Authored by Abhishek Jain, Partner and Head, Indirect Tax, KPMG in India, Vivek Johri, Senior Advisor, KPMG in India
With the Union Budget 2025-26 less than a month away, the air is rife with speculation about what it might or may not contain. However, one of the outcomes is near certain viz. a review of the Customs duty rate structure for an announcement to this effect was made in the last Budget. What might the contours of this review be?
Tax experts acknowledge that one of the cornerstones of a good tax structure is to have very few rates. Multiplicity of rates not only generates a perception of complexity but also results in more disputes owing to the arbitrage opportunities it creates. Post the 1991 reforms, for long years, our Customs tariffs for industrial products comprised four major rates viz. 2.5%, 5%, 7.5% and 10% (apart from full exemptions). Starting with the lowest rate of 2.5%, each of the four rates was applicable to a distinct stage in the value chain starting with basic feedstocks, ores and minerals to raw materials that had undergone some degree of processing to intermediates, capital goods or sub-assemblies and the highest rate of 10% to final consumer goods. By implicitly escalating the level of customs tariff according as the degree of value addition that a product had undergone, this structure generated a positive bias in favour of domestic manufacturing or value addition over imports.
In response to demands from industry for enhanced tariff support as well as a strategy to encourage domestic manufacture of products contributing disproportionately to the national import bill such as electronic hardware, mobile phones, plastic moulded products, toys etc, new rates beyond the peak rate were added from time to time. Consequently, the number of rates has more than doubled now. One reasonable expectation from the review, therefore, would be compression in the number of rates while preserving the aforesaid logic for differential tariffs.
An unintended consequence of selective tariff increases has been inversion in certain duty rates. An inversion occurs when the rate of duty on an input, raw material or intermediate exceeds that on the finished product for whose production it is used - for instance, a higher rate of duty on textile fabric compared to apparel. This could create a serious disability for a domestic manufacturer who is import-dependent for such inputs which also form a large proportion of the product cost. Inversions may also arise owing to adoption of new technology or production process or discovery of new raw materials or inputs. Correction of inversions, especially by reducing the duty rate on an input or raw material, is not always feasible for it runs the risk of creating inversions further up the value chain. Likewise, inversions arising on account of zero or low duty access to a finished product under a Free Trade Agreement are also irresoluble. However, within these constraints, it is reasonable to expect that they would be fixed in the upcoming Budget.
As pointed out by the Finance Minister in her last Budget speech, the objective of reviewing the customs duty rates is to reduce the number of disputes. There are two broad industry sectors viz. automobiles and technology products that have been prone to frequent classification disputes. In the former case, these disputes are driven partly by the existing rate arbitrage between parts, components or sub-assemblies of automobiles when classified on their own merits in the HS nomenclature (such as instruments of Chapter 90) or in a residuary/ omnibus category (parts and accessories of vehicles of Chapter 87) with the latter attracting a higher rate of customs duty or IGST. In certain situations, as in the case of plastic moulded parts for automobiles the rate differential could be reverse. Likewise, there are frequent differences of opinion, if not formal disputes, about the treatment of automobiles imported in the form of Completely Knocked Down (CKD) kits vis-à-vis the import of individual parts, components not recognizable or put together as kits. There are judicial pronouncements and advance rulings, although often conflicting, on these issues. There may be similar instances for other sectors. Taking a cue from GST, issuance of detailed clarifications providing guidance both to assessing officers and the trade about how to make distinctions between these respective headings or situations would provide greater certainty and curb the generation of disputes. There are precedents of issuing such clarifications in the Budget.
Finally, a review would be incomplete unless a thorough scrutiny of existing exemptions is done with a view to weed out the redundant ones and minimize their number. There is now a legal mandate in the Customs law to do so for all exemptions that have subsisted for two years.
Taken together, these measures would align the Customs duty structure better with the national priorities of enhancing the share of manufacturing and providing a more trade-friendly regime to stakeholders.
A version of this article was published by The Economic Times Online on January 11 2025. The same can be read here
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