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GST Tryst with Three Fault lines!

TIOL - COB( WEB) - 525
OCTOBER 27, 2016

By Shailendra Kumar, Editor

GOING by the decade-long 'baking' of the proposed Goods & Services Tax (GST) regime, it is quite fathomable to close GST-watchers that the some of the critical decisions are going to be hugely painful! It is quite natural that the pangs of birth of any new system cannot be avoided in toto despite the best of what the Union Finance Minister, Mr Arun Jaitley, has described as 'deliberative democracy'. The proposed multi-rate tax structure has triggered an intense debate in the political and fiscal space. The former Finance Minister, Mr P Chidambaram, has commented that the proposed multiple tax rates are not the characteristics of a GST. They are integral part of the present VAT system being enforced by the States. He fears that such a tax rate structure may wash off the intended benefits of the reform process. His fear is that a new system beginning with several tax rates may revive the 'ghosts' of the old tax regime such as classification and litigation over several other issues. The underlying message of his criticism is that in its proposed avaatar, the GST may not deliver the much coveted benefits which the economy has been craving for.

Some columnists and other fiscal correspondents have also expressed their apprehensions that the multi-rate tax structure is bound to invite back the painfully-settled issue of classification of goods and services. They also fear that with the abatement, there would be a minimum of two tax rates for the services, and the intended objective of the GST which means the same incidence of taxation on both the goods and services, may become infeasible. Yet another fear which has been articulated expressly, is that such distortions in the new system may lend discretionary powers to the taxmen who do not want to vacate the legal space enabling them to act arbitrarily or to be susceptible to corporate lobbying.

In response to some of these criticisms, Mr Jaitley opted for a BLOG route on one of the popular social media platforms. In his blog he has stated that nearly 50% of the weightage in the CPI basket, largely food items, are going to be exempted from the levy of GST. They are going to be zero-rated. And the objective is to dilute the regressive nature of GST which impacts the rich and the poor equally. As regards the other items, he has stated that "those presently taxed below 3% as the total tax of the Centre and the States will be taxed at a zero rate. Those between 3-9% will be taxed at a 6% rate, those between 9-15% will be taxed at 12% and there would be a standard rate of 18%. Some have suggested that multiple tax rate is disadvantageous to the GST and would neutralise some of the advantages of a uniform tax structure. The reality is that a multiple tax rate in India is inevitable for several reasons ... Air conditioners and hawai chappals cannot be taxed at the same rate. Total tax eventually collected has to be revenue neutral. The Government should not lose money necessary for expenditure nor make a windfall gain ... A commodity being taxed by the Centre and the State at 11% at present will be taxed at 12%. If its taxation is suddenly raised on standard rate of 18%, it would disrupt the market and would be highly inflationary."

Given the socio-economic diversity in the country, Mr Jaitley is perhaps right in taking a view that there cannot be just two or three rates, particularly for the goods. A good future with a single or two rate structure is desirable and can be an ideal goal but the GST cannot afford to abruptly snap off its nexus with the present tax rate structure. Any attempt to bury the present prevailing rates would necessarily be inflationary and may yield undesirable distortions in the economy. There are goods largely consumed by the poor and they have to be zero-rated. Or, it would have disastrous political consequences. Secondly, some of the precious metals like gold cannot be subjected to very high incidence of tax as it is consumed not necessarily only by the rich. Given the socio-religious importance of this metal, it is wrong to say that only the middle class or the rich consume gold. Its consumption among the labour class or the daily wagers or blue collar workers is no less. So, subjecting gold to very high rate of taxation would be too 'disruptive' for the society at large to accept meekly. However, at the same time it cannot be allowed to devour on India's forex kitty and eat into the vitals of the trade balance. So, it is inevitable to have a special or stand alone rate for this commodity. With these two rates and the proposed four rates, the total tally of rates indeed goes up to SIX. And it appears to be unavoidable. Though one may look towards the EU for the minimum rate structure but they are small countries with distinguishable patterns of economic development. There is not so much of diversity in the economic conditions of the people in these countries. Even then, there are many economies which have two to three tax rates such as France, Ireland, Finland, Italy and Austria.

This brings us to the issue of CESS in addition to the peak GST rate of 26%. Such a CESS has been proposed to tax demerit or sin goods. And the revenue earned from CESS is to be utilised for compensating the revenue loss of the States for a period of five years. In favour of the legitimacy of such a revenue-raising tool, the Union Finance Minister has argued that if the CESS route is bypassed and the higher GST rate is opted for, the Union of India would require to garner as high as Rs 1.72 lakh crore to manage a sum of Rs 50,000 Crore, for instance, required for paying compensation. And his simple logic is that this sum of Rs 1.72 lakh crore is to be divided between the CGST and the SGST which would mean only a sum of Rs 86000 Crore in the Centre's kitty. And after remitting 42% in the divisible pool, it would be left with the required Rs 50,000 Crore. And it would be quite burdensome for the economy as a whole.

Although one may tend to see merit in Mr Jaitely's arguments but another option which may look economically viable is that rather than putting the entire burden on a few sectors known as sectors of demerit goods, if the burden is shared by all, it may not have a 'strangulating effect' for the 'chosen few'. It is true that some of the goods are of sin characteristics but no society can afford to live without that. Secondly, back-breaking burden on them to reduce their consumption can also be seen counter-productive. Or, it may be seen as a state tool to limit the latitude of one's freedom to afford a sin good. Thirdly, the CESS is something which countervails the principle of seamless flow of credit. It has to be non-cenvatable by its very basic nature. And anything which is non-cenvatable, goes against the original benefit of the GST System.

More than all these issues, the three key fault lines which TIOL visualises are certainly not classification disputes or the discretionary powers of the taxmen which would automatically get diluted by the electronic compliance system. They are the back-breaking Compliance-load; complicated system to allow free flow of credit and the lack of clarity on the export promotion schemes. If one takes a close look at the forms prescribed for Returns and matching of credit and the number of returns in hundreds, the cost of compliance is going to be a mega fault line diluting the efficacy of the proposed GST. The second serious flaw which may not allow the proposed reform to take off well right in the beginning is the harsh decision to insist on input-output invoice matching before credit is allowed. When one talks about the matching business, the three embedded components are going to be the tax payments, timely return-filing and then the matching of input and output invoices. Even if there is a typographical error or an arithmetical mistake in the computation of tax or return-filing, the GST Network software is going to block the Credit. And the unblocking of credit is not going to be an easy job. No doubt, 80% of credit is going to be allowed in most cases but it is to be seen as to how it is going to be implemented. Notwithstanding a good intention, there is going to be a time lag for unblocking of credit and it would hurt the small businesses more than the large corporate. And the third fault line is going to be the lack of clarity on how export promotion schemes are going to be treated by the proposed system. If it is simply going to be treated as zero-rated which means one pays taxes and then claims rebate, there would be systemic time lag and would further hurt the tattering graph of exports from India. These are the key challenges which the law makers and the GST Council need to address on top priority apart from deciding the various other key components of the proposed system. Let's hope India's tryst with a new indirect tax regime is not going to be too flawed and painful for the taxpayers!