An imminent stride towards a comprehensive Indirect tax structure - Concept paper on Issues & Challenges

[abhi parakh]

Goods and Service Tax

An imminent stride towards a comprehensive Indirect tax structure

Concept paper - Issues & Challenges involved in successful implementation

1.0      Position Hitherto

1.1      The Indian Indirect Tax structure has come a long way since independence - (i) The 46^th Amendment to the Constitution of India (ii) MODVAT scheme in 1986 (iii) Service Tax vide the Finance Act 1994 (iv) inter-sectoral credit scheme in 2004 (v) State VAT 2005-2008.

Notwithstanding the aforesaid, the existing structure still lacks the efficiency to reap benefits expected out of a comprehensive tax system

1.2      The Union Budget 2007 brought along a ray of hope amidst the complicated & in-efficient Indian Indirect Tax structure in the form of an announcement as to the implementation of Goods and Service Tax.    

1.3      The essential benefits of the proposed tax system and the issues & challenges related thereto find its roots in the limitations &/or deficits of the present tax system, hence it would be of paramount importance to outline the hitherto position which may be explained as hereunder -        

• Cascading of Taxes hence resulting in an economically in-efficient tax structure - since,

(a)    Central Excise is not set-offable against State VAT

(b)   Dis-joint State VAT and Service Tax

(c)    Origin based Central Sales Tax - hence not creditable against State VAT

• Multiple Statutes hence entailing unnecessary complications &/or conflicts [for instance the definition, scope & ambit of input is entirely different under the Central Excise & State VAT];

• Copious compliances, like returns under every statute, declaration forms (physical in many states), multiple registrations resulting in unnecessary investment in key business resource i.e. man-hours;

• Road Movement - being hampered and rendered unusually wanting on account of multiple check points, even intra-state at times

1.4      The proposed goods and service tax seeks to address the aforesaid issues including inter alia - (a) one single tax subsuming the host of existing levies like Central Excise, Service Tax, State VAT, Additional Duty of Customs, Central sales tax, Entry Tax, Octroi, stamp duty and cesses (b) free flowing & larger pool of input credit (c) comprehensive destination based taxation hence transforming India into one single market (d) reduced compliances (e) free road movement with proposed mechanical manning hence faster and more reliable (f) single & simpler statute hence an pro-assessee tax structure

2.0      Basis Structure of GST 

            Before pondering over the issues & challenges attached to the proposed levy, it would be of supreme importance to lay out the basic features of the proposed levy as presently envisaged. The documents released by the Government of India in pubic portal in this regard primarily comprise The First Discussion paper [`FDP’] on Goods and Services Tax in India - Nov’09 & Report of the task force [`RTF’] (sponsored by the 13^th Finance Commission) on Goods and Service Tax - Dec’09.

            Based on the aforesaid documents the basic structure may be outlined as under -

• Consumption based tax, taxable event being ‘transaction for a consideration’ 

• Taxes to be subsumed - (i) GST to subsume transaction based taxes such as CE, Service Tax, VAT, Entry tax; (ii) CST to phase out; & (iii) Purchase tax, electricity & stamp duty also proposed to get subsumed in GST

• Dual Structure - both Centre (CGST) & State (SGST) to levy tax on a common base of goods & services

• Integrated GST to be levied on inter-state transactions of goods & services [at rate = CGST + SGST]

• Threshold limit for exemption - Common for both Centre & States at INR 10 lakhs for all goods & Services

• Rate structure - The speech of the Hon’ble Union FM on 21-07-10 brought up the adoption of a single rate for services to the tune of 8% (both CGST & SGST) and dual rate structure for goods in the range of 12 to 20% to be converged to 16% over a three year phase

• Input Tax Credit Mechanism - Larger pool & free flow of credit

• Destination based GST hence - (a) shift of taxable event from production to consumption (b) revenue from inter-state transaction to accrue to the destination state & not to the origin state, (c) exports to be zero rated and (d) imports to be subject to GST

• Existing exemptions & remissions related to industrial incentives to be converted into cash refund schemes. Special Industrial Area Schemes to continue up to legitimate expiry time both for the Centre & States. Any new exemption, remission etc. or continuation of earlier exemption, remission not to be allowed. In such cases, the Government to provide reimbursement after collecting GST.

