JANUARY 21, 2019

By Sumit Dutt Majumder

IN a scale of time, we have travelled one and half years since GST was introduced. As expected, there were birth pangs, more painful in case of Small Business. In the overkill to bring most of the unorganized informal sector of the economy to the organized formal sector in one go, the policymakers took certain decisions at the initial stages of GST implementation itself which had hurt the Small Business badly. Not to forget, this was preceded by Demonetization just about eight months before GST came. Consequently, sizeable chunk of the small business either closed down or cut down their business drastically. In light of countrywide protests from them, the GST Council started responding positively from November, 2017; but that was not sufficient. The impact of demonetization followed soon by the GST policy glitches in respect of Small Business broke the backbone of the MSME sector. Reportedly, this had an impact in the electoral arena as well. Finally, the GST Council in its 31 st and 32 nd meeting held on 22 nd December and 10th January respectively took certain far-reaching decisions with an eye to giving some relief to the Small Business.

Before we go into the decisions in the aforesaid GST Council meetings, let us first understand the GST worries of Small Business or Small Business worries of the GST policy makers.

One of the declared aims of introduction of GST has been that it would help formalizing the Indian Economy. Informal economy which is generally understood as the economy which runs on cash without keeping any record and without payment of any tax, had been playing a big role in the overall Indian economy, and it had indeed been a matter of concern.

Coming back to GST, in the pre-GST indirect taxation system of Centre and States, there was disruption in free flow of credit in the supply chain of goods and services. The Central Excise Duty and Service Tax collected by the Centre were not available for credit when the tax on sales i.e. State VAT was collected by the States from the purchasers.The result was that the State VAT was levied on cost of the goods plus the tax (Central Excise and Service Tax). This was a case of taxing the tax or cascading of taxes. In the GST regime, but for a few cases of Blocked Credit, the flow of credit is seamless from the first point of production of goods or provision of services till the end of the supply chain when these are sold or supplied to the ultimate consumer. It means that all taxes paid at different stages of supply chain during the Business to Business (B to B) transactions are available as credit at all subsequent stages until it becomes a Business to Consumer (B to C) transaction. It is here that finally the burden of GST, almost without any cascading of taxes falls on the consumer. The Input Tax Credit scheme is the heart of GST, inasmuch as the advantage of seamless flow of credit has made this tax quite attractive to the trade and industry in general.

However, on the flip side, a direct fallout of the credit scheme explained above is that the purchasers of raw materials and components would not like to buy these from a supplier who is not registered for GST and thus not paying GST. The reason is that he would not be able to avail of input tax credit on account of his inputs and thus the credit chain would break. Therefore, he would either ask his supplier to get registered and pay GST or he would stop buying from that unregistered supplier. In order to keep his business going, the aspiring supplier who wants to expand his business, would then voluntarily get registered and start paying GST. Thus this switch over from the informal economy to the formal economy is a voluntary one arising out of business necessity. In fact, the number of registered enterprises rose from around Sixty Six Lakhs before GST implementation to around One Crore Twenty Lakhs in December, 2018. A rise of about 100% in switch over from informal to formal economy in first one year and five months of implementation of GST was remarkable. There may have been a small percentage of rise in formalizing the economy involuntarily through Demonetization. But, going by the views of most of the economists, demonetization had very little impact in formalizing the economy and its cost in terms of disrupting the economy was vast.

Said that, it must also be remembered that a big number of the Small Business who were not aspiring to be big and preferred to remain out of the GST ambit were badly affected because of certain GST policy glitches.In the first place, the threshold for coverage under GST was kept very low compared with the international standards. It was Rs. Twenty Lakhs of annual turnover; internationally the threshold varies from equivalent of Rs. Eighty Lakhs to Rs. One Crore. In the pre GST era, the Central Excise threshold for manufacturers was Rs. One Crore and Fifty Lakhs. But, in the enthusiasm of collecting more revenue and bringing in more and more people under the formal economy in one go, the threshold has been kept very low. The VAT /GST experts worldwide recommend high threshold so as to keep the Small Business out of the ambit of GST for following reasons. Taxing the Small Business is cumbersome since they are bad at keeping records. The collection of tax from them is meager, and not cost-effective; rather, they breed corruption. Even Arvind Subramanian, then Chief Economic Advisor had in a report recommended for a GST threshold of at least Rs. 40 Lakhs.

