TRIPS-plus Customs laws add a new dimension to IPR

A signal achievement of Mr. Chidambaram that went almost unnoticed was the introduction of border measures to combat IPR infringements effectively in form of the Intellectual Property Rights (imported Goods) Enforcement Rules, 2007, notified on May 8, 2007, under section 156(1) of the Customs Act (refer www.cbec.gov.in for details). It was a landmark decision of the Government for two reasons. First, the Rules have entrusted Customs officers with comprehensive powers not only to intercept and detain infringing goods in pursuance of the Border Measures stipulated in Articles 51 to 60 of TRIPS (Trade-Related Aspects of Intellectual Property Rights) but, being read with sections 110, 111, 112 and 135 of the Customs Act (1962), also to seize, adjudicate and confiscate offending goods and to penalize and prosecute the offender. Second, while border measures under TRIPS are restricted to Copyright and Trade Marks only, the above Rules now encompass patent, design and geographical indications also. It is thus evident that Mr. Chidambaram has gone beyond the mandate of TRIPS on both counts.

It is pertinent to mention here that both Japan and China, like European Union countries and the USA, had expanded the scope of IPR enforcement at borders by covering patent and design, apart from copyright and trade marks. Besides, Japan has amended its Customs laws to impose a fine on the infringer up to 7 million yen and imprisonment up to 7 years. China has also empowered its Customs officers to confiscate infringing goods and to penalize offenders. Both the countries, like in the case of EU countries, have provided for Customs intervention in respect of both imports and exports. India, on the other hand, has restricted Customs intervention to imports only and not export as yet. Maximum penalty provided under section 112(i) of the Customs Act for an infringer of IPR is cent percent of the value (same in USA) and maximum imprisonment under section 135 (ii) is for a term of 3 years. As for European countries, it is left to each member country to decide whether the power to determine infringement of IPR at borders and to levy penalty shall be entrusted to Customs or some other authority including court (ref. Council Regulation (EC) No.1383/2003 of 22 July, 2003). Majority of EU countries have, however, assigned this power to the Customs.

Apparently though India is lagging behind Japan and China in border enforcement of IPR in that it has not covered exports as yet in its ambit, Mr. Chidambaram has stolen a march over them by integrating recordation of right holders’ notices with highly sophisticated Customs Risk Management System (RMS), perhaps the first such attempt in the world. This has led to multiple benefits for right holders apart from enabling automated detection of IPR infringement, based on right holder’s inputs. In the first place, right holders are spared the trouble of multiple recordations with Customs at all vulnerable points of entry. Second, single recordation reduces the financial and administrative burdens of the right holder in terms of security, notice fee and logistics. Third, Customs RMS through ICEGATE instantly incorporates those automated data to generate alert at all Customs stations where RMS is functional, rendering it rather impossible for suspect consignments to escape detection. Fourth, the System has enabled central monitoring and supervision.

A question may arise whether it was wise on the part of the government to entrust Customs with the power to determine infringement of IPRs, particularly Patents, designs and Geographical indications, inasmuch as such determination presupposes expertise that Customs officers generally lack. While it is possible for a trained Customs officer to determine infringement of copyright and trade marks, based on the materials provided by the right holder, the issues relating to patents, designs and geographical indications are indeed far more complex, requiring external support or consultancy before coming to any conclusion.

The contrary proposition of letting Customs merely detain suspect consignments, leaving it to the court to determine IPR infringement has certain obvious demerits. First, long-drawn court proceeding would invariably lead to accumulation of demurrage and detention charges in respect of detained cargo, which would be payable to the custodian and the owner of detained containers respectively. This extra financial burden may have to be borne by the right holder eventually. Second, confiscation of imported counterfeit and pirated goods by Customs upon determination of infringement by court would suggest redundancy and non-application of mind by the former. Third, it would lead to multiplicity of proceedings, there being two appealable orders, one by the court and the other by a Customs officer. Resultant confusion as to appellate jurisdiction would thus become unavoidable. On the balance, therefore, Mr. Chidambaram was justified in making Customs laws on IPR comprehensive enough to deal with infringing goods holistically.

It is time for the trade, both domestic and international, to draw optimum mileage out of the simplified but far-reaching Customs laws and procedure to protect their intellectual property rights.

