Friday 12 June 2015

Goods and Services Tax (GST): Fully Explained

To understand GST we must first understand VAT as GST is principally same as VAT. 

What is VAT

  • Suppose the goods are taxable @ 10% and all the goods have been purchased and sold within the State by a VAT-dealer.
  • He will total out tax element in respect of sale vouchers. Suppose it comes to …(A).
  • Similarly he will total out tax element in respect of purchase vouchers. Suppose it comes to …(B).
  • Then VAT payable by the dealer = (A) - (B). 
  • VAT stands for value added tax and “ Value Added” is the difference between sale and purchase of a business.
  • Thus VAT is nothing but a form of sales tax only and is charged at each stage of sale on the value added to goods.
  • Infact, it is nothing but a tax on retail sales collected in stages. 

What is GST?
  • Principally it is same as the Value-added Tax (VAT) — already adopted by all Indian States — but with a wider base.
    • That is because, unlike, say, an excise duty (whose base consists of manufacturers) the GST is paid by the final consumers.
  • VAT which replaced the sales tax — was imposed only on goods, GST will be a VAT on goods and services.
  • Will subsume all central and state indirect taxes and levies, including excise duty, additional excise duties, service tax, additional customs duty (countervailing duty, special additional duty of customs), surcharges and cesses, value added tax, sales tax, entertainment tax (other than the tax levied by local bodies), central sales tax (levied by the centre and collected by states), octroi, entry tax, purchase tax, luxury tax, and taxes on lottery, betting and gambling.
  • It is a value-added tax, which means a levy at each stage of production, sale or consumption will be set off against taxes paid in the previous stage.
  • As per what’s being referred to as the GST Bill [(122 amendment) Bill, 2014] — passed in the Lok Sabha, India will have not a single federal GST but a dual GST, levied and managed by different administrations. 
    • The Centre will administer the central GST (CGST) and the States, the SGST.
Who taxes what, at present?
  • States tax sale of goods but not services. 
  • Centre taxes manufacturing and services but not wholesale/retail trade. 
  • With GST, there would be an expansion of the base of each into the other’s territory.
    • This is why a constitutional amendment was necessary — to give concurrent powers to both the States and the Centre to make laws on the taxation of goods as well as services.
When was GST conceived and when will it be implemented? 
  • 2006 -  formal announcement in 2006 Budget by P Chidambaram,
  • Missed several deadlines.
  • The government is now hoping for its nationwide roll-out from April 2016. 

Arguments for introduction of GST are same as were for VAT two decades ago
  • Various kinds of indirect taxes under one rubric
  • Simplify tax administration
  • Improve compliance
  • Eliminate economic distortions in production, trade, and consumption. 
  • It taxes only the final consumer thus avoiding the ‘cascading’ of taxes, thereby cutting production costs, and making exports more competitive. 
  • According to government in net effect GST will add 2% to the National GDP.

