By M G Venugopalan, Former Member, CBEC

INDIA's GST dreams has been in the tax horizon for long. The Joint Working Group formed by the Government of India, comprising State finance ministers and senior finance ministry officials, to make suitable recommendations to the Ministry of Finance on a model Goods and Services Tax is now working on three or four GST models, and is expected finalize its report shortly. All concerned, particularly the industry/trade circles are anxiously waiting to know final outcome of the deliberations. Imposition of taxes is inherently a political decision and they have to meet a variety of political as well as economic needs. Ultimately, what model of GST is going to be introduced in India, as a culmination of the long-awaited tax reform process, would be decided by the Central Government in power, in April, 2010.

Governments have become increasingly interested in recent years in using taxes on consumption ( VAT/Sales Tax etc) as against taxes on income to finance larger share of public spending. Germany increased its VAT rate in the beginning of 2007, partly to finance its cut in social security contributions. France has supported a proposal to raise VAT and reduce employee's social security contributions. Mexico increased its share of revenue from consumption taxes by 6 percentages while the share in New Zealand, Luxembourg and Slovak Republic increased it by 4 percentages. Netherlands increased its share by 3 percentages and Poland showed smaller increase by 2 percentages. Nonetheless, 24 out of 30 OECD countries reduced their overall share of consumption taxes (38% in 1965 to 32% in 2005) with Iceland experiencing a larger fall of 22 points. Two countries with the highest share of taxes from consumption in the OECD group are Mexico and Turkey; they make heavy use of taxes on specific goods and services.

It is generally held that the move away from taxes on income to taxes on consumption would improve economic efficiency, growth , competitiveness and generate more employment in the economy. Collection of higher rates of Corporate Tax/Income tax have become difficult due to increased international tax competition. Higher Corporate Tax increases the cost of capital and hence the cost of investment / production. The affected firms may find it difficult to compete in foreign markets. Politics tend to complicate matters of taxation on electoral considerations, even when tax planners advocate tax simplicity on grounds of ease of compliance and administration. Industrial lobbies exaggerate arguments for special favors and hold the Govt.'s hand to do things in their interest. That complicate matters in the form of grant of undeserved tax exemptions. Preferential rates for a few and standard/higher rates for others lead to pervasive tax evasion. Tougher and oppressive enforcement measures to mop up unrealistic revenue targets self-imposed by the Govt, worsen the situation. The rights and wrongs of tax concessions sought are routinely analyzed in detail by the tax planners/administrators in India. But their views seldom come out in the open in our democracy, even after the introduction of Right to Information Act! As a result, undeserved tax concessions once granted remain in the statute book, eroding the efficiency of the tax measure. Tax concessions once granted, are hard to withdraw even when the underlying circumstances change.

GST, was first introduced in France in 1948. The levy was confined to the manufacturing stage without any tax credit on capital goods. The French version of GST was converted into a full fledged consumption tax in 1954. From 1990 to 2000, GST spread fast to almost 100 countries and in 2007 GST is the prime indirect tax source in 150 countries, accounting over 25% of the gross tax receipts. Why this preference for the French menu, world over ? VAT has accounted for 18.7 % of all taxes in 29 out of 30 OECD countries and 6.8% of their GDP in 2002. USA is the only OECD country which has not yet adopted GST/VAT model of taxation so far. The average GST rate in OECD countries is 18% and most the countries have varying rates from 5 to 25%, a Standard rate, a Reduced rate and Zero rate. Some countries have specific rates applicable to specified regions. Complex rate structures and procedures definitely discourage tax compliance and promote litigation and rise in the administrative cost the levy. OECD countries have a fair mix of zero, medium and high-threshold for exemption and registration. They make wide use of simplified tax liability calculation schemes and infrequent payment and return filing regimes to entice small traders/providers of taxable service into the tax net.

