Goods and Service Tax

(GST) in India Challenges Ahead

Goods and Services Tax (GST) in India
Challenges Ahead
The Finance Ministers announcement during the recent Budget that GST will be implemented in April 2010 has
generated a debate in the country about the success of the GST model proposed to be implemented. This stems from
the fact that the Government has preferred to draw a veil over its backroom exercises and did not allow its working
papers to be put on public domain for proper deliberation and debate by those who are likely to be affected by it.

It must be understood that that the actual challenge is not of drafting a model GST but of its proper implementation
and smooth transition from the extant regime. Indias march towards globalization necessitated widespread
economic changes in Indian financial system, capital market, insurance sector, foreign exchange regulations, etc.
with a view to attract more investments in the manufacturing and service sectors. From both domestic and foreign
investment perspective a suitable reform in Indirect tax was required to do away with the multiplicity of taxes thereby
reducing cumbersome compliance, high cost of transaction and nagging uncertainty in tax liability for a business.
Simple taxation regime will not only relieve the business from being a tax-driven model but also give it a space to grow
on its own.

Goods and Services Tax

The concept of Goods and Services Tax (GST), which is also called Value Added Tax (VAT), is a tax on every economic
supply in the distribution chain. The taxable event is supply of goods and supply of services. Any transfer of right to
use goods will constitute supply of goods, and, any supply not involving goods will be supply of service. However, the
tax is worked out on the value-added component of the supply. This is achieved by working tax on the full intrinsic
value of the goods or service and giving set off/credit of tax suffered at previous stage, called input stage, to avoid
cascading effect. Thus, the entire supply chain upto final consumer gets taxed with in-built mechanism of input stage
credit. In this system, the final consumer ends up bearing the full burden of tax without any set off benefit.

As supplies not involving goods will be supply of service, the ambit for services will be very large. Generally for
services to be taxed global best practices are considered. The supply is sub-classified as destination and
consumption based from taxation perspective. Further, the supply to be taxed could be Business-to-Business or
Business-to-Consumer depending on the feasibility in individual case. The GST will subsume present indirect taxes of
Central Excise, Customs, Central Sales tax, Service Tax under Union List and Sales Tax, Value Added Tax, Entry Tax,
Purchase Tax, State Excise duty, Luxury Tax, Entertainment tax, Octroi, Tax on consumption or sale of electricity, etc.
under State List. Thus, it is aiming at a comprehensive GST as a substitute for a multi-tax regime.

Challenges and way out

The dual GST model proposed for India comprises of Central GST and State GST being administered simultaneously
on supply of goods and services. In its wake, Government has several challenges to tackle.

Legislative Challenge
The federal character of the Constitution of India is essentially the autonomy of States to raise their own revenues,
and accordingly the Constitution provided powers to the Union and the States to levy and collect taxes as per Union,
State and Concurrent List. The challenge is whether this can be treated as the basic structure of the Constitution
thereby restricting the Government from bringing about any change in this structure.

In order to enable the Centre and the State Governments to levy GST, the Constitution of India requires amendment
to provide for powers to levy and collect GST both by the Union and the States, with annulment of existing powers
under Union and State Lists. If it is held that there is no harm to the basic structure of the Constitution then there is
legislative competence to bring about constitutional amendment required for levy and collection of GST. If the power
is given to the Union, then the Central Government can implement a single GST law for the Union and the States.
But, if the power is given to both the Centre and the States, then the States can exercise its own power to raise
revenue independently of the Center. It requires to be seen to what degree there is concurrence among States to
dilute its power of taxation. However, a common GST is the need of the hour to curb the possibility of different States,
especially with a dissenting political party, enacting different Acts as per their whims and fancies. It will ensure a
seamless GST regime to function across India.

Revenue Sharing Arrangement

Presently most of the States need substantial share in the central taxes apart from revenue raised at their own level
under constitutional power. This is due to imbalance economic development and other reasons. The dual GST model
will off set certain industry from Centre to States thereby reducing revenue generation for the Centre. Accordingly, the
Centre will have to depend on the revenue from the revenue-rich States to share with revenue-low States. The
challenge is multi-fold proper revenue accounting and collection, technological up-gradation, revamping baking
channel for State-wise revenue allocation, political support, etc.

Due to the inherent need of different States for revenue, any new tax regime to be successful, it must ensure that the
States get their requisite revenue for proper governance and development. With the growth of economy, the need for
revenue would be constantly on the rise and the Central Government will have to do a balancing act between the
revenue-rich States and revenue-low States by properly sharing the revenue as per their needs. Over a period of time
the States may demand a constitutional arrangement for revenue sharing mechanism.

