GST and Tax Reform: Highlights (Part 2)

The prospects for the passage of the GST Constitutional Amendment Bill have improved since the May 2016 election results. This is because some of the larger states such as West Bengal and Uttar Pradesh (UP) have realized that they as net consumer states are likely to benefit as basis of sales taxation of goods and services shifts from the ‘origin’ basis (states where they are produced) to ‘destination’ basis (state where they are consumed).
Opposing such an important economic reform due to partisan politics has diminishing marginal returns, and is perceived as being counterproductive. As the government gets ready to make another push for the GST in the upcoming monsoon session, we might see the tax reform sooner rather than later. 

Monsoon session, 2015. Source: India Today.

Monsoon session, 2015. Source: India Today.

BRINGING E-COMMERCE UNDER GST: AN ESSENTIAL STEP

(a) What should be treated as point of sale?

(b) Whether e-business is to be treated as market place or inventory model of online business ?


The point of sale in online trade i.e., where the sale is deemed to have occurred, fixes the liability and incidence of tax. For intra-state sale, i.e., where the seller and buyer are in the same state, the Value Added Tax (VAT) rate of that state is applicable and collected from the seller.
For inter-state trade i.e., where the seller and buyer are located in different states, the Central Sales Tax (CST) is applicable and is collected and kept by the state in which the sale originates and not by the destination state. In the case of online trading / selling in the business to customer model, the seller is liable to pay both CST and VAT, depending on location of the seller.
In respect of transactions through e-retailers, there is considerable ambiguity regarding where the sale is deemed to have occurred and hence, in the incidence of tax. This leads to dual tax demand, both at the point of origin as well as at the point of destination.
The second issue relates to who is responsible for the collection of tax. Large e-retailers are of the view that they are providing an online marketplace to both buyers and sellers. Under the marketplace model, e-commerce firms host third-party merchants on their websites and customers buy goods on the sites from these merchants. Thus, the third party vendor/seller is liable to collect the VAT and the online platforms only need to pay service tax on the commission they charge the vendors listed with them.
However, state governments are of the view that these online platforms are inventory-based models as many of the online traders set up warehouses and store goods before any sale has been transacted. Hence, they contend that these online retailers are liable for tax on the sales.


Various state Value Added Tax Acts and the Central Sales Tax Act, 1956 predate online retail activities and do not cover them specifically. Tax rates and rules differ widely across states. Even the definition and treatment of dealers and distributers differ. Further, if the vendor/third party is not registered under VAT in the state of destination, monitoring compliance of collection of tax becomes difficult.

TAXING E-COMMERCE: STATES' RESPONSES


Conscious of the potential loss of revenue from burgeoning e-commerce, states have been undertaking a variety of
strategies. They include:

  • Treating these businesses as inventory-based models and applying local state tax on transactions from local warehouses/distribution centers to buyer;
  • Calling for records of warehouses to verify if appropriate taxes are being paid;
  • Exerting pressure on online sites that do not have warehouses to establish warehouses and distribution centers in their states so that online trades can be easily taxed;
  • Calling for details of sales made by major e-retailers in their respective states; asking them to register themselves as dealers in the state and file applicable returns;
  • Undertaking surveys to assess the loss of revenue from online sales.
  • Apart from these administrative measures, states have also been calling for legislative measures such as amendment to the Central Sales Tax Act to make it easier for them to tax online retail transactions.
  • The Karnataka Government plans to amend its Value Added Tax Act and bring e-commerce marketplace transactions under its purview. It proposes to classify online marketplaces as ‘commission agents’ since they charge a commission from third-party sellers for using their platform and their delivery and warehousing services and make them liable to pay VAT to the state government.

INDIA-LEVEL LEADERSHIP NEEDED FOR TAXING E-COMMERCE


In view of the complex problem faced by countries in taxing e-commerce, India needs to develop a uniform model across States that is easy to implement. Leveraging technology and plugging the gaps in the Statelaws will lower the cost of compliance and monitoring of e-commerce taxation.
India has a system of consumption taxes levied at the Federal and State level on goods and services which constitute the primary source of revenues for both the Federal Government and the States (about half of India’s total tax revenue -broadly defined- is from this source). If Customs duties are added, the share increases even further.
The challenges that the tax revenue is obtained from several separate complicated tax laws, with high compliance costs, which impact the cost and methods of doing business and create opportunities for rent-seeking by various stakeholders. It is this aspect that GST will help mitigate.


