How and why of duty drawback frauds

D. Sampathkumar

THE fiscal incentive structure for promoting exports is in a total mess.

Every now and then there are newspaper reports of the Central Bureau of Investigation (CBI) registering a complaint of fraudulent claim of export incentives. Occasionally, the agency even launches criminal proceedings. But if the agency has had any success in obtaining conviction, it must be one of the best kept secrets in the country.

A recent news report has it that the CBI has recently filed a charge-sheet against Delhi-based businessmen and their accomplices and even obtained a non-bailable warrant against one of them who is continuing to evade arrest. The size of the scam has been placed by the CBI at Rs 43 crore and it involves the bogus export of bicycle parts.

It is really one of those inexplicable things. The country does not have a competitive bicycle industry for the export market. The Chennai-based Tube Investments recently closed down a unit catering to the export market for want of orders. But strangely, we seem to have a very vibrant export industry in bicycle components if the duty drawback claims for export of such components are anything to go by.

Management pundits talk of how, when the parts are brought together, the whole could become greater than their sum. In this case, there appears to be greater synergy when the parts stay as parts, and not brought together as a whole bicycle. But, of course, that is absurd. The fact of the matter is that we do not really have a competitive edge in bicycle parts that could be described as greater than what exists in the bicycle as a whole. The export is a fiction created merely to take advantage of the skewed external environment.

If the scam involving bicycle parts had been an isolated example, nothing more need have been said. But that is hardly the case. The latest scam is merely one of a series of such fraudulent claims under the country's export incentive schemes. A similar fraudulent claim surfaced earlier involving, ostensibly, consignments of readymade garments.

It turned out that what was being exported was nothing more than cotton waste and rag clothes to be thrown away at the destination point. Prior to that, a controversy broke out over export of ball-point pens at inflated prices. But any resemblance these consignments had to ball-point pens was only slight, if at all. What is it about these goods that seem to attract scamsters like flies to the honey-pot? Answering that question would require an understanding of the concept of duty drawback on exports.

Duty drawback is the process by which an exporter claims back from the Central Government, what he has paid by way of Excise and Customs duty on the inputs consumed in the goods exported. Instead of assessing the actual levies suffered by individual consignments, a standard refund is fixed on a normative basis, depending on the nature of goods exported.

The rates vary as the incidence of Excise and Customs levies on inputs differ from item to item. These are fixed either as a percentage of the value of goods exported or as a specific value for every unit of the commodity being exported. In the export of raw materials and intermediate goods of a standard nature, drawback rates are usually fixed in terms of a value for every unit (quantity) of goods exported. Steel is a classic example.

Here, the rates are fixed as so many rupees for every tonne exported. From the point of view of bogus claims, this poses a problem. The exporter has to declare a higher tonnage of exports to claim a higher sum as duty drawback. That means consignment documents have to reflect this higher tonnage. A higher freight charge implicit in the higher volumes would, however, erode the profit element inherent in a fraudulent drawback claim.

But 'drawback' rates fixed as a percentage of the f.o.b value of exports are particularly useful for raising bogus claims. For, the higher the declared f.o.b value of consignments, the higher the entitlement of duty drawback with none of the offsetting costs by way of higher freight charges as in the case of high-volume, quantity-based drawback entitlements.

When the item in question additionally enjoys a higher percentage of f.o.b value as a duty drawback, the opportunity for windfall gains from a unit increase in f.o.b. value is all the greater. For instance, if a ball-point pen is exported, the government assumes a duty incidence on inputs which is estimated to work out to 19 per cent of f.o.b value. Bicycle parts are even more attractive, at 22 per cent for saddle and 23 per cent for handle lever. A 13-hole spanner for bicycles is not too bad either, with the export of such items fetching a drawback rate of 18 per cent.

Readymade garments, too, enjoy a 16 per cent advantage on duty drawback claims. Contrast this with the export of steel sheets. A typical consignment of steel might fetch a few hundred rupees in a duty drawback claim. An exporter seeking to inflate his drawback claim on steel exports would have to contend with the huge quantity of such exports.

Even if he packs the consignment with bricks and gets an accommodating Customs appraiser to look the other way, he cannot avoid paying freight charges, which should eat into his profits. The small volume and relatively high-value exports, especially those entitled to a high duty drawback rate such as bicycle parts, are just tailor-made for a duty drawback scam.

The exporter would still have to bring in foreign exchange against the inflated value and, often, fictitious exports without which the drawback claim cannot be sustained. Official channels of remittance from India to the overseas account of the supplier, so that he, in turn, can remit it back as export proceeds, are ruled out. Though the exchange control regime has been liberalised considerably in recent years, it is not so lax that anybody can walk into a branch of a commercial bank and deposit rupee funds for remittance abroad in foreign exchange. But that should not pose a problem for the exporter who is intent on dipping into the incentive till.

The illegal, or 'hawala', channel has a long history of operation in the country. For a small premium payable in local currency, foreign exchange can always be arranged. Ironically enough, liberalisation of the foreign exchange regime means that people no longer look to the illegal channel for meeting their legitimate needs of foreign exchange.

From expenses on medical treatment abroad to holiday travel, entitlements have considerably been liberalised. Hence, a huge potential source of demand for 'hawala' money had disappeared. The result? A dramatic drop in the premium for foreign exchange in the black market. Market gossip has it that such a premium to the official exchange rate is, in recent years, down to as low as five per cent of the foreign exchange purchased.

The moral of the story is this: Wherever the duty drawback rate, as a percentage of the f.o.b. value, is higher than the going 'hawala' rate for foreign exchange, there is an opportunity simply waiting to be exploited by a cabal of unscrupulous businessmen and conniving Customs officials. We will continue to witness a huge growth in bicycle part exports even as the Chinese beat the pants off our domestic bicycle producers in the overseas markets.