One Tax, One Market, One Nation, And A Won Battle: That’s GST, In Short

The Narendra Modi government has accomplished the biggest tax reform since the country’s independence with the successful implementation of the goods and services tax (GST). It was first mooted by the Atal Behari Vajpayee government in 2000. The Kelkar Committee, which examined the issue in 2004, observed that a tax reform comprising a nationwide dual GST would be able to achieve “a common market, widen the tax base, improve the revenue productivity of domestic indirect taxes and enhance welfare through efficient resource allocation”. It took nearly 17 years before GST was finally launched on 1 July 2017.

The division of powers between the centre and states are clearly delineated in the Seventh Schedule of the Constitution, which was amended in 2016 to introduce the GST, which subsumed a number of central and state taxes. A dual GST structure has been designed, empowering the centre as well as the states to concurrently levy GST on intrastate trade. In addition, an integrated GST (IGST) is designed to tax supplies in the course of interstate trade.

Common Market

The Constitution intends through Article 301 to have “a free flow of trade, commerce and intercourse throughout the territory of India”. Since the safeguards provided in the Constitution were not in operation effectively, the central and state governments used the flexibility provided in Articles 302 and 304 to levy multiple taxes. The domestic trade barriers in the form of having different tax rates and procedures in different states and complexity of tax structure and administration stood in the way of India emerging as a single common market. The complex multi-layered indirect tax structure had fragmented Indian market into 29 regional markets. While the central sales tax was imposed on the export of goods from one state to another, entry tax and octroi were imposed on the import of goods into a local area. The administration of these taxes led to the establishment of check posts and other physical barriers.

Consequently, a good exported to another state has become more expensive than that exported to another country. For example, in the pre-GST regime, a good manufactured and sold in Andhra Pradesh attracted a 29 per cent tax inclusive of 12.36 per cent central value added tax (VAT) and 14.5 per cent of state VAT. If that good was sold in Maharashtra, the overall tax became 48 per cent because of additional taxes – 2 per cent CST and 12.5 per cent Maharashtra entry tax. If the same good was exported, neither CST nor entry tax applied, and the good attracted only 29 per cent tax! If the same good was produced in Maharashtra and sold in Andhra Pradesh, it attracted a lower tax rate driven by a lower VAT in Maharashtra. If the same good was imported, it attracted a still lower tax rate of 17 per cent only (CVD of 12.36 per cent and the SAD of 4 per cent).

Besides these anomalies in the tax rates, there were also restrictions on the free movement of goods and services across the states, leading to economic fragmentation. The main purpose of this radical tax reform is to dismantle these trade barriers and transform India into a common economic union (“one country, one tax and one market”).

For this, the multiple indirect taxes need to be harmonised and consolidated; cascading and double taxation needed to be mitigated; and overall tax burden on business and end consumers needed to be lowered. This required a uniform set of laws, rules, and rates on goods and services throughout the country. There were considerable differences in the VAT laws, rules, practices, and tax rates among the states. Building a consensus among the states and between the centre and states has not been an easy task, and it took several rounds of prolonged negotiations to arrive at a consensus on key issues and finally, to enact the needed legislation. As the Finance Minister said, “While enacting the GST, neither the states nor Centre gave up their sovereignty. They have pooled their sovereignty to make joint decisions in indirect taxation.” Thus, 17 transaction taxes in states and the centre, and 23 cesses have been subsumed in GST. Important among them are presented in Table 1. The GST has merged the indirect central and state taxes into a four-tier schedule of 5 per cent, 12 per cent, 18 per cent, and 28 per cent. The GST is same on a good or service across the country. The political freedom that had been won and political unity that had been accomplished by the Constitution had to be sustained and strengthened by the bond of economic unity. GST has brought the much-needed economic unity in the country and India has now become the biggest common market in the world.

Standalone multiple taxes have a cascading effect on cost, leading to a competitive disadvantage to Indian industry. The central sales tax (CST) on interstate movement of goods is not integrated with VAT and, hence, CST paid on interstate procurement was not eligible as a credit and so became an extra cost of doing business. Similarly, manufacturers were unable to avail themselves credit of state taxes and certain central taxes against excise duty and vice versa and these have become added costs along the supply chain, adversely affecting exports and encouraging imports. With GST, there are taxes only on value addition at each stage, with the benefit of setting off the taxes against the central or state GST paid on each consecutive purchase. Thus, the new regime aims at ensuring a continuous mechanism of tax credit and a unified tax structure benefiting manufacturers, retailers, and end consumers alike across the country.

Tax base widening

GST is neither disastrous nor has it brought the economy to a grinding halt, as many people would want us to believe. Though it took decades from concept to planning, the implementation was remarkably quick. Launching it in June rather than in September 2017 gave enough time for the government to sort out the teething problems. As GST is to be levied on all goods and services across entire supply chain (with a few exceptions), it is expected to increase the tax revenue due to wider tax base and better compliance. According to the Minister of State for Finance Shiv Pratap Shukla, a total of 10,399,305 taxpayers are registered under GST as on 2 March. Of them, 64.42 lakh taxpayers have migrated from the erstwhile tax regimes and 39.56 lakh have taken new registration under GST. These figures indicate how the tax base is widening.

