Duty Drawback is a remission scheme and is not to be confused with incentive schemes like MEIS, administered by the DGFT, or the erstwhile DEPB Scheme which was ruled as a WTO-non compliant subsidy. And yet, at a time when exporters need all the help they can get, the government continues to be miserly with drawbacks. When will we stop treating drawbacks as incentives?

Indranil Das | December 2016 Issue | The Dollar Business

These are the challenging times for Indian exporters, and for them any help is bound to come handy in sailing the rough tides of global trade. When the government had brought all goods under the duty drawback mechanism in place of the DEPB scheme (which was found to be WTO non-compliant as it was considered a subsidy), it had raised the hopes of many exporters. Duty drawbacks, for the uninitiated, is a remission (making it WTO compliant) that can be obtained when an import fee has already been paid, but the good is then subsequently exported. This is in line with the government’s declared policy that for the good of the exporting fraternity, across the country, there should be ‘no incidence of customs duty, excise duty, service tax, etc., on exports’. Because if that happens it would hurt the overall trade competitiveness of Indian exports.

Exporters need to import raw materials and intermediate goods to produce their export goods, and India with one of the highest import tariffs among peer countries, exporters pay a significant amount in import duties. Without a remission scheme in place we doubt that Indian products, which have imported inputs, would be able to find a market. The question then is if duty drawbacks are negating the impact of high import tariffs, why are exporters still unhappy?

Wrong Treatment

There are two reasons that come to mind: first, the method of deciding on the drawback rates. And second, the process of availing the drawback.

Let us first talk about the method of deciding on the drawback rate. As per the current applicable mechanism, drawback rates (also known as AIR or All Industry Rate) are determined on the basis of certain broad average parameters, including prevailing prices of inputs, standard input output norms (SION), the applied rates of central excise and customs duties, the factoring of incidence of service tax paid on taxable services which are used as input services in the manufacturing or processing of export goods, factoring incidence of duty on HSD/furnace oil, value of export goods, etc. And as such, it’s such a modus operandi of the government that paves way for the million dollar question that crops up here – is it really plausible to believe that the government can come up with a drawback rate (that includes many component i.e. excise, customs duty, deemed duty, indirect duty, etc.) that would do justice for each and every product that is exported? Especially, when we talk about value addition and differentiation? Simply put, it cannot.

To What Purpose?

Though the Central Board of Excise and Customs (CBEC) is said to have arrived at these figures after due consultation with all stakeholders in a given sector, if one were to go by the voice of the exports fraternity, many believe that the existing drawback rates and caps are not at all reflective of the import duties paid.

Let’s take an example of the Indian automotive industry, which is one of the largest in the world. Currently, the drawback rate on two-wheelers and commercial vehicles is 2%. In the passenger vehicle segment, for motor cars of a cylinder capacity of 1500cc and above, it is a maximum of 4% with a cap of Rs.45,500 for vehicles with manual transmission and 4.7% with a cap of Rs.61,100 for those with automatic transmission. According to a study conducted jointly by ICRA and Society Of Indian Automobile Manufacturers (SIAM), taxes such as electricity tax, octroi, VAT and state taxes add up to 10% of the manufacturing cost, making locally-made vehicles less competitive in the major global markets.

Let us assume, under the ‘Make in India’ scheme, Company X decides to set up a manufacturing facility to export motor cars with a manual transmission at a price floor of Rs.20 lakh. The product is eligible to a drawback of 4% with a Rs.45,500 cap per unit. Let us now consider that considering that it is a luxury car, 10% or Rs.2 lakh worth of the components were imported (which is not the case in reality, imported components accounts for a bigger share). At the average prevailing import duty rates for components (HS Code: 8708), which presently stand at 29.441%, the manufacturer would have paid a duty of about Rs.58,882 not withstanding other taxes that were suffered. The government now, in a remission measure, which is supposed to negate the impact of duties, would refund a total of Rs.45,500.

Going by the existing drawback rates, there seems to be hardly any motivation left for a high-end car manufacturer and exporters to ‘Make in India’. The government needs to understand that it is treating the drawback as an incentive, which it is not meant to be. It is a remission scheme that should all but negate the impact of taxes and duties paid.

This also brings us to the rather important problem of caps on duty drawbacks. A cap essentially means denying exporters of high-value products their due remission. Hasn’t the government time and again talked about going up the value chain? Will that not mean that we will be importing more high-value intermediate products and export higher value finished goods? The cap on drawbacks signals just the opposite, it discourages exports of high-
value items.

Cumbersome Process

And then comes the process of getting the refunds. Some exporters consider it a nightmare. Exporters are primarily unhappy with inordinate delays in the process of getting the refunds and the amount of documentation that is required to avail the remission. And once a refund under drawback goes into litigation, it may take months and years to resolve. If the idea is to encourage exports from the country, why tie exporters up in such long processes?

