An Illustrated framework for GST implementation in India

Continuous issue-14 May - August 2015 An Illustrated framework for GST implementation in India Abstract In the light of the empirical conclusions developed in this paper, it seems appropriate to conclude by briefly noting the policy implications of the results. In the first place, the macroeconomic impact of a change to the introduction of the GST is significant in terms of growth effects, price effects, current account effects and the effect on the budget balance..secondly, in a highly developed open economy with a high and growing service sector, a change in the tax mix from income to consumption-based taxes is likely to provide a fruitful source of revenue. Thirdly, the aggregate consumer price impact of the introduction of the GST in India on the macro-economy was both limited and temporary. Finally, despite falling outside the limited focus of this short note, we should record that some impact has also occurred in the administrative component of the compliance cost of the GST as well as a likely increase in tax revenue from the underground or black economy. Introduction The introduction of Goods and Services Tax (GST) would be a significant step in the reform of indirect taxation in India. Amalgamating several Central and State taxes into a single tax would mitigate cascading or double taxation, facilitating a common national market. The simplicity of the tax should lead to easier administration and enforcement. As India is a federal republic GST would be implemented concurrently by the central government and by state governments. The Country is at the behest of implementing Indian Goods and Services Tax, which is said to be by far the most radical reform which the Government of India would have ever implemented. The current taxation system in India is laced with complexity, multiplicity and Page 1

ambiguity. The plague of cascading effect of taxes, was to some extent, mitigated with the introduction of CENVAT. in the year 1986 at the Central level and further with the introduction at the State level, with a Value Added Tax system for most part of the Country, in the year 2005. Considering multiple taxes levied by the Centre and the State and absence of the facility to offset the incidence of one tax with another in most cases, the effect of cascading gets built into the transaction cost. Present indirect taxation structure India has a dual tax system for taxation of Goods And Services. The tax system is described by Central Taxes and State Taxes, which may be further subdivided into Excise Duty, Service Tax, VAT and Customs Duty. In 2005 VAT was introduced for intra-state transactions, using the input tax credit principle. History in Parliament and Empowered Committee In 2000, the Vajpayee Government set up a committee headed by Asim Dasgupta, the (Finance Minister of the Government of West Bengal) to design a model for GST and oversee IT preparations. An announcement was made by P. Chidambaram, the Union Finance Minister, during the central budget of 2007 2008 that GST would be introduced from April 1, 2010 and that the Empowered Committee of State Finance Ministers, on his request, would work with the Central Government to prepare a road map for introduction of GST in India. After this announcement, the Empowered Committee of State Finance Ministers decided to set up a Joint Working Group on May 10, 2007, with the Adviser to the Union Finance Minister and the Member-Secretary of Empowered Committee as co-conveners and the concerned Joint Secretaries of the Department of Revenue of Union Finance Ministry and all Finance Secretaries of the states as its members. The Joint Working Group, after intensive internal discussions as well as interaction with experts and representatives of Chambers of Commerce and Industry, submitted its report to the Empowered Committee on November 19, 2007. This report was then discussed in detail in the meeting of Empowered Committee on November 28, 2007. On the basis of this discussion and the written observations of the states, Page 2

certain modifications were made, and a final version of the views of Empowered Committee at that stage was prepared and was sent to the Government of India (April 30, 2008). The comments of the Government of India were received on December 12, 2008 and were duly considered by the Empowered Committee (December 16, 2008). Basic idea of GST Justification in Implementation of GST i Despite the success with VAT, there are still certain shortcoming in structure in the levy of VAT both at Central level and State level. The shortcoming in CENVAT of the Government of India lies in non-inclusion of several taxes in the overall framework of CENVAT such as VAT, ACD, Surcharge etc. 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. 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. Further, by removing cascading effect, layers of taxes and simplifying structures, the GST would encourage compliance, which is also expected to widen the tax base. But virtually every media report that mentions the GST says that the tax reform has the potential to add up to 2 percent to India s GDP. ii If VAT is considered to be a major improvement over the pre-existing Central excise duty at the national level and the sales tax system at the State level, then GST will be a further significant breakthrough the next logical step towards a comprehensive indirect tax reform in the country. However, the paper makes some crucial assumption such as pegging the revenue-neutral rate in the range of 6.2 percent and 9.4 percent. The revenueneutral rate is the rate for GST that will not make a net difference to the overall tax collection of centre and states. Salient Features of GST The GST Framework could easily be one of the most important tax reforms to be tabled for discussion in the Parliament. It does bring with some problems, like division of taxation power between Centre and State. The GST will be applicable on the basis of Destination principle. So the GST has two components:- Page 3

