Bibek Debroy deciphers the curious affair of the tax on pizza toppings


How many products are there? Maybe an infinite number. In the Harmonized Nomenclature System (HSN) used for the Goods and Services Tax (GST), the higher the number of digits, the finer the description. At the six-digit level, there will be around 5,000 items, many more as the numbers are further broken down.

Take something like HSN 62. It’s “articles of apparel and clothing accessories, not knitted or crocheted”. Should all 62 head items be taxed at the same rate? How can we do this? 62-head items can be eaten by both the relatively wealthy and the poor. The same rate will make the system regressive. In the interest of fairness, there must be a variation between the consumption of the rich and that of the poor.

It’s better done in terms of value. Therefore, 62 will be taxed at 5% if the value is less than ₹1,000 per coin and 12% if the value is more than ₹1,000 per coin. In the jargon of GST debates, we can gravitate to three rates – merit, standard, and demerit. This use of merit goods is quite different from what Richard Musgrave, in his theory of public finance, originally had in mind, as is the term demerit goods. Suffice it to say that we want people to consume merit goods and don’t want them to consume demerit goods. This must be encouraged or discouraged by indirect taxes.

Let’s take another example to illustrate self-inflicted complications. Fresh milk and pasteurized milk (0401) and curd, lassi and buttermilk (0403) are consumed by the poor and their consumption should be encouraged. Therefore, their GST rate is 0%. But as soon as the milk is concentrated, or contains sugar, or is skimmed milk powder or baby food (0402), the rate increases to 5%. If it is butter (0405) or condensed milk (this has no HSN code), the rate increases to 12%.

Milky Way

What if the product is flavored milk or flavored lassi? Note that there is no separate HSN code for either. There could have been, had we reduced that to a 10-digit level, with separate GST rates for each of the approximately 1,200 items. Otherwise, it is up to the Advance Ruling Authority (AAR) or the Advance Ruling Appeal Authority (AAAR) to decide. They are state-level bodies and they have discretion to decide, including on classification.

People are often surprised at certain cases of such use of discretionary power. For example, in accordance with AAR rulings, flavored lassi is exempt from the GST, but flavored milk is taxed at 12%. The latest example is the AAAR pizza decision.

What is the GST rate on pizzas? There are not any. That’s the point. The GST rate on pizza bread – note the expression – is 5%. But if it is not pizza bread, the rate will be 12%. In this context, there is nothing wrong with what Haryana AAAR has said. He decided that the pizza topping will be taxed at 12%, since the pizza topping is not pizza bread.

There are additional complications. As part of the compounding, if I eat pizza at the restaurant, the rate will be 5%. So if I don’t eat it at the restaurant, but have it delivered to my home, the rate will be 18%. The classification need not follow our understanding of common sense and ordinary usage.

tripod problem

Take the pizza protector – the little tripod in the center of the pizza. Many consumers might think it is a natural part of a pizza. This is not the case. If it is made from unwanted materials, there may even be a sin rate of 28%. When an AAR or AAAR decides, common usage of a term is not the only criteria. Equally relevant are ingredients and end use. Right now, the pizza decision has become the butt of jokes, just like the previous one, ‘paratha (18%) versus roti (5%). Due to discretion, AAR/AAAR decisions may also differ from state to state, although decisions are only binding on the plaintiff and the jurisdiction.

The GST was meant to be a simple tax. It is perhaps simpler, compared to the maze of indirect taxes of yesteryear. But it is still anything but simple. AAR/AAAR has discretion, as we have subject GST rates to discretion. Discretion leads to subjectivity and sometimes to abuse. As the history of indirect taxes reveals, discretion leads to high compliance costs, disputes and litigation. There is a mindset problem of giving up discretion. That is what reforms are for.

Take the recommended model of three rates – merit, standard and demerit. Everyone seems to accept that as a given. This is apparently the model that the GST Council will be moving towards, and there is a group of ministers who will be submitting a report on the simplification of the GST. Who decides which element is merit, standard or demerit? There is also discretion and value judgment in this identification.

Think pizza. We should all eat pizza bread (or pizza dough). Good for us – 6% rate (e.g. merit rate). Pizza topping? Lots of cheese – maybe not good for us – 12% rate (standard). A plastic pizza protector? Horrible – 18% demerit rate. Discretion paved the way for a simple tax to become complicated and confusing. Three rates may make it less complex, but it will still be complex. To think otherwise takes us to the realm of the imaginary. What are complex numbers made of?

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