Meet the challenges for a unique GST

The prospect of a common goods and services tax (GST) being implemented from April 1, 2010, turns tax-reformers, businesses and governments (both at the Centre and states) euphoric for valid reasons. They all foresee simplification of procedure, lesser tax burden for businesses with credit running along the supply chain thereby eliminating cascading effect on prices, and a substantial growth in revenue collection. In short, a win-win situation for all. However, all these expectations can be belied if the challenges confronting its implementation are not effectively met.

The first challenge comes from our federal structure itself and the sign of crack in the concept of common GST is already visible. It is significant that the refrain of the Union Finance Minister about the single GST coming in force from April 1, 2010 was missing in this year’s budget speech. It is clear by now that there will be no common GST and that GST for the Centre and the States will run in parallel. Hence, the businesses will necessarily have to deal with more than a single administrative authority for the same goods, like what they have been doing now.

The second challenge emanates from the compulsion of reconciling currently prevalent destination principle with the supply chain credit management under GST that smacks of origin principle. There is obviously a contradiction which needs to be resolved. To be more precise, under the current VAT system, the movement of goods from one state to the other is taken as export, and since export conceptually is tax neutral, it is the importing state that has a right to collect VAT while the exporting state refunds the tax collected. This, in short, is the destination principle which currently governs State-VAT, but not Central VAT (CENVAT) which works on origin principle. With the introduction of GST, the state barriers will disappear rendering the concept of import and export in inter-state transactions irrelevant. The only connecting thread from origin to end would be the credit of GST paid. In such a system, the destination state is expected to collect net tax on the value added, which is substantially lower than what it collects now under destination principle, thus affecting industrially weaker states like the north-eastern, Uttarakhand, Himachal Pradesh etc. However, it is technically possible to synthesize the destination principle with the origin principle by allowing end to end credit upfront, with back-end revenue adjustment on destination principle through clearing house mechanism. In no country, however, such synthesized system is in place.

Way back in 1985, EU Commission (EC) proposed to adopt the origin principle with a clearing house mechanism, but kept its implementation postponed owing to disharmony of VAT rates and governing laws, and consequently the possibility of major distortions in intra-community trade. Nevertheless, we need not be pessimistic about trying a symbiotic approach through innovative automated programmes, thereby setting an example for other countries.

The third major challenge arises from continuance of organized tax-evasion through unaccounted transactions, under-invoicing and credit-frauds under State-VAT and CENVAT. If GST is not safeguarded by a risk management system, it is likely to create an evasion-prone market that would witness gradual elimination of tax-compliant businesses. We should learn from the experience of other GST-compliant countries in this regard. On a modest estimate, the UK loses annually over 10 billion sterling pounds of VAT through Missing Trader and carousel frauds, while annual loss of VAT by the EU countries collectively on same account is roughly estimated as 100 billion Euros. In Canada, since the inception of GST in 1991 till March, 2003, about 600 individuals and businesses have been convicted of GST fraud. In Brazil, the GST experiment has failed for same reasons. The only long term solution as a safeguard, as has been envisaged by the EU Commission, is real time settlement of all VATable transactions. In India it is technically feasible to put in place a real time accounting system to raise the compliance level.

The last major challenge of GST comes from the massive expansion of tax base and the resultant demand for additional staff. As for the Centre, once the threshold limit for CENVAT is reduced from Rs 150 lakhs to the state level, and dealers and retailers are covered, the assessee base will expand exponentially. Similar expansion is likely in states for reason of inclusion of service taxes in its domain. It is well-nigh impossible to manage the expanded workload with the existing workforces unless the entire workflow is automated with an effective risk management system.

The question is, can we bring about GST on the scheduled date after meeting the above challenges satisfactorily? If we do, India will no doubt set a standard worth emulating.

