The new increased Service Tax

The Government has notified that the new increased Service Tax of 14% will come into effect from 1st June 2015. So the current rate of 12.36% including the special educational cess will now be consolidated and increased to 14%. There are some apprehensions about costs going higher due to this, especially in the light of confusion existing about how the new Swachch Bharat Cess of 2% will apply for which the dates are not yet notified. While the critics are generally ranting about how this is regressive and going to affect the costs etc. it is essential to understand the rationale behind this.

The increase of the Service Tax to 14% is essentially preparing the framework for aligning to Goods and Services Tax of the GST bill which is now referred to a Parliamentary sub-committee for approval due to opposition blocking it in Rajya Sabha, despite all States having practically accepted to implement it. When GST will be eventually applied by Centre and States, the effective taxes would be in the range of 14 to 16%, so this Service Tax increase is to align that to the GST levels.

As most of you may know, GST is an essential Tax reform that is long pending and much wanted to bring uniformity and simplicity in Taxation of Goods and Service. This would streamline all indirect taxes and would bring down cascading effect on the prices of goods and services and also remove the disparities between taxation rates among states. Presently we have intra state taxes like State VAT, interstate sales Tax, which is CST, Exccise duty on goods and Service Tax on all services. GST envisages to combine all of these and also gives the tax offset or the tax credits for any input or other taxes paid (which currently is not available for CST).

To explain how this works, let me take a very simplified example. Let us say someone had incurred Rs. 1,00,000 for buying some raw material and paid 10% of taxes for the same his total cost now is Rs. 1,10,000. If his processing cost is about 70,000 and profit margins is Rs. 20,000 and he sells the goods at Rs.2,00,000 and with a tax of say 10% again on the final product, the final product price including tax is Rs. 2,20,000/- now for the ultimate consumer. The total taxes therefore incurred in this supply chain is Rs.10,000 (for inputs/raw materials that he paid) + Rs. 20,000 (for the output he finally levied). However when GST is applied, when his own tax assessment happens, he would get a credit or offset of the Rs. 10,000 he paid upfront for raw-material so the net tax amount he has to then pay to tax authorities would be Rs. 20,000 minus Rs. 10000 credit which is Rs. 10,000. This improves his cashflow/margins and thus brings down the overall cost or cascading effect due to taxation at both ends. This in turn would improve his competitiveness and helps him to price his product more flexibly and competitively. Well this is an oversimplified example of how cascading effect of taxes are brought down through GST and hence how it is supposed to improve cost-competitiveness in the long run.

However most of the other taxes (like VAT, Excise duty etc except CST) do have this credit/offset mechanism. When GST comes in, it just includes whatever is left over under this umbrella to mitigate the cascading effect of taxation. Plus it also includes Service tax in its ambit. Thus GST is an important tax reform that aims to streamline and harmonise the different indirect taxes. With higher tax devolution to the States as part of Modi Government’s co-operative fedaralism, the complaints of the States that they get a lower share also would be addressed and the unhealthy competition between states to differentiate on tax rebates to attract investment and the instability of tax regime due to different political parties ruling different states also would be minimized or mitigated.

The Service tax increase (apart from generating more revenue through the rate hike) therefore is also a tactic by the Centre to force the States and Opposition to adopt GST quickly in order to bring down the overall tax impact and costs lower. However, until GST is implemented and its benefits materialized overtime, there is bound to be some pinch felt due to higher tax. We need to understand that this is just a little hard inconvenience in the short-term for preparing ourselves for a longer term tax reform and competitiveness. We also need to understand that by automatically switching over to GST we would not directly see any reduction or benefit as a consumer (as this is more of a consumption tax hence the ultimate consumer bears the brunt of it), but would see some marginal benefit through the tax credits that the intermediaries may pass on. In the ultimate analysis, it is naïve to assume any reduction coming in through an increase of taxrate! What we could safely assume is that once the tax structures are streamlined, GST is implemented across the board and tax base is widened enough, the rates themselves may progressively come down in the long run!

As said, death and taxes are inevitable! Maybe even after death, the undertaker may start to tax us as well, as part of the new service tax! Or GST!

Source: http://www.thefrustratedindian.com/featured/the-new-increased-service-tax/

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