The automotive industry is a major contributor to the Indian economy. Currently, it is the fourth largest automotive sector in the world and is expected to come under top 3 automotive sectors in the world by 2026. The sector also accounts for about 15% of the country’s total tax collections.
Growth of the auto sector in India is leading to emergence of new and more complicated issues with respect to indirect taxes. As an industry with multitude of components and parts, the automotive industry is particularly under the scanner of taxmen.
Generally, auto parts which are solely or principally to be used with motor vehicles classified under Chapter Heading 8708 are subject to basic customs duty @15%, subject to any exemption (if applicable). However, certain parts which are classified in other Chapters, say Chapter 84 or Chapter 85 are subject to basic customs duty as per their respective tariff rates. The major challenge for OEMs is to appropriately classify these products under Customs Tariff schedule and accordingly, pay appropriate customs duty. Broadly speaking, there was a difference in the basic customs duty in respect of auto components depending upon their classification which had an impact on the legal as well as financial aspects.
In Budget 2021, Government has taken a step to resolve the disputes regarding classification of auto parts. Government has increased the tariff rate of basic custom duty on certain goods falling under certain Chapters such as under Chapters 84 and 85 and granted exemptions to parts which are suitable for use in applications other than motor vehicles. The idea to grant exemptions to such goods seems to be to neutralize the tax rates in respect of products falling under these chapters, which are not meant for the automotive sector. To illustrate, tariff rate of relays classified under sub-heading 8536 41 has been increased from 10% to 15% in the Budget 2021. Simultaneously, exemption has been provided under Notification No. 50/2017-Cus. for all the goods classified under said sub-heading, other than those suitable for use in motor vehicles of specified heading.
Through the above amendment, though Government has clarified its intent to tax auto parts at higher rate, nevertheless, it has become imperative to understand the scope of the exemption entry vis-a vis meaning of the expression ‘suitable for use in motor vehicle’. Doubt remains as to whether the exemption entry will also cover in its ambit products which have multiple applications but ends up being incorporated in the motor vehicle. The question which pops up is as to whether the importer must trace the end use of its supply of auto components to its customers.
Additionally, other unresolved disputes have emerged from decisions of Courts, which have once again opened the pandora’s box of classification of auto parts and thereby, created doubts regarding basic customs duty rate applicable on such parts.
Recent Supreme Court decision in the case of Westinghouse Saxby, though is delivered in respect of parts of railway locomotives but will have a far-reaching impact on classification of parts of motor vehicles as well. The Apex Court while classifying the part of locomotive, applied the ‘sole or principal use’ test and held that if an item is solely or principally used with the articles of Section XVII (say, railway locomotives or motor vehicles), then the product is classifiable as part of the vehicle even if it is excluded from chapter notes relevant to classification of railway locomotives, motor vehicles etc.
It is important to clarify that above discussed principle of classification will be relevant not only for customs duty but also GST rate since rules of interpretation, Sections Notes and Chapter Notes as appearing in Custom Tariff are also applicable to GST rate notification. For instance, parts of motor vehicles classifiable under Chapter 87 attract IGST at the rate of 28%; whereas the parts which are not classifiable under Chapter 87 generally, attract a lower rate of 18% or in some cases even lesser GST rate. Resultantly, considering the rate arbitrage, importers and domestic suppliers of such parts, whether supplying directly to an automobile manufacturer or in after sales market, will need to revisit the classification adopted by them.
While the above taxation issues in the auto sector persists, Government is undertaking all the necessary steps to incentivize investors to set up manufacturing facility in the automotive sector in India. To promote domestic manufacturing in India, around INR 57,042 crore financial outlay over a 5-year period has been approved for automobiles and auto component sector under the Production Linked Incentive (PLI) scheme for enhancing manufacturing capabilities and exports. This scheme has not been notified yet, however Government will come up with the scheme soon.
Fulfilment of certain thresholds will be required for a claimant to qualify for PLI scheme that will offer maximum incentives in the form of cash back on incremental sales. Currently, it has been proposed to give cashback ranging from 2% to 12% of incremental sales and exports revenue given by automobile players. Presently, under the notified PLI scheme for Pharmaceuticals sector, cashback ranging from 3%-10% is given of the net incremental sales revenue over the base year.
However, just like every coin has two sides, everything will not be rosy for automotive sector with the mere introduction of incentives. Disruptions in supply chain and logistics might build up as shift in operations to India from outside in the background of PLI may take a long period of time due to the quality and volumes offered at the international level.
Even though Government has introduced various incentives including PLI scheme to encourage the investors to set up domestic manufacturing in automotive sector, in the background of various unresolved indirect tax disputes involved in the sector, hesitation by the investors to enter into this sector is bound to grow, more particularly owing to the potential higher quantum involved in such disputes. While increase in customs duty on auto parts and various schemes introduced by the Government including PLI scheme with an objective to promote domestic manufacturing is a welcome move, it is also imperative to bring more clarity on potential tax issues to enable domestic industry to settle in the long run. Intent is undoubtedly clear and positive, but one needs more action to develop the faith of investors in the automotive sector. It is hoped that sooner than later, the same will be restored by active participation of the Government.
[The authors are Article Assistant, Associate and Partner, respectively, in GST Advisory practice at Lakshmikumaran & Sridharan Attorneys, Gurugram]