Unveiling Indian Customs Law Framework for Effectuating Free Trade Agreements

FTAs are generally executed at a bilateral level between countries to provide preferential terms to trade in goods and services between such countries.

Free trade agreements (FTA) are the flavour of the times. Christened under different nomenclatures, such as, business trade agreements, comprehensive economic partnerships, etc. at the core, FTAs are generally executed at a bilateral level between countries to provide preferential terms to trade in goods and services between such countries. Hence, it is critical to appreciate the genesis, operational framework and nuances of FTAs.

This note makes an attempt to demystify the legal framework of FTAs in the Indian context, limited to the extent the FTAs address preferential tariffs to the trade in goods imported into India claiming the benefit of such FTAs.

Overview of multilateral setting envisaging FTAs

For decades, the rules governing the multilateral trading system under the General Agreement on Tariffs and Trade, 1947 and — since the enforcement of the World Trade Organization (WTO) framework — the General Agreement on Tariffs and Trade, 1994, have prescribed parity of trading rules amongst its member countries, principally under the most-favoured-nation (MFN) rule, which stipulates that any “advantage, favour, privilege or immunity granted by any contracting party to any product originating in or destined for any other country shall be accorded immediately and unconditionally to the like product originating in or destined for the territories of all other contracting parties”.¹

In view of the MFN rules and considering the wide-ranging membership of the WTO (which virtually subsumes the entire international trading system), the Customs duties regime of a country applies across-the-board in similar setting to all other nations. An exception has been carved to the MFN regime by recognising “Customs Union and free trade areas” for permitting flexibility to member countries to prioritise economic relationships with select countries, i.e. “increasing freedom of trade by the development, through voluntary agreements, of closer integration between the economies of the countries parties”.² Thus, special trading rules are permitting between countries comprising of “Customs Union”, such as in the case of the “European Union” and FTAs.³ It is on this account that preferential tariffs for goods are permitted for specific (i.e., FTA partner) countries which otherwise would be considered violative of the MFN rule and thus be actionable.

Envisioning FTAs in India’s domestic law framework

While the form and range of commitments offered by countries under the FTAs may differ, in substance they are similar to any other international treaty. Hence, similar to the practice in the international law setting, the negotiation and execution of the FTAs is undertaken at the executive levels, i.e. between the governments of the countries seeking to formulate the FTA. Thereafter, the constitutional scheme determines the coming into force of the FTA commitments in the partner country. Under the Constitution of India, a domestic law legislation is required for enforcement of an international treaty.⁴ Thus, for enforcement of a FTA in India, the domestic law framework becomes critical.

Since the FTAs predominantly address international trade and import and export of goods, in the context of FTA, the legislative field concerned is vested in the Union Parliament, which is empowered to enact laws levying “duties of Customs including export duties”⁵ besides the overarching exclusivity it enjoys over “foreign affairs; all matters which bring the Union into relationship with any foreign country”.⁶ As a legal consequences, 1) tariffs, which is another moniker for Customs duties, and are the subject-matter of FTAs, are regulated through the Customs law framework in India; and 2) Government of India is vested with the exclusive authority to negotiate and executive FTAs with other countries.⁷ This permits a unitary national regime unlike certain other fiscal subjects which are within the remit of the States (such as entertainment taxes, land taxes, etc.) and thus have different rules in different parts of the country.

In order to appreciate the dynamics of the domestic law setting qua tariffs on goods, one needs to appraise the two legislations which principally comprise the Indian Customs law framework: 1) the Customs Act, 1962; and 2) the Customs Tariff Act, 1975. The former legislation sets out the Customs law framework, enforcement machinery, procedural stipulations, etc. whereas the latter legislation sets out the tariff schedule for both import⁸ and export⁹, including rules governing classification of commodities, while also providing for trade-remedies, such as anti-dumping¹⁰, safeguards¹¹, etc.

Appreciating scheme of Customs law qua FTA implementation

The scope for domestic implementation of FTAs is legislatively provided for by Section 5, Customs Tariff Act, 1975, which envisages “levy of a lower rate of duty under a trade agreement”. This provision permits the Government of India to notify specific provisions to implement a lower rate commitment made by it under an FTA.¹² The scheme underlying this umbrella provision — which permits the Government of India to notify an FTA without Parliament having to enact a specific statute for each FTA — has already been judicially approved in context of a similar legislative scheme under the income tax law.¹³ Thus, the Government of India retains extensive flexibility qua the scope, effective date, operational rules, etc. in relation an FTA executed by it with another country.

As a matter of convention, Government of India notifies two distinct set of regulations towards effectuating an FTA; one to notify the preferential tariff rates agreed with the FTA partner, and, second, to notify the rules which need to be complied in order for an eligible entity to claim such preferential tariff rates. This aspect is best understood via an illustration. In the year 2010, a Comprehensive Economic Partnership Agreement (CEPA) was executed between Government of India and Government of Japan.¹⁴ Article 19 CEPA provided for “elimination of duties” wherein inter alia Government of India agreed for preferential tariffs to goods originating from Japan. The covered goods and preferential tariff schedule were also enlisted within CEPA itself, as Annexure 1 thereof. Exercising its powers under Section 5, Customs Tariff Act, 1975, Government of India notified the preferential tariffs — distinctively applicable to goods originating from Japan — thereby enacting the tariff commitments under CEPA as part of domestic law.¹⁵ Subsequently, Government of India notified the extensive rules and procedural modalities (towards implementing its commitments under the CEPA) in the form of the “Customs Tariff (Determination of Origin of Goods under the Comprehensive Economic Partnership Agreement between the Republic of India and Japan) Rules, 2011”.¹⁶ These rules include exposition of the country of origin (COO) certificate, which is identified in CEPA itself as the base document for an eligible entity to avail the benefit of CEPA. Thus, the bilateral FTA, namely, CEPA is effectuated as part of the Indian Customs law framework through detailed sets of regulations framed by the Government of India.