And then there is the spectre of the drawbacks after the implementation of GST, which for products that will taxed at higher slabs of 12% or above, has the potential to negate most of the benefits of tax simplification that the GST regime is supposed to ring in. Puran Dawar, Chairman, Agra Footwear Manufacturers and Exporters Chamber (AFMEC)agrees. Dawar while speaking to The Dollar Business says, “Drawbacks are not incentives and the government should not treat it as one. The process of getting refunds just ties up our money, creating a cash flow crisis. My concern is a post GST scenario. In the case of GST being fixed at 12-18% for leather products, a factor of 10-15% will be added to our input cost, and this will be blocked in the long maze of tax refunds. Claiming it back over a period of 3-6 months is going to be a big headache. If the government has to refund those duties to us later, what is the purpose of the whole exercise? Going forward, we suggest two ways out: either all the duties that we pay should be refunded to us in the form of duty drawbacks or duties should not be levied at all.”

Sliver of HOPE?

Dawar also agrees with us that a cap under the drawback mechanism in a way means the government is discouraging the exports of value-added products, and that certain rates are not realistic in the present context. Many exporters, we spoke to, feel that drawback rates must be revised regularly keeping into account the changing dynamics of the trade and the competition faced overseas. More importantly, drawback rates need to be realistic. And treating it like a subsidy or an incentive is an absolute no.

We must say though that the government has been revising the drawback rates, with the last revision coming into force on November 15, 2016. And drawback rates were increased as was expected. Exporters have lauded the effort and say that it will boost exports.

We do not question the intent of the government to boost exports, what we question again is the method of arriving at these rates. If import duties and taxes have not been increased, what made the government hike the rates? Are we to believe that the government has reworked the SION across product lines and hence a hike? We are skeptical and believe that the government with the intent of giving a boost to exports has reworked drawback rates, which in turn means that the government is once again treating the drawback scheme as an incentive rather than a remission.

We see a small sliver of hope though. The Customs circular (No.50/2016) also mentions that “for better product differentiation, separate tariff lines have been provided by carving out from (or replacing) certain existing tariff items. These include surimi fish paste (chapter 16), belts (chapter 39), leather woven/braided hand-bag (chapter 42), hand-bags/wallets etc of plastic and/or textile material (chapter 42), wrist bands/tie-pins/necklaces made of leather (chapter 42), fishnets/ sports nets made of different materials (chapter 56/95), kurta and salwar/salwar suits/salwarkameez/ churidar-kameez, with or without dupatta (chapter 61 and 62), blankets, etc., of blend containing cotton and MMF (chapter 63), glass artware/handicrafts with chatons (chapter 70), tube or pipe fittings of alloy/stainless steel (chapter 73), motor cars, based on four categories of engine capacity each with sub-categories of manual or automatic transmission (chapter 87), cycle frames made of aluminum (chapter 87), soft toys (chapter 95).” This means the policymakers are alive to product differentiation and are not clubbing Jack and John in the same basket. This is definitely a positive sign.

The other positive sign is that for leather products policymakers have modified the definition of leather products to all products that have total of 60% or more (inner and outer surface together) of leather. The circular sights that this has been done taking into consideration new design and commercial practices. And this raises our hopes that going forward we may see more such reality-driven steps from the policymakers.

Change Is Good

To be fair, not all exporters are unhappy. For the Indian textiles industry, which is one of the largest contributors to India’s exports, drawbacks have been an important tool to remain competitive.
“Given the challenging times Indian exports are in, an effective mechanism such as duty drawback can certainly play an important role in turning the tide in country’s exports fraternity, provided the mechanism is made more practical, pro-exports, usable and pragmatic”, believes Ashok J. Rajani, Chairman, Apparel Export Promotion Council (AEPC).

The textiles sector has recently been given a Rs.6,000 crore special package, of which Rs.5,500 crore is for an additional duty drawback to refund state levies. In a first-of-its-kind move, the new scheme that was approved by the Cabinet, in June this year, will refund the state levies which were not refunded so far. The drawback at ‘All Industries Rate’ will be given for domestic duty paid inputs even when fabrics are imported under Advance Authorization Scheme once export obligations are met. Duty drawback under special advance authorisation scheme is likely to be a silver lining for garments exporters. “Thanks to the tax incentive, the unit value realisation in the garments exports will become significantly higher,” explains Rajani while speaking to The Dollar Business.

Rajani, however, also points out that in case of Scheme For Rebate of State Levies On Export of Garments (ROSL), the government needs to address procedural delays that is being currently observed, which in his view can hamper export competitiveness of Indian exporters. Lo and behold! We are back to procedural delays. Though the intentions of the scheme seem to right, but wait a minute, why should only the textiles sector get the benefits. If it is indeed a remission scheme then it should be extended to all exporters. We understand the importance of the textiles sector for Indian economy, but giving benefits to just one segment sounds like a dole. Our apprehension is that the government is using it more as an incentive than a remission.

What Exporters Want

Besides coming up with an ever-evolving drawback policy, and not just an annual review as is the practice, the government needs to unclog the systems and processes so that exporters are ensured smooth, hassle-free and prompt duty refund as no exporter wants to see his/her fund get stuck in red-tape. In this regard, going digital is the way forward and the CBEC has been proactive in that front.

But beyond that, to make the duty drawback scheme a truely attractive scheme, policymakers would require overhauls at many levels starting with the SION. Exporters want the SION to be more scientifically designed to reflect the realities of the inputs that go into their export products. What is also sorely required is more differentiation in product categories and a removal of the cap on duty drawbacks. Only then will the scheme in chapter and verse become a true remission scheme. But that will require a change in mindset among policymakers. Is that a big ask?