The Cruel Irony of Tax Exemption

Since the “open door policy” was implemented in India in the early ‘90s, many liberal trade policies were introduced. Probably the most needed was an exemption of duties on goods produced for exports and export sales as such.

Here comes the irony

In true irony, goods for export are exempt from tax, but it doesn’t exempt the company from paying taxes on these goods at first.

To explain this in simple words, when a company manufactures a product for export, it has to pay excise duty like all other goods. After the goods are actually exported, the company has to produce proof of such export to the Excise department. After satisfying this, the department will eventually refund the excise duty initially paid. This concept is called duty drawback.

Some exceptions: Export Oriented Units

Of course there have been efforts to remedy the situation. The Export Oriented Units (EOU) policy allows tax holidays for 100% export oriented units. Manufacture under Bond (MUB) allows companies to import machinery duty free to manufacture goods for export. Special Economic Zones (SEZ) function as parallel economies with their own tax regulations. But only select industries can enjoy the benefits of these zones and policies.

And for the rest of us…

Companies who cater to both the Indian as well as global market are severely handicapped by the provision of duty drawback. The restriction is so strict that companies having both normal as well as export units cannot even transfer goods or raw materials amongst themselves (inter-unit transfers). If they do transfer, they get taxed immediately and have to resort to duty drawback eventually.

This of course is one of the government’s many precautionary measures to check tax evasion under the pretext of tax exemption. However, the fiscal regime’s inability to come up with better corporate governance measures has burdened versatile companies with immense paperwork and procedure.

So what can you as an entrepreneur do?

The sad truth is that as a manufacturer of a product, there is not much you can do. However, you can consult experts to see how you can design your procedures such that tax liabilities are minimized.

As a service provider, you are exempt from paying Service tax in many cases as per the Export of Service rules. However, you need to check whether the rules apply to you completely and if they do not, then you can check how you can reduce the tax liability.

Some tips on reducing compliance costs

Before you start any production or manufacturing process, make sure that you have systems that do the computation for you, just by entering the basic values. Shockingly, many companies even today do not have computerized systems to compute duty and tax liability.

Have your process inspected once to check for ways in which you can avoid ‘duty leakage’.

If you are a service provider, liability arises only after revenue crosses Rs. 9 lakhs. If you are, say, a graphic designing and web development company, you can create two companies instead of one – this will help you show revenues in the name of two companies and increase your exemption limit. This intelligent tax ‘avoidance’ is perfectly legal.

[About the author: Contributed by Hrishikesh Datar, founder of vakilsearch.com, online legal services provider (Legal Advice, Legal Documents & more.]

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