Four options for manufacturing in India

In November last year, the government announced the Production Linked Incentives (PLI) scheme for promoting manufacturing in 10 sectors. The initial response indicates that many new large-scale factories would soon be set up in the PLI supported product groups.

The government provides four broad options for manufacturing in India. Selection of appropriate option results in substantial cost savings. The options are: (i) Domestic Tariff Area (DTA), (ii) Special Economic Zone(SEZ), (iii) 100 per cent export oriented unit (EOU), and (iv) Manufacturing Under Customs Bond (MUCB).

To simplify, we use the example of Ria. She plans to set up a garment factory to convert fabrics into shirts for sale in India and abroad. Ria needs garmenting machines to set up the factory. Then she needs to buy fabric regularly for making shirts.

The first option before Ria is to set up a factory in DTA. A factory set up anywhere in the country outside the select areas like SEZs, EOUs is considered a DTA unit. Here are the cost implications.

If Ria buys machinery or fabric from the local market, she needs to pay GST besides the price. If Ria imports, she has to pay the basic customs duty and Integrated GST(IGST) in addition to the product’s price.

If Ria sells shirts in the Indian market, she pays GST on the value-added part. In sum, Ria pays all applicable taxes, no exemptions.

But, costs are lower if Ria exports. She can then import fabric and machinery without payment of Basic Customs duty and IGST using the Duty Exemption schemes. Advance Authorization scheme for inputs and Export Promotion Capital Goods Scheme for machinery.

Ria can also use duty paid inputs for making shirts. Then she will get a refund of duties under the Drawback and RODTEP (Remission of Duties and Taxes on Exported Products) schemes. Most firms in India operate under DTA using these schemes.

The second option before Ria is to set up a factory in a nearby SEZ.

She can then import or buy machinery and fabric from the Indian market duty-free. She can export without paying any taxes. For selling shirts in the Indian market, Ria needs to pay Customs duty and GST as applicable on the Shirt. Government charges the same duties on an imported shirt.

Third, Ria sets up an EOU. While SEZs are large areas that house many units, an EOU is just one unit. Benefits for an EOU are at par with those in SEZs except the domestic sourcing where GST has to be paid on the inputs.

Fourth, Ria sets up a unit under the MUCB scheme, which allows the import of inputs and capital goods duty-free under a duty deferment plan. A firm can register its unit with the Central Board of Indirect Taxes (CBIC). There is no physical control, and the unit is subject to risk-based audits.

The MUCB scheme offers three benefits over other schemes.

One, lower import duty liability on domestic sale of the output. Under the SEZ scheme, Ria, at the time of domestic sale of Shirt, has to pay Basic Customs duty and GST. But under the MUCB scheme, while she pays GST on the Shirt, and Basic Customs duty on the fabric. Since both value and import duties are less on the raw materials than on the finished product, this will result in a considerable saving to the MUCB units.

Two, facility of duty-free import of machinery for making products for sale in India. A DTA unit pays both the Basic Customs Duty and IGST if it imports capital goods for use manufacturing goods for domestic sale.

But under MUCB, duty-free import of machinery for making of shirts for sale in India is allowed. As long as the machinery stays inside the bonded area, it can be used for making products for sale in the domestic market, leading to significant cost savings.

Three, no linkage between export and Import. Units operating under the SEZ and EOU schemes exports should be more than imports — no such binding for units in the MUCB scheme.

MUCB scheme has few soft spots. One, it favours imports over domestic sourcing. Two, it makes the import duty protection on capital goods ineffective by allowing duty-free Import of capital goods for making products for the domestic market adversely impacting the domestic capital goods industry.

To avoid policy-hopping, all schemes must provide similar incentives, but in reality firms can can save money using the available arbitrage as mentioned above.

The writer is is Indian Trade Service officer. Views are personal.

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