The cost of making fertilisers available to farmers by itself is substantially higher than the price the Govt wants them to pay, ideally, it should not levy any tax
In its report laid in Parliament on August 9, 2023, the Standing Committee on Chemicals and Fertilizers has recommended that the Union Government should propose to the GST Council to reduce tax rates on fertilizers from the current 5 per cent. Initially, fertilizers were placed under the 12 per cent slab. However, following representation made by various states, the tax rate was reduced to 5 per cent. Now, the Committee wants this to be reduced further.
It has also asked the Government to “consider favourably the proposal to lower GST on raw materials in the interest of fertilizer manufacturing companies and ultimately farmers”. Currently, raw materials (RMs) such as sulphuric acid and ammonia used in the production of fertilizers, attract GST at a much higher rate of 18 per cent against 5 per cent levied on fertilizers (albeit finished product).
The issue of further reducing GST on fertilisers was placed before the GST council in its 45th and 47th meetings in September 2021/June 2022, but it didn’t recommend any reduction. Whether or not the GST Council will accede to the recommendation of the Standing Committee now, one can only wait and watch. Meanwhile, it is important to highlight three major flaws in the taxation of fertilizers.
First, given the critical role of fertilizers in ensuring food security, 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 just about one-tenth of the cost whereas, in the case of non-urea fertilizers, the price is nearly one-third.
When, an overwhelming share of the cost (9/10th in the case of urea and 2/3rd in the case of non-urea fertilizers) is borne by the Government – using taxpayers’ money – just to make fertilizers affordable to the farmers, it makes no sense to levy tax on those very products namely fertilizers and RMs used in their production. The taxes have the effect of increasing the cost of supplying fertilizers which has 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. There is no justification whatsoever for levying any tax on fertilizers or RMs used for making them.
The second flaw has to do with taxing two major components of the fertilizer supply chain under two different regimes; one under GST and the other under the pre-GST regime. All finished fertilizers such as urea, dia-ammonium phosphate (DAP), muriate-of-potash (MOP) and so on are taxed under GST currently attracting a tax rate of 5 per cent. Most of the RMs used in the production of fertilizers are also covered under GST attracting a tax rate of 18 per cent on sulphuric acid and ammonia and 12 per cent on phosphoric acid.
However, natural gas (NG) which is used for the manufacture of all domestic urea (small quantities are used for making ammonia which in turn, is used for making non-urea fertilizers) is taxed under the pre-GST dispensation. Taxation of electricity, a utility intrinsic to the process of manufacturing fertilizers is also outside GST. This results in a much higher cost of these two major inputs than the cost if they were to be brought under GST.
At present, NG attracts ‘nil’ central excise duty (CED) on supplies to fertilizer plants and value-added tax (VAT) varying from a high of 24.5 per cent in Andhra Pradesh (AP) to a low of 5 per cent in Rajasthan. Then, there are other local taxes; for instance, the Gujarat government collects the “purchase tax” on that portion of inputs consumed for making urea that is sold outside the State. This leads to a cascading effect on the price of NG in three ways.
First, being outside GST, gas companies viz. Oil and Natural Gas Corporation (ONGC), Oil India Limited (OIL) and so on, can’t claim credit for the taxes paid on their purchase of inputs, consumables and equipment leading to higher prices. Second, the delivered price at the factory gate increases due to the levy of VAT, the impact being the highest in AP where the tax rate is 24.5 per cent. Third, the price further increases due to local levies.
Electricity too is outside GST. Further, its generation and distribution are exempt from the levy of Central VAT (CENVAT) and VAT. This results in a situation whereby power companies don’t get any credit for taxes paid on inputs viz. equipment, stores and so on, used in its generation and distribution. This results in a higher cost of electricity.
Further, under the Constitution, entry 53 in the State list of the Seventh Schedule empowers States to impose a 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, electricity companies don’t get any offset. This further exacerbates the cost of power supplied to fertilizer plants.
To put it briefly, whereas, taxation of finished fertilizer products and some inputs/RMs used in their making under GST is intended to lower the cost of making fertilizers available to farmers, taxing other major inputs viz. NG and power under the pre-GST regime militates against this objective.
The third flaw has to do with high taxes paid on inputs used in the manufacture of fertilizers as against the tax liability on the output (read: finished fertilisers) being much lower. This isn’t just because of the much lower GST rate but also due to lower MRP. For instance, in the case of urea apart from a tax rate of 5 per cent, the MRP is a mere 1/10th of the cost of supply. This results in an ‘unabsorbed’ input tax credit (ITC) as the output tax falls far short of input tax and there is no provision in the law whereby manufacturers can claim it. Hence, the Centre has to compensate fertiliser manufacturers for unabsorbed ITC using its fertiliser subsidy budget.
To conclude, considering that the cost of making fertilisers 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/RMs should be in the lowest tax slab of 5 per cent.
While the tax rate on fertilisers is already 5 per cent (the Committee’s recommendation to lower it further to say 1 per cent or 2 per cent would unnecessarily complicate an already unwieldy GST regime with multiple slabs), this will require lowering the tax rate on ammonia, sulphuric acid and phosphoric acid from their current high of 18 per cent/12 per cent to 5 per cent. The same rate should apply to NG and power after bringing them under GST.
As for the third flaw, the recommendation of the Committee to keep the tax rate on RMs lower than on fertilizers alone won’t help. This is because the artificially low MRP has no linkage with the cost that results in low output tax liability vis-à-vis the value of tax paid on inputs in turn, resulting in unabsorbed ITC. To address this, the government should give subsidies directly to the farmers under the direct benefit transfer (DBT) mechanism and let manufacturers charge full cost–based or market-determined prices from the farmers.
(The writer is a policy analyst; views expressed are personal)
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