Goods and Services Tax A Roadmap for India

Transcription

1 Goods and Services Tax A Roadmap for India Sarkar Subhrangshu Sekhar Abstract-- India, being one of the largest democracies in the world, has to follow the convention of welfare state. The federal structure of the country provides a relatively powerful government at the centre accompanied by 28 state governments. All of them require finance to govern the country and the states. Indirect tax is one of the major sources of revenue. India has been experimenting with the tax structure since independence. After introduction of Value Added Tax (VAT) from 2005, the country is going to experiment with Goods and Services Tax (GST) from April 1, This paper puts an attempt to explore the pros and cons related to the issue of introduction of GST in India. Keywords Goods, Services, Tax, India. I. INTRODUCTION N announcement was made by the then Union Finance AMinister in the Central Budget ( ) that GST would be introduced with effect from April 1, The General Budget also proposed to integrate the tax on goods (cenvat) and the tax on services, and finally move to a common Goods and Service Tax (GST). In as much as the policy so far has sought to achieve convergence of rates, this would facilitate the introduction of GST by 1 st April, 2013, as already announced by the Government. This shift to GST is expected to significantly improve buoyancy from indirect taxes, owing to the opportunity it provides for further convergence and moderation of rates and a substantial expansion in the base which would extend beyond manufacturing all the way to retail. Reforming the tax system is important for achieving fiscal consolidation, creating instability in the economy and minimizing distortions in the economy. The wave of tax reforms across the world began in the mid 1980s and speeded up in the 1990s due to a number of factors. In many developing countries, tax policy was directed to correct fiscal imbalances. In others, the transition from centralized planning to market required wide ranging tax reforms to replace public enterprise profits with taxes as the principal source of revenue. An important reason, however, was internationalization of economic activities. The sharp reduction in tariffs accompanying globalization required that an appropriate source of revenue to replace this had to be found. On the other, globalization emphasized the need to minimize both efficiency and compliance costs of the tax system. Sarkar Subhrangshu Sekhar is working as Professor at Department of Business Administration, Tezpur University, Assam, India ( subh16@gmail.com) Over the years, tax policy in the country has evolved in response to the development strategy and its changes. In the initial years, the tax policy was directed to increase the level of savings, transfer available savings for investment as envisaged by plan strategy and the need to ensure a fair distribution of incomes, to correct inequalities arising from the oligopolistic market structure created by the co-existence of private and public sector and the existence of other instruments of planning such as licensing system, exchange control, administered price determination. Introduction of the Value Added Tax (VAT) at the Central and the State level has been considered to be a major step an important breakthrough in the sphere of indirect tax reforms in India. If the VAT is a major improvement over the preexisting Central excise duty at the national level and the sales tax system at the State level, then the Goods and Services Tax (GST) will indeed be a further significant improvement the next logical step towards a comprehensive indirect tax reforms in the country (The Empowered Committee of State Finance Ministers, 2009). II. HISTORY OF TAX REFORMS IN INDIA The history of taxation dates back to time immemorial and it is not a recent development by any account. A thorough research on the history of taxation system shows that taxes were levied on either on the sale and purchase of merchandise or livestock. Further, the history of taxation suggests that the process of levying and the manner of tax collection were unorganized. But it suggests that all historical leaders and head countrymen collected taxes to run its authority. In other words taxes on income, sale, purchase and properties were collected to run the ruling Government machineries. Further, these taxes were collected to meet their military and civil expenditure and also to meet the common needs of the subjects like maintenance of roads, drainage system, government buildings, administration of justice and other functions of the region. Today India tax machinery is very much based on that laid down foundation. Although, there were no homogeneous tax rate structures but it depended on the production capacity and commodity of that particular country and/or region. Moreover, the tax rates and quantum varied according to the annual production. These taxes were collected in cash or in kind and it entirely depended on the type of commodity or service on which it was levied upon. For example, there was a very common practice of selling food crops and cash crops to government machineries against no money. The history of taxation suggests these were done to store government buffer stocks to meet emergencies. Taxes were levied on all classes of citizens, like actors, dancers, singers and even dancing girls. Taxes were paid in 226