To add to the woes of the MSME, the policy makers went overboard in their drive to bring even the people below threshold within the ambit of GST. Two critical policy decisions in this regard hit the Small Business including small manufacturers most. First, it was decided that the threshold of Rs.20 Lakhs will be applicable only for intra-state supplies of goods and services. The persons doing inter-state supplies will not get the benefit of threshold exemption and they will have to pay GST irrespective of their annual turnover. So, if a manufacturer or a trader or Service Provider based at say Okhla (South Delhi) whose annual turnover was say Rs. Five lakhs i.e. below the threshold, supplied goods and/or services to say a recipient at Gurgaon (Haryana) or NOIDA (U.P.), the supply became inter-State and all his supplies came within the ambit of GST, although he was otherwise below the threshold limit and hence not liable to pay GST. Consequently,a person who decided to remain outside GST stopped supplying inter-state in order to avoid the GST compliance requirements, and thus his business shrank.

The other policy decision was the application of the concept of Reverse Charge mechanism for a transaction by a registered person with an unregistered person who was below threshold and thus not liable to pay GST otherwise. Here an obligation was bestowed on the registered person to pay GST and comply with all requirements on behalf of his unregistered supplier. Consequently, in order to get rid of this burden, the registered person promptly stopped business with his unregistered supplier and looked for a registered supplier. This caused further stress on the Small Business.

These two policy decisions coupled with very low threshold, all aimed at collecting more revenue and formalizing the Indian economy broke the backbone of Small Business including Small Industries.

Another factor that had hit the Small Business was the unpreparedness of the IT infrastructure support i.e. GST Net during the initial few months of the GST implementation. The Small Businesses were hoping to utilise the services of GST Suvidha Providers (GSPs) to get their compliance requirements done through the GSTN. But, neither the GSTN was fully operational on 1st of July, 2017 when GST was launched nor the GSTN could provide the Application Software to the GSPs to enable them to be the interface between the GSTN and the Small Business. Therefore, the Small Business having no IT Support faced major difficulties in the first stage of GST implementation.

Because of the foregoing circumstances, many Small Business establishments had to close down their business, which in turn resulted in increased unemployment. It is estimated that the MSME sector contributes around 70 to 75% of total employment in the country. Therefore, the decisions on going overboard on formalizing the economy involuntarily through those two clauses caused much hardship to the Small Business and in turn to the economy. This was the cost of implementation of GST because of these policy glitches.

Subsequently from end-November, 2017 some relief was given by suspending the implementation of Reverse charge mechanism. The threshold condition relating to interstate trade was also kept in abeyance only for the interstate supply of services. This condition still remains for the interstate supply of goods, much to the grief of the Small Business including manufacturers.

The doubling of threshold exemption limit will help those small businesses who do not have any aspiration to move up the ladder and hence have no keenness to pay GST and do business with the registered big business. They will be happy to remain outside the ambit of GST. However, the small businesses who aspire to become big will remain unaffected since they will continue to remain registered and pay GST although their annual turnover is below threshold. That is because the registered big business will not like to deal with unregistered ones that are not paying GST and thus breaking the credit chain. The same is the reason for not much enthusiasm among the aspiring MSMEs for the Composition Scheme, where the credit chain breaks because of non-availability of credit in composition Scheme.

While on Composition Scheme, the 32nd meeting of the GST Council decided to extend the scheme to all services upto an annual turnover of Rs. 50 Lakhs. But the rate of Composition for services has been kept at 6% as against that of goods which is at 1%. This is likely to create classification disputes. There should be a common rate of Composition for both goods and services. Thus, the recommendations are as follows:

(i) The clause relating to the aforesaid condition of denial of threshold for inter-state supply of goods may be dispensed with at the earliest. The revenue implication would be negligible.

(ii) The clause relating to application of Reverse Charge Mechanism for purchases from unregistered supplier may be dispensed with straight away. It's never a good idea to give benefit by the right hand and take it away by the left hand.

(iii) While the threshold for Composition levy in respect of goods and services may be different, its rate should be same for both goods and services.

