BCCI reveals loopholes in current Excise Duty System and suggests a new system

BCCI says the new system will not mean loss of revenue to government and will also enhance the private sectors competitive edge 

The Bhutan chamber of commerce and industry (BCCI) has proposed to bring about a complete change in the current excise tax system and thereby modify the trade agreement with India.

A study on India’s excise duty system and its impact on Bhutan carried out by QED consultancy on behalf of BCCI was presented to the 7th PSDC meet chaired by economic affairs minister Khandu Wangchuk, Thursday.

The current system, according to the study, put both the government and the economy as a whole on a disadvantageous position. It also offered little or no room for competitiveness among local businesses.

Since the Indo-Bhutan Trade Agreement was signed in 1983, a system of excise duty refund existed wherein the Government of India (GoI) pays an annual refund to the Royal Government of Bhutan (RGoB) based on documented evidence of the total amount of imports from India to Bhutan. In the early years, this system favored both countries in that the Indian government was able to prevent deflection of goods by Indian businesses during the License Raj while the Bhutan Government was able to expand its revenue base.

The government at the time lacked the capacity to monitor the border for customs duty. The private sector in Bhutan was very negligible and a small component of the economy that imported very little from neighboring countries. In fact, the RGoB was the only major importer of goods at the time, and it made sense for it to receive the excise duty refunds. However, all of these facts have now changed according to the report.

Over the past three decades, the private sector has grown substantially and increasingly imports more and more goods from India. “Therefore, it is now the case that the refund received by the RGoB is actually composed significantly of excise duty paid by Bhutanese businesses, not the government,” the study pointed out.

The QED report states with the setting up of Regional Revenue and Customs Offices nationwide, the country is now in a position to set up and implement its own excise duty system. Moreover, the significant expansion of the private sector in areas of retail, services, and manufacturing has led to exponential growth in the import of both raw materials and finished goods from India. In 2010, the Bhutanese economy imported INR 29.3bn worth of goods from India.

This report was compiled by using trade data from the Bhutan Trade Statistics 2010. QED representatives said “repeated requests were made to the Department of Revenue and Customs for more accurate data on the excise duties paid by Bhutanese importers. As the requested data was not made available, next best estimates were made using publicly available data.”

 

Key findings

The study found that on average, an excise duty rate of 11.11% was paid by Bhutanese importers on goods purchased from India in 2010. Whereas the RGoB is set to receive Rs. 1.3 billion as excise duty refund for 2010 from GoI, it is estimated that about INR 2.32bn was actually paid in excise duties for the same year. This implies a loss of INR 1.02bn in refunds for 2010 alone.

The primary reason QED said for receiving a lower than actual refund is due to the lack of proper documentation being maintained by Bhutanese importers as many goods are procured from the open markets.

“As the excise duty refund is not passed back to private businesses, their costs are higher and make them less competitive in the international market for manufactured products. The current system also discourages the establishment of new businesses,” Singye Namgyel said.

Assuming that the INR 1.3bn is borrowed for a period of three years at an average interest rate of 5% per annum, this translates into a cost in the form of interest payment to the tune of about INR 204.91mn which could have been actually avoided if excise was not paid. Based on the QED’s computations the overall loss to the Bhutanese economy due to the current excise regime between the two Governments is in the order of about INR 1.47bn.

“No other country in the world follows this kind of excise duty system except Bhutan. The whole world cannot be wrong,” QED’s Thinley Palden said.

 

Recommendations

According to the report the current system does not provide a comparative advantage to Bhutan nor offers a level playing field. The BCCI has proposed an alternative system wherein the Indian excise duty is exempted at source in India and the RGoB implements its own excise duty at the border fates when the goods enter Bhutan.

“The inland excise duty system provides a valuable fiscal policy tool to the government to foster, and regulate, certain sectors of the economy while also serving as a source of revenue,” Singye Namgyel said.

The report says that if excise duty were to be exempted at source, then Bhutanese industries and the Bhutanese economy as a whole would benefit greatly. The benefits as listed are, firstly the cost of production for Bhutanese industries would decrease, and this would help Bhutanese industries compete in the Indian market. Secondly, the growth of the economy would be hastened since Bhutanese industries would earn higher revenues due to the increased ability to compete in the Indian market.

