India’s Landmark Tax Reform GST: Suggestions for Minimizing Administrative and Compliance Costs and Improving Effectiveness

This article was originally posted at

India is set to implement a GST (Goods and Services Tax) regime from July 2017, considerably simplifying and rationalizing its tax regime for domestic goods and services. GST is set to replace a plethora of distortive taxes on goods and services provided and used in India by the Union and the State Governments.

Considerable preparatory work, including forming of GSTN (GST Network), an information technology backbone, and allocation of assessment and other tasks between the Union and the States, has been completed through consensus. Achieving such a consensus among the Union Government and 29 States including the State of Jammu & Kashmir has been a major achievement of India as a whole.

For GST taxpayers with turnover of less that INR 15 million, 90 percent will be assessed by the States, and 10 percent by the Union Government. For the taxpayers with turnover of over INR 15 million, the distribution will be on 50% each. It is essential that these allocations are done on scientific basis by an organisation such as GSTN, in which both the Union government and the States have a stake.

The GST rate structure agreed is initially somewhat more complex due to a legacy of last several decades which have resulted in a wide variety of tax rate (and base) decisions on an ad-hoc basis. India obtained disproportionate share of revenue from goods, resulting in lower competitiveness in manufacturing and less fairness as lower half of the population spends relatively higher proportion of household expenditure on goods. GST will help correct this deficiency.  

The consensus rate structure for GST is 5% (essential goods), 12% , 18%, and on select items 28%. The GST officials are in the process of allocating commodities to the respective rate bracket. This exercise should be undertaken with economic and social rationale of the GST, which is to broaden the base and have uniform rates nationwide, with due regard to clarity and minimizing sudden discontinuities in the tax treatment of individual commodities. This poses major challenges which must be addressed.

The Union government has agreed to a generous compensation formula for the first five years of GST implementation for the States. Based on 2015-16 agreed upon revenue of each State, an assured 14% revenue increase will be ensured by the Union government, much higher than around 10 to 12% revenue increase experienced in the past. The Union government will compensate each State in case their GST revenue falls below the agreed upon amount. The State thus effectively have five years to adjust and raise their capacities to enforce GST in an effective manner.  It would however be in the interest of each State to acquire competency in effective implementation of the GST as early as possible, as India’s cooperative-federalism initiative also implies constructive competition among the States to locate economic activities and retain and attract talent within their jurisdiction.

Among the remaining tasks for implementing GST is finalizing the Draft GST Law, and preparing the tax administration of both the Union and the State levels for taxing both goods and services in an integrated manner under one tax law applicable nationally. This is being applied for the first time in India, potentially making India a unified national market. Each side therefore will need to consciously plan to be learning organizations, with appropriate benchmarking of key performance indicators including minimization of administrative and compliance costs, if this landmark reform is to achieve the desired outcomes.

There is considerable scope for minimizing administration and compliance costs and enhancing effectiveness of GST. Specific suggestions are made below.

1. Minimize ambiguity in GST law and in Implementing Regulations

Clarity in wordings of the GST law and in implementing regulation is essential. This is because the clarity makes the GST consequences of a given transaction more certain to the tax payers. This will enable them to make decision on commercial logic and economic rationale rather than be affected by the tax considerations. Second, it will help reduce undue discretion which the tax official could potentially exercise. In a country with 1.3 billion population, and considerable variations in economic, social and business conditions and practices, it is essential that variations in the interpretation of a given legal provision, and in interpretation of specific implementing regulations be minimized. This is also essential for fairness in taxation.

There is a strong perception that the basic issues of when a taxable event occurs remain unclear and therefore subject to varying interpretations by both the taxpayer and tax officials even for the very common and frequent business transactions. It also appears that in the GST Draft law and in the implementing regulations issued so far, significant number of interpretations are left to the discretion of authorities which in turn has the potential to lead to large variations in interpretation, which as noted is inefficient and not consistent with the objectives of the GST to make India unified market with low costs of doing business.

To help address the above, it is useful to clearly state the economic intent and underlying commercial logic specifically at as many points as possible, while simultaneously explicitly giving some typical repetitive transactions and provide elaborate special rules for such instances.

As an example, Malaysia and Australia have issued communications giving guidance concerning the specific tax and credit applicability for typical transactions in various businesses, and for major types of book adjustments. These would significantly assist the businesses in understanding the intent of the law in context of their specific transactions, while clarifying tax consequences of a particular course of action. Such transparency is needed, and would represent needed mind-set change for the tax administration and taxpayers.

Malaysia has issued GST guides for more than 50 industries and transactions like Aviation industry, investment banking, advertising services, capital goods adjustment etc. In India also, such elaborate guidelines from the government may help the industry in taking tax positions and avoid disputes at a later stage.

An institution to respond to the interpretation issues faced by the businesses so that potential issues concerning implantation of the GST can be resolved merits serious consideration. An on-line facility to authoritatively respond to GST queries could help i9n this regard. The existing advance ruling model has its own limitations. An institutional mechanism for continuous research and availability of response to the businesses in case they wish to have authoritative view to ensure compliances may help in reducing administration and compliance costs, and help in making an unified national market. 

2. Choosing words consistent with India’s growth strategy and vision

India’s USD 2.5 trillion GDP economy has reached a stage where words in the laws and regulations must be chosen carefully. Anti -profiteering is not a kind of term which is appropriate for India’s economy at this juncture. The proposed provision for anti profiteering in the draft GST legislation entrusting power to an authority toascertain whether the reduction in taxes have resulted in reduction of prices as an anti-profiteering measure may need a relook in this context. Ascertaining the impact of GST on tax costs of a given business may not be that simple exercise and leaving such responsibility to the discretion of tax officials with inadequate understanding of pricing and other decisions could create adverse unintended consequences, including for accountability and transparency.

As noted, reduction in the discretion available to the tax officers and a professional and accountable approach in tax collection and administration of taxes would lead to better compliances. Extending discretionary powers to the officers to access the premises of the businesses for inspection of records and computer programs also is not conducive for desired environment for tax policy and administration. Defining principles for exercising and limiting such powers merits serious consideration. 

It should also be stressed that mind-set change is needed on the part of current and potential taxpayers, and on the part of those who advise on tax matters. They also have responsibility to help broaden the base and to minimize undue litigation.

3. Ensuring appropriate mind-set and skill-sets

As the union and the State governments prepare for implementing the GST, it is an opportune time to take concrete initiatives to restructure the relevant components of the tax administration. It is the government organizations which deliver services, and this major reform represents a good opportunity for organizational tune-up.

Improving service orientation, and enhancing transparency and accountability through a combination of technology, changing mind-sets and skill sets through appropriate human resource strategy, thus merits high priority. In particular, forensic accounting, risk based auditing and industry specific specialization, will need to be given consideration. A lateral entry of those with required skill sets, developing shared services between the Union and the Individual States (through use of GSTN and other alternatives) needs to be explored.

Shared services are useful when there is high capital intensity and/or skill intensity. GST administration requires both of these, making exploration of such shared services by the stakeholders feasible. This could reap significant cost benefits, while improving compliance.

In conclusion, India’s landmark GST reform is a process and not just a one-time event. Measuring to make tax administration at the union or State levels as learning organizations are essential. So is the need to minimize ambiguity and undue discretion. India has in the past demonstrated that once the decisions are taken, it is able implement complex reforms well. The past record suggests similar outcome for GST, but the success will not be automatic.