MARCH 25, 2015

By Shailesh P Sheth, Advocate

A budget should reflect the values and priorities of our nation and its people.

[Mary Landrieu]

Whereas one may discard the huge expectations everyone harbored from Budget as 'unrealistic', the taxpayers had some reasonable and rational hopes from the Budget that could not be faulted with. After all, the taxpayers were only looking forward to:

•  rationalisation of rate structure in Customs & Central Excise Tariffs;

•  mitigating the problem of inverted duty structure;

•  liberating the Cenvat credit regime from undue restrictions and providing for seamless credit, to the extent possible;

•  laying down a strong foundation for GST; and

•  simplification of the tax administration.

Has the Budget lived upto these expectations of the taxpayers? The answer is a reluctant 'No'!If one digs deeper, one would realize that the considerations for additional revenue generation and improving the cash liquidity of the Government have far outweighed the reasonable expectations of the taxpayers. As a consequence, the plight of the taxpayers is expected to only increase in the days to come. The situation is not helped in any manner due to extremely poor or loose drafting of certain key proposals of the Budget.

Rationalisation of rate structure in Customs & Excise - 'A crowded gallery ….remains crowded..!'

Even after repeated talks of need to rationalize the Customs & Excise duty rate structure and some half-hearted attempts made in the past in that direction, the Customs & Central Excise Tariff remain highly complicated pieces of legislations with plethora of rates still ruling it. There are about 19 ad-valorem rates of duty, besides Nil rate and some specific rates of duty prevalent in the Customs Tariff. The situation is no better so far as Excise Tariff is concerned. Then, both the Tariffs carry numerous exemptions, covering thousands of items and hundreds of conditions subject to which the exemption is granted.

It was, therefore, absolutely necessary that while the country is preparing itself for GST regime, the rate structures in both the Tariffs are rationalized by pruning the number of rates and also exemption notifications, as much as possible. This would have also largely mitigated the problem of inverted duty structure.

Unfortunately, the hopes of rationalization of rate structure are belied. Instead, the Customs Tariff has been made even further complicated by giving partial exemptions ranging from 2.5% to 7.5%. The avowed object of such exemptions is ' to minimize the impact of duty inversion and reduce the manufacturing cost in several sectors.' But, the attempts to reduce the impact of duty inversion are half-hearted as discussed in the ensuing paragraphs and it remains debatable whether the negligible reductions in rates of duty would really make any significant difference for the industry.

Duty inversion and SAD exemption - 'A SAD reading…!'

Acknowledging the problem of 'duty inversion' in certain sectors and the resultant accumulation of Cenvat Credit FM announced the grant of exemption from payment of SAD to all goods(except populated printed circuit boards) for use in the manufacture of ITA bound items from the payment of SAD and also reduced the SAD on imports of certain specified goods.

However, the relevant Budgetary Not. No. 11/15-Cus dt. 01.03.2015 (amending Not. No. 21/12-Cus dt.17.03.2012) shows that contrary to the general belief and understanding, the SAD exemption is granted to only specified items and is subject to actual user condition. Now, it is an accepted fact that 'end-use based exemption notifications' are extremely difficult to administer and monitor and invariably lead to litigation. It is, therefore, rather unfortunate and unjustified that this condition has been brought into play in such wholesome manner while granting the SAD exemption.

Moreover, the grant of SAD exemption has also been apparently restricted to certain specific sectors. One important sector that has been bearing the brunt of inverted duty structure and huge accumulation of Cenvat Credit is Pharma Sector. There is no respite either on the Customs side or on the Central Excise side on this count for this important sector.

Increase in rates of Central Excise & Service Tax - 'In thy name, Oh GST…!'

In a categorical reference to GST, FM declared his intention to subsume Ed. Cess and Secondary & Higher Ed. Cess ('the Ed. Cesses' for short) in Central Excise duty and claimed it ' as part of the movement towards GST' . But, dampening the spirits rising with this announcement, FM also declared, in the same breath, that the general rate of excise duty of 12.36% (including Cesses) ' is being rounded off to 12.5%'. As for service tax, FM has proposed to increase the present rate of 12.36% (including cesses) to a consolidated rate of 14% with a view ' to facilitate a smooth transition to levy of tax on services by both the Centre and the States'.

However, the manner in which the Ed. Cesses on excise duty and service tax are being withdrawn leaves much to be desired. The withdrawal of Ed. Cesses on excise duty has been by way of exemption Not. No. 14/15-CE and 15/15-CE, both dt. 01.03.2015. On the other hand, in case of Ed. Cesses on service tax, it is proposed to be abolished altogether from the date to be notified after the enactment of the Bill and when the enhanced rate of service tax would become effective. (Clause 179 and 187 of the Bill refers). If, the Ed. Cesses leviable on excise duty and service tax are being subsumed for good as claimed, why this differential manner of withdrawal ? Is it the intention of the Government to re-introduce the levy of Ed. Cesses on excise duty at any time during the year if it is considered expedient to do so ?

