The recent investigations by the Central Goods and Services Tax (CGST) officials into over 20 textile units across India, over misclassification of processing activities, highlight a critical challenge within the GST regime. At the heart of the problem is the distinction between ‘job work services’ (5 per cent GST) and transformative processes (18 per cent GST), and it reveals deeper complexities in interpreting and implementing GST within the textile sector.

Ambiguity and interpretation

The crux of the problem lies in the subjective interpretation of "change in the cloth's nature." While washing and dyeing are generally classified as job work (5 per cent), processes like printing, bleaching, and other treatments that "change its main qualities" attract an 18 per cent tax. However, the line between these categories is often blurred, leading to disputes and potential revenue leakage.

Industry concerns

Lack of clarity in definitions: The definitions of "job work" and "transformative processes" lack precise, quantifiable parameters. This ambiguity allows subjective interpretations, leading to inconsistencies in tax application. For example, the degree to which a dyeing process "changes the main qualities" of a fabric can be debated. Is a subtle color change a transformative process, or is it merely job work?

Compliance burden: The textile industry, particularly small and medium enterprises (SMEs), faces a significant compliance burden in accurately classifying their activities. The need to meticulously document each process and justify its classification adds to operational costs and administrative complexities.

Revenue implications: The CGST officials' estimate of "hundreds of crores" in potential revenue loss underscores the significant financial impact of misclassification. This shortfall affects government revenue and potentially distorts market competition, as businesses misclassifying their activities gain an unfair advantage.

Impact on SMEs: SMEs, which constitute a significant portion of the textile industry, are particularly vulnerable to the complexities of GST compliance. They may lack the resources and expertise to navigate the intricate tax regulations, increasing their risk of non-compliance.

Frequent changes in tax rates: The fact that the 45th GST council meeting discussed increasing tax rates on dyeing and printing, creates uncertainty within the industry. This type of fluctuating discussion creates problems for businesses trying to plan for the future.

Potential impact

It is difficult to find the exact quantity of tax evasion that is currently under investigation, due to these cases being in progress. However, there are numerous reports on the effects of GST on the textile industry.

For example, a report by the Confederation of Indian Textile Industry (CITI) highlights the challenges faced by SMEs in complying with GST regulations, particularly concerning job work and input tax credit. Similarly, a Textile Ministry report from 2022 shows that 80 per cent of textile units in India are classified as SMEs. Meaning that they have a very high likely hood of making accidental mistakes with the complexities of these laws.

So a textile unit specializing in organic dyeing can claim its processes are "job work" because they don't fundamentally alter the fabric's structure. However, CGST officials, argue that the specialized dyeing significantly enhances the fabric's value and marketability, thus classifying it as a transformative process. Similarly, a company that uses advanced patterning machine to create textures on a fabric labels the activity as job work because they are not adding any color. The CGST officials, however, say the processes change the fundamental qualities of the fabric, and label it as printing, or a similar taxable event.

Tax expert sa, the ambiguity in GST classification is a major concern for the textile industry. There needs to be clearer definitions and guidelines to ensure fair and consistent tax application. A lot of problems arise from differing interpretations of the term ‘job work’. The government needs to either make the definitions of job work, and process work, much clearer, or simplify the tax rates.

What needs to be done…

1.     Clarification of definitions: The government should issue detailed guidelines and clarifications on the definitions of "job work services" and "transformative processes," providing concrete examples and parameters.

2.     Simplified tax structure: Consider simplifying the tax structure for the textile industry to reduce the potential for misclassification and disputes.

3.     Capacity building: Conduct workshops and training programs to educate textile businesses, especially SMEs, on GST compliance and accurate classification.

4.     Technology integration: Explore the use of technology, such as AI-powered classification tools, to assist businesses in accurately categorizing their activities.

5.     Industry consultation: Engage in regular consultations with industry stakeholders to address their concerns and gather feedback on GST implementation.

Thus the CGST investigations highlight the need for a comprehensive review of the GST framework for the textile industry. By addressing the issues of ambiguity, compliance burden, and revenue leakage, the government can create a more transparent and efficient tax regime that fosters the growth and competitiveness of this vital sector.