[India] Decoding Indirect Tax in India - Part II: Customs Duty FAQs and Insights

Tracy Zheng & Ditipriya Dutta Chowdhury

Background

As discussed in Part I of this newsletter, the introduction of the Goods and Services Tax (“GST”) transformed India’s domestic indirect tax framework by consolidating multiple central and state levies into a unified system. However, the movement of goods across India’s borders continues to be governed by a distinct customs framework.

Customs duty is a key component of India’s indirect tax regime. Beyond revenue generation, it serves as an important tool of trade and industrial policy by influencing import competitiveness, promoting exports, supporting domestic manufacturing, and protecting strategic industries.

This edition, forming Part II of our indirect tax newsletter, examines the legal framework governing customs in India, the various duties applicable to cross-border trade, available incentive schemes, major compliance risks, and the consequences of non-compliance with the customs framework. Through these FAQs and insights, it aims to provide a practical overview of the key considerations relevant to businesses engaged in cross-border trade.

What is customs duty, and what is the legal and procedural framework governing it in India?

Customs duty is an indirect tax imposed on goods that enter India, and in a few situations, goods that leave India. As mentioned above, it is not only a significant source of revenue for the government, but it also acts as an economic and regulatory tool that shapes India’s engagement with global trade. By modifying duty rates, tariff structures and exemptions, the government can regulate the volume and composition of imports, protect domestic industries, promote strategic sectors, maintain fair competition, respond to international commitments, and ensure that goods moving across borders meet quality and security standards.

India’s customs framework is grounded in a set of legal instruments that work together to ensure uniformity and predictability in customs administration, determining how every import is classified, valued, and assessed. These include:

• The Customs Act, 1962: This is the principal legislation governing all procedural and administrative aspects of import and export operations in India, such as clearance, warehousing, audits, and penalties.

• The Customs Tariff Act, 1975 (“CT Act”): Its schedules prescribe the rates of customs duty, by adopting the internationally recognised Harmonised System of Nomenclature (“HSN”) to ensure consistent classification of goods.

• The Customs Valuation (Determination of Value of Imported Goods) Rules, 2007 (“Valuation Rules”): These lay down principles for determining the value of imported goods.

What are the different types of customs duties levied in India?

India's customs regime comprises various duties that serve fiscal, regulatory, and trade objectives. The major customs duties applicable in India are:

1. Basic Customs Duty ("BCD"): BCD is the main duty levied on most imports entering India. It is charged according to the HSN classification assigned to each product. The rate of BCD varies depending on the nature of the goods, the government's policy priorities, and international tariff commitments.

2. Social Welfare Surcharge ("SWS"): SWS is collected as a percentage of the BCD amount. It is not calculated on the assessable value of the goods, but only on the BCD payable. The purpose of SWS is to generate dedicated revenue for social welfare schemes administered by the government.

3. Integrated GST ("IGST"): IGST is imposed on imported goods in the same manner as GST on goods supplied within India. It is calculated on the value of the goods plus BCD and applicable cesses. IGST is fully creditable for GST registered businesses, which can claim ITC and set it off against their output tax liability.

4. GST Compensation Cess: It is applied on a select list of goods such as tobacco, coal, and luxury cars. When such goods are imported, the cess is levied in addition to IGST.

5. Safeguard Duty: Safeguard duty is a short-term trade remedy imposed when imports of a product increase unexpectedly and cause or threaten to cause serious injury to the domestic industry. The duty provides temporary relief to local manufacturers and allows them time to adjust to changing market conditions.

6. Anti-dumping Duty: Anti-dumping duty is imposed when goods are imported at prices lower than their normal value in the exporting country. Such pricing practices can distort competition and harm domestic producers. The duty neutralises the unfair advantage gained by foreign exporters and restores fair market conditions.

7. Export Duties: Although exports are normally zero rated under the Indian customs regime, certain items such as iron ore and specific agricultural products attract export duties. The purpose is to prevent excessive outflow of critical raw materials and maintain domestic availability.

What are the incentive schemes that can be availed under the Indian customs framework?