Current Sales Tax structure:
The Central Government levies
(i) A Central VAT (CENVAT) on the manufacture and production of goods;
(ii) A Service Tax on a specified list of services;
(iii) A Central Sales Tax (CST) on inter-state sales of goods

  • The States levy a State VAT on the sales of goods within the state.
  • A nationwide GST (Goods and Services Tax) to replace other taxes (Excise taxes, Service tax, Entertainment tax, Octroi and related taxes such as LBT-Maharashtra) all existing indirect taxes levied at the state and national levels is currently being debated.
  • “GST badly needed. Indian freight trucks spend 60% of travel time between cities waiting at check posts to pay taxes & clear formalities. India's logistics costs are 2 to 3 times the international benchmark. GST can cut this large bureaucratic cost & give a huge boost to growth.” Kaushik Basu, The World Bank Group's Senior Vice President
  • It will require a Constitutional amendment as currently the Centre cannot levy sales taxes; and states cannot levy general service taxes.
  • There are 32 parties (Union Government, 29 states, and 2 Union Territories)

PROPOSED GST STRUCTURE

  • It is proposed that a GST consisting of a Central GST (CGST), State GSTs (SGST), and IGST (Interstate Sales) be implemented. Under the GST system:
  • The Central and the State governments will tax both goods and services at each stage of the supply chain.
  • The Central Government and States will set their rates separately on an agreed basis. The rate currently being discussed is 16 percent, but no final decision has been made.
  • A destination-based tax will be levied and will operate with full input credit system.
  • Technology to deal with cross border (within the country as well) transactions. NSDL (National Securities
  • Depository Limited), which also manages Tax Information Network (TIN), has been entrusted with the task. It is a public sector company.
  • At the Union Government level, GST will be administered by the Customs and Excise Department. This is unusual as in most countries, GST is administered by the Department administering Income Tax.
  • The reform has missed several deadlines, one reason for which is a lack of consensus (with lack of trust between the two a factor) between Centre and State governments. Prime Minister Modi’s Government, current efforts of “cooperative federalism”, is well positioned to move towards consensus.
  • As Constitutional Amendment needed, earliest start date for GST would be mid-2016.
  • States are concerned about the loss of revenue as they fear that the proposed national GST may encroach the State VAT revenues.
  • They are also concerned about the loss of fiscal autonomy as far as levying taxes is concerned, which is unavoidable if there is uniformity in the rate structure of the proposed GST. The key items of disagreements are: petroleum taxes, liquor taxes, purchase tax on food grains, and entry tax. To retain integrity of GST, it is essential that petroleum tax, purchase tax, and entry tax are included in the GST.
  • The compensation to states is also an issue, but more a political bargaining issue than a technical one.
  • There is also an issue concerning level of sales below which firms need not register for GST.
  • States may prefer lower level (about INR 5 Lakh), ideal would be INR 50 Lakh to minimize administrative burden; (likely compromise around INR 15-20 Lakh).
  • In GST, the difference between Exemption and Zero rating is critical. An exempt fund must pay input taxes on their purchases but are not eligible to get credit for the taxes paid, so the only loss of revenue to the government is at the final stages.
  • A zero rating means that output tax rate is zero, and all input taxes paid by the firms are to be refunded.
  • Exports are usually zero rated, relieving exports from input tax burden. The integrity and the effectiveness of the refund process therefore acquires critical importance
  • While it is legitimate for states to bargain to retain their fiscal autonomy, they should not use it to indulge in predatory competition and export tax burden to non-residents
  • The dilemma is that state can potentially retain flexibility in GST rates and base but the economy as a whole will forego potential benefits, including relatively lower administrative and compliance costs of the GST (Ramachandran 2014).
  • Fiscal autonomy however need not just concern GST rates and base, but other areas. Example: Central government Schemes such as NREGA or Food Security Act, does require state fiscal expenditure, reducing their fiscal autonomy.
  • Narendra Modi led government has addressed this concern by moving several Centrally Sponsored Schemes to the States while increasing devolution of resources to the States to use them according to their own priorities.