Aside from the above anomaly and uncertainty, why couldn't the FM resist the temptation to raise the burden of excise duty by a marginal 0.14% ? In reality, in the guise of withdrawal of Ed. Cesses on excise duty, the net burden of duty has actually been increased! '0.14%' may look infinitesimal, but, at aggregate level in absolute monetary terms, the additional revenue generated could be substantial.

Netizens would also recall that a convergence of rate of service tax and excise duty at 10 per cent had been brought about by the then FM Shri Pranab Mukherjee vide Budget 2010-11 as a significant step towards GST. Now, after 5 years, we shall witness a tax differential between goods and services - also in the name of GST! The life appears to have come a full circle!

Finally, the marginal increase in the rate of excise duty and the proposed hefty hike in the rate of service tax would mean generation of substantially higher revenue for the exchequer, notwithstanding that, it may turn out to be highly inflationary. At the same time, the erratic manner of withdrawal of Ed. Cesses on excise duty and service tax have placed the manufacturers at a sheer disadvantage compared to the service providers inasmuch as the manufacturers will not be able to utilize -

•  the accumulated Cenvat credit of Ed. Cesses lying in balance as on 01.03.2015;

•  the Cenvat Credit availed of Ed. Cesses levied on service tax by the service providers after 01.03.2015 and till the notified date when the revised rate of service tax of 14% becomes effective; and

•  the Cenvat Credit that may be availed after 01.04.2015 to the extent of 50% of Ed. Cesses (whether fresh credit or balance of the previous year) levied on capital goods.

Needless to say, this inability of the manufacturers to utilize the Cenvat Credit of Ed. Cesses would increase the cost of manufacture, though the Government's cash position would improve to that extent!

"The point to remember is that what the Government gives,

it must first take away."

[John S. Coleman]

"Swachh Bharat Cess" - 'What is in the name? - Everything…!'

As if the increase in the rate of service tax was not enough, FM has proposed to levy a new cess called 'Swachh Bharat Cess' @ 2% on the value of all or any taxable services. The purpose of levying this new cess is to finance and promote Swachh Bharat initiatives or for any other purpose relating thereto. The levy would become effective from the notified date.

Actually, FM appears to have 'killed many birds with one stone' while proposing the levy of this cess. "Swachh Bharat" is a clarion call given by the PM and there cannot be any argument about the need for it. We, the Indians, have not much regard for cleanliness. For us, 'Cleanliness is next to Godliness' is something to preach, not to practise! Therefore, no one would seriously object if a new cess is levied to implement the 'Swachh Bharat Abhiyaan'.

Secondly, FM has repeatedly talked about the reduced fiscal space due to higher devolution to the States. While 'Swachh Bharat' is being projected as a Centre's initiative, fact remains that 'Public Health & Sanitation' is a State subject figuring at Entry 6 of List II i.e. State List of Seventh Schedule of the Constitution of India. Since the Centre is hard-pressed for cash, there is no better way than to levy such cess in the name of 'Swachh Bharat' and share the proceeds with the State as per the recommendations of the 14th Finance Commission. It is a 'win-win situation for all' except, of course, for the taxpayers and common man who would ultimately bear the burden! It is very much unlikely that Swachh Bharat Cess would be made Cenvatable.

Thirdly, a Panel of the Empowered Committee of State Finance Ministers has suggested an RNR (Revenue Neutral Rate) for GST of nearly 27% (approx.13% CGST and 14% SGST). Though, mercifully, FM may not oblige the States on this demand, it is now almost certain that the RNR will be well above 20%, somewhere in the region of 22 to 24%. Originally, Centre had proposed the RNR for GST on services at 16% to start with and this may now remain a distant dream! Nevertheless, FM could not have risked raising the rate of service tax exponentially as all-round criticism for raising the rate even to 14% would have been anticipated. FM has, therefore, adopted a safer course in increasing the rate in the name of levy of 'Swachh Bharat Cess' which is nothing but a 'service tax' as is evident from the perusal of Clause 117 of the Bill.

What is, however, rather disheartening is the fact that when GST is round the corner as being claimed and is expected to subsume all Central and State cesses and surcharges, why should there be a levy of new cess at this juncture? Don't we have enough cesses as it is?

"When a new source of taxation is found, it never means, in practice, that the old source is abandoned. It merely means that the politicians have two ways of milking the taxpayer where they had one before."

[Henry Louis Mencken]

Widening tax footprints; Shrinking Credit base - 'Welcome, GST!'

FM has significantly withdrawn certain important exemptions mainly relating to service tax. One such exemption that stands withdrawn pertains to the construction sector. The exemption hitherto granted to services provided to the Government, Local Authority or a Governmental Authority by way of construction, erection, etc. of a civil structure predominantly for use other than for commerce, industry, business or profession; or a structure meant predominantly for use as educational, clinical, art or cultural establishment; or a residential complex predominantly meant for self use or the use of its employees is being withdrawn w.e.f. 01.04.2015. Similarly, services by way of construction, etc.of airport or port is also being withdrawn from the said date.

