Classification of a product means ascertaining the tariff heading/sub-heading under which the product / service is to be categorised. This is important for determining the tax structure on its supply and also examining the exemptions available if any. In past few years, the importance of classification in central excise had reduced substantially due to the rate of 12.5 % being fastened on most goods. The variances within a chapter were also kept at minimum. The disputes in central excise & Customs had reduced to about 10% of the earlier period in recent times.
However in the State VAT rates most States did not adopt the Central Excise Classification fully. Some adopted a part. Variances, frequent changes, differences between neighbouring States caused a lot of sharp practices being adopted as under:
- Mis-declaration of high rated products as lower rated products
- Undervaluing the high rated products
- Not recording the high rated sales and inflating the lower rated ones.
- Grey market supplies in some products being as high as 50 + percent!!
For those who complied and were tax compliant there were many disputes. Consequently the corruption in VAT across the country was abnormally high.
The classification of most products was clear and settled as far as excise was concerned.
Under erstwhile Service tax Section 65A set out simple set of rules which were on the lines of Central excise in as much as the classification was to be made in terms of the sun clauses (same as Rule 1 of CET), more specific preferred, composite services based on essential service and in case of doubt the earlier entry. The fact that here again most of the services being under 15% rate, attempts at misclassification were not too many. However as much a services were in the unorganised sector, the evasion in service tax was rampant but not as much as in trade.
In GST the method of classification of goods appears to have been influenced by many of the VAT fallacies. Making schedules for each rate 5%, 12%, 18% and 28% and exempted makes law complex again. It would have easy to avoid reinventing the wheel and adopting the excise classification for at least the goods. However it appears that the State officers had to be satisfied. Hopefully over time the CET method of comprehensive classification is adopted. Services have been classified in Chapter 99.
The rules of interpretations in GST luckily are taken from the Central Excise. If rules are conclusive, then classification following trade parlance or commercial understanding is not tenable as held by the Supreme Court in the Case of Wood Polymers 1998 (97) ELT 193 (SC).
Rules for Interpretation for Goods
The general rules for interpretation of the GST schedule are similar to the interpretative rules provided in HSN. The classification should be first tested in the light of Rule 1 and if it is not possible, recourse is taken to rule 2, 3 and 4 in seriatim.
Rule 1 provides that the titles of sections, chapters and sub-chapters are provided for ease of reference and headings alone cannot be used for classification. The determination as to where the goods fall would be dependent on the relevant section and chapter notes contained in the Tariff. This has also been confirmed in the case of Excon Building Materials Manufacturing Company Ltd. 2005 (186) ELT 263 where their Lordships observed that an interpretation which is not borne out by the plain wording of the notification could not be given. In the case of Intel Design System (I) P Ltd 2008 (223) ELT 135 (SC), the Honorable Supreme Court had observed that the classification of excisable goods was to be determined according to the terms of the Heading and in terms of Section/Chapter notes.
Where the Notes are silent, classification would be as per Note 2, 3, 4, 5 and 6 of the Interpretative Rules. It would therefore be noted that Note 2, 3, 4, 5 and 6 would have to be resorted to only if the Chapter does not contain any guide to classify the particular product.
It is also observed in number of decisions that rules for interpretation are not invokable if the section and chapter notes clearly determine the classification.
Rule 2(a) provides principles for classifying incomplete or unfinished goods. It specifies that if the incomplete or unfinished goods have the essential characteristics of the complete or finished goods, then such goods would be classified in the same heading as the complete goods. Complete or finished goods would cover goods removed in unassembled or disassembled form. Ex: A car without seats would still be classified as car.
Rule 2(b) provides that any reference in a heading to a substance shall include mixtures or combinations of that material with other materials. However, classification would be according to Rule 3 in such cases.
Rule 3 supports the classification for rule 2(b) and says where goods are prima facie classifiable under two or more headings; the following shall be done sequentially:
(a) Specific description would have to be adopted in place of a general description. Ex: Cotton canvas are classifiable under chapter 52 (cotton) and not under chapter 59 (Impregnated, coated, covered or limited textile fabrics; textile articles of a kind suitable for industrial use) as items falling under chapter 52 is more specific than chapter 59 for cotton canvas. However, when two or more headings each refer to part only of the materials or substances contained in mixed or composite goods or to part only of the items in a set, those headings are to be regarded as equally specific in relation to those goods , even if one of them gives a more complete description of the goods. In such instances, classification has to be determined in terms of rule 3(b) or rule 3(c).