Potential benefits associated with the reform: (the extent will depend on the details of design and implementation which are not yet unveiled, the extent of benefits)

  • Tax administration and compliance may be simplified
  • The tax base, laws and administration procedure across the country will be harmonized.
  • GST could potentially permit cross-auditing of returns with income and other taxes, assisting in reducing tax avoidance and evasion. This will however require customs and excise department which is entrusted with the responsibility of implement GST, collaborate closely the Income Tax Department. Merging these two departments to form a unified Indian Tax Administration Service merits serious consideration.
  • May neutralize the cascading effect (i.e. taxes being levied on top of taxes)
  • May boost exports and increase the competitiveness of Indian goods and services.
  • Assist perusal of fiscal sustainability

GST: RECENT DEVELOPMENTS


For exempt firms, states would like both administrative and legal jurisdiction. The Union Government may prefer only administrative but no legal control by the states on C-GST as its revenue is at state, this issue can also be resolved with better trust.
The Bill creates envisages a GST council in which the Union government and the States are members. It will make recommendation of rates, exemption list and threshold limits.
GST decision should have a majority of not less than 3/4th of the weighted votes of the members present (Union government has a weight of 1/3rd and state government together have a weight of 2/3rd ). So the Union
government will have an effective veto over the council decisions.

RECOMMENDATIONS OF THE 13TH FINANCE COMMISSION ON GST


The recommendations of the 13th Finance Commission (FC), 2010-2015, tabled in Parliament on February 25th, 2010, on GST, are found in chapter 5 of the FC report. These recommendations were however not accepted. The main reason for discussing it is the alternate modalities of implementing GST.
The FC commissioned several studies to develop a model GST, and to assess the impact on international trade and other macroeconomic aspects. It also held wide consultations with the State and Central governments.
The key message of the FC Report is that only if the Model GST is put in place, can all its potential benefit be fully realized (p.64).

GST reform has been called ‘game changing tax reform’ as its one of the most ambitious of indirect taxes that a federal country has attempted. It has the potential to create for the first time a unified national market in India.
Dual Tax, with both Central and State GST components levied on the same tax base. This will increase complexity. The FC estimates that the Model GST will have a tax base of INR 31,000 billion: and the revenue neutral rate will be 12 percent (5 percent CGST, 7 percent for SGST). This is substantially lower that the present 20.5 percent (8 percent CENVAT, 12.5 percent VAT). 12 percent should be the target.
In 2011-12, the state general sales tax (INR 3432.30 billion), the central sales tax (INR 16.54 billion) and the central service tax (INR 950 billion) together amounted to 4.9 % of GDP. The revenue neutral GST must therefore generate the same revenue.
The expectation is that it will generate up to 1% of GDP more than the current arrangements, but much will depend on design, administration and compliance.
The main recommendation, which has been accepted by the government, is the much larger devolution of Central government taxes to the states.
Combined with revenue from coal auctions, and other mining royalties accruing to the states, States will have access to much larger pool of resources.
Challenge is to modernize public financial management systems to take advantage of this.
The opportunity cost of deviation from the 13th FC’s recommendations will be lower tax base (requiring higher rates), and greater administrative and compliance costs


URGENCY FOR THE STATES TO BEGIN TO PREPARE FOR THE GST

  • Time frame to implement by April 2016 is too short. (Earliest GST can now be implemented is April 1, 2017. Even if the Bill passes in the 2016, GST is unlikely to be implemented in the middle of the Financial Year).
  • Urgency for the states to begin to prepare for the GST however remains. States will for the first time be able to levy sales tax on services (expending their tax base significantly) but have no experience with service tax. So they could consider cooperating with services Tax Division of the Union government, and begin to prepare service Tax Registry.

TAX BASE


Current Tax Structure:

  • There is no common tax base between the Central and State governments.
  • The Central and State governments impose different types of VAT either on goods or services and therefore, on a different tax base. These taxes are not necessarily creditable against each other and this may create a cascading effect.
  • The proposed dual GST will be levied on a common base of goods and services.
  • The list of exemptions should be common and a uniform registration threshold should be applied.

