Rice Millers & Paddy Traders Tax Guide: Custom Milling (CMR) GST, Income Tax Sec 206C(1H) & Mandi Rules

In the agricultural belt stretching from Kalahandi and Koraput in Odisha to Dhamtari, Balod, and the industrial clusters of Urla and Bhanpuri in Raipur, rice milling is not just an industry—it is the financial engine of the region. Every kharif and rabi season, hundreds of modern parboiled and raw rice mills process millions of quintals of paddy procured from farmers and state nodal agencies.

However, operating a rice mill or paddy trading firm involves navigating one of the most complex tax and regulatory environments in Indian commercial law. Millers frequently manage a dual business model: processing Custom Milled Rice (CMR) on job work for government procurement agencies like the Odisha State Civil Supplies Corporation (OSCSC) or Chhattisgarh State Cooperative Marketing Federation (MARKFED), while simultaneously purchasing paddy from open mandis for commercial rice production.

This dual structure creates severe tax audit risks under GST, Income Tax, and Mandi laws. In our practice at Rabi Agrawal & Associates, we routinely represent millers facing departmental notices due to misclassified job work billing, incorrect Input Tax Credit (ITC) apportionment, cash disallowances under Section 40A(3), outturn ratio discrepancies, and misapplied TCS provisions.

This comprehensive guide details the practical tax compliance framework required for rice millers and paddy traders across Chhattisgarh and Odisha.

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Rice Mill Procurement, Custom Milling & Tax Workflow

The diagram below outlines the dual procurement channels, operational stages, and applicable tax checkpoints for rice milling operations:

                  +-------------------------------------------------+
                  |          Paddy Procurement & Inputs             |
                  +-------------------------------------------------+
                                    |
            +-----------------------+-----------------------+
            |                                               |
            v                                               v
+-----------------------+                       +-----------------------+
|  Government Agency    |                       |  Direct Farmer /      |
|  (OSCSC / MARKFED)    |                       |  Mandi Procurement    |
+-----------------------+                       +-----------------------+
| - Title remains with  |                       | - Sec 40A(3) Applies  |
|   Government Agency   |                       | - Rule 6DD(e) Cash    |
| - Delivery Challan    |                       |   Exemption for       |
| - No GST on Paddy     |                       |   Primary Farmers     |
| - Exempt from Sec     |                       | - Mandi Cess Paid     |
|   206C(1H) & 194Q     |                       |   (Sec 43B Deductible)|
+-----------------------+                       +-----------------------+
            |                                               |
            v                                               v
+-----------------------+                       +-----------------------+
| Custom Milling (CMR)  |                       | Commercial Processing |
|      Processing       |                       |       & Sale          |
+-----------------------+                       +-----------------------+
| - Job Work SAC 9988   |                       | - Branded Rice: 5%    |
| - 5% GST on Milling   |                       |   GST (HSN 1006)      |
|   Charges             |                       | - Loose Rice: 0% GST  |
| - By-Products Retained|                       | - Sec 206C(1H) TCS /  |
|   (Bran @ 5% GST)     |                       |   Sec 194Q TDS Active |
+-----------------------+                       +-----------------------+
            |                                               |
            +-----------------------+-----------------------+
                                    |
                                    v
                  +-------------------------------------------------+
                  |        Outturn Ratio & Stock Reconciliation    |
                  +-------------------------------------------------+
                  | - Raw Rice: Minimum 67% Recovery                |
                  | - Parboiled Rice: Minimum 68% Recovery          |
                  | - Stock Register Audit u/s 44AB (Form 3CD)      |
                  +-------------------------------------------------+

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1. Custom Milled Rice (CMR) vs. Commercial Rice Milling Tax Matrix

Understanding the legal distinction between Custom Milled Rice (CMR) and commercial milling is essential for correct invoicing and tax return filing.

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2. GST Compliance on Custom Milling (CMR) & By-Products

A. Milling Charges & SAC Code Classification

When a mill in Jayapatna or Dhamtari processes paddy owned by OSCSC or MARKFED, the miller provides a Job Work service.

• Applicable GST Rate: 5% (2.5% CGST + 2.5% SGST or 5% IGST).
• Service Accounting Code: SAC 9988 (Services provided by way of job work in relation to food and food products).
• Taxable Value: Milling charges prescribed by the government agency (e.g., ₹20 to ₹120 per quintal depending on state parboiling subsidies and bonus rates).

