The textile sector has recently been in news for various good reasons. The Government is leaving no stone unturned in providing conducive ecosystem to explore the textile industry’s competitive and comparative advantage. The Textile Ministry has recently launched Mega Integrated Textile Region and Apparel Parks (‘MITRA’) scheme to build mega textile parks and has also extended Rebate of State and Central Taxes & Levies (‘RoSCTL’) scheme for exports of apparel/garments and made-ups till March 2024. With the introduction of production-linked incentive (‘PLI’) scheme for Man-Made Fibre (‘MMF’) fabrics, MMF garments and technical textiles, the sector is expected to soar to new heights.

Given that the textile sector is one of the largest employers in India, it is now poised to become the largest exporter as well. While the large players in the sector may have reasons to cheer, it is to be seen if the above referred schemes can benefit MSMEs. In this article, we intend to highlight the possible consequences arising out of the changes that have been carried out in the GST rates of textiles and textile articles.

GST rate rejig

The Notifications[1] issued by CBIC last month have essentially implemented a uniform rate of GST of 12% across the MMF textile value chain with effect from 1 January 2022. Additionally, the entries in the notification have been aligned with the Customs Tariff so as to overcome the confusion over mismatch between Chapter Headings as per Tariff and the description in the notification. The Government seems to have increased the rate of tax on MMF textile value chain with an intention to correct the inverted tax structure. According to the tax administration, higher rate of tax on inputs leads to accumulation of input tax credit (‘ITC’) and consequently higher refunds to taxpayers. Thus, there was a need for correction of inversion, which would also ensure that the revenue collection figures are not distorted.

While the Government intends to support the industry by resolving the problem of accumulation of ITC, thereby reducing compliance burden of taxpayers who seek refund of the credits so accumulated, the manner in which the issue has been approached by the authorities seems to cast doubt on Government’s virtuous intentions. The issue goes back to the discussions in 39^th GST Council meeting held on 14 March 2020, wherein a few recommendations of the Fitment Committee were placed before the Council. One of recommendations of the Fitment Committee was to increase the rate of GST on MMF, MMF yarn, fabrics, garments, made-ups and associated services.

Interestingly, the above suggestion was put forth before the Council based on the recommendations of a Committee of Officers on Revenue Augmentation, which was constituted for a completely different purpose. The recommendation of these committees may have been accepted by the Council considering the relief that the industry was to get from the menace of rate inversion, but the Council in its wisdom must also have considered adverse implications that the industry may face from such a short-sighted approach.

Taxing the untaxed

Historically, majority of the textile products were exempted from payment of Central Excise duty and VAT while a few others were chargeable to a concessional rate of duty of 2%. In fact, the fabrics below retail sale price of Rs.1,000 were subjected to indirect tax under GST for the first time. The raw materials used in the manufacture of these products were leviable to duty or tax. Thus, these products have been suffering from significant amount of embedded taxes as there were no options for its offset/refund prior to implementation of GST.

The industry therefore expected some solution for these hurdles under GST regime. However, to everyone’s surprise, the Government came up with a novel idea of restricting refund of unutilized ITC. Once the refund of unutilized ITC was allowed for the sector with a rider of lapsing[2] ITC accruing upto July 2018, another roadblock by way of restriction in allowing refund of ITC on input services was implemented retrospectively, which has also been affirmed by the Hon’ble Supreme Court[3]. All these impediments have adversely impacted the sector by adding up taxes into the product cost at every stage of supply chain.

Impact of rate hike

Now, with the upcoming hike in tax rates, the Government seems to have passed the buck to the industry for collecting embedded taxes from the customers instead of approaching the authorities. The industry too would pass on the effect of the hike to their customers to maintain their already dwindling profit margins. The effect of this rate hike would therefore add to inflationary pressure, which the central bank is trying to contain.

The textile sector, unlike other industries is majorly disintegrated, unorganised and dominated by MSMEs. Thus, increase in tax rates may have significant impact on the working capital requirement and cash flow. According to the Working Capital Index, 2021 by J.P.Morgan[4], the apparel and accessories industry has experienced one of its most challenging years in recent memory as the widespread lockdowns due to pandemic kept stores shut and disrupted supply chains.

Certain textile associations have urged Government to reconsider the proposed hike in GST rates on textiles and apparels from 5% to 12%. Several representations have been made to the Government pointing out that the increase in rate of GST will only alleviate the concern of a small percentage of the players in the sector. Considering the gravity of the matter, the Textile Ministry has also approached the GST Secretariat seeking to maintain status quo on rates by restoration of 5% GST and for making any change only after discussions with the Ministry and the stakeholders.

Way forward

Inverted tax structure is a genuine problem and hiking the rate of finished products across the board is clearly not the solution as it would only add to the burden of a Covid-battered sector. The Government needs to adopt a pragmatic approach of easing tax rates of the raw materials that goes into the manufacture of MMF value chain. MMF are primarily made using polymers emerging from by-products of petroleum, natural gas or using certain naturally occurring polymers. Cutting down on GST rates on primary inputs used in the manufacture of MMF may not adversely impact Government’s revenue as the excess taxes collected by them is subsequently required to be refunded to the industry.

In the alternative, the GST Council may also revisit on its controversial stand of restricting refund only in respect of inputs as it goes against the objective of neutralizing the effect of taxes across the value chain. This would go a long way in resolving the problem of other sectors, including footwear industry, that are struggling from tax inversion. The textile sector must continue to make representations and approach the Ministry for ensuring that the industry is not adversely impacted due to skewed tax policies.

[The authors are Senior Partner and Joint Partner, respectively, in the GST Advisory team in Lakshmikumaran & Sridharan Attorneys, Bengaluru]

1. [1] Notification Nos. 14/2021- I.T.(R) dt. 18.11.2021 and 15/2021- I.T.(R) dt. 18.11.2021
2. [2] Notification No. 21/2018- I.T.(R) dt. 26.07.2018
3. [3] UoI & Ors. Vs VKC Footsteps India Pvt. Ltd. [2021-VIL-81-SC]
4. [4] https://www.jpmorgan.com/content/dam/jpm/treasury-services/documents/jpmc-working-capital-index-2021.pdf