E-mail id: akraha@gmail.com

A modified ‘Deemed Credit’ to mend VAT distortions

The reasons why Value Added System (VAT) scores over any other system of indirect taxation are twofold. First, it eliminates cascading effect on the assessable value of goods and services by rendering such value tax-neutral. Second, by providing a credit chain from origin to end, the system sets up a self-corrective mechanism by substantially reducing, if not eliminating, the risk of tax evasion. To be precise, if tax is evaded by unaccounted clearance, the credit chain automatically gets snapped and at the next accountable stage, whether manufacturing, wholesale, or retail, the full tax burden with cascading effect would have to be discharged for want of credit. If tax is evaded by under-valuation, the buyer-assessee would get a lesser credit and incur consequently a higher tax liability. Hence, it is assumed that the trade would not gain by attempting to evade tax in an ideal VAT or GST regime. The question is, do we have an ideal VAT regime at the centre and the states.

As for the states, in the absence of inter-states credit operability, credit in State-VAT does not run along the supply chain that may originate in one state and terminate in another. Therefore, the current system has an inherent lacuna which can only be plugged with the introduction of GST when credit chain will in all likelihood be operable in inter-state transactions. In Central VAT (CENVAT) also, for reason of high threshold limit for levy on goods (Rs. 1.5 crores annually) and also for restricting the levy to manufactured goods only, a large number of transactions are kept outside the purview of CENVAT thereby providing an incentive for tax evasion.

The case in point is the manufacture of ingots, rods and wires of copper, steel, Aluminium etc. out of market scraps and waste procured by the unorganized sector, mostly from dealers, without any proof of duty payment, and hence without an input credit. Since value-addition in respect of those productions, particularly of copper and aluminium, is minimal, the duty incidence on wiring and re-wiring units becomes almost prohibitive in the absence of input credit. This explains why those manufacturing units in unorganized sector pay only a fraction of the CENVAT that is actually payable, primarily to survive in a competitive market where large units invariably utilize CENVAT credit on recycled scraps and waste generated in the course of manufacturing process. As a logical corollary, the unaccounted production and clearances by the unorganized sector to evade 16% CENVAT lead to simultaneous evasion of 4% State VAT, and eventually a minimum of 33% corporate tax as well, leaving those activities outside the ambit of GDP reckoning. And the evasion continues up to the finished stage in which it reaches the ultimate consumer. The only remedy to the above evasion-prone, distorted market condition lies in the revival of ‘deemed credit’ that once co-existed with the MODVAT (Modified VAT) scheme from its very inception (1986), but was later rescinded by an Order of the ministry of Finance (Department of Revenue), dated 1.3.94, purportedly in consideration of gross misuse.

The misuse was primarily of two types. First, some inputs were suspected to be non-duty-paid or exempt in which event deemed credit was not admissible. Second, there were instances of forgery and tampering of invoices to enhance the quantum of deemed credit, and to reduce the net duty liability. However, the cure by way of rescission of the scheme of Deemed Credit was worse than the disease itself as it led to massive unaccounted production and clearances to evade not only CENVAT, but State VAT and corporate tax also, besides having its corrupting influence on tax officers.

What then is the remedy? Should we suggest revival of the old scheme of ‘Deemed Credit’ to remove current distortions in CENVAT and VAT where a large number of transactions remain unaccounted? To revive a two decades old concept sans modification would certainly be anachronistic.

The modification that is worth our consideration is to allow deemed input credit at the exit stage rather than at the entry stage, after ensuring duty liability of inputs in question. Currently, under indirect subtractive computation method, an assessee is permitted to pay entire duty from CENVAT credit account, till it is exhausted. In the proposed scheme, the assessee shall not be permitted to pay entire duty from Deemed Credit account, at any given time, so that his credit utilization does not exceed the percentage fixed, during any assessment period. Once this is done, all transactions of the rolling and re-rolling units are likely to enter into books of account, boosting central as also state revenue considerably. At the same time, prices of wires, cables etc. are likely to stabilize at a lower level once cascading effect is removed and the cost of evasion eliminated.

Before the Centre and the States venture into GST, it is imperative that the present evasion-prone market is rendered stream-lined and accountable by way of implementation of CENVAT and VAT in letter and spirit.

Is GST in India on the right track?

Amidst din and bustle of economic downswing, the governmental commitment to introduce GST from April 1, 2010, seems to rest on the backburner. One practical reason for this apathy is the intervening polls at the Centre as also in a number of States and the uncertainty whether the ruling parties will return to power to remain accountable for non-implementation of GST.