One levied by Centre (hereinafter referred to as Central GST) and the other levied by the States (hereinafter referred as State GST) However, the basic features of law such as chargeability, definition of taxable event and taxable person, measure of levy including valuation provisions, basis of classification etc. will be uniform across these statutes as far as practicable. The GST would be levied in 3 different forms. CGST This is applicable in the case of Inter-State sale of goods and provision of service SGST In case of sale of goods Intra-state then tax will be charged as per this form. Taxes/Duties Covered Taxes/Duties Covered under CGST under SGST Central Excise Duty Service Tax CVD, SAD Excise duty on M&TP etc. Entry tax (not octroi) Entertainment tax VAT/Sales Tax Luxury tax etc. Integrated GST (IGST) The scope of IGST Model is that centre would levy IGST which would be CGST plus SGST on all inter-state transactions of taxable goods and services with appropriate provision for consignment or stock transfer of goods and services. IGST will be combination of CGST and SGST and the same will be collected by the Centre in the Origin State. Tax Credit Mechanism Time bound refund of credit will be allowed in cases such as exports and inverted duty structure.it is clear that cross utilization of CGST and SGST is not allowed generally but the IGST mechanism will make this credit fungible. Page 4

Following example will give clear idea above utilisation of credit and costing under present system & GST. Example:- Assumption:- (1) Rate of Excise Duty 8%; (2) VAT Rate 12.5%; (3) Central GST Rate 12%; (4) State GST Rate 8%; (5) Profit Margin Rs. 5,000/- fixed (6)All parties are located in one state. Particulars Under Scenario Present Under GST (I) Manufacturer (D1) to Wholesaler (D2) Cost of Production 45000 45000 Input Tax Credit (Assuming nil) Add : Profit Margin 5000 5000 Producers Basic Price 50000 50000 Add: Central Excise Duty @ 12% 6000 Add : Value Added Tax @ 12.5% on Rs. 56,000/- 7000 Add : Central GST @ 12% 6000 Add : State GST @ 8% 4000 Sale Price 63000 60000 (II) Wholesaler (D2) to Retailer (D3) Cost of Goods to D2 56000 50000 Available Input Tax Credit for set off 7000 10000 Add : Profit Margin 5000 5000 Total 61000 55000 Add : Value Added Tax @ 12.5% 7625 Add : Central GST @ 12% 6600 Page 5

Add : State GST @ 8% 4400 Total Price to the Retailer 68625 66000 (III) Retailer (D3) to Final Consumer (C) Cost of Goods to D3 61000 55000 Input Tax Credit 7625 11000 Add : Profit Margin 5000 5000 Total 1,32,000 1,20,000 66000 60000 Add : Value Added Tax @ 12.5% 8250 Add : Central GST @ 12% 7200 Add : State GST @ 8% 4800 Total Price to the Consumer 74250 72000 Total Tax Payable in All Transactions 14250 12000 Verification:- VAT @12.5% [74,250 * 12.5 / 112.5] = 8250 + 6000 (CENVAT) = 14250 D1 (6000 +7000) D2 (7625 7000) D3 (8250 7625) 13,000 625 625 Verification:- GST @20% [72000 *20 / 120] =12000 D1 (6,000 + 4,000) D2 (11,000 10,000) D3 (12,000 11,000) 10,000 1,000 1,000 Page 6

Cost Benefit In the current Tax scenario credit of surcharge, VAT, ACD is not available which increases cost. With the introduction of GST credit of these taxes is available with cascading effect which will help in reduction in cost. From the above example is will clear that Tax Payable in GST is less than Current Situation. Stock Transfer Another important aspect is stock transfer. Because in GST, tax will be levied on the dispatch. Every dispatch will be taxable under GST, so at every stage i.e. factory, warehouse etc. registration is necessary. Place of Supply The main challenge in introducing GST is defining the place of supply in respect of certain services. In existing tax regime it is not a problem as Service Tax is chargeable by Centre only. But in GST place of supply has to be defined clearly to avoid dispute among states and in case of inter-state transaction. Place of Taxation Inter-State Transactions An important question in the context of the Dual GST is whether these rules for international cross-border supplies can be adopted for domestic inter-state supplies also. It is recognized that the place where the supplier or the recipient is established cannot be defined uniquely at the sub-national level within a common market. Tax-Rate under the proposed GST The tax-rate under the proposed GST would come down, but the number of assesses would increase by 5-6 times. Although rates would come down, tax collection would go up due to increased buoyancy. The government is working on a special IT platform for smooth implementation of the proposed Goods and Services Tax (GST). The IT special purpose vehicle Page 7