(b) Mixtures, composite goods consisting of different materials shall be classified as if they consist of that material or part which gives them their essential character. Ex: Concrete mix mainly consists of cement, further small proportions of stone, water and chemicals, in terms of rule 3, the classification of concrete mix is made under articles of stone, plaster, cement as concrete mix consists mainly of cement. This rule is applicable only on failure of rule 3(a).
(c) When goods cannot be classified as per (a) or (b) above, then the goods shall be classified under that heading, which occurs last in the numerical order. Ex: Where Mobile phones in addition to having the utility of phone, have certain functions of camera, computer etc classification of mobile phone should be made considering the main function rather than additional utility function.
Rule 4: In cases where the goods cannot be classified based on the above principles, they would be classified under the head appropriate to the goods to which they are most akin.
Rule 5: In respect of packing material which are specially designed or fitted to contain a specific article and given with the articles for which they are intended, shall follow the classification of the items which are packed. Ex: Camera cases, mobile cases, musical instrument case etc. such packing material if not used with the article for which it is intended for may have low or no utility. However this rule should not be adopted when packing material itself gives the essential character as a whole.
The packing materials and containers cleared or presented along with the goods are classifiable with the goods, however this provision would not be applicable when such packing material are intended for repetitive use. Ex: Gas cylinders are meant for repetitive use and therefore cannot be classified along with gas.
Rule 6: While ascertaining the classification of goods in the sub-heading of a heading it should be determined according to the terms of those sub-headings and any related Sub-heading notes and, applying the above principles of classification on the understanding that only sub-headings at the same level are comparable. For the purposes of this rule, the relative Chapter and Section Notes apply, unless the context otherwise requires a different interpretation.
Rules of Interpretation for Services
The rules have not been carried forward from the service tax law. Need to be notified as soon as possible.
Guidelines given by way of judicial precedents
Apart from the above principles of classification set out in the Rules, the Courts have given certain principles. Some of these decisions have been illustrated below. It should be noted that principles set out in the rules would have overriding precedence over these court laid down principles.
Some of the non statutory principles for classifications are:
(i) Trade parlance theory: This theory is used when the words are not defined under the act and words used in the tariff are not used in scientific or technical sense. This aspect is however generally ignored by the departmental officials leading to unnecessary litigation at times.
(ii) Function or use: This principle is used when the definition in the statute is absent and articles are identified with its utility, primary use, design, shape etc.
(iii) Constituent material: Under this theory, the essential character of the product can be derived from the raw material used.
(iv) Expert opinion: Some times classification involving complicated technical questions are decided after relying on an opinion and the opinion of the expert would not be considered when they are contrary to another expert opinion.
(v) Dictionary meaning: This principle can be adopted when the meaning given in the statute is overlapping, for finding out the trade understanding.
(vi) Classification by ISI: ISI specifications are normally meant for ensuring quality control and can be considered for classification when the product is not defined or specified in the tariff. This principle can only be considered for classification. However this cannot be the lone factor for classification. This method can be adopted only in absence of other rules of classification. The exemption for services under GST Act has followed largely the service tax exemptions. The awareness of this law is very low not only with assesses or professionals but also with the Tax administrators due to the fact that it was pushed through rather hastily. The present notification may lead to absurd logic in a few cases. It is expected that with proper representation this law would also become a simple and just law.
It is essential for the government to issue certain exemptions and concessions considering the need of the economy and public policy. Tax exemptions and concessions have been used as an instrument of fiscal policy to stimulate the economic growth of the Country.
The exemption for goods has been provided vide Notification 2/2017 & services 9/2017.