What are the advantages/disadvantages in going for VAT/GST mode of taxation? Unlike Direct taxes, GST only taxes consumption and not income or profits. This particular feature attracts investors and entrepreneurs as it is supportive of savings, investment and employment generation. No doubt, GST raises the ultimate price on consumption of goods and services; so it could be termed as regressive. Increased GST/VAT rates may increase inequality and lower the standard of living of the poor, thereby widening the gap between the rich and poor. But GST is immune to cyclical effect of economic growth as certain minimum level of consumption is assured, even in the worst of recession. GST certainly minimizes the economic ill-effects of taxes induced distortion in the economy as the input tax credit available across the board, eliminate the adverse effect.

Conceptually,GST is a simple tax levied across all taxable goods and services. Thus the essential requirement of broadening the tax base is achieved in a splendid manner. But most countries have departed from the theoretically perfect VAT design- a single low rate applied across the board. Under GST, exports are zero rated and only imports are a taxed at the same rate as applicable to the domestic production/consumption, thereby providing a level playing field to the indigenous producers/ manufacturers. GST is incredibly flexible in the sense that it operate successfully with a wide range of rate structures and relief provisions.

Globally there are three approaches to imposition of VAT on trade in services :-

++ origin based taxation - services are taxed in the country of origin of the supplier.

++ Destination based taxation - services are taxed where the customer is based or where the consumption takes place.

++ A mixture of the two- some services are taxed at the origin while others are taxed on destination basis.

Depending on the above approach to taxation, the legal provisions relating to 'export' and 'import' would be susceptible to varied interpretation. Indian VAT legislation has followed the destination principle, which is in line with the international norm. To qualify a transaction as 'export' the expression used is ¶provided from India and used outside India¶-but the scope of the expression has not been defined in the statute,which has caused considerable uncertainty in relation to treatment of specific transactions. This may bring about potentially double taxation in both exporting and importing countries. There is a need to have a global agreement in relation to the application of VAT/GST on cross border trade in respect of services. Clear and transparent legal provisions need to be introduced in this regard. India's VAT legislation is increasingly based on global principles and consequently India need to work closely with OECD and EC countries.

Inquiries reveal that we may not blindly adopt any particular model of GST followed by any other country, as such. India's present socio-economic conditions are unique in itself, and adoption of a particular country's model in toto may not suit us. Constitutionally, India is a federation with certain unitary features. But there are multifarious factors which distinguish us from other well known federations in the world such as Canada, Australia, New Zealand or Brazil. Moreover, during the last five years, India has, though reluctantly but successfully, adopted the dual VAT model of taxation as the prime mover on the Indirect Taxes front at the Centre and States. What is required now is to consolidate the gains so far made on the tax reform front and extend the base of taxation to 'goods' and 'services,' in a comprehensive manner. The benefit of tax credit has to be extended across the board, both at the Central and State level in a parallel manner so that the damage of cascading effect of taxes on taxes is minimized. Our target must remain to get as close as possible to a low rate of GST covering most of the goods and services at the level of final consumers ,except exports. But VAT/GST designs followed the world over tend to maximize tax exemptions and proceed to curtail the availment of input tax credit, which becomes a cost on doing business.

Effective implementation of GST at the Centre and States requires to be backed up by efficient system of procedures and processes and a sound administrative set up. Our success lie in synchronization of the basic legislation on classification , rates of the tax, exemptions, introduction of uniform procedures for registration, maintenance of records,submission of returns,adjudication/appeal, audit etc. A nation wide clearance house mechanism using harmonious IT infrastructure has to be created for effective implementation of the proposals. However, given the short time frame available for implementation of GST, it would be an enormous challenge to put in place efficient processes and administrative systems across the nation, using the existing rickety Govt. machinery. Many of the services may have to be outsourced in the beginning ,if Govt. intends to stick to the tight time schedule . Development of effective compliance risk management processes are central to the effective targeting of compliance risks and optimum co-ordinated use of the resources of the Central and State agencies. Many countries have reported issues of tax payer non-compliance such a sales suppression, non-payment of the tax using fraudulent/excess input claims,fraudulent refund control etc. Several countries have reported GST losses even upto 17% due to various deficiencies in administration.