Why is it held up? 
  • GST might have a negative impact on: the States’ fiscal, and therefore, political autonomy.
  • Finance ministers may lose control over the taxation system and be unable to give discretionary concessions.
    • All goods and services will be divided into certain categories. The rates will be fixed by category, and a state cannot shift a commodity from a lower to a higher rate, or put it in the exempt category.
    • The rates for both, the CGST and the SGST, will be fixed by the GST Council, whose members will be State finance/revenue ministers and chairman will be the Union finance minister. Once the rates are set by the GST Council, individual States will lose their right to tax whichever commodities they want at the rates they want
    • According to the Constitution, the States have complete autonomy over levy of sales taxes, which, on average, accounted for 80 per cent of their revenue. An attempt was made to curtail this autonomy with the introduction of VAT. But it did not totally succeed because the VAT still had four different rates that states could play with. But with the GST, which mandates a uniform rate, even this limited autonomy would be gone.”
    • In other words, while the loss in revenue of the States may well be compensated by the Centre (as provided for in the GST Bill), how does one make good a State’s loss of the political right to fix its own tax rates? The political right is important because states 
      • Perhaps it is to allay this concern that the draft GST bill speaks of the GST Council fixing not just rates but “rates including floor rates with bands”. A band would, at least on paper, give some room for states to vary their rates depending on their need.
  • Potential loss of revenue from cash cows such as petroleum, which makes up for almost half the revenue for some states.
  • Centre has assured states that it will compensate them for revenue loss due to GST roll-out, besides providing flexibility on entry tax and taxing oil products.
  • There was also an element of bargaining in the states' objections. 
    • GJ and MH want the additional 1% levy extended beyond the proposed  2 years, and raised to 2%.
    • Punjab wants purchase tax outside GST
  • With 29 states and two Union territories with legislatures, it would be unrealistic to expect a “flawless” GST. 
  • The modified bill has shortcomings, both in its coverage and in the retention of the tax on inter-state transactions. 
    • this goes against the GST’s fundamental principle of making the tax destination-based and ensuring seamless transactions across the country.
  • Extent of productivity gains will depend on the structure that will ultimately be adopted, so Optimistic projections about its gains, particularly in relation to growth, without knowing the structure of the tax, could lead to disappointments later. 
  • Exclusion of motor spirit (petrol) and high-speed diesel will add to the cascading. It is so as with almost 30-35% of sales tax being collected from motor spirit and high-speed diesel, states are hesitant
    • One solution is to include them in the GST, but have a separate excise tax or carbon tax. Similarly, in the case of alcoholic products, the international experience is to include them in the GST and have a separate “sin” tax on them
  • Important point --> The bill provides only a minimalist framework and leaves the structure and operational details to the GST Council. This implies that the entire gamut of issues relating to the structure and operation of the levy has to be negotiated and decided on by the council. These include the taxes to be subsumed, the list of goods and services to be exempted, thresholds for Central GST and state GST, structure of rates, place of supply rules, arrangements for special category states, harmonised tax laws and the date of including the tax on petroleum products, alcohol and tobacco products, operational details of the tax administration, including the GST network, and dates for discontinuing the tax on inter-state sale of goods and services. In each case, the interests of the negotiating parties are not always similar. Decisions have to be taken by voting in the council. With the Union government having two-thirds of the vote, no decision can be carried without its approval, even if it is desired by all the state governments. The important issue is, the GST that will eventually emerge out of compromises will have a number of infirmities
  • Parliamentary disruption: Lalit Modi effectively but unintentionally torpedoed the GST bill. Some issues of urgent importance overwhelm the priority issues.
  • Can we afford such a cataclysmic change at a time when there is a critical decline in the manufacturing and services sectors?
  • Single law is a myth:
    • Central and 29 state laws will make complete GST. States will not be obligated to have similar rate The GST Council can only “recommend” a model law but nothing prevents each state from going its own way. The VAT experience is testimony to this. Such multiple levies by Parliament and the states, if not in harmony, will have disastrous consequences.
  • Actual enactments and rules on the GST are still unknown; this is a dangerous area of darkness. Drafting these laws without consulting stakeholders will only compound the confusion
  • Rate is too high
    • States want @ 26 per cent, 
    • Centre - a cap of 16-18 per cent. 
      • A GST levy of even 16 per cent is bound to result in largescale tax evasion at the retail level. It is going to be very difficult to expect a consumer to pay 26 or even 16 per cent on the purchase of a refrigerator costing Rs 50,000. There is also no clarity on the basic threshold exemption and the GST can easily be derailed by multiple rates and numerous exemptions/ concessions.
  • Administration of GST
    • How many assessees will we have state-wise? 
    • Who will administer a combined GST? 
    • Will each state insist on administering the GST within its territory?
      • If so, there will be no role for the Central excise or service tax departments, except in inter-state transactions. 
    • Which are the appellate authorities? 
    • Will there be one tribunal or multiple tribunals?
  • India is very complex, heteregeneous but GST seeks to treat unequal states equally
    • Needs of states like Maharashtra and Gujarat are completely different from states like Jharkhand and Assam. 
    • It will be practically impossible for the Centre to compensate states that are likely to lose tax revenue for the next several years.
  • World's most complex GST system
    • Concept of “importing” and “exporting” states. 
    • Exclusion of petroleum products, electricity and real estate
Who gets benefited and how?
  • Households
    • Lower burden on consumers as
      • the levy will be at the point of sale
      • central and the state taxes will be merged into one levy. 
  • Corporate sector
    • Tax on real estates is expected to come down by 25% since companies will be able to claim credits or set-offs for taxes they pay on goods and services.
    • With IT backbone the refund mechanism will be more efficient
      • Currently, industry complains that refunds and credits are tough to claim and even more difficult to get. 
  • Government and economy 
    • Efficient tax system - boost to economy - more revenue.
    • Impact on the GDP growth rate could be between 0.9 and 1.7 percentage points!
Constitutional status of GST
  • States don’t have the power to levy service tax and Centre does not have the power to levy tax beyond the factory gate, i.e. VAT, sales tax, etc.
  • For this UPA brought a Bill in LS in 2011, but failed to get it passed.
  • The NDA government introduced a “slightly modified” version of the Bill in Lok Sabha
  • Bill must be cleared by two-thirds majority by both Houses, and ratified by 50% of states.
  • It is now pending in Rajya Sabha.
What if Bill is passed
  • The Centre and states have to frame and pass GST laws — Central GST and State GST —  which will provide the framework for the new tax.
  • IT infrastructure has to be ready before April 1, 2016, the scheduled date for implementation of the new tax.
  • A GST Council will be formed, which will decide on issues including tax rates, exemption list and threshold limit.
  • At present bill is lying with the select committee of the RS (June 2015)
Does GST mean increased tax?
  • The very logic of GST is such that it works best when the exemptions are zero or minimal. New Zealand comes closest to the GST purist’s dream — with very few exemptions. Once implemented — in however compromised a form — this is the direction GST regimes gravitate toward: fewer exemptions, higher rates. New Zealand introduced GST at 10 per cent — today it is 15 per cent. 
    • In the countries where the GST rate was reduced over time, it was made possible by a broadening of the base by minimising exemptions.
  • What should be the taxation rate? 
    • 13th Finance Commission’s Task Force on GST recommended 12 per cent (7 per cent for SGST and 5 per cent for CGST) in 2010. 
      • this will mean substanital revenue loss for states as already for many states the general VAT hovers around 13-14%
    • In 2014, a panel of State government representatives mooted a revenue-neutral rate or RNR (rate at which tax revenues for states and the Centre will remain the same as before GST) of 27 per cent ( 12.77 per cent and 13.91 for CGST and SGST respectively.
      • This would be an enormous tax burden on the wage-earning classes, and could prove fatal for any elected government. 
  • Solution to this problem of taxation rate?
    • Widen the base by including as many goods and services under its purview as possible.
      • But this could mean that some essential goods currently taxed at a lower rate could end up being taxed at a higher rate under a GST, but it would hit the lower income groups harder.
      • for this reason only even in developed countries like Canada and Australia  GST was opposed fiercely by the local working classes, especially the trade unions. 
The shift towards indirect taxation
  • Worldwide government have moved to indirect taxation than taxing corporates/income tax as they fear that higher corporate taxes will lead to capital flight
  • Indirect taxes
    •  have a wider base than direct taxes, 
    • are more difficult to evade, 
    • easier to administer
    • Not income-dependant beyond a point.
  • But Indirect taxes have their own problem
    • Burden of indirect tax in terms of percentage is more on poor as they spend a greater proportion of their income on essential consumption compared to the classes that are better off (Like rich might spend only 1% of income on buying rice but poor end up spending 25-30% of their income on rice)
  • At present  India’s direct taxes contribute only 37.7 per cent of total tax revenue, which makes India’s taxation regime already more regressive than that of other emerging markets such as South Africa (57.5 per cent from direct taxes) or Indonesia (55.85 per cent). With GST, is ticked, it could become even more so
    • It is called regressive here because indirect taxes charge all equally and thus burden on poor is more. But direct taxes are charged more on rich and thus bring sort of economic parity in country. Those who earn more pay more with direct taxes. 
Graphic Source: Economic Times

