India’s most transformative tax reform needs a proper design and an enabling assessment environment to succeed
Touted as the “single most important tax reform since 1947”, the Goods and Services Tax (GST) has been in the offing for a decade and continues to figure as a top priority on the economic agenda of the government. Although the model GST has been the subject of wide scrutiny and debate, most of the discussions have been centred on its road to passage or on its larger form and structure. Many issues of significance, which will be crucial to the making (or the undoing) of a robust and successful GST, have largely been underplayed.
The reality of uniformity
Much emphasis has been placed on the benefits of uniformity that the GST would usher in. Accordingly, various official documents consistently reflected the understanding that GST would comprise an equal Central GST (CGST) and State GST (SGST), with no deviations from the rates/exemption lists, so as to obviate potential “rate wars” between States.
The first indication of the dilution of a uniform GST rate has by now already manifested in the July 2015 Report of the Rajya Sabha Select Committee, which allows States the freedom to impose the SGST within a “band of rates” in order to meet revenue expediencies or as a policy tool. Recent reports also contemplate a three-tier rate structure instead of two.
Even in terms of the model law, the potential for deviation stems from the concurrent powers of the Centre and States to enact their own GST legislation, compounded by the inheritance of the existing disjointed tax structure. It may be recalled that even the Value Added Tax regime began with a pledge of uniformity, but devolved over time as each State formulated different tax events, rates and exemptions.
Most crucially, the GST Dispute Settlement Authority, which would have reined in any deviations affecting the harmonised structure of the GST, has been done away with. Instead, all issues concerning rates, exemptions, and so on are to be decided by the GST Council (of which the Centre and States are members) by consensus, which may prove elusive given the political, social and revenue dynamics at play.
Equally questionable is the voting pattern within the GST Council, with the Centre’s vote carrying a one-third weightable of the total votes cast, and the States’ votes a collective two-thirds weightage. In effect, each State, irrespective of size, representation and GDP contribution, will command an equal vote, a structure which militates against the basic spirit of representative democracy enshrined in the Constitution, and also opens up the Council to greater manoeuvring by the Centre on issues that it seeks to pass or veto.
The existing tax system has typically followed a model of rewarding States where production activity is based (origin States), as opposed to States where consumption is high (destination States). Accordingly, most States have incentivised the setting up of local industries in order to drive growth and augment tax collections.
However, this history of origin-based tax is anathema to the GST, which is by nature a destination-based consumption tax. While origin States may chalk out measures to redress the imbalance, consumption and production patterns will not alter overnight, and industrialised States could be left in the lurch, at least in the immediate aftermath of the GST. Interestingly, there seems to be no globally available precedent which offers a solution to such an imbalance.
In the inevitable shift which the Indian GST necessitates, destination States such as Bihar and Kerala clearly stand to gain in terms of revenue, while origin States such as Gujarat and Maharashtra stand to lose, and had expectedly put up more initial opposition to GST. In order to partially level the playing field, the Centre proposed a 1 per cent origin-based additional GST. However, recent reports suggest this will be sacrificed for the Congress’s support in the Rajya Sabha.
In such a scenario, it will be difficult to predict the reaction of industrialised States. There is also the troubling prospect that such an aggrieved State may seek to substantially deviate from the uniform model.
Preparedness for online compliance
Unlike the existing system, which has greater scope for manual intervention, the GST aims to achieve a tectonic shift to a singular digitised compliance set-up. While this would be a great leap forward if implemented well, what has perhaps been underestimated is the huge geographical disparity across the length and breadth of India in terms of IT connectivity and functionality. Tacit recognition of this handicap is found in the ‘Digital India’ campaign, which has only recently been launched and admittedly has a long way to go to achieve reasonable Internet penetration. As a result, in some sections of the country today, manual tax compliance remains the only option.
Further, the proposed GST will also be far more dependent on IT. For instance, the IGST mechanism, which enables the crucial fungibility of taxes across States, will be unworkable outside an automated set-up, especially given the sheer volume of transactions that the GST will subsume. The proposed IT infrastructure will have to be suitably equipped, as any snags would effectively render the levy dysfunctional.
Under the GST, States will have the constitutional power to tax on a par with the Centre, bringing a host of service sectors within their scope for the first time. Past precedent has shown that such dual taxing power has resulted in complete chaos at the cost of assesses (the clearest instances are the taxation of software, intangibles, and so on).
Additionally, it is expected that issues of place of supply will also arise, with the Centre and States each asserting that the respective supply has occurred within their jurisdiction, so as to be able to garner the tax revenue. Poorly drafted rules will only aid and abet the confusion — for instance, a draft provision which proportionately divides the tax revenue where a supply of goods/services is made across multiple States.
The other significant issue is of the culture and approach of the revenue authorities. With the implementation of the GST in India, many taxpayers will, for the first time, be exposed to the State authorities. Possibly, clear and objective guidelines may whittle down the potential for any abuse of discretion.
Along the road to GST, it is also critical that these issues are subjected to the same level of governmental and public scrutiny so that the implementation of GST is a success in letter as well as in spirit.