MAY 11, 2015

By Sumit Dutt Majumder, TIOL Consulting Editor & Former CBEC Chairman

CONCERNS have been raised by the stakeholders over certain issues relating to the form of GST proposed in the current 122nd Constitution Amendment Bill (the Bill) that has just been cleared by the Lok Sabha and pending in Rajya Sabha at the time of uploading. In the next few paragraphs, seven of those concerns which are considered serious will be spelt out serially, and my response on those concerns will be articulated.

In my response the netizens will find a common theme - compromises become necessary in democracy, and as a corollary, the compulsions of democracy more often than not lead to incremental reforms, and not necessarily big leap forward.

CONCERN NO 1

The exclusion of Petroleum & Petroleum Products and Alcohol from the ambit of GST will erode the taxbase, and knock these items out of the GST credit chain even when used as inputs for GST items. Such denial of credit will bring distortions.

RESPONSE:

There cannot be two opinions about the virtues of keeping those items within GST for the reasons mentioned above. But, just imagine - the negotiations between the Centre and the States are going on for the past nine years, and the States have not agreed to their inclusion. For most of the States, the share of VAT on Petroleum and its products constitutes around 55% of their total VAT collections. The states do not want to lose their assured revenue. They have the 'fear of the unknown' - that is loss of revenue with the introduction of GST.

The proposed Dual GST model envisages partnership built up on trust between the Centre and the 29 States, the like of which one sees in the joint ventures. In order to bring the States on board, Mr Arun Jaitley had to make the necessary compromise of keeping these items out of the ambit of GST, to start with. However, it goes to Mr Jaitley's credit that he has been able to keep petroleum and its products within GST, constitutionally. It is only that notifying the effective date for application of GST rate on those items has been left to the GST Council. It's sincerely hoped that the said date is announced sooner than later.

As for Alcohol, it is hoped that on the same ground of keeping the input tax credit chain intact, and widening of the taxbase, the GST Council decides to bring this 'demerit goods' also within the ambit of GST at the earliest, as is proposed to be done with respect to tobacco and cigarettes, the other 'demerit' goods. In the case of tobacco and cigarettes, it is proposed to levy central excise duty in addition to GST so as to cover the duty difference between GST and the present excise duty rate. It may be worthwhile to mention that in the recently held Asia Pacific Tax Forum (APTF) at Delhi, Professor Sijbren Cnossen, a well respected expert in VAT/GST, confirmed in a conversation with me that such imposition of excise duty in addition to the VAT on demerit goods is present in EU countries as well.

Having said the foregoing, I must also state that petroleum being a bulk commodity is traded in bulk. Therefore, no great harm would be caused in the way to creation of common economic market for the general merchandise.

CONCERN NO 2

The erosion of taxbase consequent to keeping petroleum, alcohol out of the ambit of GST would lead to high Revenue Neutral Rate (RNR) and, thus high GST rate of 27 present. Consequently, the inflation would go up, and there may not be further rise of GDP due to introduction of GST.

RESPONSE:

It is true that RNR has a link with the width of the taxbase and that with a shrunk taxbase, the RNR would go up. But it is now known to all that the computation of RNR of 27% was based on dated data. The RNR based on updated data has now been reported to be in the range of 20 to 23 per cent. Even the Finance Minister (FM) has conceded in the Lok Sabha that a GST rate of 27% would be very high, and assured the House that it would be much below 27%.

In terms of the Bill, final GST rate(s) would be decided by the GST Council. Before deciding on the GST rate(s), the Centre and States would, first of all, have to finalise the threshold and the number of exemptions so as to know the final taxbase. The States have favoured a threshold of Rs 10 lakhs whereas the Centre is in favour of Rs 25 lakhs. Economists across the world, including Prof Sijbren Cnossen, with whom I interacted recently on many GST related issues at the APTF meeting, are in favour of a high threshold. That will keep very small entities, who in any case do not contribute much to the revenue, out of the GST ambit. Taxing 'small business' has never been cost-effective.

While on the GST rate, it may be noted that the VAT/GST rates across the world vary between 16% to 20%. Malayasia is an exception where the VAT rate has been kept very low at 6%. This was confirmed by Mr. Subromaniam Tholasy, the Malaysian GST Chief, who was at the Delhi APTF Meet. I am yet to examine their GST model closely. With the eroded base because of the exclusion of Petroleum and Alcohol, India may decide on slightly higher than 20 percent rate to start with, and gradually bring it down after the revenue collection goes up because of tax buoyancy and efficiency of technology-supported GST collection system.

As for the inflation and growth, if the GST rate is pegged between 20 and 23 percent, that would be far below the present incidence of Central Excise and States indirect taxes that would be subsumed in GST (which is on a very rough basis estimated to be around 30%). Besides the reduction of incidence of tax, in the GST regime the compliance cost – both visible and the invisible ones - will come down because of subsuming of multiple taxes that are being administered at present by multiple tax authorities. This will also be a factor to bring down the prices of goods and services. In turn, this will lead to more money in the hands of the investors who would then make more investment and that would lead to more employment and ultimately more growth and increase in GDP.