India's customs framework has evolved into a multi-layered incentive regime designed to promote exports, strengthen domestic manufacturing, and improve global competitiveness. Rather than operating as isolated benefits, these schemes function across different stages of the value chain, ranging from input procurement and capital investment to production, export, and post-export tax recovery. When strategically combined, they can significantly reduce landed costs, optimise working capital, and enhance overall profitability. The principal incentive schemes available under the Indian customs framework are as follows:

1. Advance Authorisation Scheme: This permits duty-free import of inputs that are physically incorporated into export products, including raw materials, components, fuel, and packaging. It provides exemption from BCD, IGST, anti-dumping duty, safeguard duty, and GST compensation cess, subject to fulfilment of a prescribed export obligation and a minimum value addition requirement, typically around 15%. The scheme is particularly beneficial for import-dependent sectors, as it directly reduces input costs and improves export competitiveness.

2. Export Promotion Capital Goods Scheme: This scheme enables zero-duty import of capital goods, machinery, and related spares required for manufacturing export goods. In return, the importer must fulfil an export obligation equivalent to 6 times the duty saved, within a period of 6 years. This scheme facilitates capacity expansion and technological upgradation, especially in capital-intensive industries such as electronics, renewable energy, and advanced manufacturing.

3. Manufacturing and Other Operations in a Customs Bonded Warehouse ("MOOWR"): The MOOWR framework allows manufacturers to import inputs and capital goods into a bonded warehouse without upfront payment of customs duties. A bonded warehouse is a licensed facility where imported goods can be stored under customs control without immediate payment of duties. Duties are deferred indefinitely and become payable only when goods are cleared for domestic consumption, while exports result in duty waiver. The scheme enhances liquidity, enables just-in-time production, and allows operational flexibility without any mandatory export obligation.

4. Remission of Duties and Taxes on Exported Products: This is designed to refund embedded taxes and levies that are not otherwise creditable under GST or other mechanisms. The benefit is provided in the form of transferable electronic duty credit scrips, calculated as a percentage of the freight on board value of exports. These scrips can be used to pay future customs duties or they can be monetised, thereby improving working capital efficiency and ensuring that exports remain tax-neutral.

5. Duty Drawback Scheme: The drawback mechanism operates on two fronts to ensure that duties do not form part of export costs. First, it enables the refund of duties paid on imported inputs used in the manufacture of export goods, calculated via standard industry rates or specific brand rates. Second, where imported goods are cleared and subsequently re-exported in substantially the same form, the scheme allows for a refund of up to 98% of the customs duty originally paid.

6. Imports of Goods at Concessional Rate Scheme: This scheme allows import of specified goods at concessional or nil duty for use in the manufacture of notified end-products. It is fully digitised through Indian Customs Electronic Gateway ("ICEGATE") and requires prior intimation, execution of bonds, and end-use compliance. The scheme is particularly useful for domestic manufacturers supplying to both export and domestic markets.

7. Special Economic Zones ("SEZs") and Export Oriented Units ("EOUs"): SEZs are specifically designated duty-free enclaves within India that are treated as territories outside the customs frontiers for the purposes of trade operations and duties, while EOUs are units established within India that undertake to export their entire production, subject to limited domestic sales as permitted. Both SEZ units and EOUs are eligible for duty-free import of capital goods, raw materials, and inputs, along with other indirect tax and regulatory benefits.

8. Production Linked Incentive ("PLI") Scheme: PLI schemes operate in tandem with customs incentives by providing direct financial incentives linked to incremental production and sales in identified sectors. These include sectors such as electronics, semiconductors, pharmaceuticals, automobiles, and renewable energy. By enhancing post-production profitability, PLI complements duty exemptions and deferrals available at earlier stages of the value chain.

9. Sector-specific Duty Exemptions and Policy Measures: In addition to structured incentive schemes, the government, through annual budget announcements and corresponding notifications, introduces targeted customs duty exemptions and tariff rationalisation measures to support priority sectors and align trade policy with industrial objectives. The annual budget of 2026-27 continues this approach by providing sector-specific relief across areas such as aerospace and defence, renewable energy and battery storage, critical minerals, electronics manufacturing, and capital goods, including exemptions on key inputs, components, and machinery. It also adopts a calibrated strategy in certain sectors, such as chemicals, where selective duty increases have been introduced to encourage domestic manufacturing. Further, long-term exemptions, such as those for nuclear power equipment, reflect a broader policy intent to strengthen domestic value chains, enhance export competitiveness, and reduce import dependence in strategically significant industries.

What is Authorised Economic Operator accreditation, and how can it help business operations?

