Goods & Services Tax (GST) in IndiaImpact of Correction of Inverted Duty Structure

INTRODUCTION

Goods and Services Tax (GST) has been the greatest tax reform in India changing the tax structure of indirect taxes entirely. It has proved to be an effective system in shifting the approach from origin based to destination based taxation and subsuming the myriad taxes that were levied at different levels.

Under the GST regime, the concept of Input Tax Credit (ITC) is imperative to the execution of the entire ecosystem. ITC basically allows the taxpayers to claim refund of the excess credit that remains post the payment of taxes for purchase of inputs in furtherance of business.

One of the situations where ITC gets accumulated is that of Inverted Tax Structure. This issue has been under the radar for quite some time now and the GST Council has recently recommended the correction of Inverted Tax Structure as it causes inconvenience to the businessmen and falling revenue of the States.

WHAT IS INVERTED DUTY STRUCTURE?

Basically, when it so happens that the tax rate charged on inputs is higher than the tax rate charged on output of supply of goods or services, leading to accumulation of credit is referred to Inverted Duty Structure.

For instance, the GST charged on raw material non-woven fabric is 12% while the finished product, a fabric bag made out of it is charged 5% GST. This is the typical example of Inverted Duty Structure.

ITC REFUND UNDER GST

When the tax paid on inputs exceeds the output tax due, ITC is accumulated. Such an accumulation will have to be carried over to the next financial year until the registered person may use it to pay their production tax liability.

However, subject to certain conditions, GST allows reimbursement of unutilized ITC in two scenarios: firstly; if the credit accumulation is due to zero-rated supply and secondly; the credit accumulated due to an inverted duty structure.

A registered person may ask for a refund of unutilized input tax credit at the completion of any tax period under Section 54(3) of the Central Goods and Services Tax Act, 2017 (CGST Act). A tax period is the time period during which a return must be filed. As a result, a taxpayer can request a return of any unused ITC on a monthly basis.

Refund can be availed in cases of Inverted Duty Structure under Section 54 of the CGST Act, 2017 read with Rule 89 of the Central Goods and Services Tax Rules, 2017 (CGST Rules). However, the Government also has the power to notify supplies where refund of ITC will not be admissible even if such credit accumulation is on account of an inverted duty structure.

In exercise of the powers conferred by Section 54 of the CGST Act, the Government issued Notification No. 15/2017 of Central Tax (Rate) dated 28.06.2017 wherein it has been notified that no refund of unused ITC shall be allowed under sub-section (3) of Section 54 of the CGST Act, in case of supply of services specified in sub-item (b) of item 5 of Schedule II of the CGST Act. The Central Government has also issued Notification No. 5/2017 of Central Tax (Rate) dated 28.06.2017 in respect of goods where no refund of unutilised ITC shall be allowed, where the credit has accumulated on account of rate of tax on inputs being higher than the rate of tax on the output supplies of such goods (other than nil rated or fully exempt supplies).

CONCERNS PERTAINING TO INVERTED DUTY STRUCTURE AND ITC REFUND

Inverted duty structure has implied a stream of revenue outflow for the Government prompting the Government to relook the duty structure. For footwear alone, the Government refunds around Rs. 2,000 crore in a year.

As per news reports, the Revenue Neutral Rate of 15.5 % has come down to 11.6%. The reasons are suggested to be rate reduction and the refund due to the inverted duty structure.

Inverted rates create distortion in GST since they are a deviation from the basic philosophy of a value added tax. The adverse implications of inverted rates that were discussed in the GST Council meeting are as follows:

1. A manufacturer suffers cash flow issues even when refund of accumulated ITC on inputs is done.
2. The accumulated ITC on input services and capital goods is not refundable even if rate structure is inverted. Input services constitute significant portion of cost. Thus, accumulated ITC on input services would be significant. Accumulated ITC on capital goods is a burden for exporters too.
3. Small standalone units suffer more on account of inversion (in comparison to a large composite unit).
4. Inverted rate structure makes import more competitive putting domestic units at disadvantage. While domestic unit suffer the adversities of accumulated ITC, the import simply enjoys lower the Integrated Goods and Services Tax (IGST) without any inversion or accumulated ITC.
5. Inversion disincentives capital investment. Acquisition of capital goods for manufacturer of goods suffering inversion (say fabrics) would lead to hardship for a new unit or a unit undertaking expansion of capacity, as ITC on capital goods accumulates and cannot be adjusted with output tax liability. This has been argued by industry.
6. A consumer is also unlikely to gain much on account of lower rate on goods suffering inversion. The embedded taxes become cost and likely to be passed on. Further, as new investment is dissuaded in such sectors, customers choices get restricted and sector remain uncompetitive/inefficient leading to adverse consequences in terms of price and availability of goods.
7. Even claiming refund of accumulated ITC on inputs requires effort, cost and is often marred with litigation.
8. With technological advancement and increasing production, net unit value addition at manufacturer’s end falls. Manufacturers have been outsourcing more, including the manpower supply. This makes inversion further acute.
9. In absence of any standardised input output norms, the inverted rate structure has also led to making fraudulent refund claim that is accumulated on fake invoice in items like footwear.
10. Inverted rates also have serious implication to revenue as there has been substantial outgo in refund of accumulated ITC on inputs (no refund is given on input services and capital goods).

