Undeniably, the Indian economy will benefit from GST. It will be historic as it will be the single most significant indirect tax reform ever to be introduced in India. Economists assert GST will add around 1% to 1.5% to India’s GDP growth rate.
So why is it that even 7 years from the first call for GST in the 2007 Budget speech of Mr. P Chidambaram, we still don’t have it? What or who has been stopping GST? And why? Today, are we anywhere close to implementing GST? How long will it take from now?
We can’t answer all these questions in this article. But we can surely understand the underlying reasons for obstacles created to stall GST from being introduced.
The Concept of GST
GST will be an amalgam of several indirect taxes levied on goods and services. GST will provide an umbrella to shelter the tax payers from snowballing of taxes which occurs in the current system. With multiple taxes (both Central and State) getting embedded to the cost at each stage before reaching the ultimate customer, the taxes grows cancerously. GST will neutralize this snowballing by refunding at each stage the indirect taxes paid at earlier stages in the value chain.
Inadequacy in the current tax system
I must hasten to add that cascading in indirect taxes is not all pervasive today. Two credit mechanisms called CENVAT at the Central level (earlier Modvat introduced in 1986) and VAT (most States in 2005) minimise tax cascading. However Cenvat and VAT operateas two watertight compartments with no fungibility (cross credit) between them. Cascading is prevented only on a separate compartmentalised basis for the Central and State taxes. So cascading of taxes between Central and State taxes continues unabated.
Cascading taxes in current system
Even Cenvat and VAT credit mechanisms as they stand today do not neutralise the tax cascading totally even within separate compartments. Neither of these credit systems allow universal credit on all inputs, capital goods and input services used for producing goods or providing services. A fairly large part of the economic activity still remains outside the scope of credit, adding to cost and cascading taxes.
Illustrations of tax credit leakages
The following major types of transactions/situations go without credit under Cenvat and VAT:
1. No credit is allowed of State or Central taxes for cross utilisation on inputs or capital goods or services used by the manufacturer, service provider or trader.
2. Some goods and services even when used as an integral part of the value adding chain are ineligible for credit and covered by negative lists. E.g. petroleum products used as fuel, petroleum products used in transportation, fuel used in power generation, second hand capital goods in VAT, capital goods used outside the factory, outward freight on finished goods (disputed), ITC credit on IPR services and so on.
3. Where intermediate goods or finished products or services are exempted or not taxable, the credit is lost on the inputs and input services leading to cascading. Such exemptions break the VAT chain. Examples : power, exploration and production, exempted goods such as fertilisers, goods produced in backward area under exemption.
4. Those who are engaged only in trading of goods do not get any credit on input services they receive. Similarly, service providers who pay VAT on goods and sometimes intangible goods cannot utilize the credit.
5. Services provided for export of goods outside the factory after its removal.
6. Capital goods which are used for the business purposes outside the factory
7. ITC credit on VAT paid on intellectual property under what is termed as “intangible goods” (An oxymoron. An “article” can be goods i.e. physical or intangible NEVER both)
8. Central sales tax (CST) paid on inter-state sale. Without credit to the recipient, it is a dead loss to the buyer and adds to cost and cascading taxes along the value chain.
9. Input tax credit under VAT has to be partially reversed (@ 4%) on inputs when such inputs, intermediate products or finished goods are stock transferred outside the State.
10. Some State VAT law mandate partial reversal input tax credit (@ 2%) even on inter-State sale of finished goods.
All this simply means, the ultimate customer is short changed by the current tax system with a seriously inadequate credit mechanism which does not refund ALL the indirect taxes paid upstream. Hence we need GST!
What is GST?
In the GST regime, there will be less cascading (not completely eliminated) and greater transparency about the total taxes (both Central and State) paid on a particular good or service. The credit/refund of taxes paid upstream would improve cash flow for the business. Overall, practically everyone will benefit from GST.
So what is the hitch? Who is likely to object to GST?
GST is an amalgam of several indirect taxes. This means under GST the States’ power to levy taxes will diminish. To some extent this has already happened after VAT was introduced in 2005. There is already a lot of convergence in the VAT law, the tariff schedules and the tax rates across various States. So what really is the loss to States due to GST?
Main concern of some States is the likely tax losses on inter-State sale or movement of goods
The main reasons are spelt out in the three points appearing at serial no 8, 9 and 10 above. It will be seen that all of them are somehow connected with inter-state sale or movement of goods and CST.
The objections for GST comes mainly from some State Governments. As regards the Central Governments, the earlier UPA wanted it and now the current BJP is totally for GST. It’s only some States!
Taxes to be collected by the destination State where goods are consumed. Not on “exports” by the sending State.