The Authorised Economic Operator ("AEO") programme is a cornerstone of India's shift toward trust-based, technology-driven customs administration. The programme grants a "trusted trader" status to businesses that demonstrate strong compliance, secure supply chain practices, and robust internal controls. AEO accreditation enables faster clearances, reduced inspections, and enhanced facilitation, making it a significant operational and financial lever for importers and exporters.

AEO certification is granted at multiple levels, with benefits increasing based on compliance maturity and operational robustness:

AEO Tier	Eligible Entities	Key Features
AEO-T1	Importers and exporters	Entry-level certification with simplified procedures, faster clearance, and reduced documentation requirements
AEO-T2	Importers and exporters meeting higher compliance standards	Enhanced facilitation, deferred duty payment, reduced bank guarantees, direct port delivery/entry, and dedicated relationship management
AEO-T3	Importers and exporters meeting the highest compliance thresholds	Highest level of facilitation, minimal or no inspections, priority processing, and international recognition benefits
AEO-LO	Logistics providers, custodians or terminal operators, customs brokers, and warehouse operators	Supply-chain level recognition with faster approvals, procedural relaxations, and reduced compliance burden

With the Government's continued push toward digitalisation, automation, and trust-based governance, AEO accreditation is increasingly becoming a gateway to the most facilitated tier of India's customs ecosystem. For businesses with significant import-export operations, it is no longer merely a compliance badge, but a strategic tool for improving efficiency, liquidity, and global competitiveness. AEO accreditation provides the following operational and financial benefits for businesses:

1. Working Capital Efficiency: AEO-T2 and AEO-T3 entities benefit from deferred duty payment, allowing import duties to be paid on a consolidated periodic basis rather than transaction by transaction at each import. The 2026 budget has extended the deferral cycle from 15 days to 30 days, improving liquidity and cash flow management.

2. Faster Clearance and Reduced Intervention: AEO entities are treated as low-risk and therefore face significantly lower inspection and examination rates, enabling faster cargo release.

3. Reduced Compliance and Transaction Costs: Lower or waived bank guarantee requirements, fewer audits, and access to facilities such as direct port entry/delivery reduce logistics costs and administrative burden.

4. Enhanced Credibility and Trade Facilitation: AEO accreditation enhances the reputation of businesses with global partners, financial institutions, and regulators, signalling reliability and compliance within international supply chains.

5. Priority Handling and Dispute Resolution: Higher-tier AEO entities benefit from dedicated client relationship managers, faster resolution of disputes and refund claims, and preferential treatment across customs processes.

What are the major compliance risks under customs law that businesses should anticipate?

Customs compliance failures do not always arise from deliberate wrongdoing. More often, they stem from classification errors, valuation gaps, documentation inconsistencies, and process deficiencies that remain undetected until audit or investigation. The principal compliance risk areas are outlined below:

1. HSN Classification: The tariff classification of goods under the HSN determines the applicable rate of customs duty, eligibility for incentive schemes, and the applicability of import or export restrictions. Classification is a legal determination governed by the General Rules for Interpretation and the relevant Section and Chapter Notes to the First Schedule of the CT Act, and must be based on the technical characteristics of the goods rather than commercial descriptions. Misclassification, whether intentional or inadvertent, can lead to short-levy demands, denial of preferential tariff benefits, rejection of scheme claims, and imposition of penalties. This risk is particularly acute in technically complex sectors. In electronics, for example, minor changes in functionality or configuration may shift classification across tariff headings with materially different duty implications. Classification should therefore be documented at the product level and periodically revalidated, particularly where product specifications evolve.

2. Valuation and Related-party Pricing: Customs duty is generally assessed on the transaction value, that is, the price actually paid or payable for imported goods. However, customs authorities may reject the declared value where there are reasonable grounds to doubt its accuracy, in which case alternative valuation methods under the Valuation Rules apply. The valuation framework also requires inclusion of certain additions in the assessable value, irrespective of their treatment in commercial documentation. These include royalties and licence fees linked to the imported goods, as well as the value of "assists" such as tooling, designs, or equipment supplied by the buyer. Omission of such elements is a frequent audit issue, particularly in manufacturing arrangements involving intellectual property. In related-party transactions, the declared value is subject to scrutiny by the Special Valuation Branch to assess whether the relationship has influenced pricing. Businesses should maintain a comprehensive valuation matrix capturing all financial and non-financial flows and ensure consistency between customs valuation and transfer pricing positions.

