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International Tax

Classification of Goods and Compliance Requirements in India International Trade

Thomson Reuters Tax & Accounting  

· 9 minute read

Thomson Reuters Tax & Accounting  

· 9 minute read

The Harmonized System (HS) is an international nomenclature of goods classification developed by the World Customs Organization in 1988. It has been adopted by more than 190 countries. The HS consists of 6-digit codes for all traded goods, which are used to satisfy customs requirements worldwide. In most cases, in order to import or export a product, it must be assigned an HS code that corresponds with the Harmonized Tariff Schedule of the country of import. Most countries have added additional digits to classify goods more specifically. A code with six digits is a universal standard (HS Code) and a code with 7-10 digits (HTS Code) is often unique after the 6th digit and determined by individual countries of import. These codes are important because they not only determine the tariff/duty rate of the traded product, but they also keep a record of international trade statistics that are used in most countries.

The Indian Trade Classification (Harmonized System) (ITC) (HS)[1] code has 8 digits (the first 6 digits are common as per WCO with an additional 2 digits for added specificity). There are two schedules to the ITC HS: Schedule 1 – Import tariff, and Schedule 2 – Export tariff.   Both tariffs are a key instrument for establishing the customs duty rate applicable to imported goods per the First Schedule. The Second Schedule incorporates items that are subject to export duties and the rates of duties thereon in the Indian Customs Tariff Act of 1975. Import permissibility in terms of Foreign Trade Policy, duties that can be levied on the goods, benefits like applicability of various duty exemption notifications, identification of applicable incentives for export goods, and determining a product’s eligibility under a trade agreement are also based on HS code classification. The classification of goods for import and export purposes has always been a challenge for corporations due to the very nature of the classification process and its interpretation between customs and corporations.

Classification is most critical when new products are introduced into a company’s trade environment because it requires in-depth understanding of the product description and use as well as knowledge of the classification system process. This is supported by a study that Thomson Reuters and KPMG conducted this year. It revealed that ambiguity in product descriptions and different classifications are the biggest challenges to performing product classification globallyGovernments scrutinize HS codes and product descriptions to detect fraudulent activities.

The Comptroller and Auditor General of India, an independent Supreme Audit Institution, mentioned in its report no.12 of 2014 that the Directorate of Revenue Intelligence of India had detected 298 duty evasion cases involving mis-declaration of goods to the tune of Rs.2392.26 Crore (USD 378 Million) in the financial year 2013.

A wrong or misleading product classification brings a lot of risk to a company and can substantially erode its profitability due to increased penalties and recovery. For example, chain and sprockets used in motorcycles could either be classified under ITC (HS) Code 73151100 as roller chain in the subheading of chain and parts thereof, or under ITC (HS) Code 84839000 in the subheading of toothed vehicles and chain sprockets. The former has a preferential duty rate of 0% under the Indo-ASEAN FTA and the latter has a preferential rate of 5%. However, as for automobiles, based on the end use, these classifications mentioned above are not applicable. The product should be classified under 87141090 under the subheading of parts and accessories of vehicles, which are not eligible for preferential rates under the India-ASEAN Free Trade Agreement. Such incorrect classification could lead to a finding of non-compliance, resulting in penalties and delays in shipment clearance.

If a company is found to have misclassified commodities for import and export, the local customs authority may flag the company as needing extra scrutiny. This will lengthen the product’s review process and delay the import and export process. If misclassification is found to be a continuing problem, the government may cancel the company’s Accredited Client Programme (ACP) status and in extreme cases may cancel its Importer Exporter Code (IEC). The person responsible for classification ultimately does not want to be the source of this type of action.

Challenges faced by Exporters and Importers for classifying products:

  1. Lack of available resources (e.g. technical information, classification data, literature, etc.)
  2. Not having dedicated a person/expert within the organization
  3. Inadequate description on invoice and supporting information

The risks for misclassification of goods (summaries below):

  1. Disqualification from Risk Management System (RMS) Clearance
  2. Over/underpaid customs duty
  3. Under-claimed duty drawback and other export incentives
  4. Eligibility for export, import and licensing requirements
  5. Missed Other Government Agencies (OGA) requirements

Disqualification from Risk Management System (RMS) Clearance: Exceptional growth and complexities in international trade and increasing burdensome global security requirements have put customs in a more challenging environment than ever before. The Risk Management System wing of Indian customs plays a very important role in the Import/Export clearance process to detect fraud and drive compliance. Product classification in a Bill of Entry/Shipping Bill is one of the key parameters among many for the risk management system to alert officials for additional inspection. Inspection of Import/Export consignment could result in additional cost, time and potential delay to the clearance for the Importer/Exporter.

