Tariff loophole puts local AC manufacturers at disadvantage

Highlights:

• Tax loophole allows commercial AC imports at minimal duty
• Importers exploit "capital machinery" classification for finished cooling systems
• Local manufacturers face over 30% taxes on raw materials
• Unequal taxation distorts competition, discourages investment, slows industry growth
• Sector has strong job creation and export potential if supported
• Government may act; clearer classification and tariff reforms needed

A tax loophole allowing commercial air-conditioning systems to be imported as "capital machinery" at minimal duty is putting Bangladesh's emerging HVAC (Heating, Ventilation, and Air Conditioning) manufacturing industry under pressure, while costing the government significant revenue each year.

Industry insiders say Variable Refrigerant Flow (VRF) and chiller systems typically used in commercial buildings are being brought into the country under a concessional regime meant for industrial machinery. The result is a stark disparity: commercial AC importers pay just 1% customs duty with full VAT exemption, while local manufacturers face over 30% combined tax incidence on raw materials.

The imbalance, they warn, is distorting competition, discouraging investment, and slowing the growth of a sector with strong export potential.

Under a statutory regulatory order issued on 29 May last year, the government fixed customs duty at 1% on capital machinery imports, alongside exemptions from VAT and supplementary duty. The incentive was designed to spur industrialisation by lowering the cost of setting up factories.

However, sector players allege that some importers are exploiting the relevant HS codes to bring in VRF and chiller systems as capital machinery despite these being finished commercial cooling products.

"These are complete commercial AC systems that are being sold and installed in high-end homes, restaurants, hotels, hospitals and other establishments," said a senior industry executive. 

Such usage, stakeholders argue, contradicts the very definition of capital machinery, which is supposed to contribute to industrial value addition.

Unequal playing field

The disparity becomes more pronounced when compared to local manufacturing. Companies producing VRF and chiller systems domestically must import components at an average of 15% customs duty, along with 15% VAT. In some cases, due to classification complexities effective duties can surge as high as 61% to 108%, according to manufacturers.

"Local manufacturers simply cannot compete on cost and price with importers enjoying near-zero tax," said an industry insider. 

Bangladesh currently has a handful of companies engaged in manufacturing such systems, including Walton, Ernest Engineering Works Ltd, and MHM Machineries BD. While they cater to domestic demand, some have also begun exporting to markets such as Singapore.

Yet, despite early signs of capability, investors remain cautious.

Entrepreneurs say the inconsistent tariff regime is dampening fresh investment in what could otherwise be a high-growth sector.

"There is strong potential, both in domestic demand and exports," said a sector analyst. "But policy inconsistency is holding it back."

According to market estimates, Bangladesh's annual demand for VRF and chiller systems stands at around 1,50,000 tonnes. Meeting this demand through local production could generate up to 15,000 new jobs.

The broader air-conditioner market both residential and commercial currently sees demand of 6 lakh to 7 lakh units annually, with total investment of around Tk5,000 crore. Local manufacturers already meet about 90% of residential AC demand.

However, in the VRF and chiller segment, their share is only around 10%.

Industry players say this gap could be rapidly narrowed if policy support is aligned.

Tanvir Rahman, senior executive director and chief business officer (AC) at Walton Group, questioned the misuse of the capital machinery definition.

"Capital machinery should contribute to industrial value addition," he said. "If imported products are being used in homes, luxury restaurants, resorts or convention halls, how can they be classified as capital machinery?"

He suggested introducing clearer classifications for HVAC imports based on end-use.

"If imports are defined specifically for industrial purposes, misuse can be prevented. That would also protect government revenue," he added.

"Local companies are now manufacturing commercial AC systems and even exporting. With proper policy support, this industry can grow significantly, create jobs, and save foreign currency," the Walton executive said.

Classification challenges

Mamunur Rashid, managing director of Ernest Engineering Works Ltd, said the lack of specific HS codes for certain components leads to arbitrary classifications.

"Sometimes duties on raw materials shoot up to 61% or even 108% because of classification ambiguity," he said. "We don't have clearly defined HS codes for many inputs, so customs often place them under different categories."

He stressed that resolving these technical bottlenecks is just as important as addressing tariff gaps.

"Even if nominal duty is 13-15%, the absence of proper definitions creates unpredictability. That is a major barrier for manufacturers."

From the government's perspective, the issue also has fiscal implications. A senior official at the National Board of Revenue (NBR), speaking on condition of anonymity, said the concessional facility was intended strictly to support industrialisation.

"There is no provision to commercially sell products imported as capital machinery," the official said. "If any irregularities are found, the NBR will take action."

Lutfur Rahman, former member of NBR (Customs), said that while fixing tariffs on any product, the NBR has to consider protection for local industries, as well as the interests of consumers and industries that use the product as an input.

He said there is limited scope to raise duties if a company imports air conditioners as capital machinery for industrial use. However, tariffs on imported parts used for local manufacturing could be reduced if they are currently too high.