3.0      ISSUES - to be addressed

            The Indian Tax Structure has always been accompanied by numerous protracted litigations, long drawn and complex legal issues, thereby making any new change more susceptible to being in-efficient since it might not be able to address each one of the issues involved.

             Some of the important concerns may be explained as follows -

(i)           Determine the ‘Revenue neutral rate’ - a revenue neutral rate would be one which would be acceptable to all the states such that they would not have to sacrifice on their existing tax revenues, the Task Force on GST had in its report of Dec’2009, proposed a rate of 12% [5% CGST & 7% SGST] which is & may not be acceptable to all the states

The Union Finance Minister in his speech dated 21-07-2010 purported a rate of 16%, to be achieved over a three year phase. Hence clarity on this aspect is very important for the successful implementation

(ii)        Coverage & gamut of levy - primary considerations herein, could be the tax revenue that the government expects to generate out of the new tax system, interests of special sectors being securitised and political demands. The following may be noted in this regard -

• Threshold limits - uniformity to be maintained across SGST & CGST as per `RTP’ and the speech of Union FM on 21-07-10 to be affixed at ₹ 10 lakhs for both CGST & SGST thereby entailing a huge assessee base (about 5 million assessee), however the ‘FDP` purported a lower threshold of ₹ 10 lacs for SGST & higher one of ₹ 1.5 Crore for CGST

• Exemptions - Presently 99 items are exempt from both Central Excise & State VAT, in addition 240 items are exempt from only Central Excise (post Union budget 2011) - as per GST propositions these 240 items would also be brought under tax net post GST implementation [speech of Union FM on 21-07-10] thereby aligning the list of exemptions

• Scope of the term `consideration’ - GST as presently envisaged would be a levy on transactions for consideration, hence it would be important to note the envelope of the term consideration, as to whether it would cover branch transfers, captive consumption, transfer without adequate consideration, goods given free of cost as free samples, goods manufactured on job work basis

(iii)      Input Credit mechanism - a popular zone of litigation & conflicts is input credit availment, the new statute would need to address this issue quite delicately. Going by the propositions of the `RTF’ the input credit pool is set to expand (owing to enhanced coverage of the levy) hence envisaging credit of virtually all input GST paid

(iv)      Industrial Incentives & Area based exemptions - a developing economy without incentives would be motor car running without lubricants, hence lagging the impetuous & zing that is very much essential. However since GST purports to be a destination based VAT with the burden sticking over to the stage of final consumption and tax at preliminary stages being virtually a pass-through, an exemption and incentive free tax system may also be justifiable. This may however, not be acceptable in the political circles, hence a refund model, as suggested in the `FDP’ & `RTF’ could very well be a comfortable bargain.

However, the transition of the incentives under the grand-father clause need be addressed appropriately by the new statute and adequate provisions need be incorporated to convert exemptions to refund schemes, since the GST chain should not be broken.

(v)         Treatment of Composite Contracts during the transitional phase - Composite Contracts are contracts that envisage both supply of goods & rendering of services, the hitherto position hence necessitates taxation under multiple statutes since (a) the federal structure empowers the States to tax intra-state sale of goods and the Centre to tax supply of services (b) different rates  for taxation of goods and services thereby entailing -

• Disputes as to classification of constituents of composite contracts into goods and services
• Composition schemes, disrupting the input credit chain
• Abatement schemes & valuation disputes

          A flawless GST as envisaged provides equivocal treatment for both goods and services, i.e. similar rates, compliances, incidence and taxable event. However, in the Indian scenario the first three years of implementation would see taxation of goods and services at different rates [refer speech of Union Finance Minister dated 21-07-2010] thereby resulting in a probable carryover of the existing defects with respect to Composite Contracts.

          The new statute would have to address with utter specification the treatment of composite contracts during the transitional phase with an object to minimise the impact of existing concerns.