In the current economic depression which is likely to continue, GST would have been a welcome step for three reasons. First, it would lessen the burden of taxes on consumers considerably by eliminating cascading effects of all taxes on the price, thus rendering products and services cheaper. Second, an electronic data interchange (EDI) system in GST, as envisaged, will considerably reduce the cost of compliance for the Trade, usher in an era of fiscal discipline and consequently encourage larger investment in India. And thirdly, GST is likely to inflate the tax kitties of the Union and the States owing to enhanced efficiency resulting from electronic accounting of intra-state and inter-state credits, through the mechanism of a clearing house.

The above three reasons would provide enough justification for the States Empowered Committee (SEC) and also for Union Finance Ministry (UFM) to accord priority to GST implementation. However, the progress made so far in this regard makes one reasonably sceptical. The case in point is the prevailing vacillation to settle certain key issues such as whether there should be a single or dual GST; in the event of dual GST, as has been recommended by SEC, whether administrative control over tax collection should be vertically split between the States and the Centre or both would have concurrent and overlapping jurisdiction; whether the collection of GST on services should be assigned to States leaving out a few major multi-destination services, such as telecom, for the Centre; whether Centre’s administrative control should be confined to large tax payer units only; whether the responsibility of collection of countervailing duty (equal to GST) on imported goods should be assigned to States; and whether credit of duty in inter-state sales should be allowed to buyers instantly or only after the duty remittance has been acknowledged by the designated bank in destination State. More significantly, however, enough attention has not been given to the developing of an electronic clearing house model for credit management, which holds the all-important key to successful implementation of GST in a federal country like India.

SEC appears to rely on banks’ efficacy to serve as the Clearing House, overlooking the experience of Central Board of Excise and Customs (CBEC) while implementing Electronic Accounting System in Excise and Service Taxes (EASIEST) and of Central Board of Direct Taxes (CBDT) while implementing On-line Tax Accounting System (OLTAS). Even after years of commissioning, several banks are still in default in entering simple challan data, off-line, in the above-said electronic Systems. In the above backdrop, it is not conceivable that banks in India will be equal to the onerous task of commissioning and administering a complex electronic accounting system like the Clearing House for credit management. Thus the implementation of GST by the appointed date of April 1, 2010, is most likely to founder if SEC persists with bank-managed clearing house system.

The single most critical challenge of GST, whether single or dual, is how to administer and account for credit flow along the supply chain up to the retail stage, particularly in respect of inter-state sales. It is pertinent to mention that in the prevailing VAT administration, tax credit is not allowed to the buyer in Destination State inasmuch as all sales out of the State are considered as export which is tax neutral. In GST regime, inter-state sales will no longer be treated as export or import and, therefore, will become taxable at all stages allowing credit of tax to each buyer-assessee in an unbroken supply chain. Dual administrative control over this supply chain is not conceivable unless there is a near perfect electronic accounting system managed by a single clearing house.

Another major weakness of the SEC model is that it provides for collection of CGST by States, without addressing the issue how credit of CGST and SGST will be regulated/adjusted when systems of accounting are at variance. Besides, it does not provide for a Risk Management System to guard against tax evasion. The experience of GST compliant countries merits a mention in this regard. On a modest estimate, the UK loses annually over 10 billion sterling pounds of VAT through Missing Trader and carousel frauds while other EU countries collectively lose about 100 billion Euros annually on same account. In Canada, since the inception of GST in 1991 till March 2003, about 600 individuals and businesses have been convicted of GST fraud. In Brazil, GST experiment has failed for same reasons. The only effective anti-fraud safeguard, as has been envisaged by the EU Commission, is real time settlement of all VATable transactions. It is also imperative that unorganized sectors, notably of iron and steel, copper and other metals, are brought within the credit chain by allowing deemed credit, inasmuch as their sales by and large remain unaccounted owing to inadmissibility of credit on market scraps. There is no evidence as yet of any such effective, all encompassing system being contemplated, let alone being put on trial run. There is, therefore, every reason to doubt whether the SEC model of GST will survive eventually.

The question is how we can address the above issues in a time bound manner. As a matter of fact, there is no dearth of talents in the country. What we need is a team of highly motivated executives with sound domain knowledge cum field experience coupled with Systems background.

It is time for the EC and the UFM to address the above pertinent issues in proper perspective instead of hastily adopting a patchy model of GST.