Summary of Arguments (Source: The Hindu)

The business argument
--> Simplifies tax administration 
--> Makes compliance easier 
--> Prevents 'cascading' effect 
--> Could add to GDP

The political argument 

-->Reduces States' fiscal and political autonomy 
--> States can't exempt some goods and services 
--> Lowers States' source ability to raise money for welfare 
--> Indirect taxes burden lower income groups more 

Now the bill has got delayed because of no consensus between ruling and opposition so what can be done meanwhile?

  • Union government can begin by transforming its own indirect taxes into a GST at the manufacturing stage.
Suggestion to improve the bill

  • linking GST registration numbers with the income tax PAN in the GST network could substantially increase revenue collection from income tax
  • working out a common threshold for excise duty and service tax, 
  • rationalising the excise duty by making all rates ad valorem, 
  • converging and unifying the rates into two — one for items of common consumption and the other, a standard rate to be applied to all remaining goods and services — and providing input tax credit for goods against services and vice versa. 
  • Transforming the prevailing domestic indirect taxes into a destination-based GST is surely an important reform. 
  • In the given political environment, however, it may be better to approach the reform as a process and not an event.
  • Victor Hugo reminded us that "you cannot stop an idea whose time has come."
Latest UPDATE - Just something procedural.

  • Union Finance Minister Arun Jaitley has approved the formation of two committees to facilitate the implementation of (GST) from next April.
    • A steering committee, chaired by the Additional Secretary, Department of Revenue, and the Member Secretary of the Empowered Committee of State Finance Ministers, will monitor the setting up of IT infrastructure for the GST network, the Central Board of Excise and Customs and other tax authorities. 
      • The committee will monitor the progress of consultations with stakeholders such as trade and industry and the training of officers.
    • The other committee, chaired by Arvind Subramanian, Chief Economic Adviser, will recommend possible tax rates under the GST that would be consistent with the present level of revenue collected by the Centre and the States. While making recommendations, the committee will take into account the expected levels of economic growth, the different levels of compliance, and the broadening of the tax base. The panel would assess the sector- and State-wise impact of the GST on the economy.


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