Crucial Audit Warning: Millers must never bill CMR processing as a sale of rice under HSN 1006. Invoicing CMR output as a commodity sale distorts GSTR-1 data, triggers turnover mismatches between GSTR-3B and Income Tax ITR-6/3CD, and leads to demand notices from GST enforcement wings.

B. Taxability and Valuation of Retained By-Products

Under standard state procurement agreements, government agencies pay modest milling charges. To compensate the miller, state contracts allow millers to retain by-products generated during milling:

1. Rice Bran (HSN 2302): Essential raw material for solvent extraction plants in Raipur and Durg. It attracts 5% GST. When millers sell retained bran to oil mills, GST must be charged at 5% and reported in GSTR-1.
2. Broken Rice (HSN 1006): Generated at 1% to 5% of total volume. Taxable at 5% GST if packaged and labeled; exempt if sold loose in unbranded bulk bags.
3. Rice Husk / Paddy Chaff (HSN 1211/2302): Used as biomass fuel for boilers. It is exempt (0% GST).

The Retained By-Product Valuation Dispute

GST auditors in Odisha and Chhattisgarh frequently argue that the market value of retained by-products represents "non-monetary consideration" flowing from the government to the miller under Section 15 of the CGST Act. Officers have issued notices demanding 5% GST on the market value of retained bran and husk as part of job work charges.

Ground Reality & Practice Defense: Our firm maintains that where milling rates are fixed by statutory notifications or state policy, and the retention of by-products is built into the official economic cost sheet approved by the Ministry of Consumer Affairs, Food and Public Distribution, artificial addition of by-product value to job work charges is legally unsustainable. However, millers must ensure that every single quintal of retained bran or broken rice sold in the open market is fully backed by tax invoices and reflected in GSTR-3B.

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3. Income Tax TCS u/s 206C(1H) & TDS u/s 194Q: Government Exemptions

Large rice mills and paddy trading firms with turnover exceeding ₹10 Crores in the preceding financial year must comply with Income Tax provisions governing high-value transactions.

A. Section 206C(1H) — Tax Collected at Source on Sale of Goods

Under Section 206C(1H), a seller with turnover > ₹10 Crores must collect TCS at 0.1% on total sale consideration received from a single buyer exceeding ₹50 Lakhs in a financial year.

B. Section 194Q — Tax Deducted at Source on Purchase of Goods

Under Section 194Q, a buyer with turnover > ₹10 Crores purchasing goods from a resident seller must deduct TDS at 0.1% on purchase value exceeding ₹50 Lakhs.

C. Statutory Exemptions for OSCSC, MARKFED & Mandi Boards

A major source of confusion among rice mill accountants is whether TCS under 206C(1H) or TDS under 194Q applies to paddy transfers and CMR deliveries involving government agencies.

• Second Proviso to Section 206C(1H): TCS provisions do not apply if the buyer is the Central Government, a State Government, an embassy, a High Commission, or a local authority/statutory corporation like OSCSC or MARKFED.
• CBDT Circular No. 13/2021: The Central Board of Direct Taxes clarified that Section 194Q does not apply to transactions where the seller is a government agency or state procurement body, or where transactions are executed through Agriculture Produce Market Committees (APMC) / Mandi Samitis acting as market operators.

                    +------------------------------------------+
                    | Is the Transaction with OSCSC / MARKFED? |
                    +------------------------------------------+
                                         |
                       +-----------------+-----------------+
                       |                                   |
                     YES                                  NO
                       |                                   |
                       v                                   v
        +-----------------------------+     +-----------------------------+
        |   Exempt from TCS 206C(1H)  |     |   Check Buyer/Seller        |
        |   & TDS 194Q                |     |   Turnover Thresholds       |
        |   (Sec 206C(1H) Proviso 2 & |     |   (> ₹10 Cr Turnover &      |
        |   CBDT Circular 13/2021)    |     |   > ₹50 L Transaction)      |
        +-----------------------------+     +-----------------------------+
                                                           |
                                                           v
                                            +-----------------------------+
                                            | Apply 194Q TDS (Buyer) OR   |
                                            | 206C(1H) TCS (Seller) @ 0.1%|
                                            +-----------------------------+

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4. Section 40A(3) Cash Purchase Exceptions for Paddy: Rule 6DD(e)

To keep commercial rice mills operating during peak harvest seasons in Balod, Dhamtari, or Kalahandi, millers often purchase raw paddy directly from village farmers at procurement yards or farm gates.

