The much awaited Goods & Services Tax is expected to unleash a swathe of positive economic outcomes for the nation. CFO India checks out the reality and chronicles the challenges of this transition.
The finance function has for a long time borne the brunt of the multiplicity of taxes that afflicts India’s indirect tax regime. At meetings attended by CFOs, sharing the trials faced at the hands of the taxmen lead to instant bonding. This last year, in 2015, however, many were expecting some relief with the introduction of the Goods and Services Tax (GST). Under this new regime, customs, excise, service tax, central sales tax, value added tax, entry tax, octroi and oher taxes were all to be subsumed under an umbrella GST.
“GST would lead to a higher output, more employment opportunities, and economic inclusion. This would also help in reducing compliance cost and the litigation in India, leading to clarity on tax costs involved in the business,” Urmil Khurana, Regional Director Finance,South Asia, Starwood Hotels & Resorts India Pvt Ltd had told CFO India last summer.
Khurana like other CFOs was keenly awaiting the GST implementation. However, the GST law has been in and out of freezer numerous times in the last few years. It is just one short step away from implementation.
Since GST affects the tax-collection capabilities of both centre and states, the constitution amendment bill for its introduction needs to be passed by two-thirds majority in both houses of Parliament and by 50% of state legislatures. Lok Sabha passed the bill to introduce GST more than six months ago on May 6, 2015. Two Parliament sessions with 38 working days went off without the Rajya Sabha giving its nod to the bill technically known as the the Constitution (One Hundred and Twenty-Second Amendment) Bill, 2014. The proposed date of April 1, 2016 for GST introduction, therefore, now seems impossible to meet.
Though Minister of State for Finance, Jayant Sinha has stressed that the government will continue to push the reforms agenda even after this disappointment, there are several others who believe that GST introduction is now completely off the track. Its introduction half-way through the next financial year on October 1 also remains questionable.
Part of the rationale stems from the expectation that the introduction of GST leads to a spike in prices for up to one year after its introduction.
WHY This DELAY MATTERS?
If GST does gets pushed back inordinately, then it will be a major set back to India’s case as an investment destination. It will also dampen enthusiasm around the government’s flagship programme to encourage manufacturing in India—Make in India. India is quite unattractive for manufacturers due to the multiplicity of taxes and the difficulty along with the cost of compliance of such a regime.
“GST will bring in significant efficiency to the supply chains in the country. I was looking forward to its implementation and am somewhat disappointed by the delay. I hope it sees the light of the day soon. Whatever apprehensions there are with respect to certain states need to be ironed out quickly,” says Sugata Sircar, CFO and Country Finance Partner, Greater India Zone at Schneider Electric India. His company runs businesses across product and service lines in India.
And there are other intangible benefits. In terms of macros, usually when a country cleans up its indirect taxes, the economic growth shows a bump-up in the following years.
For India, Vijay Kelkar, Chairman of the Thirteenth Finance Commission of India reviewed the Indian economy through the GST lens a few years ago. A committee report of the Task Force on Goods and Services Tax, 2009 headed by Kelkar observed two things: First that ‘implementation of GST across goods and services is expected, ceteris paribus (all things remaning constant), to provide gains to India’s GDP somewhere within a range of 0.9 to 1.7 per cent.
Secondly, Canada—the country which has a GST model closest to what India is planning to implement—used a computable general equilibrium model to estimate the impact of a well-functioning GST on the economy. They came up with an estimated benefit of 1.4% of GDP for Canada. Assuming the same level of benefit for India—an additional 1.4% of GDP— India, Kelkar’s committee report chalked up a positive gain of $15 billion a year. Using a modest 3% discount rate, the net present value of the reform was estimated to be worth $500 billion in 2009, at a time when the economy was roughly $1.3 trillion.
Malaysian wisdom: why GST matters?
The introduction of GST has many positive spinoffs possible. Malaysia which introduced GST earlier in April 2015 enunciates the advantages of GST.
