A Goldmine Called GST

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“The income tax created more criminals than any other single act of government.” – Barry Goldwater

Our current system of indirect taxation is a cesspool of inefficiency representing institutionalized adhocism in formulating tax policies.  Ill conceived tax policies do more harm to the economy than under-taxation. As a result, tax evasion became a norm for business survival leading to creation of vested interests.  We have a labyrinth of taxes at the Central and State Level which levy cascading taxation on the same value added to the product inflating the selling price in the hands of the consumer.

Need for Goods and Services Tax (GST)

Under the current system of taxation, taxes cascade leading to higher overall taxation. For instance, a manufacturer buys raw material for Rs 100 paying an input taxation of Rs 10.  If the manufacturer adds a value of Rs 50, the sale price to the wholesaler will be Rs 176 (Rs 100+ Rs 10 (Tax) + Rs 50 (Value addition) + Rs 16 (10% Tax on Rs 160)). If the wholesaler adds value of Rs 24, the before tax price of the product becomes Rs 200. The end consumer will ultimately pay Rs 220 (Rs 200+ Rs 20 (Tax at 10%)).  The total tax paid on the product thus equals Rs 46 (Rs 10+ Rs 16+ Rs 20) while the intended tax was Rs 17.4 (Rs 10+ Rs 5+ Rs 2.4). Thus the consumer an additional tax of Rs 28.6 compared to that computed on the basis of value added at each stage.

Cascading taxes are turnover taxes which are applied at every stage in the supply chain, without any deduction for the tax paid at earlier stages. Such taxes are distorting in that they create an artificial incentive for vertical integration. They have been replaced in Europe and many other locations by a value added tax (VAT).

GST is a value added tax over the entire supply chain that avoids cascading of taxes. In the above example, the GST would have worked out to Rs 17.4 (Rs 10+ Rs 5+ Rs 2.4).  Therefore the GST is a special sort of sales tax, commonly referred to as a value-added sales tax. This type is distinctive in that it only taxes the monetary value added to a product at different stages of the production process.

GST has the following two characteristics:

– Consumption sales tax: The GST is a consumption sales tax, which means that the party purchasing the product (the consumer) is responsible for paying the tax, as opposed to the “seller” of the product. If you purchase a candy from a candy store, you (as the consumer) are charged the GST in that particular transaction. This principle operates at all stages of production and distribution. Whenever a transaction occurs, be it at the manufacturing, distribution or retail stage, the party purchasing the good or service is required to pay the GST.

– Percentage consumption tax: It means that the amount of tax you pay is based on a certain percentage of the sale cost (before taxes) of the good or service you have purchased.

In India, GST will subsume the Central taxes such as Central Excise, Additional Customs Duty, Central Sales Tax, and CENVAT along with State Level taxes such as State Sales Tax, VAT and Municipal taxes such as Octroi, Entry tax, etc.

Moreover GST will have direct benefits for a variety of sectors in the economy. Few examples are:

1. Banking and Financial Services: 

i. Banking operations will achieve greater scale as a large part of the economy comes under the purview of GST in order to claim input tax credits.

ii. GST credits on purchase of goods expected to increase the overall credit pool.

iii. Interest on loans expected to be taxed under GST.

2. Infrastructure and real estate:

i. Simplified levy and valuation on composite transactions by eliminating multiplicity of taxes such as VAT, service tax, entry tax etc.

ii. Composite contracts likely to be treated as “Services” eliminating the prospect of a lot of litigation.

3. IT & Telecom:

i. Simplified levy and valuation on composite transactions by eliminating multiplicity of taxes such as VAT, service tax, entry tax etc.

ii. End to classification disputes between goods and services for items such as sim cards, franchisee fees, AMC, etc.

4. Services:

i. End to classification disputes between goods and services.

ii. Lesser negative list to ensure higher tax compliance.

5. Manufacturing and retail:

i. Full credit of tax on inter-state sale will reduce cost of procurement and production.

ii. Credit of imported goods will make them cheaper for retailers.

iii. Elimination of entry tax.

iv. Increased fungibility of credit on goods and services.

6. Media and Hospitality:

i. Eliminates multiplicity of taxes such as entertainment tax, luxury tax, VAT, etc.

ii. Fungible credits between goods and services will benefit the media and entertainment sector the most.

However GST implementation is not expected to be a smooth affair with a myriad of challenges. Some of the prominent challenges include:

– Passage of constitutional amendment bill: A constitutional amendment bill requires 2/3 of present and voting members to ratify it. While the government can muster the numbers in the lower house, it will face an uphill task to get it passed in the Rajya Sabha. At least 15 state assemblies need to ratify the bill which will test the political skills of any government.

– Threshold limit for business under GST: Different states and centre have varied threshold limits for levying service tax, central excise duty and the state VAT. As of now there is no consensus on a uniform threshold limit for GST.

– Training of tax administration: It is a humongous task to train the tax bureaucracy for effective implementation of GST.

– Robust IT network: It will be a herculean task to synchronize the Central and State tax networks which is crucial for the success of the GST.

Conclusion

“The king should take wealth from his subjects at the proper time. Like an intelligent man milking his cow every day, the king should milk his kingdom every day. As the bee collects honey from flowers gradually, the king should draw wealth gradually from his kingdom for storing it,”

– Bhishma counseling Yudhishtara on good governance, Mahabharata, Santi Parva (Book 12), Rajadharma Anusasana Parva (chapter 88)

Though our ancient texts hold enormous wisdom on good governance and taxation, the essence of such sage advice has somehow escaped the collective conscious of our rulers. In this backdrop, the move towards a nationwide Goods and Services Tax is a step in the right direction; albeit a delayed one. However it is important to be realistic in one’s expectations. It is being believed that GST will bring down inflation which requires nuanced understanding. While GST would avoid tax cascading, the government would be loath to give up on the absolute amount of tax that it is used to collect which has set it in the search of a Revenue Neutral Rate (RNR) which will increase the GST rates to such a level that the taxes being paid remain the same.

However in the long term, as tax compliance improves, there is an opportunity for the GST rates to come down which will bring relief to the consumers. Right now, the government must focus on bringing in the long awaited tax reform to ensure equitable tax collection.

Source: http://www.thefinapolis.com/article.aspx?c=1041

One Reply to “A Goldmine Called GST”

  1. Himanshu says:

    Refer hemanshow79.wordpress.com for Tax Updates.

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