A. The General Rule of Section 40A(3)

Section 40A(3) of the Income Tax Act disallows any business expenditure for which payment exceeding ₹10,000 in a single day to a single person is made otherwise than by an account payee cheque, bank draft, or electronic clearing system (RTGS/NEFT/UPI).

If a rice mill buys ₹3,000,000 worth of paddy in cash from a single seller in a day, the entire ₹3,000,000 expenditure can be added back to business income during Tax Audit u/s 44AB, creating a massive tax liability.

B. The Rule 6DD(e) Exemption for Primary Agricultural Producers

Recognizing the rural banking infrastructure constraints in agrarian belts like Jayapatna, Junagarh, and Kanker, Rule 6DD(e) of the Income Tax Rules provides a specific exception:

Rule 6DD(e) Exception: No disallowance under Section 40A(3) shall be made where payment is made for the purchase of agricultural produce to the cultivator, grower, or producer of such produce.

                  +-------------------------------------------------+
                  |             Paddy Cash Purchase                 |
                  +-------------------------------------------------+
                                    |
            +-----------------------+-----------------------+
            |                                               |
            v                                               v
+-----------------------+                       +-----------------------+
|  Direct Purchase from |                       | Purchase from Middle  |
|  Farmer / Producer    |                       |  Trader / Intermediary|
+-----------------------+                       +-----------------------+
| - EXEMPT u/s 40A(3)   |                       | - NOT EXEMPT under    |
|   via Rule 6DD(e)     |                       |   Rule 6DD(e)         |
| - Must hold Farmer ID |                       | - Cash > ₹10,000      |
|   & Khasra / B1       |                       |   DISALLOWED 100%     |
| - Voucher + Thumb/     |                       | - Must pay via Bank / |
|   Signature Required  |                       |   RTGS / NEFT         |
+-----------------------+                       +-----------------------+

C. Mandatory Documentary Proof Required for Tax Audit

Tax Auditors will not accept verbal assertions that cash payments were made to farmers. During annual Tax Audit u/s 44AB, our audit team verifies that every cash paddy purchase voucher includes:

1. Name, Address, and Aadhaar/Voter ID of the farmer.
2. Khasra / B1 / Khatoni Copy showing agricultural land ownership or cultivation rights.
3. Signed or Thumb-Imprinted Purchase Voucher stating quantity (in quintals), rate per quintal, total consideration, and date.
4. Mandi Gate Pass / Weighment Slip from the weighing bridge (Dharam Kanta).

Critical Warning on Intermediaries: Rule 6DD(e) applies only to direct primary producers (farmers). If a rice mill purchases paddy in cash from a village aggregator, trader, broker, or Kachha Arhtiya who is not the actual cultivator, Rule 6DD(e) DOES NOT APPLY. The entire cash purchase will be disallowed under Section 40A(3). Payments to intermediaries must always be executed through banking channels.

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5. Outturn Ratio Audit & Stock Reconciliation (Raw 67% vs. Parboiled 68%)

Quantitative stock reconciliation is the focal point of every Tax Audit under Section 44AB (Clause 35 of Form 3CD) and GST Scrutiny Audit under Section 61.

A. Mandatory Technical Milling Outturn Ratios

The Food Corporation of India (FCI), OSCSC, and Chhattisgarh State Civil Supplies Corporation prescribe statutory minimum recovery ratios (outturn ratios) for converting paddy into rice:

• Raw Rice Milling: Minimum 67 kg of rice per 100 kg of paddy (67% outturn ratio).
• Parboiled Rice (Ushna Rice) Milling: Minimum 68 kg of rice per 100 kg of paddy (68% outturn ratio).