(SPV) christened as GST N (Network) will be owned by three stakeholders the centre, the states and the technology partner NSDL, then Central Board of Excise and Customs (CBEC) Chairman S Dutt Majumdar said while addressing a "National Conference on GST". On the possibility of rolling out GST, he said, "There was no need for alarm if GST was not rolled out in April 1, 2012." Renewed GST concerns With heterogeneous State laws on VAT, the debate on the necessity for a GST has been reignited. The best GST systems across the world use a single GST, while India has opted for a dual-gst model. Critics claim that CGST, SGST and IGST are nothing but new names for Central Excise/Service Tax, VAT and CST, and hence GST brings nothing new to the table. The concept of value-added has never been utilized in the levy of service, as the Delhi High Court is attempting to prove in the case of Home Solution Retail, while under Central Excise the focus is on defining and refining the definition of manufacture, instead of focusing on Figure 1 need for GST value additions. The Revenue can be very stubborn when it comes to refunds, as the Maharashtra Government proves, and software entities that applied for refunds on excess service tax paid on inputs discovered. Page 8 The all-new Cenvat Credit Rules, 2014 do little to clarify eligibility for input credits, by using general terms such as any goods which have no relationship whatsoever with the

manufacture of a final product and services used primarily for personal use or consumption of any employee. Before penning the GST Act and Rules, the Empowered Committee would do well to take a hard look at all the present laws that GST subsumes and their complexities. It could tempt them to rethink on the necessity to draft even the preamble. This change in the tax structure is going to have a huge impact in the current supply chain of India. It is currently sub-optimal, and has been structured in such a fashion to avoid taxes. The supply chain tax structure of India can be broadly classified in the following categories. Threshold limit of traders, with turnover below 10 lakhs, need not register, is a concept brought from VAT system. This can cause ambiguity. The argument that small traders cannot be handled by the system is not true. A country that can give a Unique ID to every citizen, can as well give registration service to small traders. They should not be eliminated from the Tax system. Even the compounding system, of charging 0.5% for the traders with below 50 lakhs turnover, can cause undesirable results. They also should not be eliminated from the tax system. It is not fair to restrict them from certain trade activities, such as selling to other states. The registered trader will have to face loss of input tax, if he buys either from threshold trader or compounded traders. GST in other countries While countries such as Singapore and New Zealand tax virtually everything at a single rate, Indonesia has five positive rates.a zero rate and over 30 categories of exemptions. In China, GST applies only to goods and the provision of repairs[citation needed], replacement and processing services. It is only recoverable on goods used in the production process, and GST on fixed assets is not recoverable. iii There is a separate business tax in the form of VAT. For example, when the GST was introduced in New Zealand in 1986, it yielded revenues that were 45 per cent higher than anticipated, in large part due to improved compliance. It is more neutral and efficient structure could yield significant dividends to the economy in increased output and productivity. The GST in Canada replaced the federal manufacturers sales tax which was then levied at the rate of 60 per cent and was similar in design and structure as the CENVAT in India. It is estimated that this replacement resulted in an increase in potential GDP by 24 per cent, consisting of 12.4 per cent increase in national income from higher factor productivity and 50 per cent increase from a Page 9

larger capital stock (due to elimination of tax cascading). The Canadian experience is suggestive of the potential benefits to the Indian economy. This means gains of about US$15 billion annually. This is indeed a staggering sum and suggests the need for energetic action to usher the GST regime at an early date. GST rates of some countries are given below. Country Rate of GST Australia 10% France 19.6% Canada 5% Germany 19% Japan 8% Singapore 7% Sweden 25% India 27% [a] New Zealand 15% Pakistan 18% Malaysia 6% Denmark 25% Positive impact on Indian economy Page 10 Speeds up economic union of India Better compliance and revenue buoyancy Replacing the cascading effect [tax on tax] created by existing indirect taxes Tax incidence for consumers may fall Lower transaction cost for final consumers By merging all levies on goods and services into one, GST acquires a very simple and transparent character Uniformity in tax regime with only one or two tax rates across the supply chain as against multiple tax structure as of present Increased tax collections due to wide coverage of goods and services Improvement in cost competitiveness of goods and services in the international market

Points to be reviewed Taxation of inter-state services and their method of taxation o Difficulties in defining Place of supply, place of delivery Road Permit and Check posts Stock Transfer Integration of certain Central and State taxes (Various Cess, Electricity duty etc.) Constitutional amendment authorizing state to collect and retain tax on service like Group Health Insurance, Consulting services. However most of the B2B services not a problem because of availability of credit Disputes even with regard to classification of goods Jurisdictional Issues with regard to registration and SCN / Assessments Latest updates on GST Constitutional (115 th Amendment) bill on the GST Automatic compensation mechanism Concept of GST Council Dispute Settlement Authority Conclusion In the light of the empirical conclusions developed in this paper, it seems appropriate to conclude by briefly noting the policy implications of the results. In the first place, the macroeconomic impact of a change to the introduction of the GST is significant in terms of growth effects, price effects, current account effects and the effect on the budget balance. Secondly, in a highly developed open economy with a high and growing service sector, a change in the tax mix from income to consumption-based taxes is likely to provide a fruitful source of revenue. Page 11

