JULY 18, 2022

By V K Garg

ANYONE who had driven in the past in Chandni Chowk in Old Delhi would know that it was amongst the toughest places to drive anywhere in the world. The presence of practically all modes of transport, from the hand-pulled carts and manual rickshaws to expensive cars, with hawkers occupying the sidewalks, made it a nightmare for even the best of the drivers. Ushering GST in India faced a somewhat similar navigational challenge.

Lack of harmony in key tax provisions and rates, origin-based taxation (octroi, purchase tax and CST), loss of credits on inter-state movement of goods, absence of cross utilization of tax credits between Central and State-taxes were just a few of the contributors to the bad cholesterol of cascading resulting in blockage of the economic arteries. Top five states collected more than half the taxes while the bottom half accounted for less than 10%. Successful persuasion of all the states to give up their sovereignty in an area of immense state influence and power and to join a common platform is an example with no parallel anywhere in the world. To that extent GST deserves credit, celebrations and commendations.

But there are many who feel that the goodness of Indian GST ends with the dictum: Any GST is better than no GST. Their concern arises from the understanding that VAT-systems are difficult to repair and Indian GST may have missed the proverbial bus.

GST was never meant to be a one-size-fits-all tax. Like shoes, each person tries to find his best fit. But it's essential attributes are contained in International VAT Guidelines: burden of VAT should not fall on business; similar businesses should suffer similar taxation; VAT should not impact business decisions and imports and exports should be neither advantaged nor disadvantaged. The key instrumentalities to achieve these are: fewer tax rates and exemptions, liberal inputs credits and technology-reliant system of compliance.

Many judge a VAT by its Collection-efficiency (C - efficiency) Ratio also known as VAT Revenue Ratio (VRR) i.e. ratio of actual to potential revenue. Lower the ratio, higher the distortions. Just to provide global context of this ratio: New Zealand: 0.95 (near perfect), Japan: 0.72, EU: 0.56 and Canada: 0.49. India is likely to be close to 0.40. A modern GST ushered in 2017 should have aimed for a number not less than 0.60.

The following discussion will address some of these key areas while remaining mindful that the best should not become an enemy of the good.

Nearly 75% of the countries implementing VATs after 1990 have a single rate. India is in the unenviable company of only four other countries which have 4 or more rates: Ghana, Italy, Luxemburg and Pakistan. It also has the second highest tax rate (after Chile). Apart from the multiple levies, it is the distorting character of rates across similar and substitute supplies that remains a big concern. Supplies are distinguished based on brand, price, end-use, ITC taken or not, distribution channel, location and/or status of the supplier, location of supply, nature of fuel used in case of certain vehicles and the impact on society. Tax liabilities may also change depending on how goods are packed or marketed.

A rather glaring example is transport sector which has taken it to the complete extreme with little rationale in a situation where the goods are merely being moved from one place to another:

Another example is land. While sale of land is outside GST, its leasing by Govt. agencies for industrial parks is taxed @5% while the rate of leasing by others is @18% which understandably are ineligible for tax credit. It is felt that such distortions in basic factors of production are entirely unnecessary.

Tax rates were initially set largely as a summation of the average of various taxes applicable before GST to minimize possible disputes within the Council and protect revenues. This resulted in the import of all the pre-GST imperfections in the new GST rates. For example , there was no need to exempt transportation by road and inland waterways which was a constitutional necessity in the previous regime (relevant entries fell in List II). A classic case was fully exempting Prasad (normally sweets offered at places of worship) while taxing sweets at @ 5%, Chikki(also another kind of sweet) @ 12%, many eatables @18% and those with chocolates @28%.

Problem of multiple tax rates is further accentuated by too many exemptions and exclusions. The exclusions are in two categories: (1) By Constitution: Alcohol; and (2) By GST enactment: petroleum, agriculture, land, completed buildings, securities and actionable claims barring some exceptions. Additionally, several other areas are exempted: electricity, basic food items, newsprint, hand tools, healthcare, education, social welfare, culture, religion, recreation, justice delivery, leasing of residential property, non-fee based financial sector, government and non-profit institutions and transport in certain sectors. The numbers of exclusions and exemptions, when compared to any global regime of some significance, is too large and their coverage too wide.

Additionally, there are reduced rates without input tax credits in the case of restaurants, rail-transportation, GTA, residential real estate, hospital rooms (> Rs 5,000), distribution sector up to Rs 1.5 cr. per annum and services-suppliers up to Rs 50 lakh per annum. Nearly 50% of the basket constituting Consumer Price Index is exempt and more than half the GDP is either outside the GST or tax credit chain.