2 the form of gold-coins, cattle, grains, raw-materials and even by rendering personal service. In India, the tradition of taxation has been in force from ancient times. It finds its references in many ancient books like 'Manu Smriti' and 'Arthasastra'. There was a perfect admixture of direct taxes with indirect taxes and they were varied in nature. India's history of taxation suggests existence of a large and composite taxable population. With the advent of the moguls in India the country witnessed a sea of change in the taxation system of India. Although, they also practiced the same norm of taxation but it was more homogeneous in structure and collection. The period of British rule in India witnessed some remarkable change in the whole taxation system of India. Although, it was highly in favor of the British government and its exchequer but it incorporated modern and scientific method of taxation tools and systems. In 1922, the country witnessed a paradigm shift in the overall Indian taxation system. Setting up of administrative system and taxation system was first done in the history of taxation system in India. The period thereafter witnessed rapid growth and modernization of the Indian taxation system. Systematic reforms of the tax system at the central level started only after market based economic reforms that began in The Tax Reforms Committee (TRC; India, 1991) laid out a framework and a roadmap for reform of direct and indirect taxes as a part of the structural reform process, following the unprecedented economic crisis. The paradigm shift in tax reforms adopted by the TRC was in keeping with the best practice approach of broadening the base, lowering marginal tax rates, reducing rate differentiation, simplifying the tax structure and adopting measures to make the administration and enforcement more effective. The important proposals put forward by the TRC included reduction in the rates of all major taxes, i.e., customs, individual and corporate income taxes and excises to reasonable levels, maintain progressivity but not such as to induce evasion. The TRC recommended a number of measures to broaden the base of all the taxes by minimizing exemptions and concessions, drastic simplification of laws and procedures, building a proper information system and computerization of tax returns, and revamping and modernization of administrative and enforcement machinery. It also recommended that the taxes on domestic production should be fully converted into a value added tax, and it should be extended to the wholesale level in agreement with the States, with additional revenues beyond post-manufacturing stage passed on to the State governments. 2.1 Recent reforms in the tax system The recent reforms are, in fact, a continuation of the reforms initiated in In this sense, tax reform in India has been gradual and although not always consistent from year to year, the overall direction has been to broaden the tax bases, reduce the rates, reduce rate differentiation and make the tax system simple and transparent. There has been considerable simplification and rationalization of union excise duties as well. Besides reduction in the number of rates, the tax has been progressively converted from specific into ad valorem levy. The facility of providing credit on input taxes under the CenVAT too has been progressively extended to cover about 80% of the taxed commodities. The poor information system has been a problem and has led to misuse of input tax credit facility and this has led the government to restrict the CenVAT credit to 95%. At the same time with the inclusion of input tax credit facility to the tax on services a further step was taken in integrating the two taxes. The most important reform initiative in the case of the States is the replacement of the cascading type sales tax with the state level VAT. While significant progress has been made in converting central excise duties into a manufacturing stage VAT, the reform in the states sales tax systems has lagged behind. This is critical for minimising distortions, for they contribute over 60% of states tax revenues and to evolve a coordinated consumption tax system in the country. A systematic discussion on coordinated consumption tax system was initiated in the Report on Reform of Domestic Trade Taxes in India prepared by the NIPFP 1. The report favoured the conversion of the prevailing sales taxes to VAT parallel to the central manufacturing stage VAT. There are a number of arguments for replacing the prevailing state sales tax with destination based VAT. Therefore, the decision to transform the states sales tax systems into a destination based retail stage VAT from April 2005 is opportune. However, the reform in April 2005 is only a transitional measure; it extends the sales tax up to the retail stage with credit allowed of taxes paid on purchases for all intra-state purchases. Inter-state sales tax will continue to be levied until it is phased out in the next 2 years. 2.2 Towards further reforms in the tax system In the last few years, reforming the central tax system has received considerable focus. Several reports have comprehensively examined the tax system and made important recommendations to reform. While there are differences relating to some of the specific recommendations as compared to the TRC, there is broad agreement on the direction and thrust of reforms and on the emphasis placed on the reform of tax administration Reform of central taxes: The reforms with regard to personal income tax will involve further simplification of the tax system. This includes withdrawal of tax exemptions and concessions given for specified activities, abolition of surcharge and further simplification of the tax. In fact, there is considerable virtue in having a single tax rate with an exemption limit as many transitional economies have found. The ability of income tax system to bring about significant redistribution through tax policy is limited and it is increasingly being realised that equity should focus on increasing the incomes of the poor rather than reducing the incomes of the rich and this objective is better achieved by expenditures on human development and not through the tax system. 227