To understand which States are blocking GST we have to understand another concept surrounding taxation on inter-State sale or movement of goods and CST.
Conceptually, taxes are to be levied and collected from tax payers for whose benefit the tax collected will be spent by the Government. For instance the Government’s spending on infrastructure, law and order, health services etc. This is also the underlying principle for zero rating exports. So one “exports goods but not taxes”.
Central Sales Tax and inter-State movement of goods. A need to be rationalise
Viewed through this underlying principle, CST appears as a really strange indirect tax. A tax levied by a Central Act of Parliament on inter-State sale but collected and retained by the state from where the goods originate.
Thus CST burden invariably falls on a buyer who resides outside the collecting State. The State collecting the tax has no intention whatsoever of providing any benefit this ultimate buyer/tax payer in the destination State.
CST is a tax on export. Rich industrialised “exporting” States benefit from CST
Stated differently, CST is a tax on “export” sale of goods from one State to another. Exports out of India are zero-rated. Ironically however, sale or movement of goods within the India itself (export from one state to another) attracts CST. Apart from the fact that the taxes don’t benefit the tax payer, neither is CST eligible for input tax credit. (There are logical reasons for CST’s existence of course but that does not eliminate the problem)
Simply put, the relatively rich and industrialized States with higher industrial production become net exporting States (higher exports compared to imports) and earn relatively more taxes from tax payers residing in other probably lesser developed consuming States. Quite likely that these State would need the taxes more desperately for their own development. Even from an angle of equity the current system doesn’t jell.
Each State is an independent taxing jurisdiction
Another aspect is that each State is an independent taxing jurisdiction within the same country. And the States end up taxing inter-State transactions without enabling any credit at the receiving end.
Even as this happens in India, the European Union formed by a union of 28 different European Countries now follow a common EU VAT code. This in principle means transactions of this nature between EU Member States are to be subjected to zero VAT.
How GST will change this
GST is expected to correct this major anomaly in the Indian indirect tax system by abolishing CST. Under GST tax in inter-State sale or movement will be collected ONLY by the destination States and the benefit of the taxes will therefore go to the tax payer in the consuming State.
A step towards abolishing CST was already taken when VAT was introduced. CST has been cut down from 4% to 2% but has not been entirely abolished.
So how will GST impact the States?
This means, affluent States will lose the advantage of CST and the other indirect tax collections through reversal of credit on stock transfers and inter-State sale. The revenue loss on the three counts due to a shift to a destination based tax would be :
· Loss of revenue due to abolition of Central Sales Tax–currently imposed @ 2%, it is collected and pocketed by the States from where the goods originate. One should note that sales taxes including CST is levied (can be levied) only on sale of goods. So services are currently outside the scope of State levies (sales tax and CST).
· 4% points input tax credit (ITC) reversal under VAT on inter-State stock transfer. The current State VAT law requires that when an input or finished product is stock transferred, a part of ITC availed on the input stock transferred is be reversed. In case of finished goods the reversal of credit on inputs is computed based on the ratio of sales and stock transfer and partially (disallowing 4% points of the credit)
· ITC reversal on inputs consumed in finished products which are sold inter-State under CST. This is relative recent and has not been around for too long. Mainly exporting States are restricting the credit on inter-State sales also. This means apart from paying CST @ 2%, the tax payer is also obliged to reversed credit to the extent of 2% points on the inputs consumed in the finished goods stock transferred. This is nothing but an indirect levy on inter-State sale of the inputs consumed.
Quantum of ITC reversal on inter-State sale and stock transfers – not known
The last point is that it is fairly easy to ascertain the CST collected by each state as it is collected under a separate tax head. But what exactly is the amount collected by each State on account of Sr no 8 and 9 is practically impossible to compute as the quantum would be unique for each tax payer and product. It will also depend upon the quantum of inputs, the quantum of inter-State sale and stock transfer and actual transactions during the period etc.
So when it comes to introducing GST, regardless of what people in positions of power say, one has to just look at the affluent States and the potential revenue loss and you will know which State Government is blocking and will continue to block GST.
Despite a BJP dominated NDA Government in place, it is now understood that even the BJP ruled States are resisting GST due to fear of loss of revenue.
States ignoring the fact that under GST States will be enabled to impose State level GST.
The States which are apprehensive about the introduction of GST are somehow missing a very important point. The GST will enable the States to impose a State level GST on services which are currently out of bounds for States. This will be a major positive for the States’ revenue.
So finally, with the PM, FM and many States firmly in favour of GST, and the awareness of GST benefits becoming apparent to all, let’s hope the States currently objecting will fall in line and GST becomes a reality soon.