While the GOM constituted on rate rationalization may address some of these issues by reducing both the number of rates and/or exemptions, the larger issue of micro-managing economy and delivering social justice through GST requires some serious thought. Social justice is best addressed through the instrumentalities of direct tax or DBT. Expecting a simple and C-efficient GST, while retaining such rate- distortions and exemptions, would be to like having the cake and eat it too.

Every tax credit denied in respect of legitimate business costs imparts this otherwise indirect tax the character of a direct tax. Indian GST is far more regressive when it comes to denying tax credits even in respect of bonafide business expenditures e.g. construction of civil structures, telecom-towers, transportation-pipelines, gifts for business promotion, business samples, goods lost in fire and CSR expenses. There are other indirect denials too: bad debts, credits due to place of supply issues, inputs used in manufacture of supplies which are taxable under a law other than GST law or vice versa, invoice mismatches due to supplier-end issues and payment-delays.

Another equally disturbing feature is to deny tax credits to many sectors altogether (by taxing at lower rates) practically taking these sectors outside the tax credit chain. This creates huge opportunities for diversion of tax paid invoices to other businesses, incentive for self-supplies, attempts to bundle supplies to avoid tax (e.g. transportation of fruits and vegetables by a restaurant as CIF contracts).

A rather glaring distortion is denial of tax credits relating to use of power as it is presently exempt. However, credits are admissible to inputs going into generation of power by way of self-supply through captive power plants running on environmentally unfriendly coal, but not on natural gas which is outside GST. Also concessional C- form for procuring non-GST inputs for GST supplies has been discontinued thereby further adding to cascading.

It would be reasonable to assume that the incremental tax burden of all these measures would place an additional burden of 2% to 5% of the taxable value on businesses depending on the sector. That's the advantage the imports would have over domestic supplies and the disadvantage the exports would suffer in global markets.

A GST with few tax rates and exemptions, and with liberal tax credits, is sine qua non for a simple GST. Even though it is tough to imagine India adopting a single rate, the minimum that India should try is to have not more than two rates for a Chapter, ideally even a Section. There are alternate methods (e.g. option-to-pay-tax scheme) to maintain the sanctity of input tax credit chains of many excluded and exempt sectors into GST without effectively taxing them and thereby impacting either the states' autonomy or their revenues.

The GST Council could also think of exempting and thus eliminating intermediaries like distributers, brokers, agents and their respective sub-distributers, sub-brokers and sub-agents who provide B2B services and thus bring the effective tax base to a more manageable number with little, or perhaps positive impact, on tax revenues.

It appears that close to 75% of the GST revenue accrues from less than 5% of the tax-payers and close to 50% from less than 1%. Is it fair to expose them to the vagaries of the same compliance system that is targeted at fly-by-night operators? They can be given treatment on the lines of Authorised Economic Operator scheme of Customs allowing them accelerated refunds and adjudications, centralized clarifications on contentious issues (ARA are often revenue-driven), and eliminating irritating interventions like blockage of credits for petty reasons. Thus, close to 75%, or even higher, revenue can be liberated from the rigour of the GST and monitored through periodic audits and, in exceptional cases, through enforcement actions. They can also be exposed to higher penalties in case of willful transgressions.

Centralized registrations across geographical territories and common registration for a business group of multiple related parties will further help in eliminating intra-business and distinct party transactions without impacting either revenues or their respective distribution to States. This will also pave way for comprehensive audits on a nation-wide basis thereby eliminating multiple audits of same entity while enabling the tax officers to see and appreciate the big picture for meaningful interventions .

The world is fast embracing technologies of the Fourth Industrial Revolution. These technologies can help in making GST compliances driverless if the irritants in law requiring manual interventions are removed.

It is always a tough call to strike the right balance between the needs of facilitation and enforcement. However, the contours of enforcement of an economic law, still in nascent stage, have got to be much different from laws that deal with criminal offences. Government would do well to make the process of enforcement far more transparent with due accountability so as to ensure that various tools available at the hands of officers are put to judicious use only after carefully and holistically weighing the seriousness of the challenge and the consequences of their actions, both direct and collateral .

Eventually, the taste of the GST pudding would be in the eating! Raising the C- Efficiency of GST on the one hand and reducing the cost of compliance for businesses on the other will make this pudding toothsome! Chandni Chowk may have been given a facelift and become more hospitable to some but it's make-over to be truly meaningful will have to be such that the common man finds it tempting enough to visit in preference to the swanky malls which have mushroomed all around and continue to charge hefty margins taking advantage of the surmountable constraints and limitations of a market like Chandni Chowk.

[The author is Ex-IRS and a Tax Professional. The views expressed are strictly personal.]