In addition, tax revenues are increasing. Contrary to the expectations of sceptics, the government is able to collect, on an average, around Rs 90,000 crore every month during the last fiscal. As GST is to be levied concurrently by the centre and the states, the taxpayers with turnover of more than Rs 1.5 crore are equally divided between the centre and the states and those with a turnover of less than Rs 1.5 crore are divided in the ratio of 90:10 between the states and the centre for administrative convenience. The tax officers are cross-empowered both under central and state laws.

Cooperative federalism

GST is a destination-based tax and the tax accrues to the state where final consumption takes place. The manufacturing states thus have a disadvantage. They have apprehensions about probable shortfall in the revenues and the centre assured not only to protect their revenues but also provide for a 14 per cent nominal growth every year for a period of five years through the compensation cess levied on select demerit and luxury goods. The newly created constitutional body, the GST Council, has emerged as a unique institution, where the centre and the states are willing to pool their sovereignty and give fiscal space to each other. The Council, since its formation in September 2016, has worked at a fast track and has been responsive to the needs and feedback of the trade, industry, and other stakeholders and made a number of mid-course corrections after the roll-out of GST. The Council’s structure and working gave inspiration for being replicated in other crucial areas for the promotion of cooperative federalism.

Many proactive steps to ease out the difficulties, faced especially by small enterprises and exporters, have been initiated. The composite scheme has been extended to taxpayers having an annual aggregate turnover of up to Rs 10 million, benefiting the small and medium enterprises (SMEs). The government's move to issue refunds of GST paid by exporters as soon as possible and introduce an e-wallet system with automatic credit of a notional amount from 1 April 2018 will ease the working capital problems of exporters. GST is expected to provide a boost to exports by mitigating costs, which could increase exports in the range of 3.2-6.3 per cent.

No relief to common man

The implementation of GST has had more than its fair share of problems. The GST is supposed to eliminate the cascading effect of taxes, i.e., tax on a tax. Tax is to be paid only on the value added at each stage. Besides, there is credit for the tax paid on the inputs. Only the input cost should enter the pricing of the product and not the taxes paid on the inputs. Input tax credit thus results in lower cost to the business, leading to a lower basic price on which the GST is to be levied. However, prices of many essential goods have in fact increased after the implementation of the GST.

The common man is clueless as to why prices have increased with the GST. The prices should remain the same at least as they were earlier, if not decline. Most of the essential goods are kept out of the GST net by the GST Council. Why then are prices rising? Even the retail prices of those products on which GST has been reduced have not come down. Some have argued that important items such as petroleum products are out of the purview of GST and are heavily taxed. Since they are the key inputs, there is a strong cascading effect associated with them. But that was also the case earlier.

Even though essential goods are not taxed, they need to be transported and stored, and accounts have to be kept. All these services attract GST. Besides, many goods and services which were earlier exempt from taxation are brought under GST. Prices of most services have increased as they are now taxed at 18 per cent while they were charged at 15 per cent in the pre-GST regime. The burden is silently passed on to the consumer by the service providers, be it the banks, insurance, finance, or transport firms, and others. The rise in the prices of services is not reflected in the inflation index based on WPI (wholesale price index) since they are not part of it, leading to an underestimation of inflation. There is a strong case for the downward revision of service tax to benefit the common people.

Woes of taxpayers

The taxpayers expected a simple and uniform tax structure, clarity and transparency, ease of compliance, faster and a simpler grievance redressal mechanism with this major tax reform. However, multiple revisions in the format of returns and rates created confusion. The software companies providing GST software also have had difficulty in revising accordingly. Collating the GSTN registration number of customers and vendors and entering them into the system was not easy as any error would lead to delay in claiming input tax credit. Previously, returns were filed centrally. With state-level compliance requirements, documentation and return filing, GST necessitated branch-level accounting. Inter-branch and intra-branch invoicing has become necessary due to internal tax transfers.

The valuation of services, particularly in cases where services are shared within the organisation across the states, has given scope for manipulation both in valuation and categorisation. As input tax credit for interstate transfers of goods can only be claimed at a later stage, working capital got blocked for manufacturing companies with warehouses across the country. Compliance requirements under GST is causing a lot of hardship to small traders. Presently, there is no scope for revision or rectification of returns, once filed. In some cases, where the amount of tax paid on the inputs is more than the amount of tax paid on the output, the trader has to wait indefinitely for getting full credit for the tax paid on the inputs, resulting in the blockage of working capital.

Trickle-down benefits

Now that the major objective of dismantling trade barriers has been achieved with collateral benefits of a widening tax base and increasing revenue yield, every effort must be made to further standardise and simplify the processes and procedures, keeping the small businessperson and the ultimate consumer in view. The selection of four- or eight-digit Harmonised System of Nomenclature (HSN) codes should be made standard across the value chain. Each and every business should be made to register under GST, irrespective of whether it is liable to pay taxes or not. This would eliminate the need for reverse charge mechanism, and even big companies can deal directly with smaller vendors. Small firms should be allowed to file their return and pay taxes on a yearly basis instead of quarterly. The GST implementation process has shown that policymakers are willing and capable of quickly reacting and responding to unique problems as and when they have arisen. They have not shown any complacency leading to a policy paralysis. The enthusiasm shown to manage the change is remarkable. Hope the Modi government works with the same spirit and brings down the prices to benefit the common people. Let the benefits of GST trickle down sooner than later.