India: Changing tax landscape as India moves towards GST

In global terms indirect taxes are becoming increasingly important. This is also true in India where although reform has been gradual and not always consistent, it is part of an attempt to simply the tax regime. While the reforms have largely been intended to introduce more consistency and to make India a single common marketplace, in practice the present indirect tax structure has left the market fragmented. This has led to high compliance costs, frequent litigation and uncertainty about the tax positions to be adopted both at the time of setting-up a business and for purposes of supply chain planning.

The Thirteenth Finance Commission, a constitutional body set up for determining, among other things, the sharing of tax revenues between Central Government and the states, has termed GST an 'economic game changer' which could provide significant impetus to economic growth.

The proposed national GST regime is slated to revamp substantially the existing indirect tax landscape. The present system is complex and entails significant tax leakages. It does not provide tax set-offs in a seamless manner. To help address this the proposed GST regime is a multi-stage consumption based tax aimed at integrating taxation on goods and services from the original producer or service provider up to the point the goods/services reach their ultimate consumer and eliminating cascading effects at succeeding levels of the value chain. This is expected to both widen the tax base and lead to a simplified compliance system.

As India is a federation, where the responsibility of taxation is shared between Central Government and the states, the proposed new model envisages a dual system of GST. A Central GST (CGST) is proposed to replace the central levies such as excise, customs, service tax and central sales tax and a State GST (SGST) replaces, for example, the existing state VAT, entertainment tax and luxury tax. The CGST and SGST will be levied concurrently on supply of goods and services. While the Constitution Amendment Bill 2011, which facilitates the introduction of GST, proposed keeping entry tax (applicable on entry of goods from one State to another) outside the purview of dual GST, the Standing Committee of the Parliament has recommended inclusion of entry tax within the ambit of GST. To date there has also been little consensus on the structure of rates. However, the Standing Committee on Finance recommended recently that a band of rates with a floor rate should be adopted.

Today the taxation of goods and services by the Central Government and the state governments is fundamentally inconsistent with the scheme of seamless flow of input tax credit across the entire supply chain. This is sought to be addressed in the GST regime through a mechanism of cross utilisation of credit under an Integrated GST (IGST) model. This would require a robust IT infrastructure in the form of a GST Network (GSTN) for GST administration and tracking credits.

The existing indirect tax law contains exemptions based on the requirements of specific industry, sectors or class of taxpayers. However, the efficiency of these exemptions is questionable and does not always achieve the desired long term objectives. The proposed GST envisages calibrating the tax exemptions by either removing them or converting them into refund mechanisms.

Despite numerous efforts by Central Government and the states to strike a balance on considerations of fiscal autonomy as between the centre and the states, a consensus towards an acceptable GST design continues to elude those involved. However, there has been considerable progress in establishing the underlying constitutional platform on which the ultimate design will depend, including the introduction of the necessary Constitutional Amendment Bill, 2011, due to be passed by the Parliament by 2014.

In anticipation of the proposed GST, both the central and state governments have also been introducing changes in their existing indirect tax structures. While some of these changes are in the positive direction, others have been directed mainly at short-term revenue raising.

For instance, the introduction of negative list approach-based taxation of services by the Central Government is a positive step to replace the orthodox classification based service tax law. By this all the services are taxable except those covered in the negative list or specifically exempted. The state governments on the other hand, have been increasing VAT rates. There are also many instances where the demarcation for the purpose of taxation between goods and services is becoming blurred leading to double taxation. This is particularly so in the cases of software, leasing and transfer of intellectual property rights (IPRs). The continuing system of entry tax check-posts at the state boundaries also adds to the burden on industry and inefficient trade relationships.

India has always been ranked poorly in terms of ease of doing business, particularly because of uncertainties in the tax framework due to retroactive amendments by the government and indecisive tax administration. In this regard, GST is not only about tax regime change, it could also change the way business is done in India.

Nevertheless, the efficacy of the GST system will depend on its implementation. Only a neutral and rational design in the system of GST that considers the needs of all the key stakeholders will be able to provide the growth impetus as estimated in terms of GDP by the Thirteenth Finance Commission. The formation of the new Central Government may provide the impetus for an effective and timely implementation process.

Prashant Deshpande Deloitte