* It is possible to introduce tourist refund schemes to boost the tourism spending in the country. Exports can be zero-rated to make goods more competitive globally
* It is possible to introduce tourist refund schemes to boost the tourism spending in the country. Exports can be zero-rated to make goods more competitive globally. It is possible to introduce tourist refund schemes to boost the tourism spending in the country. Exports can be zero-rated to make goods more competitive globally
For these purported benefits to be realised, however, the design of the GST system has to be simple with clear definitions of terms and minimal exemptions. “It is a complex change in a complex country,” says Siddharth Mehta, Partner – Indirect Tax, KPMG. In India’s federal structure where GST is a legislative change that needs not just the Parliament but also a majority vote from the states to pass a bill, it is difficult to align everyone’s interest together on certain issues.
While the centre’s focus is on the implementation, states’ focus is on preserving their revenue base and retaining fiscal autonomy. Once GST is operational in the proposed model of GST, individual states will lose the power to increase the tax rate according to their needs. Since the GST is a consumption-based destination tax, the manufacturing states especially feel vulnerable.
Although the centre is compensating the loss of revenue of the states by 100% in the first three years, 75% for the next two years followed by 50% in the last and 5th year, the states remain nervous. In a bid to bring all parties to the table, a tax rate band has been provided to allow states flexibility in initial years. To alleviate the concerns of the manufacturing states, an additional 1% tax over and above the interstate GST (IGST) has been proposed on interstate trade of goods.
Another big olive branch to the states has been on the treatment of petroleum and petroleum products under the GST regime. Since they are a source of 50-55% of taxes collected by states, states have been apprehensive of losing their current revenue base. The Modi government has worked around the problem by keeping them within the ambit of the GST law but for the purposes of immediate implementation keeping them out for now. Both the rate and date of application will be decided by the GST Council—the main body for this complex implementation.
A committee led by Chief Economic Advisor, Arvind Subramanian in December suggested possibilities for what the GST tax rate could be to ensure that there is no impact on the existing revenues of the states. The Committee recommends the revenue neutral rate (RNR) in the range between 15 percent and 15.5 percent (Centre and states combined) with a preference for the lower end of that range based on its analysis. This RNR could include multiple rates including the standard one which applies to a majority of goods and services.
The jostling around rate is particularly relevant in the context of sin or demerit goods such tobacco which again rake in huge revenues. According to the 2013 estimates of All India Brewers` Association (AIBA) Roughly one-fifth of most State government budgets are funded by alcoholic beverage category. And since there is limited public support for the consumption of sin goods, they suffer from high rates of taxation.
Imposition of a single rate of tax on all goods and services may well lead to a lower tax on such sin goods. Hence, there has been a clamour to keep them out of the GST ambit. The Arvind Subramanian Committee recommends a rate of 40% for sin goods such as luxury cars, aerated beverages, pan masala, tobacco and tobacco products for the state governments.
However, for the present potable alcohol has been kept out of the GST ambit. “The suggested rate of GST in the range of 17-18% may be seen as a welcome step, in the wake of earlier indications which hinted at a standard rate of GST upward of 20%,”says Manish Mishra, Partner, Mazaras. (Read the interview below)
|Interview | Manish Mishra
To A Seamless National Market
Q: How will GST benefit the economy and industry in India?
A: GST introduction may result in improving investor sentiment and increased economic activity. Being an integrated tax structure applicable across the country, GST may result in better certainty and clarity in the tax administration and structure, thereby significantly reducing the indirect tax litigation. Further, GST may also significantly reduce the tax-cascading by way of ensuring better credit flow across the value-chain. With GST applying on a lower cost base, i.e., the manufacturing costs, the overall tax incidence on the goods is expected to come down. With the entire compliance mechanism moving online, compliance costs may reduce significantly. This may result in creation of a seamless national market, leading to greater ease of doing business and effective planning and decision-making. At an economic level, since the tax is going to apply on a broader base, it may increase the tax revenues for the Government. Further, GST may result in uniform distribution of economic activity and resultant increase in export competitiveness may boost exports.
Q: How should the industry move forward with GST?
A: Industry should keep a close watch on the developments and keep itself updated with regard to issuance of the draft Act and Rules. Companies may need to fine-tune operations in sync with the proposed GST. Most importantly, the logistics and supply-chain for procurement and distribution of goods and services, should be reviewed. Further, the businesses need to review existing supply and procurement contracts, renegotiating them wherever required. GST impac needs to be factored in when bidding for long-term projects.