3 On the corporation tax, base broadening involves getting rid of the tax preferences. In particular, the exemption for profits from exports, free trade zones, technology parks, area-based exemptions for backward area development, for infrastructure should be phased out. Similarly, the present rate of depreciation allowance, even after the reduction in is quite generous and needs to be reduced to more realistic levels and the rate should be aligned with that of marginal tax rate on personal income tax. There has been a lot of flip flop in regard to taxation of dividends from one year to another. The most satisfactory solution in this regard is to have partial integration of the tax with personal income tax. With regard to import duties, the reform will have to move in the direction of further reduction and unification of the rates. As most non-agricultural tariffs fall between zero and 15%, a uniform tariff of 10% would considerably simplify and rationalize the systems. Equally important is the need to get rid of plethora of exemptions and concessional treatment to various categories including project imports. In fact, a minimum tariff of 5% on all exempted items would rationalize the duty structure and help the cause of revenue as well. Wide ranging exemption is a problem also with excise duties. Therefore, one of the most important base-broadening measures should be to reduce the exemptions. In particular, the exemptions given to small-scale industry has not only eroded the tax base but has inhibited the growth of firms into an economic scale. Similarly, various exemptions given to project imports have significantly eroded the tax base. Another important reform area is to fully integrate the CenVAT with the taxation of services Reform in tax administration: In India, the poor state of tax administration has been a major reason for low levels of compliance and high compliance cost. A major aspect of this is the virtual absence of data on both direct and indirect taxes even at the central level. Not only that this rendered proper analysis of taxes to provide adequate analytical background to calibrate changes in tax structure, but also it made proper enforcement of the tax difficult. Thus, the changes in the tax structure had to be made in an ad hoc manner. Another critical element in tax administration is the networking of the information from various sources. As mentioned earlier, systems have to be evolved to put together information received from various sources to quantify the possible tax implications from them in a judicially acceptable manner to improve tax enforcement. The information networking should get the data from various sources such as banks and financial institutions on various assesses. There must be meaningful exchange of information between the direct and indirect tax administrations and it is necessary to exchange information between central and state taxes. Building computerised information system will help to improve enforcement of taxes. One of the biggest taxation reforms in India -- the Goods and Service Tax (GST) -- is all set to integrate State economies and boost overall growth. GST is supposed to create a single, unified Indian market to make the economy stronger. III. EMERGENCE OF VAT Since the GST at the Centre and States would be a further improvement over the VAT, a brief review of the process of introduction of VAT in India is noteworthy. There was a burden of multiple taxation in the pre-existing Central excise duty and the State sales tax systems. Inputs were first taxed, and then after the production of finished commodity which already includes input tax, output was taxed again. This has been causing burden of multiple taxation with cascading effects. Moreover, in the sales tax structure, when there was also a system of multi-point sales taxation at subsequent levels of distributive trade, then along with input tax load, burden of sales tax paid on purchase at each level was also added, thus aggravating the cascading effect further. This was done away with the introduction of VAT in the Centre and in the States. In case of VAT, a deduction is made from the overall tax burden for input tax. This set off relieves from a substantial amount tax burden not only for input tax paid but also for tax paid on previous purchases. Thus, with VAT, the problem of multiple tax and related burden of cascading effect gets removed. Furthermore, since the benefit of set-off can be obtained only if tax is duly paid on inputs (in the case of Central VAT), and on both inputs and on previous purchases (in the case of State VAT), there is a built-in check in the VAT structure on tax compliance in the Centre as well as in the States, with expected results in terms of improvement in transparency and reduction in tax evasion. In India, VAT was introduced at the Central level for a selected number of commodities in terms of MODVAT on March 1, 1986, and gradually all commodities were included by In the Centre was empowered to levy taxes on services, and services were also brought under the purview of CENVAT in Introduction of VAT in the States has been a more challenging exercise in the country, where each State is free in levying and collecting State taxes. Before introduction of VAT, in the sales tax regime, there was no harmony in the rates of sales tax on different commodities among the States. Not only were the rates of sales tax numerous, and different from one another for the same commodity in different States, but there was also an unhealthy competition among the States in terms of sales tax rates. It is in this background that attempts were made by the States to introduce a harmonious VAT in the States, keeping at the same time in mind the issue of sovereignty of the States regarding the State tax matters. The first preliminary discussion on State-level VAT took place in a meeting of Chief Ministers convened by Dr. Manmohan Singh in Thereafter, in a significant meeting of all the Chief Ministers, convened on November 16, 1999, two important decisions were taken. First, to do away with the unhealthy sales tax rate war among the States and harmonize sales tax rates by 228

