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Inverted duty structure - A Case study
By K Srinivasan (IRS)
Oct 19, 2020

THIS was a pending demand of railway wagon, coach and engine builders, and other manufacturers doing the roof and side walls of the railway coaches and the issue was flagged by the Confederation of Indian Industry (CII).

The input components attract a tax of 12-18-28 per cent. This creates a situation when there is higher tax on inputs and lower tax on output products, popularly known as Inverted tax structure in GST.

This led to an increase in cost, which had to be borne by the manufacturers to the extent of the gap between the taxes.

Manufacturers of rail equipment have welcomed the GST Council's decision to raise GST on rail equipment such as wagons, coaches and rolling stock to 12 per cent from 5 per cent. Metro rail coach-makers are also set to get a similar push.

The move is also expected to increase the competitiveness of the products made in India, by organizations such as Alstom, Bombardier, Wabtec, and other rail-equipment makers.

Boost to Make in India

The move will provide a huge impetus to global players like Alstom, Bombardier, GE Diesel and Wabtec to continue supporting the Make in India programme.

The GST Council's move is thought to remedy the inverted duty structure that has burdened rolling stock manufacturers for over two years, besides resulting in lower prices to various metro companies across the country

The GST move will boost the Make in India initiative, while the reduction in corporate tax will go a long way in competing in global markets.

But what is the net incentive in this move for the Rail-component makers which are MSME's and medium sized firms functioning as an adjunct industry to the Rail-coach making.

The case of MSME rail-component manufacturers

Majority of their business is with Rail-coach factories like Integral Coach Factory, Modern Coach Factory and other zonal railways, of which 70 to 80 % of goods supplied by them comprise of HSN code 86.07 attracting 5% GST while other 20 to 30% business with them represents trading of goods attracting 18% GST.

As per Notification No. 5/2017-Central Tax (Rate), GST on goods of HSN code 8607 will be 5% (no refund of the unutilized input tax credit 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).

Against the above notification, the component manufacturers represented the Inverted duty structure issue to the Railway board/Hon'ble Finance Minister through letters and got a reply from Finance ministry, that it will be getting addressed in the GST council meeting After 30 months, on 1st October 2019, GST Rate for HSN 8607 was revised to 12% as per notification no 14/2019. Based on the above notification, they started charging 12% GST on sales to Railways from 1st October 2019.

But Railway Coach Factories released funds only with 5% tax and withheld 7% tax. They circulated a format to all the suppliers in which it was asked to furnish the total turnover and tax, based on HSN code and submit the same for the release of 7% GST.

On the other hand, it is learnt that the Railway Coach Factories issued amendments to Corporates (who are doing multiple businesses and setting-off the Excess ITC related to HSN 8607 with other HSN outward supplies attracting higher rate of tax say 18% and reportedly carried no unutilized excess credit). Based on this explanation from corporates, they released the 7% GST to them alone.

The MSME's have brought the above discriminatory practice, to the knowledge of the officials of the Railway Coach Factories of their decision to release the withheld payment of 7% GST to the corporates alone, while rates fixed are commonly the same for all the successful bidders. It would, therefore, look unfair to release 7% to the former and not to the latter namely the MSME's.

The point of Law


GST Council in the 37th meeting held on 20.09.2019 at Goa took the following decisions in respect to rates relating to goods

II. GST rates have been recommended to be increased from, - a) 5% to 12% on goods, falling under chapter 86 of tariff like railway wagons, coaches, rolling stock (without refund of accumulated ITC). This is to address the concern of ITC accumulation with suppliers of these goods.

Precursor to the 37 th GST Council decision

The following agenda items were listed for discussion in the 29th Meeting of the Council:

1. Confirmation of the Minutes of 28th GST Council Meeting held on 21st July, 2018.

2. Discussion to address issues and concerns of Micro, Small & Medium Enterprises (MSME) in GST regime.

3. Incentivising Digital Payments in GST Regime.

4. Any other agenda item with the permission of the Chairperson.

5. Date of the next meeting of the GST Council.

The proposed changes in GST rates emanate from the recommendations made by the Fitment Committee as detailed below.

9 . Supplies to Railways

86 5% on goods in chapter 86 without refund 12% on goods in chapter 86 without refund

1. Railway products are classified under Chapter 86 and attract 5% GST with no refund of, unutilized input tax credit is allowed.

2. The Industry has requested that the rate structure has led to inversion and industry is saddled with huge accumulation of ITC affecting their cash flow. Hence they have requested to increase the GST rate to 18% with no restriction on ITC.

3. However, certain Metros have requested for duty rate to be 5% with refund, so that cost for Metros remains low.

4. The issue had been examined earlier by the Fitment Committee and was also placed before the GST Council in its 31st GST Council dated 22.12.2018. The Council had directed re-examination of the matter by the Fitment Committee before the issue is brought to the Council for its recommendation.

5. The Fitment Committee has examined the issue. During deliberation, it was pointed that there is substantial accumulation of credit and a possible solution is to raise GST on these goods so as to address the issue of accumulation of ITC.

