The GST Council, responsible for tax rate decisions has yet to resolve the tax discrepancies despite multiple discussions and recommendations

For over five years now, the fertilizer industry has been facing an ‘inverted duty structure’. Inverted duty structure refers to a situation in which raw materials (RMs) are taxed at a higher rate than finished products in whose manufacture these are used. But, there was little that the Budget presented by the Union Finance Minister (UFM) Nirmala Sitharaman on July 23, 2024, could do to address it.

Fertilizers and RMs used in their making are mostly taxed under the GST (Goods and Services Tax) regime. The GST Council - headed by the UFM that includes finance ministers from all States and UTs - has the mandate to fix tax rates besides deciding the procedures for registration, payment of taxes, GST return filing, and other related matters. So, the responsibility for fixing any anomalies in their taxation also lies with the GST Council.  

The issue was discussed in the 45th (September 2021) and 47th(June 2022) meetings of the GST Council; but no decision could be taken.  

Meanwhile, on August 9, 2023, the Standing Committee on Chemicals and Fertilisers recommended that the Union Government propose to the GST Council to reduce tax rates on fertilizers as well as RMs used in their making. In its 53rd meeting held on June 22, 2024, the Council referred the matter to the Group of Ministers (GoM) on rate rationalization to a take holistic view.

At the outset, let us look at the present structure of taxing fertilizers.

To make fertilizers affordable to farmers, the government controls their maximum retail price (MRP) at a low level, unrelated to the cost of production and distribution, and reimburses the excess of the cost over MRP as a subsidy to the manufacturers. In the case of urea, the MRP is about one-tenth of the cost, whereas for all other fertilizers, the price is nearly one-third.

When the government spends heavily from its budget to make fertilizers available to farmers at a fraction of their cost, it makes no sense to impose a tax on them. This increases the cost, only to be reimbursed as an additional subsidy, to the manufacturers. It is a typical case of taking from one hand and giving back from the other.

Two major components of the fertilizer supply chain are taxed under two different regimes: one under GST and the other under the pre-GST regime. All finished fertilizers such as Urea, di-ammonium phosphate (DAP), ammonium sulphate etc are taxed under GST at 5 per cent. Most RMs such as sulfuric acid, ammonia, phosphoric acid etc (these are used for making DAP and other complex fertilizers) are also covered under GST. While sulfuric acid and ammonia are levied 18 per cent GST, phosphoric acid attracts 12 per cent tax. 

However, natural gas (NG), used for the manufacture of all domestic urea, is taxed under the pre-GST regime. Electricity, a utility intrinsic to the fertilizer-making process, is also kept outside GST.

GST is a single nationwide tax with a provision for set-off tax paid on inputs. It subsumes within it more than a dozen taxes from the pre-GST era, namely central excise duty (CED), service tax, and sales tax/value-added tax (VAT). The Constitutional Amendment Act of 2016 on GST, while providing for the inclusion of NG (besides other petroleum products such as petrol, diesel, ATF etc) under its ambit, kept it ‘zero-rated’ meaning it continues to be under the pre-GST regime. The GST Council has put fixing the rate for NG (besides ATF) on its agenda umpteen times only to defer it.

Taxing under pre-GST results in a cascading effect on the cost of NG and electricity. Gas companies like Oil and Natural Gas Corporation (ONGC) and Oil India Limited (OIL) are outside the GST ambit and can’t claim credit for the taxes paid on their purchases of inputs, consumables, and equipment, leading to a higher price. Even as NG attracts nil CED on supplies to fertilizer plants, its delivered cost is boosted by VAT, which can be as high as 24.5 per cent in Andhra Pradesh (AP).

Other local taxes, for instance, Gujarat’s “purchase tax” on that portion of inputs consumed for making urea that is sold outside the state, also add to the cost. In the case of electricity, power companies don’t get any credit for taxes paid on inputs viz., equipment, stores, and so on, used in its generation and distribution, leading to higher costs.

Further, under the Constitution, entry 53 in the State List of the Seventh Schedule empowers states to impose tax (or electricity duty) on the sale and consumption of electricity, except when it is consumed by the Union Government or the Railways. For electricity duty, too, electricity companies don’t get any offset. This further exacerbates the cost of power supplied to fertilizer plants.

Even in areas where the materials are covered under GST hence, no cost cascading effect, the inverted tax structure plays a spoiler. The higher GST levied on ammonia/sulfuric acid/phosphoric acid as against much lower GST on finished fertilizers results in an ‘unabsorbed’ input tax credit (ITC), as the output tax falls far short of the input tax. The situation gets exacerbated because of the government’s control over the MRP of fertilizers at a low level.     

Considering that the cost of making fertilizer available to farmers (sans taxes) by itself is substantially higher than the price the Union Government wants them to pay, ideally, it shouldn’t levy any tax as the proceeds from such levy will have to be paid back as an additional subsidy. Even if it wants to levy, ideally, all components in the supply chain have to be brought under GST and fertilizers, and all inputs and RMs should be in the lowest tax slab of 5 per cent.

While the tax rate on fertilizers is already 5 per cent, this will require lowering the tax rate on all RMs viz. ammonia/sulfuric acid/phosphoric acid from the current 18/12 per cent to 5 per cent. The tax on micronutrients such as zinc (Zn), boron (B), manganese (Mn), iron (Fe) etc should also be lowered from the existing 12-18 per cent to 5 per cent in line with the recommendation of the Standing Committee as their importance for plant growth and ensuring balanced nutrient use. NG and power should be brought under GST and taxed at @5 per cent.

Lowering tax on RMs by itself won’t address the problem of unabsorbed ITC. This is because the MRP of finished fertilizers is substantially lower than the cost, even with the same GST, tax paid on RMs/inputs would still be higher than output tax liability. This can be resolved only when the government gives subsidies to farmers under direct benefit transfer (DBT) and lets manufacturers charge full price from the farmers.

Lowering tax on ammonia/sulfuric acid/phosphoric acid on supplies to fertilizer manufacturers to accommodate their special needs but leaving GST on supplies to other industries such as detergents, paints, dyes, plastics, etc unchanged can lead to large-scale diversion and misuse as it is impossible to track every grain of supply and ensure that it is used for the intended purpose. We have seen this happening in the case of urea where setting its MRP at a low level prompts diversion.     

Diversion/misuse is inevitable in any regime of differential taxation/pricing based on the end use of the product. The only way to prevent it and yet meet the intended objective is DBT. Well, this is shaping up!

(The writer is a policy analyst; views are personal)