Despite the extensive reforms that India’s indirect tax system has undergone since 1991, our country still has a highly fragmented, inefficient and distortionary tax structure characterized by multiple tax rates, barriers to inter-state trade and cascading of taxes. The numerous amendments over the years have also made it one of the most complicated legislations in the country. As a result, considerable time and large amounts of money are spent by both the taxpayers as well as the government in long-drawn tax disputes, which in turn locks up billions of rupees in taxes. All these tend to hike up the cost of our products and services.
Besides this, the firms that desire to sell across states face a border tax, local sales tax, central service tax, federal excise, central sales tax and other duties that often vary from state to state and from product to product. This multiple tax system has increased incentives for corruption. Moreover, over the past few years, India has witnessed long-drawn litigations with regard to cross-border transactions and transfer pricing issues involving big multinationals such as the Vodafone Group, IBM, Royal Dutch Shell and Nokia, which have made headlines internationally and also dampened foreign investor sentiment in India.
In this fast-globalizing world when developed nations are striving to bring down tariff barriers, our Union government has also been trying to introduce a simple, stable and predictable indirect tax regime comprising a national sales tax known as the Goods and Services Tax (GST). It aims to streamline the tax administration and creating a single, unified market, while also bringing in higher revenue for the Central government and the states. Unfortunately, as GST requires a Constitutional Amendment and ratification by half the state governments, its implementation has been pushed back several times since it was first announced in the Union Budget of 2007-08.
Furthermore, the 115th Constitution Amendment Bill was introduced in Parliament in March 2011, but consensus on the modalities of the GST has remained elusive. However, according to latest media reports, Prime Minister Narendra Modi has given directions for GST to be rolled out by April 2016. On September 15, 2014 Mr Modi met Finance Minister Arun Jaitley to find out how far the GST preparations have progressed.
The Finance Ministry has already set up a GST cell headed by a joint secretary-level officer. This cell, which also has officers from the Central Board of Excise and Customs, will be the secretariat for the empowered committee of state finance ministers and it will pilot the key bills through Parliament and monitor their subsequent progress through state legislatures. The setting up of the cell shows the ministry has now begun to rush the timetable for the GST roll out.
The only way to untie the GST knot is to treat it as a federal (ie, centre-state) issue and not just an economic efficiency issue – which is well known. This means Prime Minister Narendra Modi must wear his old hat as Gujarat CM to sort out the issue from the point of view of the states. Mr Modi has reportedly advised the Finance Ministry to ensure that all the elements are in place, before making the announcement for a nationwide roll-out of the tax. When implemented, GST will replace all the domestic taxes on production and sale of goods and services. While the Finance Ministry is in favor of a single rate of tax in the bill, it has conceded to the demand by the states for a band within which their levies would flourish. Currently, a rate of 12-20% is suggested as tax band, and this is reasonable for growth.
GST thus has two clear beneficiaries – business and central government – and one possible loser, the states. I say ‘possible loser’, because some states will gain from GST and others lose. States as a whole may not lose, but as long as there are some losers, one can hardly blame states for fearing a post-GST world. The Confederation of All India Traders, which has most retailers under its umbrella, has argued for a single rate. Meanwhile, representatives of major industrial houses have stepped up their lobbying with the Centre in a bid to make GST a reality. States are demanding different rates of GST. Now irrespective of such diverse demands of stakeholders, the actual rollout of the GST will be the single most economic reform in our country.
Likely challenges in implementation of GST
Implementation of GST may not be easy in view of the many glitches and diverse challenges that are likely to crop up right from the beginning. Some of the expected challenges are as follows:
- The federal character of the Constitution of India gives autonomy to states to raise their own revenues. Accordingly, our Constitution gives powers to the Union and the states to levy and collect taxes as per Union, State and Concurrent List. So, one of the major challenges to the introduction of GST is the apprehension of states that the federal system would get diluted. As such, implementing the proposed GST legislation across the country will require a Constitutional Amendment via voting in both houses of Parliament, plus the support of 15 of the 29 state governments.
- GST has to be implemented simultaneously by the central and state governments. While doing so, the central government would only be able to offer the proverbial carrot, but cannot weld the stick as it doesn’t have the constitutional authority to impose such ideas on the states. In this scenario, some states may express stiff opposition to GST fearing loss of autonomy. So the Centre would be at the mercy of the state governments with regard to this decision. And striving to arrive at a consensus among all the 29 states having different political parties with their own ideologies and agendas won’t be an easy task.
- Under GST, taxes would be levied on the basis of the Destination Principle, which means goods and services would be taxed where they are finally sold or rendered. As such, many state governments have a fear that they may lose revenue or may have to forgo some portion of the tax they may otherwise be entitled to. Though the central government has put forward a tax revenue sharing program, some States are yet not fully convinced of its feasibility.
- In the initial stages of its implementation, the Indian economy is likely to witness high inflation rates, and product prices may go up. The central and state governments may also have to incur unanticipated administrative costs thereby pushing up tax collection costs. There are also concerns that the tax burden on the low income group may go up. Furthermore, the industries would also need some handholding to understand GST mechanism and to be able to follow them faithfully.
- Finally, implementation of GST may not be easy to begin with, given the migration to a new and untested information technology (IT) system. Even more difficult would be tackling the complex taxes and integrating them into the new model. For example, CENVAT conversion to an input tax credit mechanism could be complicated and excise duties, exemptions, conversion of specific tariffs into ad valorem duties, etc would add further layers to the task. So, one of the biggest challenges in the run up to the GST is setting up of a national IT framework that can act as a clearing house for the taxation of inter-state movement of goods.