Q: What are your views on RNR document released by government?
A: The suggested rate of GST in the range of 17-18 percent may be seen as a welcome step, in the wake of earlier indications which hinted at a standard rate of GST upward of 20 percent. Also, doing away with 1 percent origin based tax on inter-state supply of goods is a positive move, since it would have diluted the concept of GST.
However, the proposed rate may see an increased impact of taxation on the services, which are currently being taxed at a rate of 14.50 percent, resulting in higher costs. A proper road-map for phasing the area based exemption along with the transition mechanism need to be clearly laid out.
GST implementation is a complex change management exercise for the Indian economy. And building the consensus on the finer details is a time-consuming exercise.
Since the winter session of Parliament did not get any progress on GST, many of items which were considered settled also remain open to some minor tweaks. This currently lends a measure of uncertainty to the final stage of this critical reform. And negotiations, of course, will continue on items like the 1% additional interstate tax and dispute resolution mechanism.
These knots apart, a robust technology backend is one of the prerequisites for the GST transition. Infosys has been awarded the five-year contract for setting up the GST Network (GSTN). Mazar India’s Mishra says that without a GST Information Technology (IT) infrastructure in place GST cannot be implemented.
All roads lead to GST: types of federal VAT systems
|Nature of VAT||Countries||Disadvantages|
|Independent VATs at Centre and States||Brazil, Russia, Argentina||
Independent VATs at Centre and States Brazil, Russia, Argentina Differences in base and rates weaken administration and compliance. Inter-state transactions difficult to manage
|VAT levied and administered at Centre||Australia, Germany, Austria, Switzerland, etc||State government relieved of responsibility of raising taxes which also takes away fiscal discretion of States|
|Dual VAT||Canada and India today||A combination of the above two and hence limits both their disadvantages|
|“Clean” dual VAT||India||Common base and common or similar rates facilitate administration and compliance, including for inter-state transactions, while continuing to provide some fiscal autonomy to States|
Source: World Bank (2015)
International Experience Is Readily Available
|Country||Year of Introduction||GST Rate (%)|
Standard rate: 20
Reduced rate:5.5 & 10;
Super reduced rate: 2.1
Standard rate: 20;
Reduced rate: 5
|Japan||April 1989||Standard rate: 8|
|India||April 2016 (proposed)||
Latest revenue neutral rate suggestion ~ 15%
It is a complex reform process and hopefully when India moves to GST it will transition well. Often it is not realised that we have arrived at this stage via certain compromises, negotiations and new models. Former CBEC chairman, Sumit Dutt Majumder told CFO India that GST is different for different countries. “It depends on an individual country’s economic, political structure and scenario.” Agreeing with him, KPMG’s Mehta says that there is no comparison between GST in India with GST in other countries. “Our federal structure is something very peculiar, so we have come to a workable version which has been refined over the years and years to come,” he adds.
In the meantime, the finance function in companies will be keeping an eagle eye on the pace of this transition. The introduction of GST will necessitate a relook at the current business model by finance professionals, especially as GST comes hand-in-hand with the Ind-AS.
Rajendra Prasad, Group CFO, SRF is of the view that GST will force the organisations to renegotiate things with their vendors and buyers in order to align with each component of their business. “It will impact finance, IT and each aspect of business so, it is partly going to take you to the drawing board for redesigning your business model and how you do business. The stakeholders in supply chain need to be in a win-win situation with the entire organisation,” he says.
The CFOs, however, have always managed to ride their way through rough seas fairly well in most complex change management programmes. This one, while on a national scale, is clearly not out of scope for them. The only challenge that remains is whether the Modi government will have the appetite for this reform in 2016. A high GST rate in line with the high RNR would definitely lead to high inflation or the first couple of years. And a government seeking re-election simply cannot afford a track-record of high inflation.
Yet, this is not always a given. On the official website for GST an article with reference to its impact on the economy says, ‘it will provide balm for an inflation-bruised government.’ And currently, the government is trying to use this delay to beef up the back-end processes and systems. The draft business processes on GST registration, GST refunds and GST payments are being worked upon.
The signs still appear full of hope and conviction. And hopefully the Modi government will show the strength of its political will and economic conviction. This is too important to be jettisoned. To a gamechanging 2016 then.