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Fix the flaws in fertiliser taxation

The Standing Committee on Chemicals and Fertilisers has recommended that the Centre propose to the GST Council to reduce tax rates on fertilisers from the current 5%. It has also sought a reduction in GST on raw materials (RMs) used in the making of fertilizers. Currently, RMs such as sulfuric acid and ammonia are levied 18% GST, while phosphoric acid attracts 12%.

The present structure of taxing fertilisers and RMs used for making them has three major flaws.

1. To make fertilisers 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 non-urea fertilisers, the price is nearly one-third.

When the government spends heavily from its budget to make fertilisers available to farmers at a fraction of their cost, it seems senseless to tax them or the RMs used for making 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.

2. Two major components of the fertiliser supply chain are taxed under two different regimes: one under GST and the other under the pre-GST regime.All finished fertilisers, such as urea and di-ammonium phosphate (DAP), are taxed under GST at 5%. Most RMs are also covered under GST. 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 fertiliser-making process, is also kept outside GST. This results in a cascading effect on the cost of these two major inputs. 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 no central excise duty (CED) on supplies to fertiliser plants, its delivered cost is boosted by VAT, which can be as high as 24.5% in Andhra Pradesh.

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 fertiliser plants.

3. The third flaw has to do with the high taxes paid on RMs used in the manufacture of fertilisers as opposed to the tax liability on the output (finished fertilisers) being much lower. This isn’t just because of the much lower GST rate but also because of the lower MRP. For instance, the MRP of urea is a mere 1/10th of its cost. This results in ‘unabsorbed’ input tax credit, as the output tax falls far short of the input tax and the law has no provision for manufacturers to claim it.

Hence, the Centre has to compensate fertiliser manufacturers for unabsorbed input tax credits using its fertiliser subsidy budget.

To conclude, considering that the cost of making fertiliser 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. Even if it wants to levy, all components in the supply chain have to be under GST and fertilisers, and all inputs and RMs should be in the lowest tax slab of 5%.

While the tax rate on fertilisers is already 5% (the Committee’s recommendation to lower it further would unnecessarily complicate an already unwieldy GST regime), this will require lowering the tax rate on ammonia, sulfuric acid, and phosphoric acid from their current high of 18%/12% to 5%. The same rate should apply to NG and power after bringing them under GST.To address the ‘unabsorbed’ input tax credit, the government can give a subsidy to farmers under the direct benefit transfer mechanism and let manufacturers charge a full cost-based or market-determined price from the farmers.

(The writer is a policy analyst)

(Published 09 November 2023, 19:43 IST)

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