Incentivising Manufacturing of Mobile Phones in India

On December 12th, 2016, I wrote a note titled "How GST Impacts Manufacturing of Mobile Phones in India". The purpose of that note was to highlight the collapse of the existing incentive structure (designed to promote manufacturing of mobile phones in India) as soon as GST gets rolled out (now likely by 1st July 2017). The key reason for this outcome is that the current CVD (countervailing duty), which was used as a tool to increase the cost of imported mobile phones (vs those manufactured locally), will now get subsumed under the GST and therefore, can no longer be used for that purpose. My earlier note also explains the reasons for this outcome (see link above). This understanding was corroborated by the revenue secretary (ET article dated 3rd April 2017). Then on 26th April 2017, there was another article in the economic times indicating that "Government may slam custom duty on imported mobile phone". This is significant, as, under the GST regime, the only way to increase the cost of imported mobile phones is by raising the basic customs duty (currently pegged at zero) since this category of tax is not part of the GST regime. Now, if raising the "basic customs duty" was an easy option, then why India waited so long to tinker with it? Why did it use a complicated CVD based scheme to promote manufacturing of mobile phones in India? The purpose of the current note is to tell that story.

India & ITA

India signed the ITA (Information Technology Agreement) on 25th March 1997. This agreement is an umbrella agreement under WTO, aimed at expanding world trade in information technology products. Through this agreement, the member countries agree to eliminate the basic customs duties on all IT products that are listed in the attachments A, and B of the agreement (page 2 clause 2 (a) & (b)). Hence, India reduced the basic customs duties on imported mobile phones to zero, after interpreting "mobile phones" as part of the agreement.

Mobile Phones & ITA

In the ITA, the IT products are classified by the International Harmonized System (1996) - HS96. This system maps an IT product with a harmonized code. Under this system, there existed an HS Code 8525 20 (Transmission apparatus incorporating reception apparatus - Page 8 of ITA agreement, Attachment A, Section 1). This was an umbrella code used for classifying various two-way radio communication equipment, like Walkie talkie sets, Cordless handset, Car telephone, Cellular phones etc. Under this mobile phones got classified as 8525 20 17. Later the HS code system undertook a major revision - resulting in the reclassification of many IT products. In this new system, the mobile phones got reclassified under a broad section 8517, as 8517 12 10 for push button type, and 8517 12 90 for others. Please note that the heading 8517 was part of the original ITA, but the subheading 8517 12 is new and was not listed in the original ITA. Normally, all changes of HS codes must be transposed to reflect in the original agreement, but I am not sure if this has been done in this case. Nevertheless, to align with the ITA agreement, Indian Customs issued a notification 24/2005 dated 1st March 2005 exempting all IT products falling under this head (8517) from basic customs duty. This practice continues till date and explains why India had to invent a complex CVD based incentive scheme to promote manufacturing of mobile phones locally.

Circumventing ITA 

As stated above, with the roll out of GST the only way to increase the cost of imports is by increasing the basic customs duty of mobile phones. But given the history and the legacy of the past, will it be possible for us to do so without blatantly violating the ITA agreement? We might argue that the latest generation mobiles phones were developed much later after we had signed the ITA agreement, and hence cannot be considered as part of the original agreement. This means that these new technology based phones should be part of the ITA-II list - the new agreement which India has not yet signed. But the perusal of this new list finds no mention of the new technology based phones either. Even if we assume that we will find a legal way to get around the ITA agreement for the new technology based mobile phones, but what about the associated components? Most of these are part of the original ITA list. Hence, if we are unable to get these also out of the ITA agreement then we will not be able to promote manufacturing of these components in India, as these components will continue to have "zero" basic customs duties, thereby making mobile manufacturing in India limited to low value add assembly of imported components. Therefore, we have to find some other way to incentivise manufacturing of mobile phones in India.

Incentivizing Manufacturing

Recently E&Y under the banner of BIF (Broadband India Forum) did a study to figure out a sustainable solution to this vexed issue. It suggested that to promote "Make in India" of mobile phones, the GST paid by the manufacturer should be refunded back to them as an incentive. This will not economically damage government's earnings as under the CVD regime the government is not collecting that money anyways. On the other hand, it will motivate the manufacturers to add more value - more the "value add" will result in more GST payable - leading to more refunds. This will not require the need to reclassify any products out of the ITA agreement and prevent all legal risk that we might have to face at the WTO (translating into higher investment risks in case India is forced to unwind duties at a later date). Refunding GST back to the manufacturers will also scale well, simple to administer and will motivate the manufacturers to add more value, thereby leading to the success of the PM's "Make in India" vision - saving in crucial foreign exchange, and the creation of more jobs.

(Views expressed are of my own and do not reflect that of my employer)