3. Rules of Origin: For preferential duty claims, a Certificate of Origin is no longer sufficient on its own. Importers must maintain and, upon request, furnish supporting documentation demonstrating compliance with applicable origin criteria, including bills of materials, production processes, supplier declarations, and value content calculations. Where the officer questions the validity of an origin claim, preferential treatment may be suspended pending verification. Failure to substantiate the claim can result in denial of the benefit, recovery of differential duty with interest, and enhanced scrutiny of subsequent imports. Businesses relying on preferential duty structures must therefore implement robust documentation and supplier verification processes.

4. Documentation and Record-keeping: A significant portion of customs disputes arises from inconsistencies across transactional documents rather than the underlying nature of the transaction. Variations between the Bill of Entry, ICEGATE filings, commercial invoices, and GST returns, particularly in respect of HSN classification, quantity, or value, may be treated as misdeclaration. While the law permits correction of bona fide errors, such amendments must be supported by contemporaneous documentation. Retrospective reconstruction of records is generally not accepted. Effective compliance requires pre-filing alignment of documentation and post-filing reconciliation with financial records.

5. Scheme-specific Compliance: Duty incentive schemes impose ongoing compliance obligations as a condition of the benefits granted. These include export obligations, value addition requirements, end-use conditions, reporting requirements, and reconciliation procedures. Failure to meet these obligations typically results in recovery of duties originally exempted or deferred, along with applicable interest and penalties. As these obligations are time-bound, businesses must establish internal monitoring systems to track compliance in real time.

6. Restricted, Prohibited, and Dual-use Goods: Certain categories of goods require regulatory approvals in addition to customs clearance. These include telecommunications equipment, products subject to mandatory standards requiring Bureau of Indian Standards certification, goods subject to environmental regulations, and dual-use items requiring Special Chemicals, Organisms, Materials, Equipment, and Technologies (SCOMET) licensing. Imports of food, pharmaceuticals, and medical devices may also require approvals from sectoral regulators. Failure to obtain the requisite authorisations prior to import may result in confiscation of goods and imposition of penalties, including personal liability in certain cases. Compliance requirements should therefore be identified at the product planning stage and integrated into procurement processes.

How do customs duty and GST interact during an import transaction?

When goods are imported into India, two parallel tax regimes apply simultaneously, namely, customs duties under the Customs Act, 1962 and the CT Act, and IGST under the IGST Act, 2017. Their interaction determines the landed cost of goods, the availability of input tax credit, and the overall cash-flow impact of an import transaction. Understanding how these levies are computed, and which components are recoverable, is essential for accurate pricing and efficient working capital management.

1. Sequencing and Structure of Import Levies: Import duties are computed in a prescribed sequence, and each component forms part of the base for the next. The starting point is the assessable value of the goods, which is generally the cost, insurance, and freight value, adjusted for additions such as royalties, licence fees, and assists in accordance with the Valuation Rules. BCD is first levied on this value, followed by the SWS, which is calculated as a percentage of the BCD. Where applicable, additional cesses such as the Agriculture Infrastructure and Development Cess are added. IGST is then levied on the aggregate of the assessable value and all applicable customs duties, at the rate corresponding to the GST rate on similar domestic supplies. In specified cases, a GST Compensation Cess may also apply. This sequential structure results in customs duties forming part of the base on which IGST is calculated.

2. Creditable and Non-Creditable Levies: A critical distinction within the import tax framework is between duties that constitute a permanent cost and those that are recoverable. BCD, SWS, and applicable cesses are not creditable under the GST framework and therefore form part of the landed cost of goods. IGST, on the other hand, is generally available as Input tax credit and can be set off against output tax liabilities. Accordingly, while the total duty outflow at import may appear significant, only the non-creditable components represent a true cost from a pricing perspective.

3. Refund Mechanisms for Exporters: Exporters are entitled to recover GST through two routes. They may export under a Letter of Undertaking without payment of IGST and claim a refund of accumulated input tax credit, or export on payment of IGST and subsequently claim a refund of the tax paid. The choice between these routes depends on working capital considerations, refund timelines, and the nature of credit accumulation.

What are the penalties and consequences for non-compliance with customs provisions?

Non-compliance with customs provisions attracts a wide range of consequences, from monetary penalties and interest to confiscation of goods, criminal prosecution, and personal liability of directors and officers. Penalties escalate with the gravity of the offence, the financial quantum involved, and whether the violation was inadvertent or deliberate.

