While the globally accepted norm is that customs duty rates on final products are always equal to or higher than the rates on components or raw materials used for the manufacture of the final products, in certain cases the converse is true, which results in an “inverted duty structure”. Such an inverted levy is distortionary and results in tax inefficiencies as the manufacturer builds up unused credits.
The natural corollary of an inverted duty structure is that imports of the final products become cheaper, which adversely affects the competitiveness and sustainability of the domestic manufacturing industry.
The issue of inverted duty structure arises mainly because: (a) import duty on finished products is lower than import duty on raw materials; (b) import duty on finished products is lower than duty rates on domestic procurement of raw materials; (c) free trade agreements/regional trade agreements (FTAs/RTAs) with various countries ensure that finished products attract negligible or concessional rates of duty; and (d) this inversion is not solely because of basic custom duty (BCD) but in some cases a result of other additional duties.
The anomaly created by inverted duty structure needs to be corrected to promote domestic manufacture in key sectors, in line with the “Make in India” theme, and to ensure the effectiveness of the credit system under the goods and services tax scheme when it is introduced.
This problem in India has been accentuated by the duty concessions granted for exports into India of final products under various FTAs which India has entered into. The government in 2006 set up a committee under the chairmanship of Planning Commission member Anwarul Hoda to study and suggest ways of shielding domestic manufacturers from the impact of inverted duty structure arising out of FTAs. However the problem was not immediately addressed and India has entered into various FTAs/RTAs since then, which has further accentuated the issue.
The present government has promoted the “Make in India” programme to spur and promote domestic manufacturing. As set out in the foreword to the Foreign Trade Policy, 2015-20, the government’s focus is two-fold: to provide a framework for increasing exports of goods and services, and to generate employment and increase value addition in India, in keeping with the “Make in India” initiative.
The twin objectives of fostering domestic manufacturing and fostering exports through FTAs which require reciprocal export concessions to be granted to foreign partner countries are however greatly affected by the problem of inverted duty structure, which not only adversely affects the competitiveness of domestic industry but at the same time favours cheap imports of final products into India.
This issue has time and again been highlighted by industry, and the government has taken note of the issue. In the budget for 2014-15, the government had, with a view to boost domestic manufacture and also to address the issue of inverted duties, reduced the BCD on various inputs or components. The BCD had also been reduced on various key inputs in order to encourage new investment and capacity addition in the chemicals and petrochemicals sector. This initiative was carried forward in the budget for 2015-16, in which the rate of BCD was reduced on 22 key inputs/components across various sectors with a view to enhance job creation through revival of growth and investment and promotion of domestic manufacturing and “Make in India”.
While the government has taken several commendable steps to address inverted duty structure by way of reducing the BCD on key inputs/components across certain sectors, it is important to note that the existing FTAs contain long-term contractual obligations, which cannot simply be tailored or modified. Although the government can consider invoking the “safeguard clause” (embedded in most of the FTAs to sanction the adoption of counter-measures to guard a domestic industry facing “threat of serious injury” from substantial imports), maintaining a symmetry between applying the safeguard measures and striving for the objective of trade liberalization is always a challenge.
Given the economic position India is presently in, it is imperative that there is a cohesive and coordinated effort to collectively promote and foster the “Make in India” initiative as well as the stated goal of promotion of exports from India. While seeking to ensure greater exports from India, it is necessary to ensure that India’s push towards regional and bilateral agreements results in meaningful and result-oriented FTAs/RTAs and comprehensive economic cooperation agreements (CECAs).
To provide a reality check of existing RTAs/FTAs/CECAs, the performance of the items for which duty concessions have been given along with the impact on domestic production needs to be evaluated. It is also advisable and necessary to have greater involvement of all stakeholders while negotiating further RTAs/FTAs/CECAs, so that the interests of all Indian stakeholders are understood and fully protected.
Karthik Sundaram is an associate partner and Tejus Golchha is an associate manager at Economic Laws Practice. This article is intended for informational purposes and does not constitute a legal opinion or advice.
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