CONCERN NO 3:

Allowing the States to vary the SGST rate, within a narrow band of ceiling rate and a floor rate will lead to different rates of SGST in different States and this will harm the goal of common economic market.

RESPONSE:

While I would agree with the proposition to a certain extent, it may also be recalled that the Standing Committee of Parliament on Finance in the previous Parliament (2009-2014) had recommended for giving the 'elbow room' to the States to vary their SGST rates so that they feel more comfortable with this additional financial autonomy. The Union Finance Minister earned the trust of the States by accepting the Committee's recommendation.

Prof Sijbren Cnossen, the VAT expert referred to in previous paras, also confirmed to me that in the EU and Canada, there are provisions for varying the provincial rates of VAT/GST within a very narrow brand. The GST Council will have to keep the band very narrow - not exceeding the maximum of one per cent. It may not then hurt the overall aim of achieving a common economic market across the country.

CONCERN NO 4:

Basic food and a big chunk of processed food are now exempt from Central Excise Duty. This will now come under the GST ambit and that will lead to inflation of food items.

RESPONSE:

At present the basic food and a large chunk of processed food are exempt from Central Excise Duty. But, most of the processed / packaged food are subjected to States VAT. Besides, cereals in bulk like wheat, paddy etc are subjected to 'Purchase Tax' by the States. Therefore, with the introduction of GST, a holistic view will have to be taken about the way to go.

As explained by Prof Sijbren Cnossen in a session on Food Processing Industries at the APTF, Delhi meet, internationally the VAT/GST regimes treat the basic food items and the processed / packaged food under one or more of the following categories:

a) Exempted or zero-rated

b) Lower Rate

c) Standard Rate

In my view, in the Indian situation it may be necessary to resort to all the three categories; - 'Basic Food' - may be exempted or zero-rated; identified processed food / packaged food that are consumed by the poorer sections of the population may be taxed at lower rate and the rest may be taxed at the standard rate.

Mr Tholasy explained in a session at the Delhi ATPF about the GST treatment of food items in Malaysia, which implemented GST about just over a month back. Malaysia has zero-rated the supplies of:

a) Food items like rice, flour, sugar, salt, cooking oil, infant formula, coffee powder, tea dust, white & whole meal bread etc

b) Farm products like paddy, fresh vegetables and fruits;

c) Farm animals like meat and

d) Sea food including dried fish.

All other food items attract 6% standard rate, which is the single GST rate.

Further, in order to take care of the poor, Malaysia has introduced a scheme of Direct Cash Transfer to very poor people so as to offset the impact of GST, instead of allowing case by case exemption.

I am sure the officers at Centre and the States are working out the details in consultation with the Ministry of Food Processing industry as well as the chambers of industry.

CONCERN NO 5:

In order to please the manufacturing States, the Bill has proposed imposition of one per cent tax on all inter-state supply of goods and services in addition to the GST and that tax will be assigned to the origin States. This will undermine the spirit of the destination-based GST regime, and it would lead to cascading of taxes since there will be no credit for such a tax, and in turn, this will also add to inflation.

RESPONSE:

I could not have agreed more with this concern which is a serious one. Reportedly, this proposal has been added in the Bill at the last stage of negotiations so as to please the predominantly manufacturing States who are the origin States for manufactured products. This tax would be a retrograde one. First of all, no input tax credit (ITC) would be available for such taxes, and thus with each inter-state supply there will be cascading of taxes leading to inflation. It will be worse in the case of stock transfer which takes place over a spread of number of States. At each border, there would be inevitable compliance costs, and besides that, this tax would keep on accumulating (in the absence of any credit), finally making the credit-less tax a huge burden on the taxpayer.

In this context, one must understand the less-talked-about benefits of a destination-based tax like the GST. It has an element of equity embedded in it. Because of the uneven development of infrastructure across the States, some States are much more industrialised such as Gujarat and Maharashtra than others like Bihar, Assam and West Bengal. These less industrialised States have however high level of consumption due to large population. In the GST regime, the States' share of GST (SGST) will move from the manufacturing origin States like Gujarat to the destination consuming States like Bihar. In the process, the States like Bihar would have more resources in their hands which is expected to be spent on developing the infrastructure which in turn would attract the investors to set up plants. Thus, over a period of time an industrially backward state like Bihar would also become industrialised, thus reducing poverty in that State and improving the purchasing power of an average citizen.

This principle must not be undermined by bringing in this origin-based credit-less tax of one per cent. This way of compensating the manufacturing States is not at all necessary since the Bill itself envisages that the Centre will compensate the States whenever there would be revenue loss due to introduction of GST. Therefore, the GST Council should consider withdrawing this Credit-less origin-based tax at the earliest.

CONCERN NO 6:

Have the taxpayers including the India Inc made their business process GST-ready? Given the enormity of GST, what about the training of the taxpayers to cope with it?

