SEPTEMBER 05, 2019

By M G Kodandaram

THE comprehensive destination based Goods Service Tax (GST) started with an objective of having a simple, harmonious law, uniform rates and digitally driven procedures in indirect taxation, in certain aspects, has turned out to be a complex system, very difficult to understand and implement by the stake holders. One of the areas, little understood by a registered person is the classification of services, which is full of ambiguity and vague elements. At the first place one will fail to answer the requirement of such a convoluted exercise by the administration for our domestic business environment which consists, mainly, of MSMEs. I have also failed to understand the rationale and necessity of having such an unplanned way of implementing the classification of services at the beginning of a new system, which has added to the woes of such small players. This will further pose uncalled for disputes in the future and count up to the litigation garbage that has climbed up, with no relief in sight.

Conventionally an appropriate classification system is evolved depending upon the requirements of the system, its stakeholders and authorities. Later it gets into the taxation system so as to bring in an element of equity and fairness in the regime. The methodology so used should be useful and easy for compliance by the registered persons. But in the present system of classification of services adopted, all the above elements are missing as the following deliberations indicate. The primary purpose of any part of the legislation made should be to meet the requirements of the objectives of such system. The key objective as stated in the Constitution 122nd amendment bill was to have "An ideal GST regime intending to create a harmonised system of taxation by subsuming all indirect taxes under one tax. It seeks to address challenges with the current indirect tax regime by broadening the tax base, eliminating cascading of taxes, increasing compliance, and reducing economic distortions caused by inter-state variations in taxes." Therefore the classification methodology adopted should also aim at simplifying procedures, increasing compliance and reduce distortions in such proposed regime.

The classification of goods, at present, adopted in GST regime is based on the HS of Nomenclature, which is already in force in respect of international trade. The same has been trimmed and adopted into the GST regime. This has caused uncalled for problems to MSMEs, which I will not be addressing in this article, as here I intend to concentrate only on classification of services. To the said HS Tariff [the Customs Tariff], which consists of exclusive principles for classification in respect of movable goods, an additional chapter, namely chapter 99, detailing the classification of the services has been inserted. This prima facie makes such an inclusion out of place as there is no legal backing for such an exercise. Further, everyone fails to understand as to how the principles adopted in respect of classification of goods could be borrowed to the realm of classification of services, as services are totally different in form, transaction and delivery. By doing so the legal sanctity of HS tariff for goods itself has been diluted. There is no proper basis for such an insertion, which has caused unwarranted complication to all concerned. Here it includes the administrators, as they fail to address and explain the ambiguities involved in classifying of services. It is pertinent to mention here that no principles for interpretation of classification of services have been prescribed under the notification and the principles of classification as applicable for Goods cannot be borrowed to services.

While mandating the classification of services, the following explanations have been added: "Explanatory Notes to the Scheme of Classification of Services - Preface

The Scheme of Classification of Services adopted for the purposes of GST is a modified version of the United Nations Central Product Classification.

2. the Explanatory notes for the said Scheme of Classification of Services is based on the explanatory notes to the UNCPC, and as recommended by the committee constituted for the purpose, is annexed.

3. the explanatory notes indicate the scope and coverage of the heading, groups and service codes of the Scheme of Classification of Services. These may be used by the assessee and the tax administration as a guiding tool for classification of services. However, it may be noted that where a service is capable of differential treatment for any purpose based on its description, the most specific description shall be preferred over a more general description."

When the words such as 'may be used' 'guiding tool for classification of services' are applied in a communication, it indicates the uncertainty and doubts in the minds of lawmaker in such a legislation. From a plain reading of the preface it is evident that the administration is not in a position to emphasise the usefulness of such a measure. Now the administration is forcing every registered person to adhere to such a faulty methodology makes it litigation prone. It must be noted that the GST administration doesn't derive any benefit out of such halfhearted measure. The registered person is not at all conversant and comfortable with this imprecision approach which runs to over 150 pages, over 725 entries, in respect of services alone. Is it reasonable to expect a registered person to go through such a voluminous stipulation, just to find out the appropriate code for the service provided by her/him? This has extended the worry of the registered person starting from adopting the same in preparation of invoices for proper accounting purpose, and to sorting out the classification that has been adopted by the input service providers, on whose documents the supplier will have to avail credit. This has also badly affected timely filing of returns as no one is sure of the right classification code to be employed. The mute point to be noted here is whether making such an experiment at the start of the GST era is sensible? When the group consists of huge number of smaller domestic trade members, is it a wise move? Now being in the middle of this 'Chakravyuha', what is the way out?

Now we shall examine the origin of the stipulated classification of services in the GST regime. The principles of such a classification are said have been borrowed from the United Nations Central Product Classification, and a look at the said UNCPC establishes the faulty approach followed by the makers of the present classification. In the Preface to the document issued by Department of Economic and Social Affairs (Statistical Division) of United Nations in 2015 titled "Central Product Classification-Version 2.1", it is stated thus:

"The Central Product Classification (CPC) constitutes a complete product classification covering all goods and services. It serves as an international standard for assembling and tabulating all kinds of data requiring product detail, including statistics on industrial production, domestic and foreign commodity trade, international trade in services, balance of payments, consumption and price statistics and other data used within the national accounts. It provides a framework for international comparison and promotes harmonization of various types of statistics related to goods and services".

Further, the following remarks in the said document shows that what is copied is partial and faulty.

"Para 21 - The main purpose of the Central Product Classification is to provide a framework for the international comparison of statistics dealing with products and to serve as a guide for developing or revising existing classification schemes for products in order to make them compatible with international standards."