6. Fitment committee has recommended for increase in GST from 5% to 12% on goods of Chapter 86 for resolving this issue. Condition of no refunds for accumulated ITC would continue. The industry shall be able to utilize the ITC over a period of time.

7. As regards the request of Metros, it is submitted that means for public transport like buses and goods transport like trucks attract 28% GST, while public transport is exempt and goods transport attract 5% GST without ITC. Therefore 12% GST would be reasonable to address the ITC inversion of wagon manufacturers.

The Fitment committee has recommended for increase in GST from 5% to 12% on goods of Chapter 86 for resolving this issue. Condition of no refunds for accumulated ITC would continue. The industry shall be able to utilize the ITC over a period of time.

The battle is won but the war lost by the MSME rail-equipment makers

The rail-equipment makers after the 12% rate hike of GST announced by the Government in its 37th GST Council meeting which went effective from September, 30, 2020 are forced to lose the fruits of their two-and-a-half year battle to the Railways by a series of circulars shot at them - who are mainly MSME's and Medium Industry Players engaged in this sub-assembly work for the National Carrier.

The malady of the rail-equipment makers explained

To claim the revised GST rate of 12%, the Railway's Circular mandated them to roll back the impact of the rate hike from 5% to 12 % GST, by maintaining an all-inclusive rate of their Purchase Orders under Chapter 86 that covered Railway parts, by duly reducing their basic price on the Pending orders tendered from First July, 2017 to 20th, September, 2020.

They are required to roll back in their PO's the difference of 7% between the new rate of 12% and the old rate of 5% in their tender Prices already quoted and duly approved by the Railways and in place for the years 2017-18,18-19 and 19-20.

The reasoning behind the Advisory issued by the Railways as disclosed by a Railway Ministry official, on condition of anonymity, is that;

1. The rail-equipment makers have 70% to 80% of their business under Chapter 86 and even after adjusting ITC reversals due to write-off and Transitional credit earned from past regime post GST, there is still a large amount of closing balance of unutilised excess credit lying in their accounts.

2. Since those firms will be able to utilise the entire ITC now, the firms may be advised and persuaded to maintain the all-inclusive rate of the Purchase Orders pertaining to the past, wherein a few thousand cores of old orders are still waiting to be executed.

The Metro rail coach-makers are also said to be in for a similar whop by the Railways like their counter-parts supplying various sheet-metal roofing and side-walling and other electrical and mechanical sub-assemblies through a tendering process.

The move is seen as a measure to extract the excess credits, accumulated due to inverted duty structure between July, 2017 and September, 2020 without realizing that it has the potential to kill the business completely in the bargain.

The small equipment manufacturers were already put to huge losses by railways due to the write-off route they were forced to choose, less travelled by their Competitors who had other outward supplies @ 18% GST to off-set their accumulated credit.

The small manufacturers were forced to write off the accumulated credits in hundreds of cores so far, over the past year to abate at least a third of it from their taxable income for claiming rebate of income tax, due to Railways withholding payment of the tax amount representing 7% (12%-5%) on the value of supplies made out of the past tender quantity.

The increased competitiveness of the products made in India, by large players like Alstom, Bombardier, Wabtec, GE Transportation and other rail-equipment makers are putting the MSME's further on the back seat on the one hand and the action of cost cutting imposed on them by the Railways, on the other.

The Indian Railways at cross purpose with the intention of the Government notified in the 37th GST Council Meeting

The announcement to increase GST rate from 5 to 12 per cent on rail goods reinstates the government's intention to bring the (Indian rail) industry back on track.

But the action of the Railway Ministry to roll back the accumulated ITC by insisting on a transmission of the rate hike by a corresponding price reduction portrays a bad picture of the Government giving by one hand a rate hike and taking it back through the other by demanding a price cut from the MSME's.

Different strokes by the Rail Coach Factories

It is learnt reliably that one of the Arms of the Indian Railways, at Uttar Pradesh had accepted the plea put forth by the MSE'S and other medium scale railway-equipment makers and in the process of releasing the difference in tax amount of 7% hitherto withheld by them.

While no doubt the master stroke played by another arm of the Indian Railways, located in Chennai is advantage the Railways, by pushing for a Price reduction from the SMSE's to roll back the rate hike, is not seen as a good move viewed either from the interests of the MSME's or from the view point of the new Economic Policy reform GST.

Back to square one

It is important to note that the rate structure for this sector has always been inverted since the days of Central Excise where Input Purchases were charged to duty @ 12.5% while the duty on the final product falling under Chapter 86 was attracting duty @ 6%.

At the end of the day, we are back to square one of the same inverted-duty structure that existed a decade ago with the same gap in tax rate of 6%(18%-12%), and still no light visible at the other end of the Tunnel for the MSME rail-component makers.

Will the Government step in to do a course correction, is the question persisting in the minds of the MSME's and as also the Author.

(The Author is a former Assistant Commissioner of GST, Chennai and a CBIC Master Trainer, GST and currently a Senior Associate, Indirect & Corporate Taxes, at a Chennai-based Law Firm, RANK Associates. The views of the Author are purely personal.)