Why on earth is it taking so long and will tax officers end up having nothing to do if it simplifies things?
The concept of a Goods and Services Tax (“GST”) as a single tax on any supply of goods or services or both is known and administered in most other jurisdictions.
However, it does not (yet) exist in India.
What do we have right now?
The scheme of indirect taxation in India (as opposed to direct taxation, such as income tax) provides for the division of the powers to tax between the Centre and the states.
Various duties and taxes are therefore imposed and collected either by the centre or the state(s) from businesses in respect of different economic activities. As you can imagine, sometimes these overlap when both a state and the Centre seek to tax the same economic activity. This multiplicity of taxes substantially adds to the compliance and administrative costs for businesses and often results in avoidable litigation relating to duality of taxation, non-adherence to procedures, etc.
Further, the absence of a comprehensive credit mechanism for taxes levied by the states and the Centre, which would enable them to harvest the benefit of taxes already paid, adds to the woes of businesses, which have to account and pay separately for many different taxes and duties, rather than allowing them to simply set off one tax liability against another tax credit.
On top of that, the line demarcating goods and services has become increasingly blurred, as in the case of intellectual property rights, which are deemed to be goods for the levy of sales tax by the states but deemed to be services for the levy of service tax, making the separate taxation of goods and services untenable. Another prime example are transactions of works contracts.
That does sound complicated.
Yes, it is.
Imagine a toothpaste manufacturer who receives some services from India and others from overseas (some latest research perhaps).
These services are used in relation to the manufacture of toothpaste in India. While the Indian service provider charges our manufacturer service tax, the toothpaste manufacturer has to ‘reverse charge’ the tax in respect of services received from overseas.
Further, our manufacturer will receive various components and ingredients, all of which would (subject to concessions or exemptions) be subject to central excise duty. Additionally, since these would be sales to our manufacturer, value-added tax (VAT) or central sales tax (CST) would be added to the bill, depending on whether the sale was intra-state or inter-state in nature; these would also accrue on (and be available for set-off) when he finally sells the toothpaste on, down the supply chain.
Oh, and wait, some states or jurisdictions also levy an entry tax. I also forgot to mention that if our manufacturer has any imports of goods from overseas, he will be liable to pay up customs duties which comprise acronymys such as BCD (basic customs duty), countervailing duty (CVD), SAD (special additional duty) and applicable cesses.
And should you want tax credit (set-off), you need to ensure the proper (prescribed) documents are available in the required format but, taxes and duties levied by the Centre and states cannot be set off against each other for credit purposes, so separate silos of each tax liability and credit must be maintained. Additionally, no credit is available in respect of certain levies such as BCD, CST, entry tax or cctroi, which then become a cost to business.
That explains why business tax returns are always so complicated. How can GST help?
The proposed GST regime, intended to be introduced from 1 April 2016, also emphasised in this year’s Union budget, is said to be a watershed reform in India’s tax landscape. In the words of finance minister Arun Jaitley in December 2014, it is the “single most important tax reform after 1947”.
The GST will basically wipe the indirect tax slate clean, replacing around a dozen indirect taxes and duties levied by the Centre and state.
GST will basically leave behind only three types of GST (central, state and integrated GST) as well as basic customs duty for imports from abroad. This will finally provide for a single, uniform mechanism of levying indirect taxes.
Hopefully, this will also address the complexities of the present system, encourage tax compliance, and streamline the system of tax credits.
From the perspective of the Constitution, GST will nearly eliminate any distinction between the taxing powers of Centre and states, by equally empowering both. However, a dual GST, as proposed, would not violate the constitutional requirement of fiscal federalism, under which the Centre and states have demarcated taxing powers in order to raise revenues.
So what would happen to our toothpaste manufacturer above, after GST?
There is lot of streamlining and simplicity: imports and inter-state movement of goods or services will be subject to IGST (integrated GST), while all local “supplies” will suffer CGST (central GST) + SGST (state GST) or IGST (which is effectively the total of CGST and SGST). All of these are subject to only minimal exemptions.
Imports of goods will remain chargeable to BCD as before.
When selling goods or services, our manufacturer would also charge IGST, or CGST + SGST.
Therefore, VAT, CST, entry tax, central excise duty, service tax, CVD, SAD, and various other cesses are all going to be subsumed within the folds of GST.
That’s amazing. Why did no one think of this before?
More than a hundred countries actually have some form of GST or other, which is also known as VAT in other jurisdictions.
In the Indian context, the idea of GST dates back to the year 2000, when the Atal Bihari Vajpayee-led government initiated the discussion on GST by setting up an empowered committee headed by Asim Dasgupta.
After that, the concept of GST was mooted in the Union Budget Speech on 28 February 2006 and the deadline to embrace GST was set for April 2010.
With a view to creating a roadmap, the government and finance ministry’s joint working group (JWG) undertook detailed study of international models of GST and came up with the recommendation of a dual GST, to complement the existing federal structure of India.
Its first discussion paper was released in November 2009.
In 2011 the task force formed by the 13th Finance Commission issued its report emphasising the need to adopt a dual GST model. The Constitutional (115th Amendment) Bill, 2011 was introduced in the Lok Sabha, which lapsed with the dissolution of the 15th Lok Sabha in May 2014.