Penalty / Consequence and Application	Quantum / Extent
Confiscation of Goods:	Goods that are misdeclared in value, quantity, or description, or that are imported or exported in violation of any prohibition or restriction, are liable to seizure and confiscation. The adjudicating authority may offer release on payment of a redemption fine in lieu of confiscation, but for prohibited or hazardous goods, absolute confiscation is frequently ordered with no release option available.
Monetary Penalty:	Imposed on any person whose act or omission renders goods liable to confiscation.  Prohibited Goods on Import: Up to the value of the goods or INR 5,000 (approx. USD 54), whichever is greater.  Dutiable Non-prohibited Goods on Import: Up to 10% of the duty sought to be evaded or INR 5,000 (approx. USD 54), whichever is higher.  Improper Export of Prohibited Goods: Up to 3 times the declared or determined value of the goods, whichever is greater.
Mandatory Penalty:	Applies where duty has been short-levied or not levied by reason of fraud, collusion, wilful misstatement, or deliberate suppression of facts by the importer, exporter, or their agent. A mandatory penalty equal to 100% of the duty and interest determined. This is reduced to 25% if full duty and interest are paid within 30 days of the show cause notice, and to 50% if paid within 30 days of the adjudication order.
Enhanced Penalty:	Applies where a person knowingly uses false or incorrect material particulars, declarations, statements, or documents in any customs transaction, including misdeclaration of origin, value, or description. Penalty of up to 5 times the value of the goods in question.
Short-Landing Penalty:	Applies to carriers where goods loaded for import into India are not fully unloaded at the declared port of destination and the shortfall cannot be satisfactorily explained by the shipping or airline agent. A mandatory fine of up to 2 times the amount of customs duty ordinarily payable on the goods that were not unloaded, imposed on the carrier or their agent.
Residuary Penalty:	Applies to any contravention of the Customs Act, 1962 for which no specific penalty has been prescribed elsewhere, including general procedural and compliance lapses. Up to INR 4 lakh (approx. USD 4,300) per contravention.
Interest on Unpaid or Short-paid Duties:	Interest is charged at the rate of 15% per annum from the date the duty was due until the date of actual payment, for any duty that is short-paid, unpaid, or erroneously refunded, regardless of whether the liability arises from voluntary disclosure or is determined in audit or investigation.
Criminal Prosecution and Imprisonment:	Applicable in cases of wilful evasion of duty, smuggling, misdeclaration of value, or fraudulent availing of export incentives or drawback.  Where the duty evaded exceeds INR 5,00,000 (approx. USD 5,380) or the market value of the goods exceeds INR 10,00,000 (approx. USD 10,750): imprisonment of up to 7 years, with a minimum of 1 year in the absence of special reasons recorded by the court, plus a fine.  Other Cases: In all other cases, imprisonment of up to 3 years, or a fine, or both.  Repeat Conviction: Repeat conviction mandatorily attracts 7 years' imprisonment.
Attachment of Property and Bank Accounts:	Invoked where a person fails to pay adjudicated duties, interest, or penalties following an order of the customs authority, and recovery through normal means has not been possible. Authorities may attach and sell the defaulter's movable and immovable property, freeze corporate bank accounts, and detain or sell any goods belonging to the defaulter that happen to be under customs control at the time.
Personal Liability of Directors and Officers:	Where a company commits an offence under the Customs Act, 1962, individual liability extends to those responsible for the conduct of its business at the time of the offence. Every director, manager, and authorised signatory of the company is deemed personally liable and subject to the same penal consequences as the company, unless they can affirmatively establish that the offence was committed without their knowledge or that they had exercised all due diligence to prevent it.
Suspension or Cancellation of Licences and Registrations:	Triggered by serious or repeated non-compliance under any customs scheme or provision, often running in parallel with monetary and penal proceedings. AEO accreditation, Importer-Exporter Code, incentive licences, MOOWR permissions, and SEZ approvals may all be suspended or cancelled. In practice, this consequence often exceeds the monetary penalty in commercial impact, as it directly freezes import-export operations and the benefits of all facilitation schemes simultaneously.

A robust customs governance framework anchored in accurate classification, defensible valuation, complete origin records, diligent scheme compliance, and prompt voluntary disclosure remains the most effective protection against these cascading consequences.