“I think the time has come that we should maybe scrap the existing duty refund system and put in place a Bhutan excise duty,” Singye Namgyel said.

He also implied that the Bhutanese excise duty should, in principle, be about 2% below the excise than in India to incentivize Bhutanese importers.

Another key recommendation is that the finished goods being exported should be exempted from the Bhutan excise duty to enable the goods to become competitive in the export market.

A two-part implementation process has been proposed. During the first phase, the excise exemption at source could be implemented only for industries that purchase raw material or semi-processed raw material originating from India and where Indian excise has been levied. In the first phase it will also be very important to initiate a policy that incentivizes trading companies to maintain proper documents, and to purchase from principal companies required by the RGoB to get 100% refund from the GoI for all goods imported from India. In the second phase, once the custom agencies have fully adapted to the new system of excise exemption at source, it should be implemented for all goods being imported from India.

“On the whole, this alternative system is expected to increase both private sector growth and government revenue,” the report concludes.

This study estimates that the RGoB will not; incur a loss in revenue if the proposed system is put in place. In a worst-case scenario, there may be a slight revenue decrease in the first year when the transition takes place, but over the long term the taxes collected will increase substantially as the Bhutanese enterprises will be able to take advantage of the level-playing field created by such an excise system.

The study also states equity will be maintained because the excise duty of India will be exempted at source for the Bhutanese importers. “To ensure its effective implementation a mechanism of taking approval from the RGOB by the importing party and documenting the transaction at the entry point on the border could be put into place,” it states.

Earlier justifications made by the government on the issue

The government agencies till now have repeatedly reiterated that excise is a tax of the GoI, and that the finance ministry and RGoB have no say in the matter. QED found that this is one of the main reasons why the private sector in Bhutan feels that it should not be paying the Indian excise duty in India.

The government also cited the agreement between the two countries that the refund is from government to government and not to individuals. “This is precisely the reason the private sector of Bhutan has requested for excise exemption at source and not refund from the GoI,” QED representatives said.

Citing the example of Nepal, QED representatives said the argument that the RGOB cannot do anything regarding the way the current excise duty functions is not true. “There is precedence set by Nepal that Bhutan can follow. Obviously Bhutan need not reinvent the wheel. Nepal has already shown the way and all that is required is to adjust the process to suit Bhutan and to start the process of negotiation with the GoI to make the changes to the excise duty that is recommended,” the study states.

 

Adoption of proposal left to the next government

While PSDC chairman Lyonpo Khandu and members who are secretaries to the government acknowledged the issue, they resolved that further studies be carried out and the adoption of a new system could be approved by the next elected government.

This is the first time that the government has indirectly acknowledged that the excise duty issue.

“It’s a very good study and we welcome it. We recommend that the excise duty issue be considered very seriously by all the stakeholders. I only suggest at this point that for us to say that we will adopt this will be a little premature and also the fact that the government is nearing its end of term,” Lyonpo said.

The chairman also said BCCI could do a little more study in terms of the “ramifications that we will have on existing trade agreement between the two countries.”

“As and when the new government is elected, the issue should be taken up,” he said.

Finance secretary Lam Dorji also commended the study report besides pointing out a few factual errors and said anything to do with taxes has to go through parliament which only means that the next government needs to look into it.

On the factual errors, QED representatives cited reluctance by government agencies in providing requested data. “At one time the court was mentioned. That we will be taken to court,” Singye Namgyel said.

BCCI and QED representatives said they are ready to do more work if necessary as directed by the chairman for it is in the interest of the country and the economy as a whole and not just the private sector.

BCCI president Ugyen Tshechup Dorji said, “In the past we had a definite answer that the government is not in a position at all to look at this excise duty refund. Today QED is proposing that the government doesn’t lose its revenue and at the same time make sure that the industries that are exporting are made competitive.”

The study was carried out by QED and BCCI following an order from Lyonpo Khandu Wangchuk during the 6th PSDC meet in May last year to the Association of Bhutanese Industries (ABI) to submit a full report on the impact of the excise duty regime on industries and to recommend possible solutions to address the problem.