The withdrawal of these exemptions would mean that such construction contracts, even if meant for non-commercial or non-industrial use, and undertaken for the Government or a Local Authority or a Governmental Authority would attract the levy of service tax henceforth. The valuation and quantum of service tax payable on such contracts would be in terms of Rule 2A of the Valuation Rules since such contracts are generally executed as 'works contract'. It is pertinent to note that with the withdrawal of exemption, even the sub-contractors providing works contract service to the main contractors executing such works contract would also be liable to pay service tax as the exemption available to the sub-contractors vide clause (h) of Sr.No. 29 of Not. No. 25/12-ST dt. 20.06.2012 as amended would not be available.

While the pruning down of the exemptions may be a step in right direction towards GST, it is rather unfortunate that the availability of Cenvat Credit still remains rather restrictive. The Cenvat Credit of duty paid on construction materials used by the contractor for construction of say, a medical college for a State Government, would not be available due to restriction to this effect in Rule 2A of the Valuation Rules. This would only increase the cost of construction and higher outgo of service tax in cash which the contractor would recover from the State Government. Whereas the service tax would initially go to the coffers of the Centre, the same would subsequently be shared with the State under devolution scheme. Isn't this a 'round-tripping' of a high order?

Even while rationalizing the abatement rates in respect of transportation of goods by road, rail or vessel, the burden of service tax has been increased in an effective but oblique manner by prescribing a uniform condition of non-availment of Cenvat Credit on inputs, capital goods and input services in all the cases.

FM has also ensured gargantuan revenue by bringing into the tax net certain new services. Notable amongst these are:

•  manufacture of alcoholic drinks for human consumption on job work basis;

•  services by way of access to amusement facility or admission to entertainment event;

•  all services provided by Government to a business entity;

•  services provided by a chit fund foremen by way of conducting a chit;

•  services provided by a distributor or a selling agent of State Lotteries;

•  services provided by aggregators

There is a disturbing feeling amongst certain sectors hit by the new levy that the Centre is nonchalantly encroaching upon the State's turf. However, FM, desperate for additional tax revenue, appears to have taken a calculated risk here even though the levies may be susceptible to Constitutional challenge.

On the other hand, Cenvat Credit regime is already restrictive in nature and the availment of credit on any input or input service is always fraught with uncertainty and risks of litigation. Instead of addressing this perennial problem, FM has continued with the policy of expanding the coverage of levy while leaving the restrictive credit regime practically untouched. The taxpayers are thus facing 'double whammy' of 'widening tax footprints and shrinking credit base'! Obviously, the whole approach is geared to generate additional revenue. But, does this augur well for the impending GST regime?

Measures for 'ease of doing business' - 'Feeling rather uneasy …!'

Finally, FM has announced three measures to facilitate the ease of doing business and they are, fast-track central excise/service tax registration; facility to issue E-invoice and maintain E-records and raising the time limit from 6 months to one year for taking Cenvat credit on inputs and input services.

However, except the facility granted for issue of E-invoice or to maintain E-records, are the other two measures sufficient enough to make such tall claims of 'trade facilitation' and 'ease of doing business' in India? What is so great about 'registration in two days' when the whole process is online? Isn't it also the obligation of the department to grant registration immediately when a person has invested a tidy sum in setting up, say a factory after a colossal investment of time, money and energy in obtaining all regulatory approvals and land and who wishes to commence his production as expeditiously as possible so that he can start paying excise duty and all other taxes to the Government? In any event, is this such a grand tax administrative reform so as to figure into the budget speech of FM? As regards the time limit for taking Cenvat Credit on inputs/input services, trade and industry were desperately expecting a total withdrawal of this impractical and unjustified restriction and not a mere raising of the time limit.

It is rather distressing that FM has not taken any steps to remove the innumerable glitches prevalent in the current indirect tax regime - both, in tax legislations and tax administration - and to make it more conducive for and responsive to the taxpayers. A familiar lip-service, instead, has been provided to the revolutionary and pragmatic recommendations of the Tax Administration Reform Commission (TARC) and a promise is made that these recommendations which are in advanced stage of examination, will be implemented during the course of the year. Let's hope for the best! However, TARC also stands for Transparency, Accountability, Responsibility & Commitment. If, only these four elements are instilled in the Tax Legislation, Tax Administration and Tax Collection, there won't be any necessity for 'tax reforms'! The entire tax system is suffering from 'deficit crisis' and that is, a crisis of 'deficit of trust' between the 'tax collectors' and 'taxpayers' and hardly anything is being done ever to bridge this gap. One of the main culprits for this state of affairs is the rigid tax revenue targets mandated through Budget. It may well nigh be remembered that a target-oriented tax system would invariably become a terror-driven tax system!

To conclude …

The Budget 2015 presented by the FM can, at best, be described as his ' Letter of Intent'. Various policy initiatives have been announced, but the question of raising the required funds and the manner of augmenting it looms large. The various numbers in the Budget are neither inspiring nor comforting. The Budget sadly lacks any pragmatism, innovation and boldness and toes traditional lines with usual thrust on the tax revenue generation. The only kind comment that can be made about this Budget is it's a golden opportunity missed!

It's a weird world. The strong take away from the weak, the clever take away from the strong, and the government take away from everybody. [Anon]

(The author is Sr. Advisor - Indirect Tax BDO India LLP.)

Editor - Series stands Concluded

See Part-I here.