GST Rate Structure

  • A single rate is often advocated for GST on the assumption that gains from lower administrative and compliance costs outweigh the loss from efficiency and equity arguments.
  • Optimal tax theory however, argues for multiple tax rates depending on the price elasticity of demand. But amidst information, administrative, equity, distributional and political economy considerations, it may not be viable to have such a policy.
  • A uniform rate structure across states could potentially reduce fiscal autonomy of the States, but will be hugely beneficial in lowering distortions and compliance costs, improving India’s competitiveness' floor rate across states rather than a uniform rate will give states some leverage, but may lead to a complicated multiple rate structure similar to the one prior to the introduction of State VATs.
  • The GST reform proposes that the various Central, State and Local taxes (i.e., amongst others, the CENVAT, Service Tax, CST, State VATs and various entry or luxury taxes) to be replaced by a dual GST.
  • This GST would allow the two levels of government to tax both goods and services at each stage of the supply chain. The Central Government and States will set their rates separately.
  • The Central Government would levy a Central GST (CGST) and the States would levy a State GST (SGST) and each level would determine the tax rates.
  • The CGST, SGST, and IGST are different taxes, hence they should not be creditable against each other.
  • The basic features of the CGST and SGSTs however, such as the provisions regarding the chargeability, taxable event of the tax or valuation and classification, would be harmonized. Rules and procedures should be uniform as well.
  • Unprocessed food items, government and meritorious services like education and healthcare, stationary and books, and life-saving medicines are among the things that are best exempted for equity and administrative reasons.
  • However, it is also important to keep exemptions to a minimum, as they will not enhance the States’ fiscal autonomy, will make the tax base narrower, and will not facilitate comprehensive crediting of input taxes.

In the discussions surrounding the 2016 Budget, the following points relevant to GST have emerged:
1. Minimizing GST exemptions to keep base broad
2. Keeping combined GST rate of Union and State Governments to around 18%. This would imply nominal
service tax rate will increase (it was 14 percent in 2015-16, though effective rate varied, and on many goods,
particularly intermediate inputs used by Indian businesses to decline). This would moderately improve
fairness of the Consumption taxes, including that of Customs duties.
3. The GST rate should not be decided on the basis of revenue neutrality with existing distorted tax system, but
on the basis of wider competitive considerations, and to achieve objectives of reducing compliance costs,
expanding base, and encouraging Make-in –India initiatives. (Asher, 2016).
The IGST of 1% (Proposed for initial years) could be scrapped. This will improve GST design as inter-state
sales should not be taxed. GST does move the taxation from ORIGIN to DESTINATION basis. This may lead
to loss of revenue by states who produce more on net basis than consume. But as the Union Government will
compensate for the shortfall in revenue for full five years, IGST of 1% has little significance for revenue, but it
reduces the benefits from GST.


ADMINISTERING THE TAX

The Central Government administers the CENVAT, the Service Tax and the CST.
The States administer the State VATs with some coordination between the State VATs as far as the tax base
and tax rates are concerned.
The CGST be levied by the Central Government while the SGSTs will be levied by the States.
The CGST, SGST and IGST are to apply on international cross-border supplies of goods and services, and SGST would accrue to the State of consumption according to the destination principle.
Inter-State supplies of goods and services will normally be subject to an aggregate of CGST and SGST called the Integrated GST (IGST) administered by the Central Government. Since inter-State trade should be taxed at the origin, the Central Government would operate like a clearinghouse compensating the State of consumption.


COMPENSATION


A compensation package for any revenue loss further to the introduction of VAT was implemented. States were compensated for any revenue loss at the rate of 100% of revenue loss during years 2005- 2006, 75% during years 2006-2007 and 50% during years 2007-2008.
It is envisaged that the Central Government will compensate deficit-revenue States for the first five years following the implementation of the GST. Any compensation should be paid on a monthly basis to smoothen tax flows.
An important issue is that concerning revenue-neutral rates, which have been arrived at by the task force by averaging five different estimates found by different methods. States do not want to lose tax revenue on account of lower rates in the long term, even though they will receive compensation from the central government in the short-run.

TAX REVENUE


In the current system:

  • The CENVAT, Service Tax and CST are levied by the Central Government.
  • The revenues of the CST accrue entirely to the States.
  • The States levy the State VAT and the revenues of the State VATs accrue to them
  • The CENVAT applies only at the production or manufacturing of goods. The Service Tax and the State VATs are destination-based taxes whereas the CST is an origin-based tax.


