The Goods and Service Tax Council is scheduled to meet on September 9, 2024 in New Delhi.
The reforms in inverted duty structure is expected under the rate rationalisation deliberations which is undertaken by the Group of Members (GoM). The inverted duty structure is a condition where there is higher duty on input and lower duty on output for sale.
The are challenges associated with inverted duty structure which affect businesses severely. “The inverted duty structure presents significant challenges for multiple sectors. One major issue is the blockage of working capital due to accumulated input tax credits (ITC), which strains liquidity for businesses. This challenge necessitates adjustments in GST rates or mechanisms to expedite refunds on these credits,” said S. R. Patnaik, Partner (Head – Taxation), Cyril Amarchand Mangaldas.
The government policies has been emphasising on sourcing inputs domestically rather than relying on imports. However, the challenges of inverted duty structure tends to discourage domestic manufacturing which are based on imported raw materials. Thus, frustrating the competitiveness in the manufacturing sector. Additionally, “on customs side, Free Trade Agreements can exacerbate the problem by granting duty-free import privileges to finished goods, creating further imbalances when domestic raw materials are taxed at higher rates. This can disadvantage local manufacturers and impact their competitiveness,” said S. R. Patnaik.
Addressing these challenges requires targeted and tailored policy adjustments to both GST rates and customs rate, ensuring that domestic industries are not unduly burdened and can maintain operational efficiency and competitiveness.Partner (Head – Taxation), Cyril Amarchand Mangaldas
Adding that, “It is expected that in the next GST Council meeting there may be a rejig in tax rates which may resolve the inverted duty structure.”
The inverted duty structure has found to be undesirable to private companies engaged in commercial activities for raising the cost of procuring input goods and thinning of the profit margins while also affected competitiveness. “Inverted duty structures are highly undesirable to private companies engaged in commercial activities – as this raises the cost of procuring input goods. This further thins the profit margins for local manufacturers while providing a competitive advantage to importers competing with them in the market,” said Shivam Kumar, Associate, SKV Law Offices.
The free trade agreements also bring challenges considering customs duty. “Challenges include existence of Free Trade Agreements, increased costs, cash flow issues due to delayed refunds, and complexities in tax compliance. Changes expected include rationalizing duty rates to ensure raw materials have lower duties than finished goods, streamlining refund processes to improve cash flow, and simplifying compliance requirements to reduce administrative burdens,” said Aditya Chopra, Managing Partner, The Victoriam Legalis.
The inverted duty structure is required to be understood in a global context, with an wider outlook on the subject as “inverted duty structure is an absolute disaster in this era of global markets,” said Kamal Aggarwal, Senior Advisor, Singhania & Co. He adds, “We cannot have duty structures making our industry uncompetitive in the global market. The government must find a way or give refund of the excessive duty element. One cannot even imagine government saying that we would collect the duty even if it is at cost of exports. Government and industry must work together, else China plus one would remain a dream only.”
The inverted duty structure undermines our global competitiveness. The government must rectify this or offer refunds for excess duties. Sacrificing exports for duty collection is not an option. Success in the “China plus one” strategy requires strong government-industry collaboration.Kamal Aggarwal, Senior Advisor, Singhania & Co.
Tushar Kumar, Advocate, Supreme Court of India said, “The Inverted Duty Structure poses significant challenges to businesses and the taxation system.”
He adds, “inverted duties lead to a buildup of unutilized credits, causing cash flow issues and operational difficulties for businesses” which not only reduce working capital but also hampers competition as “exemptions provided under Free Trade Agreements (FTAs) hinder the correction of inverted duties, necessitating a comprehensive review of these agreements.”
The Income Tax Credit on account of inverted tax structure can be claimed at the end of any tax period where the credit has accumulated on account of higher duty on input and lower duty on output.
The another problem which stems from violations of GST regulations is demand notices inviting penalties. “These notices are issued often due to suppliers failing to report transactions or remit collected GST. Additionally, penalties may occur if companies claim more ITC than allowed, or on items not eligible for ITC, such as construction services,” said S. R. Patnaik, Partner (Head – Taxation), Cyril Amarchand Mangaldas.
Issues can also arise from improper documentation or failure to reverse ITC on exempt supplies. A significant challenge arises from the tax authorities’ varying interpretations of what constitutes exempt supplies.S. R. Patnaik, Partner (Head – Taxation), Cyril Amarchand Mangaldas
He adds, “These interpretations can seem inconsistent and arbitrary, complicating compliance for businesses and underscoring the need for clearer guidelines and consistent enforcement.”
The demand notices highlights the complexity of tax system which results in GST demand notices levying penalties. “There could be a discrepancy in ITC on the import of goods that doesn’t reflect or inward supplies from SEZs that might not appear. But most peculiarly – the specificity and complexity of structuring in tax systems could be a reason for the same,” said Shivam Kumar, Associate, SKV Law Offices.
Customs duties are usually imposed on goods and services by a thorough classification. This classification is based on agreements that may already be in place, the nature and necessity of goods or services etc. Sometimes there is a discrepancy or a lack of clarity on how a good is classified.Shivam Kumar, Associate, SKV Law Offices
The other reasons for the same cane be mismatches between supplier invoices and recipient claims, incorrect classification of goods/services, or misinterpretation of tax laws. “Demand notices for excessive Input Tax Credit (ITC) arise when companies claim more ITC than they are entitled to, often due to errors in computing eligible credits. This can happen because of mismatches between supplier invoices and recipient claims, incorrect classification of goods/services, or misinterpretation of tax laws,” said Aditya Chopra, Managing Partner, The Victoriam Legalis.
The challenge lies in accurately computing ITC, which requires meticulous record-keeping and reconciliation. Excessive ITC claims invite penalties as they lead to revenue loss for the government.Aditya Chopra, Managing Partner, The Victoriam Legalis
The demand is further accompanied with interests and penalties. Thus, “to mitigate this, companies need robust internal controls, regular audits, and thorough understanding of GST regulations. Adding contractual covenants specifically to ensure records are adequately updated and uploaded on GST portal in the course of entering into contracts, is an effective measure to ensure counterparties in a contract comply with their GST related obligations,” said Aditya Chopra, Managing Partner, The Victoriam Legalis.
Kamal Aggarwal, Senior Advisor, Singhania & Co. said,”The frequent issuance of demand notices reflects the entrenched mindset of tax authorities.”
Even with numerous reforms, these notices will persist unless this mindset changes. Tax authorities often prioritize revenue collection over their true duty of enforcing tax laws fairly and consistently. Proper tax collection should result from the correct application of the law, not from a relentless focus on revenue alone.Kamal Aggarwal, Senior Advisor, Singhania & Co.
The demand notices are issued to companies availing of excessive ITC, leading to penalty, due to several reasons.
Tushar Kumar, Advocate, Supreme Court of India highlights, “Discrepancies between the ITC claimed and the actual inputs utilized, resulting in excessive credits.” He added, “claims for ITC on ineligible or non-existent inputs, leading to unjust enrichment” to be a reasons for issuance of demand order. Further noting, “omission to reverse ITC on supplies not used for business purposes or exempt from tax” and “errors or miscalculations in computing ITC, resulting from the intricacy of tax laws and regulations” to be the reasons for issuance of demand notices to companies availing excessive ITC.