(vi)      PAN India uniformity as to SGST - a lesson from drawbacks in VAT implementation

State VAT introduced in 2005 had assured interalia a PAN India integration of tax system as much as tax rates & treatment of various constituents was concerned, thereby creating one single market. However, on account of political needs and conflicts the states diverted from the white paper issued by the EC and distorted the overall objectives of a flawless VAT system. The imminent GST should necessarily address the said flaw by setting up a system of taking key decisions on the structure of the statute.

In this regard - The Constitution [one hundred and fifteenth amendment] Bill, 2011 (Bill no. 22 of 2011) vide insertion of Article 279A provides for the constitution of a Goods and Service Tax Council by the President of India, basic propositions in this regard are summed-up as under -

• Said council to comprise - (a) the Union Finance Minister (chair person) (b) the Union minister of the State in charge of revenue (c) Minister in charge of Finance or taxation or any other Minister nominated by each State Government.

• Decisions are to be taken by way of consensus of the members present at meetings, and same are proposed to be recommendatory in nature with respect to inter alia taxes to be subsumed, list of exemptions, rates of tax and threshold of exemption.

• In addition the bill also provides that every decision of the said council should be guided by the need for a harmonised structure of goods and service tax and for the development of a harmonised national market for goods and services

Though the aforesaid structure may ensure tax uniformity across the economy, it may however be noted that the aforesaid bill while at drafting stage had been vehemently opposed by the states and same may not be passed with ease given the present political position.

(vii)    Taxation of Inter-state transactions - inter-state transactions are the presently subjected to (a) Central sales tax in case of sale of goods and (b) Service Tax with respect to inter-state supply of services.

Under GST the following issues related to taxation of inter-state transactions need to be addressed -

• Determine the appropriate model for taxing inter-state transaction

• Determination of taxing Jurisdiction - (a) in case of goods, GST since being a destination based VAT tax revenue to accrue to the state wherein the goods are finally consumed (b) in case of services, since intangible appropriate place of supply rules need be defined so as to determine the taxing jurisdiction under different genres of transactions

• Treatment of inter-state branch transfers - GST since purported to be a tax on transaction for consideration, branch transfers since not involving consideration should not prima facie be taxed [though, RTF has recommended levy of GST on inter-state stock transfer FDP has not explicitly conveyed the same in it discussion paper]

• Setting up of Central agency to control &/or regulate the transfer of GST credit amongst states

(viii) Compliance Procedures - major drawback of the present system lays in the multiple compliance procedures that it entails, hence it would particularly important for the new statute to address this issue. Present propositions envisage the following -

• Single registration under CGST & one SGST registration per state, aligned with the PAN under IT Act (compulsory for assessees having an annual aggregate turnover of more than 10 lacs) - to be finally replaced by the Unique Identification Number (UIN) as and when it is introduced

• Returns - a combined payment and transaction reporting statement in Form No. GST-I for both CGST & SGST, E-filing, quarterly return for dealers opting for composition schemes 

• Monthly tax payment 

4.0      CHALLENGES &/or HURDLES - to be overcome 

            Re-engineering of a sixty year old tax system could never have been a cake walk, more so even for a democracy like India. Development is something which does not arrive but has to be achieved, through better & fruitful planning. In-order to overcome the hurdles it would be very important to identify them well in advance & more so over ponder over them so as to derive viable solutions. Some of the imminent hurdles that could come in the way of GST Roll-out are detailed hereunder - 

(i)          The Political scenario - Federal &/or divided powers of taxation clubbed with a democratic framework of governance entail a situation wherein changes are driven by political requirements more than economic necessities - 

• Implementation of a unified GST requires vesting of equal powers in the state & central which in-turn mandates amendment of the Constitution of India [since presently constitution purports divided taxing powers]. 

• Now, amendment of the Constitution where dealing with provisions relating to the states requires in addition to the approval by both the houses of Parliament, the approval of each & every state legislative assembly. 

Thus, introducing impact of politics . . . .    

