Classification under GST: Role of HSN
What is classification?
There are thousands of tradable commodities chargeable to different rates of tax. Then how does one ascertain the applicable rate of tax on a particular product? The answer to this question is by classifying goods in different groups and sub-groups according to their nature, composition etc. and then specifying rate for each such group of commodities.
One may think that it would take some logical understanding and trade knowledge to classify goods, but this is easier said than done. For example, how would a gold pen be classified — as an item of gold or as a pen? The HS comes to rescue here by providing a uniform and standardized system of classification. The HS Code and the description of the commodity may not always be in tandem with the general commercial parlance and may throw surprises e.g., a commodity which should be charged at 5% as per general understanding, may either be exempted or charged at a higher rate given the HS code and the Chapter under which the same is found.
What is HS?
The Harmonized Commodity Description and Coding System generally referred to as “Harmonised System” or “HS” is an international product nomenclature developed by the World Customs Organization (WCO) to ensure uniform classification of goods in international trade. In addition to its use in customs, HS is also used by Governments across the globe as a statistical tool in economic research and devising trade policies.
HS comprises of more than 5,000 commodities grouped under Sections and then Chapters, which are arranged in a logical structure. Under a chapter, each commodity is identified by a 6-digit code and a uniform classification is ensured by way of well-defined rules to read and interpret the HS.
Historical Timeline & Global Governance of the HS Convention:
- Entry into Force (1 January 1988): India adopted the Convention as one of the founder-Contracting Parties. With 13 countries on board, 4 more countries were required by September 30, 1987. On September 22, 1987, 15 new countries joined, enabling the global rollout on January 1, 1988. Today, more than 200 countries have adopted HS in formulating customs tariffs.
- Governing Treaty: “The International Convention on the Harmonized Commodity Description and Coding System” governs the HS. The Explanatory Notes published by WCO provide the official interpretation of the HS.
- Harmonized System Committee: Entrusted with providing uniform interpretation and updating the HS every 5–6 years to keep pace with technological developments and trade patterns, deciding classification questions, settling disputes, and preparing amendments.
- Periodic Amendments: In May 2019, WCO held the 1st ever public consultation on the revision of HS. Since 1996, HS has been amended 7 times; the 7th amended version became applicable from January 1, 2022. Contracting parties are obligated to amend Tariff Schedules in alignment with HS, using correlation tables for transitions.
How HS Facilitates Global Trade & Its Adoption in India
The WCO Preamble to HS:
“Desiring to facilitate International Trade
Desiring to facilitate the collection, comparison and analysis of statistics, in particular those on international trade
Desiring to reduce the expense by re-describing, reclassifying and recoding of goods as they move from one classification system to another in the course of international trade and to facilitate the standardization of trade documentation and the transmission of data”
The HS aims to establish a taxonomy system for goods with a standardized hierarchy across member nations (e.g., a balloon, being a toy, is uniformly classified under HSN 9503 across all member countries).
How is HS adopted in India?
In India, the classification of imported and export goods is governed by the Customs Tariff forming part of the Customs Tariff Act, 1975. The Customs Tariff is divided into two Schedules:
- First Schedule: Import Tariff (specifying goods liable to import duty).
- Second Schedule: Export Tariff (specifying goods liable to export duty).
Initially, the Import Tariff was based on the Customs Co-operation Council Nomenclature, also known as the “Brussels Tariff Nomenclature”. However, with effect from 28.2.1986, the Tariff was revised basis the HS adopted by WCO (which came into force globally on 01.01.1988).
Transition to 8-Digit Classification (1 February 2003)
WCO codes commodities up to 4 digits (Heading) and 6 digits (Sub-heading), allowing member countries flexibility to extend digits for statistical tracking provided codes at 4 and 6 digits remain unchanged. Until 31 January 2003, the Indian Customs Tariff consisted of 6-digit codes. With effect from 1.2.2003, India adopted an 8-digit level classification to monitor trade data and provide statistical codes for domestic products.