RESPONSE:

Naturally, it's very important for the taxpayers from all sections of the society including the corporate India to be GST-ready. GST would impact every segment of the business from financial reporting and tax accounting to supply chain. The taxpayers would have to streamline processes and procedures suitably to reconfigure their IT and ERP systems and optimise their supply chain. GST would provide an opportunity for the industry to make their supply chain GST efficient. Preparing for GST itself would be a big management event. Given the complexity of taxing inter-state supply of services, the services sector would need a much higher effort in making a smooth transition to the compliance framework of GST.

The stakeholders would need to start training their employees without any further delay. It must be remembered that with the support of the GST Network, the robust IT infrastructure, the GST administration will be completely technology-based. Therefore, IT ability of a taxpayer is a minimum requirement. The clock is ticking - time available is less than 11 months now.

CONCERN NO 7:

Are the Government machineries of the Centre and the States GST-ready? Will the GSTN be ready by April 2016? People are in the dark about the GST preparation.

RESPONSE:

I would like to start my response on this concern with a few precepts for implementing tax administration reforms as highlighted by the former Permanent Secretary of HMRC, UK, Mr Dave Harnett, in a session at APTF last week. The session was on tax administration reform in Asia Pacific region and was chaired by him. In the course of interactions he said that before embarking upon a tax reform, Government must bring out high quality consultation documents for extensive consultations with all stakeholders. He said that even the draft laws and rules relating to the reforms must be put in the public domain well in advance so as to have effective consultations. At a later stage when the laws and rules are finalised, government should publish 'Guidance on Application of Law' and publicise it. Mr Harnett further said that government should win the taxpayers' trust by starting 'Roadshows' explaining various aspects of the reforms, and pointed out how it would help taxpayers in doing business with more ease.

Against the backdrop of these precepts set out by Mr Harnett, let's examine how they go with India's GST preparations. Unfortunately, after the release of the document (First Discussion Paper) by Empowered Committee in 2009, there has been no release of any other important document till date. We are aware only through news reports that the preparations relating to the GST legislation, rules and business processes are advancing at a rapid pace. But non-release of these documents has resulted in denial of participation by taxpayers. They would know better about where the shoe pinches only when the documents are available to them. Their feedback about deficiencies, if any, would help the policy makers to a large extent. A few documents of utmost importnace would be 'place of supply of goods and services rules', business processes like registration, returns, audit and refund - just to name a few, and of course, the Draft Model GST law which would be followed by both the Centre and the States. With less than 11 months left, it is imperative to put these documents on government websites sooner than later. Similarly, the GSTN - the SPV that would provide the common platform for all stakeholders, may also inform the stakeholders about the progress of work in this most important area of GST implementation.

In the absence of disclosure of such vital information, taxpayers are having doubts about the introduction of GST from April 1, 2016.

I am sure with the clear directions coming from the Prime Minister and the Union Finance Minister, the officials at the Centre and the States must have been burning midnight oil to make it happen. But it is equally important to share the document with all stakeholders and get the feedback from them. Keeping the taxpayers in the dark is not helping at all; the government must now open up in this regard.

CONCLUDING REMARKS:

A strong criticism by certain section is that the proposed model of GST is not ideal and it's fractured due to compromises made, mostly at the instance of States. At the outset, let me point out that all models of GST in federal countries all over the world are imperfect. As I mentioned in the beginning of this long piece, the compulsions of democracy have its price and hence the compromises become necessary. Perfect and ideal GST has never been practiced in any federal democracy. Let me start with the worst GST. Brazil's GST has been called a 'Patchwork Quilt' by the economists - it's very complicated and it's cited as a model not to be followed. The VAT in the EU is much better; but their structure is also defective inasmuch as lot of cash sale is involved in poorer countries like Italy and Spain. A few years back there was a big VAT 'carousal fraud' in the EU. The best form of duel GST, somewhat like the one that is being proposed for India, is prevalent in Canada. But even in Canada it is not perfect GST; - each State in Canada collects its own sales tax apart from the Central levy of GST. In India the sales tax (State VAT) would be subsumed and that way it is an improvement over the Canadian model.

I reiterate that duel GST model proposed in the Bill would be like a joint venture - first, amongst the 29 States and then between the Centre and the 29 States. In order to make this joint venture successful, all the States have to be taken on board. Therefore, Mr Jaitley has to make necessary compromises in the structure of the GST. I am sure he is aware of the ill-effects of the additional one per cent origin-based tax. But then, that was the compulsion of democracy. A purist may not like these compromises. But how long can the country wait with seemingly endless negotiations between the Centre and the States since 2006? Let's move forward with an 'imperfect GST' and let the all powerful GST Council make course corrections at the earliest opportunity so that we can quickly move to get a perfect GST in the near future. It's doable. Today's imperfections in the GST model can surely be corrected when the unfounded fear of the States about loss of revenue is dispelled by virtue of tax buoyancy which would definitely happen with wider taxbase and technology-based efficient tax collection machineries in the GST regime.

(Also See TIOL TUBE for interview of Malaysian GST Chief and noted GST Expert from the Netherlands - https://www.youtube.com/watch?v=87By3dx-B1A)