4 implementing uniform floor rates of sales tax for different categories of commodities from January 1, Secondly, steps to be taken to implement state level VAT by states on the basis of achievement of the first objective. For implementing these decisions, a Standing Committee of State Finance Ministers was formed which was then made an Empowered Committee of State Finance Ministers. Within a period of about a year and a half to achieve, nearly 98 per cent success was achieved in harmonizing of sales tax structure and therefore further steps were taken for introduction of Statelevel VAT. Steps were also taken for necessary training, computerization and interaction with trade and industry. While these preparatory steps were taken, the Empowered Committee got a significant support from the central government in providing Central financial support to the States in the event of loss of revenue in transitional years of implementation of VAT. As a consequence of all these steps, the States started implementing VAT beginning April 1, 2005 and now all the States and Union Territories have implemented VAT. The Empowered Committee has been monitoring closely the process of implementation of State-level VAT, and deviations from the agreed VAT rates has been contained to less than 3 per cent of the total list of commodities. The rate of growth of tax revenue has nearly doubled from the average annual rate of growth in the pre-vat five year period after the introduction of VAT. Thus, the replacement of the state sales taxes by the Value Added Tax in 2005 marked a significant step forward in the reform of domestic trade taxes in India. It addressed the distortions and complexities associated with the levy of tax at the first point of sale under the erstwhile system and resulted in a major simplification of the rate structure and broadening of the tax base. IV. WAY FORWARD TO GST Despite the success of VAT, there are still certain shortcomings in the structure of VAT both at the Central and at the State level. The shortcoming in CENVAT lies in noninclusion of several Central taxes in the overall framework of CENVAT, such as additional customs duty, surcharges, etc., and thus keeping the benefits of comprehensive input tax and service tax set-off out of reach for manufacturers/dealers. Moreover, no step has yet been taken to capture the valueadded chain in the distribution trade below the manufacturing level in the existing scheme of CENVAT. The introduction of GST at the Central level will not only include comprehensively more indirect Central taxes and integrate goods and service taxes for the purpose of set-off relief, but may also lead to revenue gain for the Centre through widening of the dealer base by capturing value addition in the distributive trade and increased compliance. The existing State-level VAT structure also has certain weaknesses. For instance there are even now, several taxes which are in the nature of indirect tax on goods and services, such as luxury tax, entertainment tax, etc., and yet not subsumed in the VAT. Moreover, in the present State-level VAT scheme, CENVAT load on the goods remains included in the value of goods to be taxed under State VAT, and contributing to that extent a cascading effect on account of CENVAT element. This CENVAT load needs to be removed. Furthermore, any commodity, in general, is produced on the basis of physical inputs as well as services, and there should be integration of VAT on goods with tax on services at the State level as well, and at the same time there should also be removal of cascading effect of service tax. In the GST, both the cascading effects of CENVAT and service tax are removed with set-off, and a continuous chain of set-off from the original producer s point and service provider s point up to the retailer s level is established which reduces the burden of all cascading effects. This is the essence of GST, and this is why GST is not simply VAT plus service tax but an improvement over the previous system of VAT and disjointed service tax. However, for this GST to be introduced at the State level, it is essential that the States should be given the power of levy of taxation of all services. This power of levy of service taxes has so long been only with the Centre. A Constitutional Amendment will be made for giving this power also to the States. Moreover, with the introduction of GST, burden of Central Sales Tax (CST) will also be removed. The GST at the State-level is, therefore, justified for (a) additional power of levy of taxation of services for the States, (b) system of comprehensive set-off relief, including set-off for cascading burden of CENVAT and service taxes, (c) subsuming of several taxes in the GST and (d) removal of burden of CST. Because of the removal of cascading effect, the burden of tax under GST on goods will, in general, fall. The GST at the Central and at the State level will thus give more relief to industry, trade, agriculture and consumers through a more comprehensive and wider coverage of input tax set-off and service tax setoff, inclusion of several taxes in the GST and phasing out of CST. With the GST being properly formulated by appropriate calibration of rates and adequate compensation where necessary, there may also be revenue/resource gain for both the Centre and the States, primarily through widening of tax base and possibility of a significant improvement in tax-compliance. In other words, the GST may usher in the possibility of a collective gain for industry, trade, agriculture and common consumers as well as for the Central Government and the State Governments. The GST may, indeed, lead to the possibility of collectively positive-sum game. Keeping this significance of GST in view, an announcement was made in the Union Budget to the effect that GST would be introduced from April 1, After this announcement, the Empowered Committee submitted a report on a model and road map for GST. The Empowered Committee also took steps to phase out CST on the understanding with the Centre that, since phasing out of CST would result in a loss of revenue to the States on a permanent basis; an appropriate mechanism to compensate the States for such loss would be worked out. The rate of CST has already been reduced to 2% 229

5 and will be phased out with effect from the date of introduction of GST on the basis of such GST structure which, with necessary financial support to the States, should adequately compensate for the loss of the States on a permanent basis. With these steps at preparation in mind, it is important now to turn to the proposed model of GST. REFERENCES [1] Report on Reform of Domestic Trade Taxes in India, National Institute of Public Finance and Policy, New Delhi, 1994 [2] Budget Speech by Union Finance Minister, Government of India,