+---------------------------------------------------------------------------------+
|                            PADDY MILLING YIELD MATRIX                           |
+---------------------------------------------------------------------------------+
| 100 KG RAW PADDY INPUT                                                          |
|  |                                                                              |
|  +---> Raw Rice Yield (Minimum)        : 67.0 KG (67%)                          |
|  +---> Rice Bran (Oil Extraction Grade): 5.0 to 7.0 KG                          |
|  +---> Broken Rice (Kana / Nakku)      : 3.0 to 5.0 KG                          |
|  +---> Rice Husk / Chaff (Boiler Fuel) : 20.0 to 22.0 KG                        |
|  +---> Moisture Loss & Dust Impurities : 2.0 to 4.0 KG                          |
+---------------------------------------------------------------------------------+

B. Audit Scrutiny & Clandestine Removal Allegations

If a mill's financial accounts show an outturn ratio lower than 67% (e.g., 63% or 64%), tax authorities immediately raise red flags:

1. GST Department: Officers allege that the missing 3% to 4% of rice was manufactured and sold in cash without issuing tax invoices, creating a demand for unpaid GST plus 100% penalty and interest.
2. Income Tax Department: Assessing Officers treat the yield shortfall as unrecorded sales, adding estimated gross profit to business income under Section 69C / Section 145(3).

C. Defending Legitimate Outturn Shortfalls

Yield variations do occur in actual mill operations due to technical and environmental factors:

• Excess Moisture Content: Paddy procured early in the kharif season often contains 18% to 22% moisture compared to the standard 14% norm. Drying reduces total weight.
• Paddy Variety: Fine varieties (e.g., Sonam, HMT, Swarna) yield higher broken percentage than coarse varieties (e.g., IR-64, Maha Maya).
• Quality of Paddy: High percentage of damaged, discolored, or immature grains.

Practitioner Recommendation: Millers must maintain a daily Milling & Moisture Log Register (Form-C). When moisture loss exceeds standard limits, test reports signed by the mill supervisor must be logged on the day of milling. This daily record provides defensive evidence during GST audits and Income Tax assessments.

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6. Mandi Cess & Krishi Upaj Mandi Shulkh Accounting

In both Chhattisgarh (under the CG Krishi Upaj Mandi Adhiniyam) and Odisha (under the APMC framework), purchasing paddy attracts Mandi Cess (typically ranging between 1% and 2% plus Nirashrit Shulkh where applicable).

A. Income Tax Deductibility u/s 43B

Mandi Cess is a statutory liability levied by state government market committees. Under Section 43B of the Income Tax Act, statutory fees, taxes, and cesses are deductible as business expenditure only in the financial year in which they are actually paid, on or before the due date for filing the Income Tax Return u/s 139(1).

If a rice miller accrues ₹1,500,000 in Mandi Cess for FY 2025-26 but fails to deposit the amount with the Mandi Samiti before the ITR filing deadline, the entire unpaid amount will be added back to taxable income under Section 43B.

B. Accounting Treatment

Mandi Cess must be accounted for as an direct operational expense:

Debit:  Mandi Cess Expense Account
Credit: Mandi Samiti Payable Account / Bank Account

It should not be merged into the basic purchase price of paddy in ledger master setup, as Tax Auditors must report statutory tax liabilities separately in Clause 26 of Form 3CD.

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7. Practical Audit Case Study: Jayapatna Parboiled Rice Mill

To see how these compliance frameworks interact in practice, consider a representative audit case handled by our firm:

Background & Operational Setup

A parboiled rice milling unit located in Jayapatna, Kalahandi, processed 2,00,000 Quintals of paddy during FY 2025-26 under a dual operational model:

• CMR Contract for OSCSC: 1,50,000 Quintals of paddy processed into 1,02,000 Quintals of parboiled rice delivered to OSCSC godowns.
• Commercial Milling: 50,000 Quintals of paddy purchased directly from local farmers and village mandis, processed into 34,000 Quintals of commercial rice sold to wholesalers in Durg and Raipur.

