Bond vs. Letter of Undertaking (LUT): An Advanced Examination of Mechanisms for Zero-Rated Supplies Under GST

The Goods and Services Tax (GST) framework in India designates exports and supplies to Special Economic Zone (SEZ) units or developers as ‘zero-rated supplies’. This classification fundamentally means that the final burden of GST on these supplies is nil. To achieve this zero-rating, the GST law provides exporters with two primary operational choices: either effect the zero-rated supply upon payment of Integrated Tax (IGST) and subsequently claim a refund of the paid tax, or effect the zero-rated supply without payment of Integrated Tax, subject to furnishing a safeguard mechanism to the tax authorities. This safeguard mechanism takes the form of either a Bond or a Letter of Undertaking (LUT), both governed primarily by Rule 96A of the Central Goods and Services Tax (CGST) Rules, 2017.

While both Bond and LUT fulfil the identical objective of enabling zero-rated supplies without upfront tax payment, they represent different legal instruments and are applicable under distinct conditions, reflecting varying levels of trust and security required by the tax administration based on the exporter’s profile and compliance history. Understanding these differences is crucial for exporters to determine the appropriate mechanism for their operations.

At its core, the difference between an LUT and a Bond lies in their very nature as legal instruments. A Letter of Undertaking is a simple promise, a self-declaration by a compliant exporter. A Bond, conversely, is a more formal, legally binding agreement, often reinforced with financial security.

To provide a clearer picture of their distinctions, let’s look at a detailed comparison:

Detailed Comparison: Bond vs. Letter of Undertaking (LUT)

Eligibility Criteria: A Deeper Dive into Rule 96A

As highlighted in the table, the most significant statutory factor differentiating the requirement for an LUT versus a Bond lies in Rule 96A. This rule specifically restricts the LUT facility to registered persons who have not been prosecuted for any offence under the specified tax laws where the evasion amount exceeds INR 250 lakh. This condition serves as a critical eligibility filter, ensuring that the simpler, trust-based LUT mechanism is available only to exporters with a clean record concerning serious tax non-compliance. Exporters who fall outside this criterion, perhaps due to a past prosecution for significant tax evasion, are mandatorily required to furnish a Bond, which provides a higher level of assurance to the revenue.

Security Requirement: The Role of the Bank Guarantee

The presence or absence of a security requirement, particularly a bank guarantee, is a major practical divergence between Bond and LUT. While the LUT relies solely on the exporter’s promise, the Bond mechanism typically demands a bank guarantee. This bank guarantee acts as a financial buffer for the government, allowing for easier recovery of tax, interest, and penalty in case the exporter fails to fulfil their obligations. Although the maximum value of the bank guarantee is generally limited to 15% of the bond amount, the Commissioner retains the power to waive this requirement entirely based on the exporter’s credibility and compliance history, adding a layer of administrative discretion.

Procedural Nuances and Cost Implications

Both instruments are initiated through the electronic filing of Form GST RFD-11 on the GST portal. However, the Bond process involves additional steps outside the digital realm, requiring the physical execution of the bond document on stamp paper and the submission of the bank guarantee (if applicable) to the jurisdictional officer. This adds procedural complexity and cost to the Bond mechanism, including stamp duty and bank commission charges, making the LUT the more straightforward and cost-effective option for eligible exporters.

Impact on Working Capital and Refund Claims

Both Bond and LUT are instrumental in improving exporters’ working capital by allowing them to export without blocking funds as upfront IGST payment. Instead of claiming a refund of paid IGST (which can be a time-consuming process), exporters operating under a valid Bond or LUT are eligible to claim a refund of the accumulated Input Tax Credit (ITC) on their inputs and input services used for making zero-rated supplies, a process that is generally considered smoother.

Conclusion

In summary, the Bond and the Letter of Undertaking furnished under Form GST RFD-11 are both vital components of the GST framework for facilitating zero-rated supplies. However, they are distinct pathways chosen based on the exporter’s eligibility, primarily determined by their past compliance record, especially concerning tax evasion. The LUT represents a trust-based, simpler, and cost-effective mechanism for compliant exporters, while the Bond, often backed by a bank guarantee, provides a more secure, albeit slightly more complex and costly, alternative for those who do not meet the stringent eligibility criteria for LUT. Understanding this distinction is crucial for exporters to ensure compliance and effectively manage their international trade operations under the GST regime. The choice between Bond and LUT reflects the delicate balance the GST law strikes between facilitating exports and safeguarding revenue interests.