The notification of FTA so as to enact it as part of domestic law is crucial because then alone it creates rights to eligible entities within the Indian legal system; in the absence of its domestic law enforcement no rights arise only because of the FTA’s execution.¹⁷ Thus, by way of notification under the Customs law framework, FTA which represents a bilateral international treaty, gains the status of enforceable rules under the domestic law in India.

Positioning “country of origin” certificates

The discussion on FTA under the Indian framework will not be complete without reference to procedural modalities for claiming FTA benefit. This requires a deeper appreciation of the COO mechanism and its larger context. The foundational premise of the FTA is that goods originating in the partner countries should be eligible to concessional tariff rates vis-à-vis the generally applicable tariffs. Towards enforcing this pivot and towards simultaneously ensuring against third-country goods wrongfully gaining access to the FTA, the FTAs generally stipulate two distinct set of rules.

1. The first set of rules institute the “value addition” norms, i.e. the minimum value addition that must be achieved in one FTA partner country in order to be eligible for preferential tariff in the other FTA party country. To illustrate, the CEPA distinguishes between “Wholly Obtained or Produced Goods” (Article 28) versus “Goods Produced Using Non-Originating Materials” (Article 29) to prescribe the tests (which are further supplemented by a formula for “calculation of qualifying value content”) which must be satisfied before the goods can be considered as eligible to claim benefit of CEPA. These tests are further supplemented by various other eligibility criteria, such as, “De Minimis” requirements (Article 32), negative list of “Non-Qualifying Operations” (Article 33), etc. which are stipulated in CEPA itself.

2. In order to ensure that the eligibility criteria are satisfied by every consignment of goods on which CEPA benefit is claimed, the second set of rules, which are also set out in CEPA itself, provide for “Operational Certification Procedures” (Article 40). Documenting the bilateral understanding on how CEPA benefits shall be pragmatically executed, CEPA itself sets out the detailed Operational Certification Procedures (Annexure 3) which provide for the issuance of certificate of origin” certificates (Section 3), period of their validity (Section 4), etc. Thus, CEPA, similar to other FTA, forms a complete code of substantive stipulates and procedural modalities qua preferential tariff for goods.

At the ground level, the COO certificates are of extreme relevance as these form the primary basis for claiming the FTA benefit. Hence, in order to ensure the propriety of certification, the COO certificates are issued by competent governmental authority of the exporting country. The procedure to be adopted by such authority, checks and safeguards to be observed by such authority, etc. form part of the FTA itself, which inter alia include provisions for verification, including visit by the competent governmental authority of the importing country, etc. to confirm the veracity of the COO certificates.

Given the elaborate scheme under the FTA for inbuilt safeguards, which is also replicated in the Government of India Notification effectuating the FTA, traditionally COO certificates have carried higher probative value and importers were allowed FTA benefit basis the COO subject to routine inquiries. However, to further empower the Customs officers to intercept fraudulent claims, the Customs Act, 1962 was amended in 2020 thereby setting out a distinct scheme for addressing FTA claims¹⁸ by stipulating the “procedure regarding claim of preferential rate of duty” to be observed qua FTA claims. The new statutory scheme stipulates that furnishing of COO issued by competent governmental authority of the exporting country “shall not absolve the importer of the responsibility to exercise reasonable care”.¹⁹ Furthermore, making a departure from the scheme under the FTAs — wherein the competent governmental authority of the importing country is exclusively responsible for confirming the veracity of the COO certificates — the new statutory mechanism simultaneously obliges the importer to furnish required information to substantiate the FTA claim. The consequences enjoined upon the failure to observe the procedure are also specifically entailed,²⁰ which may extend to disallowing FTA benefit “to the imports of identical goods from the same producer or exporter”.²¹

The new statutory scheme is enforced through detailed regulations²² which are further supplemented by executive directions.²³ The power of the Indian Customs Authorities to satisfy themselves of the correctness of the FTA claim,²⁴ and the obligation of the importer to submit the required information²⁵ has been judicially approved. Thus, under the incumbent regime further checks and balances have been installed to guard against abuse of FTA benefits.

Conclusion

With increasingly new FTAs being executed by the Government of India, while the overarching Customs framework remains unchanged, distinct tariff regimes have come into vogue in India which set out distinct tax-incidence consequences depending upon the country of origin of the goods and the ability of the eligible entities to claim the FTA benefits. The importers of such goods have the option to claim the FTA benefits or forgo them; however, in the event the benefits are claimed, under the extant regulations, it is incumbent upon them to demonstrate satisfaction both the substantive terms and procedural compliances set out in the FTA terms as also the Customs regulations.