Value Addition
World over it is defined as
(The FOB value of exports – The CIF value of imports) / (CIF Value of Imports)
The theory is called (A-B)*100%/(B) = 33%. Here, A = 133 (value of goods exported after value addition), B=100 (value of goods imported)
This theory exists in developing countries like India, Brazil, Russia, China (BRIC countries) and not in trading countries like Dubai, Singapore. Hence, in a trading nation, the % value addition can be just 4% - 5% as against 33% (Exception – Only goods with very high value like Gold, Diamond; hence, value addition can’t be very high).
If value addition is = or more than 33%, the import of raw material is DUTY FREE. Hence, cost of raw material is cheap, so, cost of finished goods is cheap; hence, selling price of finished good is cheap and more buyers from world over will buy the goods.
Theory says, I will allow one to import provided the raw material imported is used in the exportable product. Government says – it will give incentives only on FOB value of exports and not on CIF (which includes insurance and freight, calculated at actual); if Government gives on CIF, it will give more incentive (as CIF > FOB). Also, govt gives incentives on value addition. Since, there is no value addition by the exporter on insurance and freight, why Govt should give incentive on it (i.e. CIF price).
But when something is imported, the incentives are calculated on CIF price and not FOB price.
Advance License - One gets this license from a government body. In India, one gets it from DGFT (Director General of Foreign Trade). This license allow one to import raw material duty free in India provided the material is used to add value (33% or more) in the exportable product (It is a pre-shipment incentive – Exporter already has the export order with him, hence, he is importing). In case, the raw material is received duty free and then the order gets cancelled, then one has to pay duty to Government.
Corollary 1 – People import the raw material, sells into local market, buys a substandard replacement raw material and use it in exportable goods and can easily get away.
Corollary 2 - If someone buys raw material from India, all the local taxes like excise (Central Tax), Vat (State Tax), Octroi (Municipal / City tax) on raw material will be refunded if the finished good made out of this raw material is exported.
Corollary3 – In case, I am a trader (buy goods and export) and exports goods outside the country, will my support manufacturer who imports raw materials for making that good can get AL - Here, the trader can apply for advance license. But here, trader has not paid duty. The manufacturer can only apply for AL, if the name of manufacturer appears in a document called shipping bill. (The shipping bill is filed with every export and similarly, bill of entry is filed with every import). For that, the manufacturer’s name is mentioned as support manufacturer (gets recognition by the government), else he won’t get the AL. Hence, trader has to import the goods on his name to get AL so that overall cost of export is under control. Hence, AL can’t be sold or transferred to anyone else (unlike DEPB).
Duty Drawback –
Scenario – Assume, I receive a local order from A for 5 shirts (every shirt uses 5 buttons). But A wants buttons from Bangkok. So, I import 100 buttons and pay the duty. I can’t claim advance license as the processed / final product – shirt is to be sold locally. I use 5*5 = 25 button for 5 shirts and is left with 75 buttons. I receive a similar order from a foreign client B for 15 shirts. I use the remaining 75 buttons and export. But I have already paid the duty on buttons, but now I am earning foreign exchange for the nation for those 75 buttons. How can I claim it? (The foreign client will not want to pay a higher price for the shirt because of the duty I paid on raw material).
Here, Government says we will give you the duty back called as duty drawback. It is given by the drawback section of Ministry of commerce via cheque after the exporter shows proof of exports (invoice with custom’s stamping, bill of lading, calculation of refund of duty amount showing how much buttons I imported and how much shirts I exported with those buttons). Government will not pay interest on the credited duty (via cheque) though it might take 3-4 months after duty is paid. Also, the amount will come to another account (and not current / working capital account of company) called drawback account. Instead of above process, Govt says they will come with a drawback booklet published by ministry of commerce.
Corollary 1 – Government of India says - duty drawback amount for an exported pure cotton shirt will be 10% of FOB price of shirt. In case my value addition to shirt is high because I sell it as branded product at a much higher price, hence, my FOB price for the shirts will also be high. Hence, the duty drawback on exported shirt >>> Import duty I paid on buttons (raw material). The government incentives the local exporter (kickback to exporter) because he is earning far more foreign exchange for the country for the same set of goods, which was sold cheaper earlier to branded companies like GAP who would in turn sell it at 20 times the price of it. In China, it is as high as 60%. Hence, the exporter is in huge profit and can reduce the prices of its product sold in foreign market at lowest possible prices.
Duty drawback is paid in local currency. DD is given by many countries and not specific to India.
Hence, I am dumping / flooding the world market with my cheap exported goods – DUMPING. Hence, there is an anti-dumping clause attached to it. WTO wants to curb dumping because of Duty Drawback advantage because of local government. But for that, WTO needs to prove it, which they can’t, as the governments of nations never publish this.
Corollary 2 - But, China and Bangladesh finished goods cost are India’s raw material cost. Hence, I can’t compete on those simple products. I need to climb up the value chain and sell designer shirts which are branded as against simple shirts. For that, I may have to show my collection in Paris (branding and marketing). Hence, Government of India now subsidizes the marketing cost also by having a Marketing fund (ITPO – Indian trade promotion organization @ Pragati Maidan, New Delhi).
Corollary 3 – Even if I am buying buttons locally and paying local taxes and will export the shirts to foreign nation, Government will still incentivize the duty drawback as 10% of FOB price of shirt >>> price of buttons + local taxes. Here, even I am not importing the good, I get incentivized under duty drawback because I am earning foreign exchange for nation. But one can’t claim both, the import duty as well as local taxes.
DEPB (Duty entitlement passbook scheme)
Like DD, DEPB has rates fixed (like 10% of FOB of cotton shirts) and it has a handbook which describes the details. Example – 8% of gross FOB price of shirt; if agent’s commission is there, it will be 8% of net FOB.
I will get the credit in the form of a hand written book, but I can’t en-cash it. But one can use this credit for the following purpose –
I can offset the credit amount with the duty I / anyone else pays on import of goods. Here, I can import anything under the sun and can get the offset and the imported material where I get DEPB need not to be exported after value addition (except negative list of imports like weapons, drugs, animal skin, ivory tusk, peacock feathers, tiger skin, crocodile leather, fur).
In case the product is not listed in the DEPB booklet, one can write the self made DEPB rates to Government via the export council. Hence, many times, industry decides the rates of DEPB.
It has validity of 12 months. Also, 6 months extension is also possible.
Corollary 1 –
· Can one sell a DEPB credit (I have exported and have DEPB credit, and I do not have money to import, so the credit has not off-set) – YES, but too many DEPB credit floating, hence, the importer might give me INR 2 as against DEPB credit claim of INR 8.
· Can I sell AL credit – NO. Only Exporter of the support manufacturer can get it (if his name is mentioned in shipping bill.
Government gives either DEPB or AL or DD or refund of local taxes, and not all for the same set of goods. Also, the offsetting is done in INR (local currency) and not in $.
DEPB is pre-shipment incentive (as I will claim and nullify the import duty upfront rather than waiting for exports to happen made of imported goods). DD / AL are post-shipment incentives (I need to export 1st, then claim the refund).
DEPB rate is less than AL / DD as in AL, one has the restriction of export the finished goods made out of imports with a certain % of value addition.
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