The Bill was suitably re-worked and was introduced as the Constitutional (122nd Amendment) Bill, 2014 in Parliament in December 2014.
On the other hand, with a view to moving closer towards GST, India adopted the negative list approach for taxing services (i.e. all activities to be taxed unless they featur in the negative list) from July 2012 and came up with the Place of Provision of Services Rules 2012 so as to determine the place where a service ought to be taxed.
Why on earth is it taking so long? Who could possibly be against something as great as the GST?
When the Constitutional (115th Amendment) Bill 2011 was put to vote, the states saw the proposed regime as a serious threat to their constitutionally guaranteed freedom of fiscal federalism (i.e., their own independent powers to impose and collect taxes).
The states expressed their disapproval over various issues: one major worry is the abolition of the CST, levied on inter-state sales, which is a major source of revenue for states.
The states also demanded a constitutional framework to be put in place to compensate them for revenue they’d lose by adopting the GST.
In an effort to assuage states’ concerns and to bring them on board the proposed introduction of GST, the Constitutional (122nd Amendment) Bill, 2014 proposes to levy an additional 1% tax on the inter-state supply of goods, which would be paid to states where goods originate, as compensation for the lost CST revenue in the first few years of the change to GST.
Besides this there were other areas of concern, such as the proposed form and powers of the dispute resolution mechanism (the GST Council).
If GST is so simple, won’t thousands of tax officers at the state and central level lose their jobs because they won’t have anything to do anymore?
They are unlikely to lose their jobs. They can be gainfully engaged to ease the transition, and thereafter to facilitate and ensure compliance, detect leakages, widen the tax base, etc.
There must also be other stumbling blocks that remain, right? What does the government still have to do?
While a lot needs to be done for implementation of India’s most ambitious tax reform to date, the following remain some of the major steps and roadblocks:
(i) passage of the Constitution Amendment Bill, and its ratification by at least half of all states;
(ii) arriving at a revenue neutral rate for the levy and a minimum threshold value, beyond which a supply of goods or services would attract GST;
(iii) agreeing on model legislation to be adopted by states to implement the proposed GST;
(iv) formulating comprehensive ‘place of supply’ rules for determining where goods and services should be taxed; and
(v) designing an effective information technology infrastructure, websites, etc, which will be called the GST Network to administer GST and enable credit flows.
What is so important about ‘place of supply’?
These rules will determine where a transaction takes place, for GST purposes, and who is liable to pay the GST.
These rules will be drafted by parliament and the Central Government.
Because service transactions involve intangibles and often span multiple states, it will be necessary to have clearly defined rules to determine the right to tax and which state should get how much of the revenue raised.
These rules will form the backbone of the levy of GST and the framers of the provisions have been keenly studying the models in Malaysia, the European Union, etc.
Under the Constitutional (122nd Amendment) Bill, 2014, Parliament will have exclusive powers to make and fine tune those rules. Right now, India proposes to adopt a GST regime premised on the ‘destination based consumption’ principle, which, generally speaking, means that the GST liability would be attracted in the place where the goods were supplied to or where the service was consumed.
So how will all these grand plans likely be implemented?
The Constitutional (122nd Amendment) Bill, 2014 will have to be passed by a majority of the total membership of each house, and by a majority of at least two-thirds of the members of that house who are voting.
The amendment must also be ratified by the legislature of not less than one-half of the states before the Bill is presented to the president for his assent. The Place of Supply Rules can be made effective after that.
Is this likely to happen any time soon?
Given that introduction of GST features fairly high on the pronounced agenda of the Narendra Modi government and that there is an apparent conscious effort on the part of the government to obviate bottlenecks, if any, it’s not impossible that they will hit their 2016 target.
What will the GST rate be?
No one knows precisely right now, but experts speculate—based on present trends—that it could be anything from 24% to 27%. The recent budget that hiked service tax to 14% in another step to bringing current rates up another step towards GST.
So if GST arrives, will this mean that companies will pay more taxes and things will get more expensive? How will government and the economy deal with that?
Initial tax costs may rise owing to what is likely to be a higher applicable rate of tax, however, the net burden or impact of having to pay those taxes is expected to decrease. This is because the entire credit mechanism will be streamlined and the burden of every tax borne will be available as credit to offset the taxes you pay.
Also, due to elimination of multiple taxable events and points of taxation, instances of the very same transaction being brought to tax by the states and the centre and situations of tax on tax (known as cascading effect of taxes) will hopefully be history.
GST, in its proposed simplified model over the present-day multifarious systems of levies, is likely to witness a widening of the tax base and is bound to encourage tax compliance.
And interestingly, a recent study by the Tax Force (headed by Vijay Kelkar) has estimated that the GST will provide gains to India’s GDP from 0.9% to 1.7%.
Taxes will hike GDP? Well, in that case, fingers crossed it all works out!
Indeed, let’s hope the government can push it through while having all stakeholders on board.
Rohan Shah is the managing partner and Ranjeet Mahtani is an associate partner at Economic Laws Practice, Advocates & Solicitors