The 1%-levy militates against the shift to destination-based taxation, creates conditions for cascading of tax
With the passage of the 122nd Constitution Amendment Bill, 2014, (the GST Bill) in Lok Sabha, the action has now shifted to Rajya Sabha where the GST Bill has been referred to the Select Committee. A consensus seems to be emerging and therefore the discourse now shifts to the implications which could arise from some of the proposed amendments.
The fact that India may not get the ideal Goods and Services Tax (GST) structure was fairly evident in initial stages of conceptualisation given the duality of tax structure embedded in our Constitution. Hence, it was always a challenging task to get everyone (or at least, the majority) on board. Building consensus required giving concessions. The moot point is whether the concessions have distorted the very tenet of the GST structure.
Due to severe opposition from the manufacturing states, the GST Bill has proposed an additional levy of 1% additional tax (1% ADT), over and above the regular GST, which is intended to enable them recoup revenue losses arising due to introduction of GST. The introduction of the 1% ADT will have several and far-reaching consequences.
First, the premise for the levy of 1% ADT is that this revenue will accrue to the originating state. The entire framework of the proposed GST law is to move from origin-based taxation to destination-based taxation. Levy of 1% ADT militates against the very framework which is sought to be replaced, leading to a situation where both origin-based and destination-based taxation will co-exist! This will require separate ‘place of supply’ rules for determination of origin and destination.
Second, while the intention is to compensate the manufacturing state (and hence, the origin-based tax), there is lack of clarity on whether any mechanism will be devised to limit the collection only to the manufacturing state. As per clause 18 of the GST Bill, any inter-state ‘supply’ will attract 1% ADT. This would imply that even after the manufactured goods have been supplied to second state (after levy of 1% ADT), any subsequent inter-state movement from the second state will also attract 1% ADT. So, the revenue is accruing not only to manufacturing (origin) state but also to any subsequent state making inter-state supplies! This perhaps is not the intention.
Third, even if the concept of origin is introduced, how does one really monitor the compliance? Would there be any mechanism to identify the origin and thereby subsequent supplies from another state will not attract this levy? This will only complicate and increase the cost of compliance and disputes.
Things can get more complex, if one considers scenarios where there are minor processing, or bulk to retail packing or minor alterations which do not alter the character of goods, will the levy of 1% ADT apply or not? Are we again revisiting concepts of what is manufacture, deemed manufacture, etc, to determine origin and whether the levy will be attracted?
Fourth, the levy is on inter-state ‘supply’. Thus, not only sales but other transactions like stock transfers, job work arrangements will come within its ambit. Take a simple example—Company A has a policy of central procurement and purchases its raw material from Company B. Let’s assume it being an inter-state supply, 1% ADT will be charged on raw material procurement. Now, if the raw material is supplied to another plant located in different state, it may entail 1% ADT again without any value addition! In the absence of any clarity on 1% ADT being creditable, it is going to have huge cascading effect.
Take another example, Company A has procured the raw material from another state and incurred the cost of 1% ADT. It processes the raw material and produces intermediate goods which are supplied to another factory located in a different state for further processing and returned back to the factory for completion of the manufacturing process. Applying the proposed provision, Company A will be incurring 1% ADT at the time of procurement of raw material, when the intermediate goods are sent to another factory and also when it is returned back for final processing, i.e., on three occasions! If there is inter-state supply of finished goods, it will suffer another round of 1% ADT. In absence of credit mechanism, the cascading effect will be significant.
The finance minister, during the discussions in Lok Sabha at the time of passage of GST Bill, has assuaged the concerns of cascading effect of 1% ADT. While one sincerely hopes that appropriate mechanism is provided to avoid the draconian impact of this levy, the introduction of a tax credit mechanism could pose challenges in terms of identifying the state eligible to retain the revenue being collected. Any mechanism which would result accruing this tax collection to the supplying or consumption states instead of the manufacturing ones will find little acceptance.
Last, in its present form, this 1% ADT may also apply to goods which have been kept outside the purview of GST, viz.
petroleum products and tobacco. There is a strong argument to keep such goods outside the purview of 1% ADT as they don’t enjoy the benefit of the GST reform. An exemption may be in order for such goods till the time they come within the ambit of GST.
It is evident that levy of 1% ADT is not in the best interests of overall trade and would be an impediment in achieving the goal of enabling business decisions neutral of tax impact. The discussions around redrawing the supply-chain design, which has so far been tax-dependent, may continue and will have to factor this new variable.
The period of levy of 1% ADT is two years unless extended further. It would be worthwhile to revisit the need for imposing this levy, despite various compulsions, as it is distorting the entire framework and defeating the objective of landmark transformational reform to convert whole of India as a single market.
The author is CEO, Dhruva Advisors LLP. Views are personal