Thus, overall, inverted rate structure would make domestic industry less competitive, result is cash flow issues besides accumulation of ITC that sticks to cost, lead to unfair practices, creates disincentive for investment in newer technology and expansion, does not really benefit the consumer much in terms of cost reductions and has serious implication to revenue. Thus, a proposal for correcting the Inverted Rate Structure on Footwear and Textiles is placed before the Council.

GST COUNCIL TO CORRECT INVERTED DUTY STRUCTURE

Recently, the Committee of Officers on Augmentation of Revenue identified ‘Inverted Duty Structure’ as an important issue that has led to certain complications in the GST tax regime. Thus it is required to go through correction.

The inverted duty structure leads to accumulation of ITC with the person making the supply. The recommendations made before the GST Council by the Fitment Committee in the 39^th meeting held on 14.03.2020 on the issue of correction of Inverted Duty Structure with respect to the industry of textiles, footwear, mobile and fertilizers were as follows:

• GST rate on mobile phones and its parts to be increased from 12% to 18%.
• GST rate on Chemical fertilizers to be increased from 5% to 12%.
• GST rate on footwear with value up to Rs.1000/- per pair to be increased from 5% to 12%.
• On textiles, 5% GST on cotton and other natural fibres (except raw jute, silk and wool) and all-natural fibre yarns; 12% GST on manmade fibre; 12% GST on MMF yarns; 12% GST on all fabrics; 12% GST on all garments and made-ups; 12% GST on dyeing services.

The GST Council accepted the above recommendations to the extent of mobile phones and its parts while the rest was put to hold for discussion in further meetings. However owing to the economic situation due to Covid-19, the GST Council in its further meeting held on 12.06.2020 although acknowledged the need for correction of the Inverted Duty Structure but postponed the issue.

The matter has been taken up for deliberation and accelerating towards final decision as noticed in the discussion done in the recent 45^th GST Council meeting. The Council took note of the revenue losses that have been occurring owing to the Inverted Duty Structure and rate rationalization is thus sought to be done. A course correction mode is to be adopted for correcting the Inverted Duty Structure on items of footwear, textiles, etc.

Earlier the GST on footwear up to Rs. 1,000 was only 5 %. The inputs used like in-soles, heel cushions, etc. fall under the tax slab of 18 %. This Inversion of rates is sought to be corrected by having a uniform rate for all category footwear of 12%

Textiles, which are currently classified under 5% GST slab but the fabrics and man-made yarns are classified under the 18% slab, is also likely to attract a 12% tax rate with exceptions for some categories such as cotton products.

IMPACT ON VARIOUS INDUSTRIES

The present structure currently raises the cost of procuring input goods, which makes manufacturing more expensive and higher costs ultimately makes businesses less competitive. A complicated refund process under GST creates additional compliance requirements and finally leads to more cost of compliance.

The industries primarily affected such as Textiles and Footwear will thus benefit from the correction of Inverted Duty Structure.

Textiles

Ministry of Textiles has recommended for correcting inverted rate structure so as to free the textile industry from the burden of taxes with accumulated ITC. It has been stated that liberating this sector will also substantially increase employment opportunities in the textile industry.

The differential rates and slow-refunds of accumulated ITC have affected the competitiveness of the industry and have proven to be  deterrent for investment in the sector. Ministry of Textile is of the view that for tax uniformity across the value chain, MMF fibres and yarns need to be brought under a uniform tax slab to take care of inversion in tax structure. This will benefit the spinning and power loom sectors, which in turn will boost the garment sector and create a large number of job opportunities.

Removal of inversion would give boost to the garment sector and with increasing production customer would also benefit. Besides, there exists a strong economic justification, as argued by Ministry of Textiles, that refined rate structure will help the sector to grow at faster pace.

Footwear

In general, the dual rate structure needs to be avoided as it creates distortion and leads to evasion of taxes. As such an ad valorem rate ensures that in absolute term the lower segment would suffer lesser tax incidence.

AMLEGALS Remarks

The objective behind the introduction of GST was to put into place a tax structure
wherein seamless tax ecosystem can be created which could not be even achieved under VAT. This was in turn related with the bigger objective of ensuring revenue of the Centre and the States.

However, with the Inverted Duty Structure, the taxpayers have been facing inconvenience in complying with the complicated refund process of the ITC. The inverted duty structure is a result of a phenomenon wherein the difference in taxation leads to accumulation of ITC. This causes unfair obligations.

Nevertheless, with the recent amendment and its effects on the Footwear and Textile sector; there is a possibility of exponential growth of unaccounted business and this conundrum of inverted duty structure could be exterminated if the taxing differential for import is taken care of instead of changing the tax value at later stages.

Team AMLEGALS assisted by Ms. Kulsoom Farhat Khan (Intern)

For any query or feedback, please feel free to get in touch with chaitali.sadayet@amlegals.com or aditi.tiwari@amlegals.com.