• United Progressive Alliance (UPA) the current ruling alliance at the centre since very keen on adding the implementation of GST to the list of its achievements, has left no stone un-turned to facilitate its implementation since 2007. However, out of the 28 states & 2 UT’s it has purportedly on one half to its favour hence resulting in a biased conflict within the Empowered Committee (comprised of the FM’s of the States) 

          The UPA would hence require to arrange a grand bargain and bring the states to a consensus over GST 

(ii)    Mass Opposition - VAT implementation had faced massive opposition from trade associations & general public, the GST framework since - (a) cutting short the exemption list (b) bringing new sectors into tax net (c) creating a capital intensive framework hence un-employment (d) higher rates i.e. 20%, may very well invoke long drawn protests all across the country and a probable effect on vote bank 

(iii)   Creation of a robust IT Infrastructure - a sound Information technology infrastructure is a pre-requisite for successful implementation of GST. The setting & working up of the Central agency, E-filing and E-regulation of returns & assessees would all require a hi-tech IT system. Moreover, such a system need be place substantially before the Roll-out of GST 

          The CG with the approval of the EC has constituted an empowered Group chaired by Dr. Nandan Nilekani with joint representation from the Centre and the States which would be authorized to take decisions about the size, features and functionalities of such a system 

(iv)   Timely completion of cadre review & re-organization - of the excise and service tax commissionerates country-wide as GST commissionerates along with separate commissionerates for audit and anti-evasion would take time, and rushing the process through without much thought can prove disastrous for the tax department as lesson learnt from many mergers of companies would illustrate.  For instance, the merger of Air India and Indian Airlines continues to suffer from many unresolved human resources management problems. 

          Presently proposed idea is that each commissionerate handle about 35,000-50,000 tax payers. Further, the GST commissionerates may be organised as a one, two or three tier structure or a mixed model of three, depending on the density of taxpayers in the jurisdiction of each commissionerate. Within each GST commissionerates, work is to be divided along functional lines to encourage specialisation rather than on territorial basis as is the norm now. The reorganisation would without doubt help the tax payers, as among the changes proposed include allowing companies with multiple premises within a state to choose the commissionerate with which it would prefer to file returns. 

(v)    Implementation of a flawless GST - in the drive to meet deadlines it could be possibility that the law makers sacrifice over maintaining the basic principles of the levy. Take for instance the recently released Constitution Amendment Bill proposes to keep Real Estate, petroleum, natural gas outside the purview of GST, thereby flawing the principle of comprehensive coverage and larger pool of credit. Moreover, it also proposes that Entry Tax is not to be subsumed thereby resulting in the carryover of the existing defect of multiple levies.         

          Though the aforesaid propositions have not yet attained finality, they do expose the governments haste in Rolling-out GST that could well result in a flawed GST 

(vi)   Post-implementation blues - the key performance indicator of successful implementation of GST is the continuance of uniformity. Promises & commitments made at the time of VAT implementation were shrugged off by the states by diverting from the rate structure & other provisions. Hence it would be very important to ensure that appropriate arrangements are made so as to prevent &/or supersede any subsequent diversions on the part of states. 

5.0      The Way forward 

            India is a country with extreme diversity in culture, religion and socio-economic status of its peoples. Segments of its populace are constantly vying with each other either to gain control over governance or to have its share of the opportunities. Therefore it will be futile to expect total consensus of all the stakeholders on any subject or issue be it education, health, social welfare, fiscal policy, etc. except of course in a situation of external aggression.        

            Hence the present development of near consensus for the road map to bring-in GST, in the political leadership is indeed a very good sign. It is better we adopt GST for levy and collection of tax on goods and services, in a phased manner, in preference to endlessly continuing to debate  on its model, methodology, rates, taxable base, etc.

            It is important to bear in mind that GST can be implemented only when all the States and Union Territories join-in. In other words there is no option for partial implementation just as it was possible when we transited from sales tax to VAT. The message is clear: we can get on to the GST bus only when all the States have boarded. It is the responsibility of all stakeholders - political leaders, intellectuals, industrialists, business houses, tax consultants, fiscal policy makers, etc. to participate in the debate and discussions leading to the launching of GST by April 2012. The media, needless to mention has a crucial role to play in co-ordinating and promoting these efforts.