"Para 38. Among the variety of criteria generally used for distinguishing between goods and services (tangible versus intangible, storable versus non-storable or transportable versus Non-transportable), none provides a valid, practical and unambiguous distinction between goods and services in all cases. As a result, all criteria used in the definition of goods and services in the SNA [The 2008 System of National Accounts] need to be applied to make that distinction."

As could be concluded that the source documents are in respect of goods as well as services and it is mainly for the purposes of generating statistics. Another important aspect to be examined in this regard is, whether administration is using it for statistics purpose effectively? As per the feedback obtained by the author, the registered person is finding it impossible to determine proper classification of services. The reports generated based on such inputs will be misleading and naturally serve no purpose to the administration. The said compilation is in experimental stage as it is an attempt to integrate HSN classification with that of services. Choosing such a new untried methodology and that too in a fractured way into a unique GST experiment has resulted in causing an unwanted barricade in smooth implementation of GST, I earnestly feel.

A bit of history

As early as in July, 2004 itself, the 'report of the task force on Implementation of Fiscal Responsibility and Budget Management Act, 2003'[GOI], had recorded the vision for a common code of indirect taxes as follows: "a well designed destination-based value added tax on all goods and services is the most elegant method of eliminating distortions and taxing consumption. Under this structure, all different stages of production and distribution can be interpreted as a mere tax pass-through, and the tax essentially 'sticks' on final consumption within the taxing jurisdiction." When we examine the present GST law and its implementation, I feel we have a long way to go for achieving the above cherished goal.

In this regard, it is pertinent to mention the extracts of the Report of the Task Force on Goods and Services Tax of the Thirteenth Finance Commission dated 15th December 2009, which was set up to make recommendations on various issues relating to the design and implementation of the Goods and Services Tax (GST).

"Executive Summary

1. the taxation of goods and services in India has, hitherto, been characterised as a cascading and distortionary tax on production resulting in misallocation of resources and lower productivity and economic growth. It also inhibits voluntary compliance. Therefore, it is necessary to replace the existing indirect tax system by a new regime which would foster the achievement of the following objectives:

(a) The incidence of tax falls only on domestic consumption; (b) The efficiency and equity of the system is optimized; (c) There should be no export of taxes across taxing jurisdictions; (d) The Indian market should be integrated into a single common market; (e) It enhances the cause of cooperative federalism. (Para 2.1)"

"3. The 'flawless' GST recommended by us comprises of the following elements:

i. It should be a dual levy imposed concurrently by the Centre and the States, but independently to promote cooperative federalism. (Para 2.4)

iv. The tax base should comprehensively extend over all goods and services upto the final consumer point. (Para 2.7)

v. There should be no classification between goods and services in law so as to ensure that there is no classification dispute. (Para 2.7)"

The extract of Para 2.7 of the said report are as follows:

"Para 2.7 - from an economic growth perspective,….we recommend that-

(a) The Centre and the States should adopt a consumption type GST, i.e. there should be no distinction between raw materials and capital goods in allowing GST credit. Only this GST variant is equivalent to a retail sales tax.

(b) The tax base of both CGST and SGST should comprehensively extend over all goods and services going up to the final consumer (retail level), reflecting the tax base of a typical consumption VAT.

(c) Since the tax base will extend to all goods and services, no distinction will be maintained between goods and services. A registered dealer will be required to collect taxes on every invoice irrespective of whether the supply is for goods or services. Therefore, no classification of goods and services should be provided for in law. This will eliminate all classification disputes."

Now if you glance through the present system, the distinctions between goods and services, instead of coming together have further widened and it is very much against the basic principles of having common code for taxing the goods and services. The best practice approach in an effective and successful tax regime consists of (i) having a broad base, (ii) low tax rates, (iii) less differentiated rates and the procedure prescribed should be simple and transparent. The present GST structure entails six rate categories [slabs] namely, 0%, 5%, 12%, 18%, 28% and compensation cess on like aerated drinks, luxury cars and tobacco products to fund the compensation for revenue loss. There is a special rate of 0.25% on rough precious and semi-precious stones and 3% on gold. Only by reduction in number of slabs will avoid dependence on classification of goods and services, and litigations therein could be reduced.

The way forward

Further, as we are all aware of, even after two years of rolling out of GST system, the GSTN as on date is not yet fully equipped and wholly functional. It is still 'the work in progress' and existence of glitches has become a routine factor. But it is somehow bridging the gap and expanding and extending its technological facilitation in a phased manner. The return business process as recommended by the joint committee on business process on GST return in October 2015, has totally failed as the GSTN could not find ways and means to make necessary preparation, due to complexity in the form and the matching of data has not been achieved as on date. As the registered person found it impossible to file such a return electronically, only as a transitional measure GSTR3B was prescribed, which is a stopgap arrangement. The prescribed annual returns and the reconciliation statements are full of unrelated details and ambiguities. In such a time, the classification of services has only added further fuel to this confusion, making it to be a herculean task to comply with the procedures on time. On the technological front, less said the better as it is challenging both in terms of preparation and uploading or filing of such returns, which could have eased to some extent by not resorting to classification of services in the early part of implementation of GST. The proposed new return system envisaged in the coming months, still needs to be fully operational. In the meanwhile there is a hope that the lawmakers will understand the ground realities and move towards simplifying the classification system so as to remain appropriate to the needs of the domestic trade.

In such a situation I am of the opinion that the classification of services needs to be simplified along with classification of goods. We need not borrow the HS classification for domestic needs. As of now, being in the middle of this 'Chakravyuha', it cannot be taken out of the system at this moment. Then we should think of ways of overcoming the present hurdles with least injury to the trade and commerce in general and MSMEs in particular.

In this regard the following suggestions the author desires to make for due consideration -

(The author is IRS, Assistant Director (Retd), NACIN, Advocate and Consultant and the views expressed are strictly personal.)