Karnataka GST (Amendment) Act, 2025: Strengthening Compliance, Accountability and Digital Enforcement

Introduction

The Goods and Services Tax (GST) regime, introduced in India in 2017, has undergone several amendments at both the Central and State levels to address interpretational issues, streamline compliance, and plug revenue leakages. The Karnataka Goods and Services Tax (Amendment) Act, 2025 (“Amendment Act”), notified on 2nd September 2025, represents a significant recalibration of the State GST framework.

The Amendment Act incorporates provisions aimed at enhancing digital enforcement, tightening compliance obligations, and harmonising State law with developments under the Central Goods and Services Tax (CGST) Act, 2017 and the Integrated Goods and Services Tax (IGST) Act, 2017.

Expanded Definitions – Section 2

The definition section of the KGST Act has been a recurring source of interpretational disputes. The Amendment Act expands and clarifies several key terms:

• Clause (61) – Scope of Taxable Supplies:  Supplies covered under Section 9 of the KGST Act are now expressly extended to include supplies falling under Section 5(3) and Section 5(4) of the IGST Act. This ensures seamless taxation of cross-border transactions within the federal GST framework.
• Clause (69) – Local and Municipal Funds: The Amendment introduces detailed explanations for “local fund” and “municipal fund”, recognising them as funds managed by local self-governments vested with taxation powers. This removes ambiguity around whether levies collected by municipalities or Panchayats fall within the GST framework.
• Clause (116A) – Unique Identification Marking: A new definition introduces digital stamping and marking as part of a broader track-and-trace mechanism. This signals the State’s intent to implement technology-driven monitoring of goods movement, particularly in sectors prone to tax evasion (e.g., liquor, tobacco, pharmaceuticals, and high-value FMCG goods).

Omission of Certain Sub-Sections

The omission of Sections 12(4) and 13(4) simplifies provisions relating to the time of supply. These sub-sections had earlier created uncertainty in determining tax liability when services or goods involved deferred or continuous supply contracts.

By eliminating these provisions, Karnataka has aligned its law with recent GST Council recommendations that aim to remove redundant clauses and avoid overlapping tax triggers.

Input Tax Credit Restrictions – Section 17(5)

Perhaps one of the most contentious areas under GST has been eligibility of input tax credit (ITC). The Amendment clarifies that “plant or machinery” shall be read as “plant and machinery”, with retrospective effect from 1st July 2017.

Implications:

• Judicial Conflicts Resolved: Several High Court rulings had taken a liberal interpretation of “plant or machinery,” allowing ITC on standalone items. This amendment overrides such interpretations.

• Retrospective Effect: Taxpayers who availed ITC based on favourable judgments may now face retrospective reversals. Ongoing assessments and litigation will require urgent review.

• Sectoral Impact: Industries with capital-intensive investments (manufacturing, infrastructure, renewable energy) will be directly affected.

Apportionment of Tax – Section 20

• By extending the apportionment mechanism to include provisions of the IGST Act, Karnataka ensures greater interoperability between State and Central tax flows.
• This will have practical significance in cases involving inter-State supplies, input service distributors (ISD), and cross-border e-commerce operators, where accurate tax settlement between Union and States has been a recurring challenge.

Credit Notes – Section 34

The revised proviso imposes stringent conditions on suppliers seeking to reduce tax liability through credit notes. Specifically, no reduction is permitted unless:

1. The recipient has reversed the corresponding ITC, or

2. The incidence of tax has not been passed on.

Implications:

• Businesses must now synchronise credit note issuance with ITC reversal mechanisms, requiring closer supplier-recipient coordination.
• This will reduce the scope for circular trading practices and artificial credit claims, a long-standing concern of tax authorities.

Communication of Inward Supplies – Section 38

Replacing the term “auto-generated statement” with a broader “statement” widens the scope of prescribed reporting. The amendment also inserts flexibility to capture “other details as may be prescribed”, providing the Government discretion to expand reporting requirements in future.

