India is on track to become the second-largest producer of steel in the world. The National Steel Policy, 2017 (NSP-2017) aims to increase crude steel capacity to 300 MT by 2030-31, with the secondary steel sector expected to contribute 35-40 percent of total production. The ferrous scrap market, currently worth Rs 10,000 crore, is set to soar to Rs 35,000 crore by 2030 as the industry shifts towards scrap-based steel production. However, the industry is facing a peculiar situation under the goods and services tax (GST) regime as steel scrap is taxed at 18 percent GST. The peculiarity lies in the complex supply chain of procuring steel scrap, an important raw material for the industry, from different dealers, both registered and unregistered ones.
There are two types of steel scrap – ‘old scrap’ generated from white goods and automobiles discarded by households or industry and ‘new scrap’ generated from manufacturing processes. The old scrap of households is generally bought by smaller unregistered dealers, who in turn sell it to larger registered dealers, without levying any GST. On the other hand, the new scrap, generated during the manufacturing process is bought both by unregistered dealers or by registered dealers from the manufacturing units. Now, the registered dealers must charge 18 percent GST when they further sell to the steel-producing industry and pay the same to the government.
Where the new scrap is supplied by a registered person to a registered dealer, who further sells it to the registered steel manufacturer, all parties charge GST at each stage and there is a free flow of input credit in the entire chain. The problem arises when scrap is purchased from unregistered dealers, as in absence of sufficient input credit (on scrap purchased from unregistered dealers), registered dealers have to pay GST in cash on their outward supply.
Fake Invoices
The GST authorities allege that few registered dealers have resorted to generating fake purchase invoices (of other activities) to create a pool of input credit of GST which they use to pay the output GST of 18 percent on steel scrap. This was resulting in a loss to the government. Hence, they have initiated investigations against various dealers and are also asking the steel producers who have purchased scrap from such dealers to reverse the input credit so availed by them. This is resulting in a blockage of working capital for producers who had paid the tax but were not able to avail of the ITC.
The industry has made several representations to the government to instruct GST authorities to desist from taking adverse actions against them as they had genuinely paid the GST to the supplier but were not in a position to check the problem of fake invoicing by suppliers. The empowered GST Council is seized of the matter and might deliberate on the issue at its next meeting.
Options Before The GST Council
- Reduce GST on scrap to 5 percent: One option is to reduce the GST rate on steel scrap from 18 percent to 5 percent. Lowering the tax rate will substantially reduce the cash flow burden from the supply chain and discourage the generation of fake input invoicing. However, the problem of fake invoices may not be completely addressed because unregistered dealers will sell scrap without GST and some dealers may continue to indulge in malpractice to avoid paying the lower 5 lower GST on the outward supplies.
- Distinct Harmonised System of Nomenclature codes for old and new scrap: The GST Council could consider creating two different categories of scrap - old scrap and new scrap - and provide different GST rates for each category. Since old scrap was already subject to GST at the time of sale of the original product and was coming from the unorganised sector, a nominal GST rate of 1 percent can be levied. This will bring the supply chain under tax net and e-compliance can be used to track transactions effectively. The GST rate for new scrap can be reduced to 5 percent. The reduced gap between the input and output liabilities will discourage fake invoicing.
- Introduce reverse charge mechanism: Another effective way to handle the problem could be to exempt the entire supply chain of steel scrap from the levy of GST and make the steel-producing industry ultimately buys the scrap for consumption liable to pay GST at the applicable rates under the reverse charge mechanism. Such reverse charge mechanism is applicable on the real estate industry where promoters pay the tax on purchases of cement from unregistered persons. This option has the ability to effectively end tax leakage from the entire supply chain.
The reverse charge mechanism will need to be accompanied by a lower GST rate to reduce the burden of cash outflow for steel producers. Thus the GST council can provide effective relief to the industry by adopting a two-pronged approach - reduce the GST rate on steel scrap to a lower rate of 1 percent or 5 percent which will be discharged by the steel producers under the reverse charge mechanism.
Conclusion
To help the iron and steel industry to grow, it is imperative for the GST Council to take a decision to allow steel manufacturers to pay the tax under the reverse charge mechanism on purchases of scrap from unregistered dealers under Section 9(4) of the CGST law. Several categories of supplies such as services provided by law firms/lawyers, goods transport agencies and sponsorship services are already taxed under the reverse charge mechanism. By making manufacturers of iron and steel accountable for GST, tax collection will be streamlined. The government will not suffer any loss of revenue by not requiring scrap dealers to pay GST. This is a reasonable and effective solution for both the industry and the government as metal scrap has no other alternative use.
Jatin Arora is Partner, Phoenix Legal. Views are personal and do not represent the stand of this publication.