These steps will no doubt reduce the scope of formalizing the informal economy for the present. But as explained before, the cost of closure of Small Business establishments with resultant loss of employment is bad for the economy; in course of time those who would be left out now will also join the formal economy in their own interest, voluntarily, because of the very structure of GST. Voluntary formalization would bein the right spirit of GST.

Before concluding, it will be important to point out that all these relaxations coupled with rationalization of tax structure through drastic reduction of GST rates in five stages from November, 2017 to January 2019 have made the GST revenue target topsy-turvy. Already, as on 31 st December, 2018, the collections are substantially below the budgeted target. In terms of a report by Kotak Institutional Equities, the present run rate of GST collections, after adjusting for refunds, works out to around Rs.89,600 crore as against a monthly target of Rs.1,04,400crore. The government has collected Rs. 8,71,043 crore as GST during the first nine months of this financial year, i.e. April-December 2018. In order to reach the overall annual target of Rs. 13.48 lakh crore, the government will have to collect Rs. 4.77 lakh crore in the next three months. This is extremely difficult.

Firstreason for such shortfall is a series of GST rate cuts in five rounds from the later months of 2017 till December 2018. In fact, the idea of putting so many items in the higher slabs of 28% and 18% right in the beginning was itself a flawed one. Good that the Council finally corrected most of these aberrations.

The second reason for the shortfall is low compliance rate in payment of taxes. Union minister of state for finance Shiv Pratap Shukla recently said in response to a LokSabha question that the percentage of taxpayers who had not filed returns associated with payment of GST had steadily increased from 10.56 percent in November 2017 to over 28 percent in November 2018. The data further showed that under the Composition scheme the percentage of non-filers has risen to 25.37 percent in July-September 2018 as against 15.03 percent in the corresponding period of 2017.

The third reason is that there has been considerable slowdown in the economy, particularly in manufacturing and also in the service sector. This impacted revenue collection adversely. Thus, the government has reasons for revenue collection worries.

It is not difficult to identify the people who had got registered, but were not filing returns. Thereafter, leaving aside the people who had stopped paying tax for legitimate reasons of subsequent relaxations given by the government, GST officers can proceed against other GST registrants who had not been paying tax and filing returns. GST is based on the principle of trusting and facilitating trade, while simultaneously taking stern action against those who are non-compliant.

The structure of GST is such that not many officers are now necessary for the basic assessment work. The main responsibility of officers now is in the areas of scrutiny of returns, including the detection of non-filing, selective audit based on risk factors and collection of intelligence and detection of cases of non-compliance and follow-up enforcement actions.

In fact, in his written reply to Parliament, the minister stated: "The details of the non-filers of returns are regularly shared with the jurisdictional tax authorities and measures including inspection, visit of premises, search and seizure are being undertaken wherever required." It has also been disclosed that 499 cases of fake invoices used for claiming input tax credit that involved tax evasion of Rs. 3,894.94 crore was detected in this fiscal up to December 2018. Fake invoices were generated without any actual supply of goods and/or services just to utilize the credits that were facilitated by them. This current amount of tax evasion (Rs. 3,894.94 crore) shows a marked increase in detection of such cases, as from July 2017-March 2018, only four cases were detected involving Rs 9.75 crore.

Thus, stringent enforcement action with revamped anti-evasion wings of the GST Commissionerates and the Directorate General of GST Intelligence, together with simulations extension of trade facilitation to the bonafide taxpayers is the need of the hour.

There is another challenge before the government. This is an election year and there are political compulsions for being kind to the people in respect of taxation. There are expectations that some more items such as cement, air conditioners, etc. will be brought down from the 28 percent slab. Further demands from small business are of course justifiable.

Identifying missing tax payers and enhanced enforcement will, no doubt, add to the revenue, but won't be enough to meet the overall GST target in the next two and half months. Thus, we are heading towards interesting times on the GST front. Judicious steps after the election months should help GST stabilize in all respects.

But, it must also be remembered that on the last day of the financial year, the Finance Ministers have generally been asking the taxmen "Where's the Money, Honey?" Answering this question with conviction will be another challenge before the taxmen.

(The author is former Chairman, Central Board of Excise & Customs and author of three books on GST - the latest one, "GST- explained For Common Man".)