In his budget speech in February 2015, Arun Jaitley announced an ambitious goal of implementing the Goods and Services Tax (GST) nationwide by April 01, 2016. Ever since that declaration by the finance minister, passing the bill through parliament has been the topmost priority of the Narendra Modi government.
The GST is India’s most important indirect tax reform, and it aims to make the country a common market by removing fiscal barriers between states. It will subsume most indirect taxes like excise duty and service tax at the central level, and value-added tax at the state level. Eventually, having a common base (i.e. common taxable threshold) and single rate (across goods and services) is expected to facilitate administration and improve compliances. With a simpler tax administration, foreign investments are also expected to significantly improve.
Currently, India has a federal tax structure wherein the states do not have the power to impose service tax, while the central government cannot levy VAT on sale of goods that takes place within a state. The proposed GST will empower state governments to levy tax on the supply of services, and the central government to levy tax on supply of goods within a state. This necessitates a constitutional amendment.
In May 2015, the lower house of the parliament passed the Constitution Amendment Bill. However, the bill is now stalled in the Rajya Sabha, the upper house where the ruling political party lacks majority.
It is, therefore, important to understand why some states are opposing the introduction of GST despite its obvious benefits. The major areas of contention are:
Loss of revenue
The model GST proposed for India has two components: central GST (CGST) and state GST (SGST). Any supply of goods and services within a state will attract both CGST and SGST.
Effectively, one component of GST will go to the central government’s kitty and another portion of GST will go to the destination state.
With the shift in the basis of tax collection from the origin state to the destination state, most producing states anticipate a sharp drop in their revenue collection under the GST regime. Therefore, states want high revenue-generating sources such as petroleum and alcohol to be kept outside the ambit of GST. State governments also want some guarantee from the centre for potential revenue loss in the initial years of GST implementation.
After much debate, the government addressed a majority of these concerns and agreed to keep alcohol outside GST. The centre also agreed to provide 100% compensation to states for the revenue loss incurred, if any, during the first five years of GST implementation.
Levy of additional tax
To address fears of the manufacturing states—like Tamil Nadu and Gujarat, for instance—on the potential drop in revenue collections, the central government also proposed to levy a non-creditable 1% additional tax on inter-state sale of goods for the initial two years of GST implementation. This additional tax will go to the coffers of the origin state.
However, this proposed levy is against the spirit of GST, in as much as it would lead to tax arbitrage between local and inter-state supply of goods. The 1% additional tax will also entail incremental taxes in the supply chain, which may have a multiplier cascading impact.
Revenue neutral rate
The states and industries are also awaiting a decision on the revenue neutral rate (RNR) of GST. Simply put, RNR means a tax rate that seeks to achieve similar revenue under the GST regime as collected from taxes under the present regime. The primary objective of RNR is to ensure that the governments’ revenue collection under GST is not worse off than their present revenue position.
The National Institute of Public Finance and Policy initially proposed an RNR of 26.68% after considering the current tax rates applicable on goods in India. But this has become another matter of concern since such a high GST rate would mean that India may not be a commercially feasible market for many industries, especially the goods enjoying the merit rate of taxation such as IT, food processing and the service sector.
Further, in the name of securing taxpayers’ interests against arbitrary GST rate increase by the central or state governments, the Congress party has demanded to put the cap on RNR as part of the Constitution Bill.
While this proposition sounds sensible, it limits the government’s power to tweak the GST rate in order to meet any urgent economic needs of the country.
This month, a committee led by chief economic advisor Arvind Subramanian proposed to eliminate the additional 1% levy. Also, RNR was proposed in the range of between 15% and 15.5%. On the basis of this, the standard rate of GST has been recommended at between 17% and 18%, and a lower merit rate of 12% for certain goods.
In the present system, the Central Board of Excise & Customs (CBEC) plays the role of an advisory committee to give a point of view on tax controversies regarding levy of central level taxes. The clarifications issued by CBEC are mandatory for tax department, whereas assesees and appellate authority are not legally bound to follow them.
Under the GST regime, differences could crop up between the centre and states on various issues such as destination states’ share of revenue, treatment of inter-state movement of goods and services etc. To deal with such anticipated tussles, the Congress party endorses the idea of formation of an independent dispute resolution mechanism under GST.
However, the government has proposed to form a GST council to monitor such issues and check deviations so that centre and states cannot change the tax rates on their own. While the need of an independent dispute resolution mechanism cannot be undermined, its absence should not be a reason to stall the bill.
The winter session of parliament will end by Dec. 23, leaving very little time for policy makers to arrive at a consensus. Any further delay in GST’s implementation will not only impact India’s industrial growth but will also send wrong signals to global investors keen to invest in Asia’s third largest economy.