Why GST should now top India’s agenda
Currently, the GST system is the most important taxation reform that is being contemplated in our country. Any tax-related reform is difficult to implement, and in a federal republic like India where states weld immense powers, the related problems tend to get compounded. So despite all the likely glitches and challenges, the Union government should go ahead and expeditiously implement the GST framework as it will bring in the following advantages and benefits for the stakeholders.
- The GST framework will usher in a simple, stable and predictable indirect tax regime. It would also be a comprehensive and all-encompassing tax on both goods and services as they pass through the value chain. It would replace most of the complex multiple taxes that are currently being imposed at various levels by the central and state governments as well as the local bodies and thereby make India a single market. Thus, GST aims to economically unify our country by removing all kinds of barriers to trade among states. As such, the supply chain would become faster, seamless and more efficient.
- The introduction of the GST system will ensure a transparent, unambiguous and easy-to-comply-with tax law that will ease the pressure on industry and help growth. Hence, as soon as GST is implemented, our country’s GDP is expected to receive a big boost because of a major drop in transaction costs. Economists and industry analysts believe GST will add as much as 1.5-2 percentage points to the growth rates. At a time when the Indian economy is sub-performing, this measure has the potential to kickstart a new investment cycle. The manufacturing sector in particular will be a big beneficiary of GST as the economic system becomes more competitive.
- The benefits of GST are obvious. It is a self-policing tax with little scope for avoidance because whenever anyone sells a good or service he adds the fixed rate of GST to it. However, since he will get a rebate on GST already paid on goods and services bought from his suppliers, he will demand proof of GST payment by his suppliers. Thus all GST taxpayers ensure that GST is paid by their suppliers to get the rebate.
- As GST is aligned with a corresponding information technology platform, the tax payment system will get streamlined. With manufacturing growth, the objective of employment generation on a large scale will also be promoted. Simultaneously, in the long run, GST would also help moderate inflation by the lowering of transaction costs. Timely credit refund, where applicable, will incentivize firms in compliance, which in turn will bring in more revenues for both the central and state governments. Eventually, India will have a better tax system that is rational, standardized and stable and also simple, fair and neutral.
- The GST system will immensely benefit the Indian economy as it will simplify India’s tax structure, broaden the tax base, and create a common market across states. It will also ensure a transparent, unambiguous and easy-to-comply-with tax law that will ease the pressure on industry and help growth, which in turn will lead to increased compliance and push up India’s tax-to-gross domestic product ratio. According to a study conducted by the National Council of Applied Economic Research (NCAER), GST is expected to increase economic growth by between 0.9% and 1.7%. Exports are expected to increase by between 3.2% and 6.3%, while imports will rise between 2.4% and 4.7%.
- India’s business and corporate sector will also benefit as the average tax burden on business enterprises and companies will decline. This will bring down production costs thereby making our country’s exports more competitive in the international market. The highest rate of taxation under GST is expected to be around 15% in the first year, and it will come down to 12% in the second year. By comparison, the rate of various indirect taxes currently being levied in India amounts to roughly 20% or even more. Goods deemed necessary or of basic importance will be taxed at a lower rate. In view of these benefits, the business sector has already indicated that it will more than welcome the GST.
- As GST is an all-inclusive tax at the national level on the manufacturing, sale and consumption of goods, it will ensure that Indian consumers are not taxed multiple times like it happens now. This means that taxes like octroi, CENVAT, central sales tax, state sales tax, entry tax, license fees, turnover tax, etc will no longer be present as all of them will be subsumed into GST. This will lead to a more willing and increased compliance, thus increasing the total amount of tax collected and that too at a lower cost of collection. Of greater importance will be the end result – lower costs of goods and services. This will immensely benefit the consumers, leading to more consumption, which in turn will give a major boost to India’s economic growth.
- GST will not only simplify the taxation structure, but it will also broaden the tax base by bringing more taxable goods and services under its purview. As the proposed GST framework will have two components – a central GST and a state GST, with the central GST going to the centre, and the state GST going to states, none of the states will lose control on their revenues after its implementation. Once the total GST rate is decided, the Central GST and the States GST will be agreed upon. The modalities of sharing of tax revenues with the states and the reimbursement of any shortfall in their tax kitty will also be worked out and a consensus reached on that. The central government has agreed to give states compensation for revenue losses arising out of GST for three years, after its implementation.
- Furthermore, GST is not simply VAT plus service tax, but a major improvement over the previous system of VAT and disjointed services tax, which is a justified step forward. Moreover, with the collection of both the central and state taxes proposed to be made at the point of sale, there won’t be any confusion about when this has to be paid. Currently, different taxes are collected at different stages of the process so there is a tax on manufacturing, one at the time of sale and even another one when goods move from one place to another. Under the GST all of these will be eliminated making it easier to implement and follow.
- Finally, as India currently has a complicated tax structure, complying with all the provisions therein tends to make it very burdensome, tedious and time-consuming. Since most businesses also face commercial and legal hassles in this regard, our taxation structure is also corruption prone. The end result is that goods cost more, and customers naturally seek cheaper alternatives. Since India already faces competition from China and other countries, if we continue with the current taxation structure, we will effectively price ourselves out. To avert such an unwelcome scenario, India should invariably implement the GST system as early as possible.