Architecture of the Indian Customs Tariff:
In each Chapter, commodities are arranged in an increasing order of manufacture: first natural products, then raw materials, then semi-finished goods, and lastly fully finished goods / articles / machinery. Digits denote:
- 4 digits: Heading
- 6 digits: Sub-heading
- 8 digits: Tariff item
The titles of Sections and Chapters are solely for ease of reference and do not have legal authority. Legally correct classification is determined using the texts of Section Notes, Chapter Notes, Headings, Subheadings, and the General Rules for Interpretation of Import Tariff (GIR). The 6 rules in the GIR must be applied sequentially.
Why is HS Applicable to GST in India?
Notification No. 1/2017-CT (Rate) dated 28.6.2017 (GST Rate Notification) contains the schedules of tax rates levied on goods supplied under GST. Originally there were 6 schedules; the 7th was added with effect from July 18, 2022. Notification No. 2/2017-CT (Rate) dated 28.6.2017 enlists goods exempt from GST. In both notifications, goods are classified basis Chapter / Heading / Sub-heading / Tariff Item.
(iii) “Tariff item”, “sub-heading”, “heading” and “Chapter” shall mean respectively a tariff item, sub-heading, heading and chapter as specified in the First Schedule to the Customs Tariff Act, 1975 (51 of 1975).
(iv) The rules for the interpretation of the First Schedule to the Customs Tariff Act, 1975 (51 of 1975), including the Section and Chapter Notes and the General Explanatory Notes of the First Schedule shall, so far as may be, apply to the interpretation of this notification.
This establishes the primacy of the Customs Tariff Act in classifying goods under GST. The 8-digit HS code forms the basis of the codes in the GST Rate Notification. Whenever there arises a need to find the rate of GST, the Customs Tariff Act should first be referred to, and the result compared with the GST Rate Notification. If there is a difference, the GST Rate Notification prevails; however, the anomaly should be reported to the Fitment Committee. Without reconciliation, an imported commodity falls under the Customs HSN while domestic supply merits classification under the GST notification entry, creating potential rate disparities between IGST and domestic supply.
Manufacturing Processes and Ingredient Differentiation
The process that goods pass through and the concept of manufacture from excise jurisprudence remain highly relevant:
- Ingredients added: Flavoured milk in plain form is differentiated from flavoured milk with nuts.
- Preparation stage: Commodities differentiated by whether they are ‘ready-to-cook’ versus ‘ready-to-eat’.
- Omissions / Mismatches: Mango pulp is specifically mentioned in Customs HS, but was missing in the GST rate notification, creating taxability disputes.
Professionals should visit the place of production, review technical literature, packaging, and marketing strategies, and consult past judicial precedents to establish proper heading classification.
How are Services Classified in GST?
GST is levied on the supply of both goods and services. Once an activity falls within the four corners of ‘supply’, the taxpayer classifies it as goods or services using section 2 definitions and Schedule II of the CGST Act.
While goods are classified under Chapters 1 to 98 of the Customs Tariff, the Customs Tariff provides no aid for services as it contains no chapters for services (there is no Chapter 99 in the Customs Tariff).
Scheme of Classification of Services (Notification No. 11/2017-CT (Rate)):
Service codes (tariff) are provided by way of a ‘Scheme of Classification of Services’ as an Annexure to Notification No. 11/2017-Central Tax (Rate) dated 28.06.2017. The Annexure contains entries under Chapter 99 and Explanatory Notes based on the United Nations Central Product Classification (UN CPC).
- Rule of Specificity: The Preface lays down that where a service is capable of differential treatment based on description, the most specific description shall be preferred over a more general description.
- Exemption & Reverse Charge Alignment: Notification No. 12/2017-CT (Rate) (exempt services) and Notification No. 13/2017-CT (Rate) (reverse charge services) both utilize these service codes.
Conclusion
Accurate classification of goods and services is vital for determining the correct GST liability. Classification can be done accurately by following the General Rules of Interpretation in case of goods and the Explanatory Notes to the Scheme of Classification in case of services; logical understanding, common sense, or experience alone will not suffice.
Classification is not only relevant for ascertaining tax rates, but also determines the availability of exemptions and applicability of reverse charge. Appropriate classification is a sine qua non to avoid legal disputes and demands from tax authorities.
“Accurate classification of goods and services is vital for determining correct GST liability — appropriate classification is sine qua non to avoid legal disputes and tax demands.”