+---------------------------------------------------------------------------------+
|                       JAYAPATNA MILL FY 2025-26 RECONCILIATION                   |
+---------------------------------------------------------------------------------+
| 1. OSCSC CMR Milling Service Revenue                                            |
|    - Milling Charges Billed: 1,50,000 Qtl @ ₹60/Qtl = ₹90,00,000                 |
|    - GST Billed @ 5% (SAC 9988)                      = ₹4,50,000                 |
|    - Retained Rice Bran Sold: 9,000 Qtl @ ₹2,400/Qtl  = ₹2,16,000                 |
|    - GST on Rice Bran @ 5% (HSN 2302)               = ₹10,80,000                |
|                                                                                 |
| 2. Commercial Paddy Procurement & Cash Verification                             |
|    - Commercial Paddy Purchase Value                 = ₹11,50,00,000             |
|    - Direct Farmer Cash Purchases (Rule 6DD(e))      = ₹45,00,000                |
|    - Verified with Farmer Aadhaar, Khasra, Vouchers  = 100% Compliant           |
|    - Intermediary Purchases via Banking Channels     = ₹11,05,00,000             |
|                                                                                 |
| 3. Stock Outturn Ratio Reconciliation                                           |
|    - Parboiled Rice Delivered to OSCSC               = 1,02,000 Qtl (68.0% Yield)|
|    - Commercial Parboiled Rice Recovery              = 34,100 Qtl   (68.2% Yield)|
|    - Total Average Recovery Ratio                    = 68.1% (Above 68% Norm)    |
+---------------------------------------------------------------------------------+

Audit Key Action Points Implemented

1. GSTR-1 vs. GSTR-3B Matching: Reconciled ₹90,00,000 CMR billing under SAC 9988 at 5% GST and ₹2,16,00,000 commercial bran sales under HSN 2302 at 5% GST, avoiding high-risk automated discrepancy flags on the GST portal.
2. Form 3CD Clause 31 & 35 Compliance: Verified all 100% of cash paddy purchases against landholding Khasra documents under Rule 6DD(e), securing 0% disallowance under Section 40A(3).
3. Outturn Compliance Certification: Documented a 68.1% net recovery ratio, eliminating exposure to revenue yield shortfall additions.

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Key Compliance Checklists for Rice Mill CFOs & Tax Managers

To maintain clean compliance, rice mill management teams in Chhattisgarh and Odisha should implement this internal checklist every month:

• Verify CMR Invoicing SAC Code: Ensure custom milling invoices to OSCSC / MARKFED use SAC 9988 with 5% GST, not HSN 1006.
• Report Retained By-Product Sales: Bill all rice bran sales with 5% GST (HSN 2302) and record customer GSTINs accurately for GSTR-1 matching.
• Audit Cash Purchases u/s 40A(3): Confirm every cash paddy purchase exceeding ₹10,000 is directly from a farmer and supported by a Khasra copy, Aadhaar ID, and signed voucher under Rule 6DD(e).
• Verify Intermediary Payments: Ensure all payments to brokers, traders, or Arhtiyas are routed exclusively via RTGS/NEFT/Cheque.
• Maintain Daily Outturn Log: Track daily outturn percentages against the mandatory 67% (raw) and 68% (parboiled) standards. Record moisture loss data on days when raw paddy moisture exceeds 14%.
• Verify TCS / TDS Exemption Documentation: Ensure state agency purchases (OSCSC / MARKFED) are correctly flagged as exempt from Sec 206C(1H) and Sec 194Q.
• Reconcile Mandi Cess u/s 43B: Clear all outstanding Mandi Shulkh payables before the ITR filing due date to avoid tax add-backs.

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Specialized CA & Tax Representation Services for Agribusiness

At Rabi Agrawal & Associates, our practice specializes in agricultural business compliance, tax representation, and statutory audits for rice mills, solvent extraction plants, and agri-traders across Chhattisgarh and Odisha.

Whether your unit requires assistance with GSTR-9/9C reconciliation, Section 44AB Tax Audit, OSCSC CMR yield reconciliation, Section 40A(3) audit defense, or representation in GST Audit & Appeal proceedings, our experienced partners provide dedicated, ground-level professional support.

Head Office & Regional Branch Contact:

• Raipur Head Office: Commercial Complex, Urla / Bhanpuri Industrial Area, Raipur, Chhattisgarh.
• Jayapatna Branch Office: Main Road, Jayapatna, District Kalahandi, Odisha - 766018.
• Bhawanipatna Office: Collectorate Road, Bhawanipatna, District Kalahandi, Odisha.

Schedule a practice consultation with our Tax Audit & Agribusiness team to review your mill's compliance architecture.