Besides being a source of funding of public expenditure, taxes also enable influencing expenditure patterns thereby distorting individual behavior. Indirect taxes distort expenditures primarily by affecting the price of consumption goods. In India, the existing indirect tax system has become extremely distortionary with its plethora of exemptions and exceptions, and the cascading effect, which favour some goods and services at the expense of others. Consequently, rather than being driven by own needs and preferences, the consumer preferences tend to be driven more by the decisions made in the Ministry of Finance. Thus the distortions yield inefficient resource allocation and in economic terms, come at the price of inferior Gross Domestic Product (GDP) growth.
So the primary question before the policy maker is: how to shift to non-distortionary consumption taxes which enable increase in production efficiencies and enhance international competitiveness of Indian goods and services? The Goods and Services Tax (GST) is being proposed as the answer to this question.
As regards the industry, the indirect taxes are taken as a pass-through in their hands and hence perhaps are not given the due attention they may deserve by the industry. But the actual reality is quite different.
It may not be possible to shift the entire burden of indirect taxes to final consumers due to say competition from the grey market or other market forces. There is also the cascading effect whenever there is a break in the input tax credit chain. For example, the inter-State purchases are liable for payment of the Central Sales Tax which is not eligible to be taken as input tax credit. Similarly, Cenvat credit of the excise duty paid on inputs is disallowed where a service provider is undertaking a works contract. Further, there are several location/area-based or end-use based tax incentives and exemptions which also significantly influence supply chains and business decisions.
An ideal GST should be in the nature of a destination-based consumption VAT on all goods and services with no exemptions or exceptions. The question is whether the proposed GST conforms to this ideal or not? To answer this, let us take a look at some features of the proposed GST.
Proposed GST in India
- The proposed GST will be on all ‘supplies’ of goods and services. The term ‘supply’ has not been defined as such, but is expected to include both sale and consignment transactions. Though the tax paid on stock transfers would be eligible to be taken as input credit by the recipient, if we take into account the higher GST rate, there could be an impact on the working capital and financial costs incurred depending on the working capital cycle.
- ‘Services’ has been defined as anything other than goods and hence goods and services together, at least at the definitional level, constitute everything! However, alcoholic liquor for human consumption is proposed to be kept out of GST. During the initial years, five specified petroleum products will also remain out of the GST net.
- The levy will subsume multiple existing levies such as central excise duty, service tax, cesses and surcharges levied by the Central Government, and the sales tax/value added tax, purchase tax, entry tax, entertainment tax, etc. as well as the cesses and surcharges levied the State Governments.
- The levy will be dual with separate GST levies by the Centre and also by each of the States. The Central levy will be called the Central GST (‘CGST’) and the State levy will be called the State GST (‘SGST’). The inter-State supplies will attract Integrated GST (‘IGST’) to be levied by the Centre. This will mean that the compliance requirements for taking and utilization of input credit of SGST and IGST will need to be watched for.
- A temporary levy in the form of a 1% additional origin-based tax is also proposed on inter-State supplies for consideration. This tax is not eligible to be taken as input credit and hence will have a cascading effect.
Rate variations and exemptions
- The Constitutional Amendment allows for the Goods and Services Tax Council (GSTC) to recommend the rates including floor rates and bands for the GST. Already there is a discussion on having at least two rates – one lower normal rate and a higher rate for demerit goods such as tobacco and luxury items. GSTC will also recommend on the goods and services which may be subjected to or exempt from GST. Special provisions may apply with respect to 11 specified States.
Place of supply
- GST credit chain will follow the underlying documentation whereas the supply chain will flow with the use/consumption of the goods or services. Input credit availability would require that the GST chain should closely follow and integrate with the supply chain. Otherwise there will be loss of credit and the consequent cascading effect. The Place of Supply Rules which are still being finalized will be crucial in this aspect.
Distortions in GST
Read together, it would appear that the policy elites do not want to give up any of the complications or discretions of the existing indirect tax structure and would like to carry them forward into the GST as well. The 1% additional tax adds to the complexity with some cascading effect as well. The GST will also have multiple levies, multiple rates, exemptions and exceptions and special dispensation for certain States. Thus the regime of area-based and end-use based exemptions and exceptions may not exactly be over as such, but would only require a more difficult and much more elaborate political process before they can come through.
So the transition into GST may not be as smooth for the industry as is generally made out to be by some tax experts and in certain media presentations. Hence there may also be a case for the industry to take stock of where they stand now vis-à-vis what could be in store for them once the GST is implemented.
[The author is Director, Lakshmikumaran & Sridharan, Delhi]