempt supplies.

But unlike exempt supplies, there’s no ITC reversal calculation—these never had ITC eligibility to begin with.

The Ghost Errors: Where Classification Goes Wrong

Problem 1: Intermediary Services Losing Zero-Rating

Pre-2026, intermediary services (arranging supplies between two parties) were stuck in a place-of-supply mess under Section 13(8)(b).

If you were an Indian agent connecting a foreign buyer with a foreign seller, you’d lose zero-rating because the old rule treated the supply location as India.

The 2026 fix: Section 13(8)(b) was omitted. Now intermediary services follow the general place-of-supply rule (recipient’s location).

If your recipient is outside India, it’s zero-rated, full ITC refund. This saved thousands of SME service exporters.

If you’re in this boat, file an advance ruling to lock in your classification—it’s free insurance against future disputes.

Problem 2: Inverted Duty Structure Cash Flow Crunch

Manufacturers buying inputs at 18% but selling finished goods at 5% (like certain processed foods) faced 4-month refund waits.

Their working capital was stuck in ITC claims.

The community fix: Classify eligible supplies under “deemed exports” to access the new provisional refund route.

File via GSTR-1A (the real-time reconciliation form introduced in 2025) to auto-match invoices and speed up processing.

The 90% provisional release typically hits your account in 7-10 days now.

Problem 3: Post-Sale Discount Audit Nightmares

FMCG and pharma companies offer volume discounts after quarter-end. Pre-2026, tax officers demanded written agreements dated before the original supply, triggering litigation.

The fix: Issue credit notes under amended Section 34, clearly stating “post-sale discount as per revised valuation.”

Ensure your buyer reverses their ITC proportionally and reflects it in their next GSTR-3B.

Keep email trails of discount approvals—that’s your audit defense.

Common Mistakes to Avoid

1. Treating exempt as zero-rated: You can’t claim ITC on exempt supplies. Ever. That ₹5 lakh hospital equipment purchase? If 60% of your revenue is exempt healthcare, you’re reversing 60% of that ITC.
2. Not reporting nil-rated supplies: Just because the rate is 0% doesn’t mean you skip GSTR-1. These supplies count toward your turnover and registration threshold.
3. Claiming ITC on non-GST supplies: Fuel, alcohol, electricity—none of these generate GST input credit (with narrow exceptions for manufacturing use of fuel).
4. Misclassifying intermediary exports: If you’re arranging cross-border deals, check if your supply qualifies for zero-rating post-2026 rule changes. Don’t assume the old classification still applies.

How This Affects Your GST Returns

GSTR-1 Implications

• Zero-rated supplies: Tables 6A/6B with shipping bill references.
• Nil-rated, exempt, non-GST: Combined in Table 8.
• ITC reconciliation: Only zero-rated supplies trigger refund claims in GSTR-1A.

GSTR-3B Implications

• Your tax liability (Table 3.1) won’t include nil-rated, exempt, or non-GST supplies—but zero-rated supplies appear as ₹0 tax.
• ITC claims (Table 4) must exclude inputs used for exempt supplies (proportionate reversal).

The Audit Trail

Post-2026, GSTN’s AI-driven risk scoring flags mismatches between:

• Your GSTR-1 classification and actual supply nature (e.g., you marked something exempt, but your invoice shows GST).
• Your ITC claims and your exempt revenue ratio.
• Your export shipping bills and your zero-rated supply values.

Getting this right at the invoice level prevents downstream chaos.

FAQs: Implementation Questions

Can I claim provisional refunds on zero-rated exports in 2026?
Yes—Budget 2026 extends 90% provisional refunds under Section 54(6) to zero-rated supplies and IDS cases. File via GSTN with LUT, and funds release within 7-10 days post-risk assessment, eliminating the old 120-day wait for exporters.

How do post-sale discounts affect my zero-rated ITC claims?
Post-2026, post-sale discounts reduce taxable value without pre-agreement requirements. Issue credit notes under Section 34, ensure your buyer reverses proportional ITC in their GSTR-3B, and your refund claim adjusts automatically—no audit disputes.

Are intermediary services zero-rated after Budget 2026?
Yes—omission of Section 13(8)(b) applies general place-of-supply rules (recipient location). If your client is outside India, it’s zero-rated with full ITC eligibility effective April 1, 2026. File an advance ruling for confirmation.

What’s the difference between nil-rated and exempt for ITC purposes?
Both block ITC, but nil-rated supplies are taxable at 0% (appear in turnover, affect registration thresholds), while exempt supplies are non-taxable (require proportionate ITC reversal if you have mixed revenue).

Do non-GST supplies like petrol appear in my GSTR-1?
Yes, in Table 8 alongside nil-rated and exempt supplies. But there’s no ITC reversal calculation because these were never ITC-eligible. They’re reported for turnover transparency only.

How do I calculate ITC reversal for exempt supplies?
Use the formula: (Exempt turnover / Total turnover) × Common ITC. “Common ITC” means inputs used for both taxable and exempt supplies (like electricity, rent). Reverse this amount in GSTR-3B Table 4(B)(2).

Can I use LUT for zero-rated supplies to SEZ units?
Yes—LUT covers both exports and SEZ supplies. Upload on GSTN Portal 2.0, get e-verification within 24 hours, and supply without paying IGST. Your ITC refund claim files separately via GSTR-1A.

What happens if I misclassify a nil-rated supply as zero-rated?
You’ll claim ITC refunds you’re not entitled to. GSTN’s auto-reconciliation will flag the mismatch (nil-rated goods don’t have shipping bills or SEZ invoices), triggering a demand notice plus 18% interest. Fix this at invoice level before filing.

 

 

Running a business is complicated enough. Your GST classification shouldn’t add to the chaos.

Get these four categories right, and your returns become predictable, your refunds arrive on time, and your audits turn boring—which is exactly what you want.

For deeper dives into GST compliance mechanics, check out our guides on GST invoicing requirements, GSTR-1 filing workflows, https://cleartax.in/s/gst-interest-calculation-changes-2026 and tax payment reconciliation.