Implications for Companies:


Transition Issues -Detailed Rules

  • Each Company will need to examine in detail what are the exact software program changes that are needed to be GST compliant. Sound homework by each company on this issue could potentially save fees to be paid to the outside consultants.
  • From the perspective of the Group having several companies, it may be useful to have a central shared services concept, so that the transitional issues into the software program changes needed including SAP and ERP are made coherent on a Group basis.
  • The GST will imply a higher tax rates on services than the current rate of 12%, and may imply lower rates for some goods. This will help pricing policies and marketing strategy implications.
  • Some states such as Gujarat have indicated that they would like to have the provision of additional one percent rate over the standard GST for a limited time. This one percent levy is sunset clause for two years unless the GST council agrees to extend further. This may also complicate the software programs for implementing the GST, and pricing and marketing strategies of the companies.
  • Changes in accounting
  • Each state VAT and Service Tax merged
  • No separate service tax
  • No Octroi and related taxes such as LBT in Maharashtra
  • Entry Tax? : coherence of GST demands abolition of entry tax
  • Exemptions vs zero rating

Implications for Alcohol and petroleum

  • Petroleum is zero rated in the proposed GST Bill, alcohol is excluded from the GST tax base. These features, unless addressed, will reduce the benefits from GST as they lack economic rationale.

CONCLUSIONS


India’s GST initiative deserves to be considered a project of national importance. With GST, India will have two Broad-based taxes (the other being income tax), in line with requirements of a modern tax system.
It has the potential to make India a more unified common market, improve revenue generation, and promote equitable tax of goods and services while reducing administration and compliance costs.
But the Federal nature of the country and complex objectives, including preserving fiscal autonomy of the states, will require constitutional change, solid technological base, and a degree of mutual respect and trust between the Union Government and the States.
The challenges of training the staff, and reorientation of tax administration towards greater professionalism, (including modern risk-based auditing practices) will also need to be met.
A strong low cost and efficient arbitration and dispute resolution mechanism for all stakeholders will be essential to reap the benefits of GST. It is evident that a very small proportion of the large tax arrears outstanding currently are recoverable, but it takes disproportionate resources of the tax department. Thus, Minister of State for finance in a written reply in Rajya Sabha has stated that as of April 1, 2015, income tax arrears alone were INR 8.3 trillion, equivalent to 6.6 percent of India’s 2014-15 GDP. This phenomenon must be avoided for GST and kept in mind in other tax reforms.
Given the technical and administrative complexities of VAT/GST, and aggressive tax planning concerning GST, India’s relevant tax authorities would find an active participation in OECD’s Global Forum on VAT.

Networking, regular communication with other VAT officials from different countries, and conscious promotion of learning organization attributes will be essential as India strives towards a modern tax system suitable for its projected USD 5 trillion economy some time before the year 2025.

References:
Asher, Mukul G. (2016), How To approach Setting the Rate structure for India’s GST? MYINDMAKERS, March 2
Asher, Mukul G. (2015) Rationale & Key Requirements For Implementing GST In Indian States, Swarajya,
Bird Richard M. & Smart Michael (2014), “VAT in a Federal System: Lessons from Canada”, Public Budgeting & Finance, Vol. 34, Issue 4, pp. 38-60.
Cnossen S. (2013) ‘Preparing the way for a modern GST in India’, International Tax and Public Finance, vol. 20, no. 4, pp. 715-723.
Ernst & Young: Worldwide VAT, GST and Sales Tax Guide 2015. 
Government Accountability Office, U.S., 2008. Value-Added Taxes: Lessons Learned From Other Countries on Compliance Risks, Administrative Costs, Compliance Burden and Transition.
Gupta, Atul Kumar, 2015 GST Concept & Roadmap, New Delhi: LexisNexis Inland Revenue Authority of Singapore: Annual Report 2012/2013
OECD (2014), Consumption Tax Trends 2014: VAT/GST and Excise Rates, Trends and Administration Issues, OECD Publishing.
OECD, Revenue Statistics in Latin America 1990-2010.
Ramachandran, Narayan, GST: small reform, big impact, Pragati, August 31, 2014.
Nair, R., GST rollout: CBEC looks to curb tax evasion, Live mint