OCTOBER 03, 2018

By V K Garg IRS (Retd.)

WITH the objective to attract new investments, it has been a practice for long to refund net VAT, in full or part, to new units or those undertaking substantial expansion. After GST, many States have rehashed these schemes by replacing the VAT to its new avataar SGST without realizing the new paradigm. The basic rationale for tax incentives is to bring value-addition activities within a State. Net direct gains to a State in taxes - earlier as net VAT and CST and now as net SGST - are taken as proxy for such value addition.

In the new paradigm net SGST is not only after deducting SGST on sourcing but also unused IGST credits after utilizing them for paying IGST and CGST on outputs in that order. To that extent the net SGST will be often far less than the earlier net VAT.

Take an extreme example where a person uses entirely in-house materials and labour for a totally inter-State supply worth Rs 100. With no tax credits the entire IGST will be paid in cash. Contrast this with another situation where he buys inter-State supplies worth Rs 60 but sells his output entirely within the State. With IGST on inputs of 7.2 he would pay the entire CGST of 6 out of tax credits and use the left over 1.2 for SGST, paying the remaining 4.8 in cash (assuming IGST of 12%; SGST & CGST @ 6% each).

Under existing incentive schemes he will get nothing under the first situation even though the entire value addition has happened within the State. On the contrary, in the second example he would have got 6 as the reimbursement under VAT but will get only 4.2 now, which is still higher than the first situation even though the value addition within the State is a meagre 40% of the first situation.

States need to be conscious that that even though they may get far less tax on inter-State output supplies, the value addition within would yield a future tax inflow from those who contributed to this value while in the latter situation the new consumption within the State may end up cannibalizing existing taxes. This revenue matrix is amply evidenced now with many origin-based manufacturing States doing well in revenues while they were extremely apprehensive before GST.

There are other issues as well. There is no reason to distinguish between IGST and SGST either at input or output stage. SGST can be easily converted into IGST or vice versa by just having a layer of pseudo-manufacturing or even trading. Some States have plugged loopholes relating to trading but with the concept of manufacturing having withered away it is not an easy exercise. The bill-to-ship-to provisions, where goods are billed to one person while actually delivered to another, have made it far easier.

Having already announced schemes, of immediate concern are issues as to how to even calculate net SGST. Is it merely equal to SGST paid in cash or is it the difference between SGST payable and SGST tax credits, ignoring IGST credits? With the recent amendments in law (that are likely to be operationalized soon) the CGST liability is to be first discharged with IGST and thus limiting the availability of IGST for payment of SGST. This will raise the amount of net SGST without any changes on the ground. Job work provisions allow value creation outside new capacities thus compromising the very purpose of such incentives. Can SGST number be so arbitrary that it fluctuates so widely depending on some elementary tax planning?

If the purpose of incentive schemes is to bring value addition within the State, a more correct measure of incentive would be as follows:

First calculate total tax accruing to all States in India from value addition in the incentivising State = [Net IGST + Net CGST + Net SGST] on sale (not mere supply) ÷ 2; let us call it X

The State may then decide to refund a portion of this measure X - depending on its share of all-India GDP or likely local consumption - as incentive.

This will produce even results ordinarily but will fail to address situations where the duty rates vary widely between inputs and outputs. Naturally a unit having principal inputs taxed at higher rate and output taxed at lower rate may even be seeking a tax refund or at least be liable to pay negligible net tax. This will leave little incentive to set up the new unit on grounds of GST benefit. The situation will reverse where the principal inputs are largely exempt or taxed @ 5% while the outputs are liable to tax @ 18% or even 28%.

A possible solution may be to calculate the net value addition based on accounting standards and calculate the total net SGST by applying the applicable SGST rate on such net value addition which should produce more or less the same result as X as per the above formula. The State can then refund a portion of that as stated earlier.

It is thus evident that unless the schemes take note of the new evolving paradigm the incentive schemes will remain ambiguous, difficult to operate or even fraud-prone and divorced from the objective to promote industrialization. Definitely these require a relook.

(The author is Former JS (TRU), CBIC and now Advisor (Financial Resources) to Chief Minister, Punjab and the views expressed are strictly personal)