JUNE 10, 2019

By S Murugappan, Advocate

INVERTED duty/tax structure is not a new phenomenon in India. When the rate of duty/tax on finished goods is less and the rate of tax on the inputs/raw materials used in the production/supply of the finished goods is more, inverted tax structure results. At times, such inverted structures are driven by policy considerations. But, most of the times, these are a result of apparently in appropriate tax planning or ill-suited tariff description.

In respect of imports, in addition to basic customs duty, tax equivalent to IGST as applicable to similar goods is to be paid and, therefore, there may be cases where duty on the parts/inputs imported for manufacture of the finished items is more when compared to import of the finished item itself, attracting a lower rate of duty. In respect of domestic supplies, a manufacturer may find the tax rates higher on the inputs when the tax rate on his end product is less, resulting in accumulated input tax credits.

A classic example of such inverted duty structure relates to pens and parts of pens. Assembled pens are covered under Schedule-II to Notification 1/2017-Integrated Tax (Rate) dated 28.06.2017 and attract 12% tax (SI.No.232 in Schedule-II) (or CCGST at 6% & SCGST at 6%); whereas parts of pens, because they are not specifically mentioned in the above serial number, are treated as falling under SI.No.453 of Schedule-III as "goods which are not specified in other schedules" and attract 18% IGST (or 9% CGST + 9% SGST). The parts, which are imported by manufacturers for production of pens include refills, pen nibs etc.

Another example will be the duty rates applicable for power driven pumps that are primarily designed for handling water, including submersible pumps. At four-digit level these fall under Heading 8413 and attract 12% IGST in terms of Notification No. 1/2017-Integrated Tax (Rate) dated 28.06.2017 (Serial No.192 of Schedule-II). On the other hand, since their parts are not specified in the notification at the above serial number, they have to be classified under Schedule-III as "goods not elsewhere specified" against Serial No.453 and thus, they end up attracting a tax of 18% IGST.

Rubber tyres attract basic customs duty of 10% at the time of import, whereas natural rubber, which is a raw material for tyre manufacture attracts 25% or Rs.30/- per kg. whichever is lower, at the time of its import. The higher rate for the raw material in this case can be due to fiscal policy considerations since rubber, as such, has multiple uses and not only for manufacture of tyres.

However, in the other examples referred to above, the inverted duty structure appears to be more of because of flaws in the tariff schedule/structure and product description adopted at the time of implementation of GST, rather than due to any conscious tax planning. Prior to 01.07.2017, the VAT/Sales Tax Schedules of most of the States were based on items description comprised in a few schedules. On the other hand, the Central Excise Tariff relating to levy of excise duty on manufactured goods was based on the Harmonised System of Nomenclature, a code, formulated by the World Customs Organisation and which is universally adopted by almost all the countries. The HSN code is a scientifically developed code making provisions for classification of any product or its parts at appropriate places under appropriate tariff heading and is governed by specific rules of interpretation. When GST was introduced there was a marriage of convenience between different States' VAT schedules and Central Excise Tariff. The result was adoption of a few schedules based on rates with description and classification of products, mostly at four-digit levels as opposed to a full-fledged eight-digit level classification. This was with a rider that the rules for interpretation of the first schedule to the Customs Tariff Act 1975, including the section/chapter notes etc. shall, insofar as may be, apply to the interpretation of the tax rate notifications.

The schedules to the Central Excise Tariff Act, 1985 and the Customs Tariff Act, 1975 in most of the cases tend to classify parts of machinery/equipment within the same headings. Thus, in respect of pens and pen parts, all these items are classifiable under heading 9608 at four-digit level. At eight-digit level various parts such as refill, pen nibs are specifically mentioned.

However, in the schedules to the GST tax rate notifications, the description is only "pens (other than fountain pens, stylograph pens)" with the classification code as 9608 in Schedule-II. Thus, according to tax authorities, parts of pens will not be covered under this entry. Even though there is no separate heading for "parts of pens" in any of the Schedules, the authorities seek to classify these parts as goods which are not specified in other Schedules, against SI.No.453 of Schedule-III attracting 18% IGST. Because of this skewed interpretation, 'pen parts' end up in Schedule-III attracting a higher rate of tax than fully assembled pens attracting a lower tax rate. Therefore, it will not be competitive to manufacture a pen in India but it will be cheaper to import it or buy it locally.

The GST law recognises inverted duty structure and provides for refund of accumulated tax credit in such cases in terms of Section 54 of CGST Act, 2017. However, here also, there are exceptions where such accumulated credit will not be available in respect of supplies, which are notified and secondly, the refund mechanism as stipulated in Rule 89 of CGST Rules contains a complicated formula for working out the eligible refund that a small-scale assessee has to seek expert help. For example, railway rolling stock, such as bogies, axles and wheels and traffic control equipment for railways, roads, inland waterways etc. attract a lower tax rate at 5% IGST whereas most of the inputs used in the manufacture of such rolling stock and traffic control equipment attract a higher tax rate. Inspite of this, as per Notification No. 5/2017-Integrated Tax (Rate) dated 28.06.2017, refund of accumulated credit is denied to manufacturers of these goods. The net effect is that the cost goes up and the government is unduly enriched with the accumulated credit. There is no transparency as to why in such cases the refund is not to be permitted.

Added to all these, when parts attracting higher rates of IGST are imported and when the importers, oblivious of these subtle differences, claim a lower tax rate or claim an exemption, then, they are saddled with the charge of attempting to evade payment of proper tax and proposals are made to slap them with penalties. Thus, in the case of pen parts, if an importer, by mistake, claims the rate applicable to pens, then, he is taken to task with issue of show cause notices with penalty proposals accusing him of not honouring the trust reposed on him by the government in the era of self- assessment.

Added to their misery is the fact that in respect of domestic supplies, small units are given the benefit of mentioning only four-digits in their invoices and returns and at four-digit level, supply of pen parts at concessional duty of 12% goes through the system without hitches and only when it comes to eight-digit level, large scale manufacturers face difficulties. Thus, within the country, different rates and different practices thrive.

The net result of all these is making manufacturing these products uncompetitive and unviable and the resultant tax planning complicated. In this background, the concept of "Make in India" gets a beating and consequently these tax anomalies would become really taxing.