The tax liability will be reduced for the seller and the amount will be reversed from ITC of the buyer’s GSTR-2A and GSTR-2B. If the incidence of tax has been passed to another person (i.e., for any reason ITC cannot be reversed) then there will be no reduction in tax liability. For unregistered buyers, the entire amount must be refunded to the buyer returning the items.
If the amount is not refunded for some reason even though goods are returned, then the tax liability will not be reduced. Thus, GST follows the general law of unjust enrichment that no one will be allowed to profit at another’s expense.