JULY 23, 2020

By Amit Sarker and Aniket Singh

THE impact of the coronavirus pandemic (COVID-19) is being felt by businesses around the globe. Companies are required to navigate a wide range of inter-related issues that include keeping their employees and customers safe, shoring up cash and liquidity, reorienting operations and navigating complicated government support programs.

To build on the enforced global supply chain restructuring triggered by disruptions imposed by the current pandemic, the government recently announced multiple incentive schemes for the electronics, pharmaceutical and medical devices sectors. The schemes envision creation of common infrastructure facilities with production-linked incentives to attract multinationals to Make in India and help transform India as a manufacturing hub for domestic as well as export markets.

The importance of exports to any economy cannot be emphasised enough. Exports play an important role in the Indian economy as well, influencing the level of economic growth, employment and the balance of payments. One of the crucial factors, which determines the level of exports, is relative competitiveness. Competitiveness is determined by factors such as labour costs, inflation, productivity, infrastructure and price of materials. With regard to price of materials, while the Goods and Services Tax (GST) law has the concept of zero rating of exports, the concept needs to be applied in the context of evolving supply chain and business requirements, to ensure that export supplies do not have any incidence of any indirect tax. In the event there is an increase in the price of materials on account of tax cascading, especially in context of goods meant for exports, it will be a dent on India's competitiveness and could directly influence the export performance. Before discussing the issue of GST and the hindrance in context of export of specified goods under financing arrangements, it would be relevant to briefly understand some operational modalities of such contracts.

Depending upon the exporter's requirements, there are various forms of financing available to them, from long-term/short-term advances against supply orders, long term and short term loans to additional credit lines etc. In this context, it is should be noted that as early as May 2014, the RBI issued a circular permitting certain categories of exporters to receive long-term export advances up to a maximum of 10 years, to be offset against the execution of long-term supply contracts. Prior to this, Indian foreign exchange regulations did not offer an option for Indian exporters to receive long-term advances from foreign buyers. As an exporter, such funds received through the financing channels were to be used in preliminary stages while incurring capital expenditures.

In such commercial arrangements with foreign buyers, it is feasible that the contract includes incurring capital expenditures in the form of procurement/manufacture of capital goods, which would, in turn, be used to manufacture the finished goods for exports. The contracts in such scenarios could include supply (export) of such capital goods subsequently to the overseas buyer after a defined period along with the export of the finished goods. In such cases, the capital expenditure is generally not accounted in the books of the exporter but in the books of the foreign buyer. To enable this, it is feasible that the transfer of title in the capital goods could take place upon receipt of the long term advance with the physical exports of the same deferred to a future date - generally upon completion of the export order. It is also feasible that some part of the capital goods may not be exported and could be required to be disposed off locally as well. The moot question and the point of contention here is the applicability of GST in context of the deferred export of the capital goods upon fulfilment of the export order for which the consideration was paid as a long-term advance.

With the above background, it is relevant to discuss the recent Advance Ruling issued in the case of the Dolphine Die Cast (P) Ltd by the Karnataka Advance Ruling Authority (KAR ADRG 35/2020 dated 20/05/2020)- 2020-TIOL-106-AAR-GST. The facts of the case are similar to the arrangement discussed above, wherein the exporter is engaged in the manufacturing and export of aluminium and zinc die castings. The company first manufacturers the steel die (capex) as per the requirement and specifications given by the foreign customer. After seeking approval from the overseas buyer, the applicant uses steel dies for making aluminium and zinc die castings. The manufactured aluminium and zinc die castings are exported to the overseas customer along with sub-assemblies and other components against the export order. The company retains the steel die till the completion of the export order or completion of the life of the die, post which a decision is taken to export the capital goods or dispose the same locally. The facts are silent on the nature of financing (long-term advance, loan etc.), when exactly does the transfer of title to the capital goods takes place and the accounting aspects of the capital expenditure incurred.

In the above scenario, the AAR has ruled that since the invoice was issued immediately after manufacture of the steel dies without actual physical export of goods, export conditions as per the IGST Act are not fulfilled and, therefore, the transaction is taxable under GST. While it can be said that the applicant's presentation of facts, framing of questions and proposed tax positions were a factor for the AAR in reaching its conclusions, the fact remains that taxing statutes are required to be subjected to a strict interpretation. A strict conjoint reading of the zero-rating provisions available under section 16 of the IGST Act and the definition of export under section 2(5) as "taking out of India to a place outside India" could lead to a conclusion that this supply is taxable. However, the limitations and the rigidity of the definitions in the present case is against well-known international principles of VAT/GST - "exports should be tax free". In this regard, VAT/GST statutes in UK, Australia, Singapore, New Zealand provide for an enlarged scope of zero-rated supplies for capital goods in such scenarios, to the extent they are used for exporting finished goods outside the country. This removes applicability of VAT/GST on use and export of such capital goods, thereby reducing the cost of the final product for the foreign buyer.

If India has to realise its ambitions of becoming a global manufacturing hub, the GST law should keep up with the evolving supply chain practices and also not have a narrow interpretation of the GST provisions while assessing the tax implications on dynamic business situations within the framework of law. The definition of export and zero rating under GST needs to be amended, in line with international principles, to give way for removal of GST on such capital goods, which are used for manufacture of export goods and eventually exported themselves. As mentioned above, relative competitiveness is the key cornerstone for determining level of exports for any country. With the RBI stepping in to remove regulatory challenges in export financing, we hope the Central Government would act proactively and not let GST play spoilsport.

(Amit Sarker is a Senior Director and Aniket is a Manager with Deloitte Haskins & Sells, LLP - The views expressed are strictly personal.)