Effective Credit Mechanism

If for any reason the proposed dual GST model does not allow credit of State GST in respect of inter-State
transactions, it will lead to increase in cost and cascading effect of multi-stage taxation and give rise to lopsided
market in Indian economy. The challenge for the Government is to introduce a seamless mechanism of credit across
India.

The success of dual GST model will depend on effective credit mechanism to avoid cascading effect of multi-stage
taxation in the supply chain. The credit mechanism is the lifeline of GST. As far as Central GST is concerned, there is
no difficulty in giving credit of Central GST anywhere in India as is evidenced by success of the present CENVAT
scheme. But, in case of State GST presently there are issues in giving credit in relation to inter-State transactions. If
the new tax regime is going to convert India into an economic union, then Federal structure should not come in the
way of giving credit. The challenge is to treat both the Centre GST and State GST as one receipt or kitty to make way
for credit across India in a seamless manner. Government should make full fungibility of credit of State GST.
Moreover, the credit should be allowed for all inputs, raw materials, capital goods, input services and all business
expenses treating the business entity as a unit since GST is a broad based tax. It is therefore essential to define input
and input services liberally so that the credit mechanism is litigation-free. Otherwise a single litigation issue at any
point of supply chain will affect all the following points in the supply chain.

Inter-State suppliesrole of banks

In case of destination based principle of taxation, the recipient State will have to levy the tax as per the law of the
dispatching State. This is bound to create problems if there is no uniform law and rates across India. This requires tax
collected by the recipient State to be credited to the exporting State. For the Governments it would be a challenge to
allocate revenue to the respective States without proper administrative and supervisory machinery.

The banks as an intermediary can play a key role in collection and transfer of revenue to respective States in Dual GST
model. The person collecting the tax on his supply in case of inter-State transactions should deposit the tax in the
account of the State where the supply has been made. Then on the basis of revenue reports of the respective
Governments, the banks can allocate the revenue to the respective States or the Central Government, as the case
may be. The banking system needs to be revamped for this purpose. The challenge can be met by proper training, up-
gradation of tax administration with technological interface.

Defining place of supply or consumption

The concept of place of supply or consumption presents complication in respect of certain services and intangible
properties. The challenge is one of legal conception to define the place of supply or consumption.

Dealing with transitional issues

There are a large number of customs duty exemption notifications governing various schemes under Foreign Trade
Policy which are intrinsically linked to the system of extant regime under customs and central excise. The benefit is
quantified in terms of customs or central excise duties as applicable presently. The transition to GST will affect such
schemes and a great amount of uncertainty will hover over all these areas for businesses leading to confusion and
administrative issues. A large number of bonds executed by the importer and exporters with the Government will
have to be suitably amended for changed liability in view of new GST. The challenge for the Government is to make the
transition a smooth exercise.

The Government should devise special provisions to deal with such exigencies. In case of offence or non-fulfillment
of conditions of Foreign Trade Policy or Customs exemption notifications or debonding, the liability should be
worked out in a given manner so as to avoid the need to refer to past provisions under Customs or Central Excise
Acts.

Job work
In case of jobbing activities, the job worker should be allowed credit of raw materials/inputs consumed by him for
value-added supply for payment of GST. In case the job workers activity results in finished goods, the challenge is to
allow credit of job workers GST to the principal.

The job worker will be paying GST on his job charges. The principal will sell the finished goods at a price which will
include the job charges paid to the job worker. Thus, the principal should be allowed to take credit of job workers GST
for payment of GST against his own supplies. Such special provisions should be incorporated in the GST of Union and
States.

Centralized Administration for large units

Large tax paying units with branches/factories/distribution network across India will face problem in multiplicity of
compliances. However, the respective State GST may not exempt such units. The challenge would be to provide ease
of compliance to such units.

For large tax paying units, the concept of centralized registrations, credit/set off and payment should be introduced
to avoid multiplicity of compliances under different taxing jurisdictions and it should be under the Central GST
Explosion of Assessees
The dual GST model will widen the tax net by taxing every economic supply in the distribution network. This will lead
to an explosion of assessees.

The new GST regime requires a paradigm shift in taxation. It will not only add a new flavour to GST but will also align
India with global tax system. This new regime will see India as one economic entity with uniform tax structure. It will
necessitate some of the businesses to restructure their distribution network to reduce additional tax burden on the
consumer with a view to be price competitive. Though it will generate revenue in a neutral and transparent way, the
Government will have to ensure that the ultimate consumer is not burdened with tax beyond his capacity.

Victor Vincent
Associate Director- Indirect Tax,
BDO Haribhakti Consulting Pvt Ltd
Email: victor.vincent@bdoharibhakti.co.in
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