Tax Rates under Not. 1/2017
5% rate - Schedule - I
12% rate - Schedule -II
18% rate - Schedule -III
28% rate - Schedule IV
3% rate - Schedule - V - Products of Precious stones & gold jewellery
0.250% rate - Schedule VI - Jewellery Base items
Services- Chapter 99
In goods the difficult job of attempting to expand the base and tax hitherto nil rated / exempted goods has led to many unintended higher rates. These mistakes would be corrected over a period of time if the Government keeps the doors open for representation for at least 6 months from now. It is certainly essential in the view of the paper writer.
In service tax the general exemption are under Not 9/2017- IGST ( Mostly following the earlier ST exemptions except for infrastructural exemption and a few more.
Further the trader, manufacturer, service supplier (provider/person liable to pay GST under reverse charge) would be interested to understand to know the availability of any exemption. While examining the applicability of GST, the interpretation beneficial to the assessee would be preferred. However when the assessee wishes to avail the benefit of any exemption notification, it is the opposite i.e. the benefit would be towards revenue. Therefore any person who is intending to avail exemption should ensure that all the conditions specified in the respective notification are substantially complied as held in the case of CCE v Hari Chand Shri Gopal 2010 (260) ELT 3 (SC). Otherwise the exemption may be denied resulting in payment of GST out of pocket expenses possibly without any credit ( as it stands today) added with interest and penalties if applicable.
The GST law allows for the credit of tax paid at an earlier point of time for the future within time. The law is also clear that where there is an unconditional exemption there would be no option to pay GST. This has been borrowed from the central excise regime which was a fairly settled law. Therefore one cannot choose to pay GST due to the fact that the receiver is eligible for credit.
This also means that where there is a doubt it would be advisable to err towards revenue or non claiming of the exemption if it were conditional.
The receiver/ consumer of the service would also require understanding the taxability or exemption for the specified services/service providers so as to compute their cost impact.
Possible Action Points for assessees
- The classification of goods and services has to be done carefully using the rules and confirming from the old case laws. Customer should not lose out on credit due to incorrect classification.
- The multiple rates in goods and services is expected to g=create havoc and is certainly not – ease of doing business- nor is it making the law simple and certain. We can see large number of changes every week in the next 6 months. Consequently the same should be done carefully after confirmation of the latest notifications. .
- Change in old classification may require cogent reason and correction of incorrect classification may result in litigation.
- When in doubt of the classification, confirmation in writing maybe sought from the revenue by communicating by RPAD/Speed Post.
- Where the classification is patently incorrect, representation to the GST authorities, GST council and CBEC Officers who are involved in drafting has been found to be fair and reasonable till date.
- The Harmonised System of Nomenclature – 2017 could be a good guide for confirming the understanding when in doubt for goods.
Possible Action Points for GST Council/ Govt.
- Follow a policy of moving from Nil rate for base products moving towards higher rate for each level of processing and usage. Actively seeking through the newspaper to resolve issues of the trade who have a different experience. Example Tamarind ( dried) falling under 0813 - is at 12% Tamarind Paste at Nil falling under 0810 and Tamarind Powder at 5% if registered brand and in container under chapter 11!!
- All conditional exemptions like registered brand name (100s of traders have applied for deregistration to avoid paying the 5% )
- Start the exercise of rationalization of rates into fewer rates similar to the exercise carried on for Central excise in last decade. (Example - Textiles 5% + 18% for job work)
- Trim down the exemption and also making them free of end use, procedural conditions. We are inviting mis classification and litigation.
- In the first 2 years make it mandatory to reply to queries to the GST office and make the decision legally binding. The non legally binding tweets, press messages are eroding the confidence of the assessees to no small effect.
- Get rid of the very high cesses and 28% for common goods. Only maybe applicable within limits to SIN goods. 88%, 188% final rate presently applicable would only be an incentive to evade as it is worth it. Also not in line with philosophy of bringing all into the net and having moderate tax rates which were the original ideals.
This is not a comprehensive article but considering the number of issues and trades who have either started only transaction in cash or stopped the trade, an attempt to shed some light and provide some thoughts on the way forward.
This article has been adapted from the book in progress on Classification & Exemption under GST to be published by Bharat Law House in coming month.
The authors can also be reached at madhukar@hiregange.com or nagendra@hiregange.com
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