Thirdly, the aggregate consumer price impact of the introduction of the GST in India on the macro-economy was both limited and temporary. Finally, despite falling outside the limited focus of this short note, we should record that some impact has also occurred in the administrative component of the compliance cost of the GST as well as a likely increase in tax revenue from the underground or black economy. The task of fiscal consolidation for this government will not be easy. There will be little scope to cut overall expenditure, as it has already been trimmed sharply in the last 2 years. The government must instead focus on switching expenditure from unproductive subsidies towards spending on sector such as health, education and infrastructure. The only way to reduce fiscal deficit, therefore, is to raise revenues as a share of GDP. To do so, the government must implement structural tax reforms such as GST, improve tax compliance and widen tax coverage. The scope to lower fiscal deficit in fiscal 2015 is limited given large roll-over of subsidies from last fiscal and little possibilities of implementation of GST within this year. Beyond that, however, implementation of GST could facilitate a much needed correction in fiscal deficit. In the base case, it is believed that partial GST one that excludes petroleum goods is most likely. Even with this, fiscal deficit could correct to 3.3% of GDP by fiscal 2017. On the downside, a complete failure to implement GST would result in the fiscal deficit being higher at around 4-4.2% in fiscal 2016-2017. References I. Poddar, Satya, and Eric Hutton, (2001) II. Poddar, S. and M. English (1997) Poddar, S. and M. English (1997) III. IV. McLure, Charles (2000): Implementing subnational VATs on internal trade: The compensating VAT (CVAT). International Trade and Public Finance, Vol. 7, Barrand, Peter (1991), The Treatment of Non-Profit Bodies and Government Entities under the New Zealand GST, International VAT Monitor, January 1991. Page 12

V. Bird, Richard and Gendron (1998), Dual VATs and Cross-border Trade, Two Problems and One Solution, International Tax and Public Finance 5(3), 1998 VI. VII. Canada Department of Finance (1987), Federal Sales Tax Reform, Government of Canada, 1987. Empowered Committee of State Finance Ministers (2008), A Model and Roadmap for Goods and Services Tax in India, New Delhi. VIII. Keen, Michael and Stephen Smith (2000), Viva VIVAT!, International Tax and Public Finance, Vol. 7, 741-751 IX. Kelkar, Vijay, et al (2004), Report on Implementation of the Fiscal Responsibilityand Budget Management Act, 2003, Ministry of Finance, Government of India, New Delhi. X. Kuo, C.Y., Tom McGirr, Saya Poddar (1988), Measuring the Non-neutralities of Sales and Excise Taxes in Canada, Canadian Tax Journal, 38, 1988. XI. Poddar, Satya, and Eric Hutton, (2001): "Zero-Rating of Inter-State Sales Under a Subnational VAT: A New Approach", Paper presented at the National Tax Association, 94th Annual Conference on Taxation, Baltimore, November 8-10, 2001. XII. Poddar, Satya (2003): Consumption Taxes, The Role of the Value Added Tax, in Patrick Honohan (ed.) Taxation of Financial Intermediation: theory and practice inemerging economies, (World Bank and the Oxford University Press). XIII. Poddar, Satya (2007), VAT on Financial Services Searching for a Workable Compromise, in Krever, Richard and David White (ed): GST in Retrospect and Prospect, Brookers Ltd, New Zealand. XIV. Poddar, Satya and Amaresh Bagchi (2007), Revenue-neutral rate for GST, The Economic Times, November 15, 2007. XV. Poddar, Satya (2009), Treatment of Housing under VAT, mimeograph, presented at the conference on VAT organized by the American Tax Policy Institute, Washington, Feb. 18-19, 2009 XVI. Rao, M. Govinda (2001), Report of the Expert Group on Taxation of Services, Government of India, March 2001. Page 13

XVII. Rao, M. Govinda (2008), Unfinsihed Reform Agendum: Fiscal Consolidation and Reforms A Comment in Jagdish Bhagwati and Charles W. Colomiris, XVIII. Sustaining India s Growth Miracle Columbia Business School, 2008 pp. 104-114 XIX. www.icai.org. KCG-Portal of Journals ******************************************************************** Prof. Kesarisinh S. Parmar I/c. Principal & Assistant Professor at Government Arts and Commerce College - Kadoli Copyright 2012-2016 KCG. All Rights Reserved. Powered By : Knowledge Consortium of Gujarat Page 14