Businesses should anticipate more granular disclosures in GST returns, possibly including real-time reconciliation of vendor invoices, credit utilisation, and supply-chain disclosures.

Returns and Appeals – Sections 39, 107 & 112

• Section 39 now mandates that returns be filed “subject to such conditions and restrictions”, granting the State regulatory latitude to impose compliance prerequisites.

• Sections 107 and 112 introduce higher financial thresholds for appeals, mandating a 10% pre-deposit of penalty amounts in penalty-only cases.

• This will likely deter frivolous appeals but could also financially burden SMEs facing genuine disputes.

Track-and-Trace Mechanism – Sections 122B & 148A

• The most significant reform introduced is the creation of a statutory track-and-trace mechanism.
• Section 122B prescribes penalties of ₹1,00,000 or 10% of tax payable, whichever is higher, for non-compliance.
• Section 148A empowers the Government to specify goods requiring unique identification markings, enabling electronic storage, affixation of codes, and reporting of machinery capacity and output.

Strategic Significance:

• This brings Karnataka in line with global best practices where supply chains for sensitive goods are digitally monitored.
• Likely target sectors include alcovqholic beverages, tobacco, pharmaceuticals, luxury goods, and high-value electronics.
• Businesses must prepare for IT system upgrades, ERP integration, and supply chain audits to ensure compliance.

Schedule III – Taxability of SEZ/FTWZ Transactions

A critical amendment with retrospective effect from 1st July 2017 deems supplies of goods warehoused in SEZs or FTWZs to be taxable when supplied prior to export or to the Domestic Tariff Area (DTA).

Implications:

• This amendment clarifies that intra-zone transactions within SEZs/FTWZs will not escape GST merely by virtue of warehousing.
• Exporters and warehousing operators will need to re-evaluate contract structures to avoid unexpected tax liabilities.
• Logistics companies must realign invoicing mechanisms to ensure compliance.

Refund Restrictions

• By prohibiting refunds of taxes already collected (even if collections would have been invalid under the amended law), the State has safeguarded revenue interests.
• While constitutionally defensible, this provision may face legal challenges on grounds of equity, particularly from taxpayers who bore the economic burden of such taxes.

Sectoral Impact Analysis

• Manufacturing: Tighter ITC rules and retrospective changes will increase cost pressures.
• Retail & FMCG: The track-and-trace mechanism will impose additional compliance requirements, particularly for consumer goods.
• SEZ/Export-Oriented Units: Expanded taxability of warehoused supplies may affect pricing models.
• Start-ups & SMEs: Increased pre-deposit requirements for appeals could raise litigation costs.

Compliance Strategies for Businesses

1. Supply Chain Audit – Businesses should immediately conduct a GST compliance audit focusing on warehousing, SEZ supplies, and credit note reconciliations.

2. ERP Upgrades – Adoption of ERP solutions capable of integrating digital stamping/unique identification is critical.

3. Contractual Review – Revisit supplier and customer contracts to incorporate ITC reversal conditions.

4. Litigation Strategy – Reassess ongoing disputes, particularly ITC-related, in light of retrospective amendments.

5. Training & Awareness – Build capacity within compliance teams to adapt to expanded reporting obligations under Section 38.

Conclusion

The Karnataka GST (Amendment) Act, 2025 reflects a decisive move towards digitalisation, stricter compliance, and revenue protection. By introducing a track-and-trace mechanism, tightening credit note provisions, and redefining appeal thresholds, Karnataka has signalled its intent to curb evasion and strengthen tax administration.

For businesses, the challenge lies not only in meeting these enhanced compliance requirements but also in restructuring supply chains, upgrading systems, and re-evaluating tax strategies.

As the GST regime continues to evolve, companies operating in Karnataka must view this Amendment not merely as a compliance burden but as a call to adopt best practices in tax governance, digital readiness, and supply chain transparency.