The long wait for a harmonised indirect tax system in India will soon be over with the introduction of Goods and Services Tax (GST) system from 1 July 2017. After the passage of four GST Bills (Central GST, Integrated GST, Union Territory GST and GST Compensation to States), GST rules and regulations will be finalised soon and notified. The state GST bill needs to be passed in each state Legislative Assembly and in the Union Territories (with Legislative Assembly) before the GST is rolled out. The GST Council has made a commendable effort in achieving consensus on the GST bills, hopefully resulting in a smooth passage of the state GST bill in the forthcoming sessions of state Legislative Assemblies.
It is expected that the GST Council will assign tax rates for commodities (according to the Harmonised System Nomenclature (HSN) Code) in May 2017. The distributional impacts of GST across different socio-economic strata will largely depend on careful allocation of tax rates to different commodities and services. Keeping in mind differences in consumption patterns by socio-economic groups in different states and locations (rural and urban) could help the government to achieve equity in the proposed tax system.
As already decided by the Council there will be four different GST rates (5%, 12%, 18% and 28%). It is expected that the Council will come up with a short list of exemptions, comprising some essential goods and services. The Council has also set a maximum GST rate of 40% as an enabling provision without the need for parliamentary approval. There will be additional ‘GST compensation cess’ over and above the highest GST rate on some demerit goods (e.g., tobacco products, aerated drinks) and environmentally harmful goods (e.g., coal). The proceeds of the cess will be put into a separate fund. The Centre will retain 58 percent of the fund and the rest will be transferred to states as compensation for any revenue loss during first five years of introduction of GST.
After the end of the compensation period, it is expected that the cess will be subsumed under the GST rate, except clean environment cess. The Council has also decided on the highest rate for the cess for different commodities: 135% for pan masala, 15% for luxury cars, INR 400 per tonne of coal. Extending the list by including a few more environmentally harmful commodities would be desirable to initiate the next level of environmental fiscal reforms in India. The actual rate for GST compensation cess for different commodities is yet to be decided. An input tax credit will be provided against the GST compensation cess and there will be no cascading of taxes on account of the cess.
The Council has also discussed that GST compensation will be based on a 14% nominal growth rate of revenue across all states with respect to revenue collected in the financial year 2015-16. GST compensation to states will be decided on the basis of net revenue, excluding revenue accruing from non-GST items. For non-GST items, except entry tax, all other taxes (e.g., sales tax, central sales tax) and cesses will continue and it is expected that central government will compensate states for any revenue loss on account of scrapping of entry tax on non-GST items.
The emergence of a common market in India will be contingent upon harmonisation of the GST rate across states. Deviation from the common rate by any state may lead to a higher compliance burden for businesses with pan-India operations. Harmonisation in rules and regulations, as well as the GST rate, is desirable from a business point of view. It is not yet clear whether tax preferences/ exemptions given by different states under industrial incentive schemes will continue under the GST regime. If not, industries may demand alternative incentive schemes. However, any provision for such tax incentives will erode the tax base of the concerned state.
In the present indirect taxation system, some sectors are taxed more than others. For example, manufacturing is taxed by both central and state governments whereas services are taxed once. Some states tax agricultural produce selectively. Consequently, the present indirect taxation system not only provides an unequal tax base between central and state governments, but also distorts consumer choice by taxing goods and services differently.
In the GST regime, it is expected that the effective tax rate for manufacturing goods will go down and it will go up marginally for services. Imports in India will attract Integrated GST (IGST) in addition to a basic customs duty/tariff. If imports are used as inputs for further value addition, then input tax credit will be allowed. All exports will be zero rated. These provisions will facilitate ease of doing business in India and make Indian exports competitive in the global market.
Tax administration
The GST Council has decided to set the threshold for GST registration at INR 2 million (USD30,000) (INR 1 million for special category states). Businesses with annual turnover of up to INR 5 million (USD75,000) will have the option of a composition/compounding scheme. The applicable tax rate is 2% for manufacturers, 1% for traders, and 5% for restaurants. For central tax administration, the registration threshold under the present regime is INR 15 million (USD225,000). There will be vertical and horizontal division of assessees between tax administrations. 90% of the registered entities (including service providers) having annual turnover up to INR 15 million will be assessed by the State tax administration and the rest by the Central tax administration. For taxpayers with an annual turnover above INR 15 million there will be equal distribution of assessees between state and the central tax administration.
The proposed system is expected to reduce the compliance burden for small taxpayers and also encourage a cooperative environment in tax administration. However, there is no clarity on the criteria for selection of cases/assessees for assessment under state or central tax administration. There is also discussion that uniform criteria (risk parameters) will be applied across all states for selection of cases for scrutiny assessment. However, some states have developed extensive methods for selection of cases for scrutiny assessment; it would be desirable that GST Network (GSTN) will incorporate the expertise in the developing of general system. There are also some contentious issues related to assigning assessment authority which require consensus – e.g., IGST cases with contentious place of supply provision, high sea sales.
For IGST, GSTN will work as a clearing house for seamless movements of input tax credits across states, and there will be cross empowerment for all taxes under GST (CGST, SGST and IGST). It is expected that new field formation (allocation of manpower and resources) of the Central Board of Indirect Taxes & Customs (CBIC) (earlier used to known as Central Board of Excise & Customs) will take into account the existing field formation of State Commercial Taxes Departments for better coordination, enforcement and facilitation of tax compliance in the GST regime.
GST and petroleum products
Since the Council has already set an enabling condition by setting maximum GST rate to 40%, and reached a consensus to levy cess over and above the GST rate for environmental harmful goods, the inclusion of petroleum products (like petrol, diesel, and aviation turbine fuel), natural gas and crude petroleum under GST should be easier now. Imposing a standard GST rate for such non-GST items with an additional state-specific regulatory levy could achieve revenue neutrality. Keeping these major sources of energy out of the GST system will result in retaining substantial tax cascading of the present tax system and it will hamper competitiveness of Indian industries.
Anti-profiteering provision
In the GST regime, the central government may consider monitoring prices of the commodities closely and it is expected that businesses will pass on the benefits of reduction of tax rates to consumers. The central government may consider constituting an authority or delegate power to an existing authority to take penal action against businesses if any anomaly found in passing on the benefits of tax reduction to consumers. There is no doubt that reduction of tax rates, cascading of taxes, and transaction costs will provide additional profit margin to some businesses and therefore it will encourage investment and competition. However, setting up such an authority may intervene in normal functioning of market forces and discourage market competition.
The success of the GST system in terms of tax compliance and revenue mobilisation will largely depend on modernisation and the simplification of tax administration; provision of incentives for tax-invoice-based transactions; facilitating voluntary compliance by simplifying rules and regulations; providing tax payer services; tax coordination and automatic exchange of information across tax jurisdictions; and effective tackling of tax evasion and tax frauds.
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