Over/underpaid customs duty: Customs calculates duties based on the HS code of the product declared by the importer in the Bill of Entry (BOE).  An incorrect HS code could result in higher or lower duty based on the tariff rate. The product code selected might also have a higher rate of total customs duty because of Anti-dumping (ADD) or safeguard duty or both, depending upon the origin of the goods. If the importer realizes the HS code declared in the BOE is incorrect, an amendment to the BOE is required. That can be expensive and time-consuming.

Under-claimed duty drawback and other export incentives: Availability of duty drawback (DBK) is linked to HS codes, although one DBK code could be applicable to a similar set of HS codes. For example, menthol falls under 2 ITC (HS) codes. Code 29061100 represents menthol, which has DBK under the All Industry Rate (AIR) schedule of 1.4%, and Code 30039021 represents menthol crystals which have a 1.9% DBK. However, both codes have the same export benefit rate of 3.0% in the recently announced Merchandise Exports from India Scheme (MEIS).  If the exporter is exporting menthol crystals using the code 29061100, which has a 0.5% lower DBK (AIR) available, and if the shipment has a value of USD 150,000 FOB, the exporter could lose about USD 750 on this shipment. This is a very large amount when the exporter has a high value of shipments/turnover. If a company is exporting USD 150 million in value per year it can lose up to USD 750,000 annually.

Eligibility for export, import and licensing requirements: The Directorate General of Foreign Trade (DGFT) issues a Foreign Trade Policy every five years with a focus on the country’s interest. The policy prohibits some goods from export and import transactions, linked to their product classification or HS code. Importers/exporters should be well-informed before agreeing to any contract for export or import of such goods and comply with licensing requirements as prescribed in the policy.

Missed Other Government Agencies (OGA) requirements: OGAs play an important role in international trade controls. The HS code listed in the BOE and shipping bill is one of the criteria on which the customs officer marks the documents for additional requirements, such as a No Objection Certificate (NOC)[2]. NOC is required for pharmaceutical and cosmetic products. It is issued by the Assistant Drug Controller and classified under Chapter 30, which automatically qualifies a product for ADC-NOC (Additional Drug Controller). Some products may fall under Chapters 1-10, 29 and 33 and be subject to the OGA for a wildlife NOC. The exporter and importer should be aware of the NOC requirements to avoid delays in customs clearance and meet the regulatory requirements for declarations.

Summary: In today’s complex trade environment, product classification remains a major challenge for companies and regulatory authorities. As companies are continuously developing new products that serve more than one purpose/end use, product classification becomes more challenging for trade professionals and customs officers. Companies are looking at options to reduce costs by applying relevant exemptions under certain conditions, avail themselves of export benefits etc., and be compliant with the requirements. Customs agencies are continuously enhancing their systems with additional controls to avoid fraud and protect the nation’s interests. In both these conditions, having a good product classification approach plays a major role in avoiding conflicts.

Automation of product classification and other tools to keep trade professionals up-to date on regulatory changes could assist in driving compliance and cost benefits.

To learn more about import or export, visit our ONESOURCE Global Trade page

[1] ITC (HS) codes are better known as Indian Trade Clarification (ITC) and are based on Harmonized System (HS) of Coding. It was adopted in India for import-export operations. Indian custom uses an eight digit ITC (HS) code to suit the national trade requirements.  This schedule has two parts – First schedule with an eight digit nomenclature and the second schedule with description of goods chargeable to export duty. The first schedule is based on H.S code system. The Indian Tariff Code has 8 digit which has been designed in such a way without any modification of first 6 digit as per H.S code system, but followed by another two digit classified as ‘tariff item’. So ITC has been classified as first four-digit code called ‘heading’ and every six digit code called ‘subheading’ and 8-digit code called ‘Tariff Item’. This addition is done, within the permissible limit of World Customs Organization – WCO, without any changes in H.S. code system.

[2] A type of legal certificate issued by any agency, organization, and institute or in certain cases, an individual, which does not object to the covenants of the certificate.

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