During the presentation of the Union Budget 2007-08, erstwhile Finance Minister P. Chidambaram indicated that an integrated Goods and Services Tax (GST) would be implemented by April 1, 2010. Since then, the Finance Ministry and the Government of India have taken significant steps to keep to their commitment. However, come 2010 it seems unlikely that this could be effected by the proposed date. Not just that, but there also appears to be uncertainty as to when this GST legislation will precisely be implemented. However, it is certain that this will eventually be implemented, timing being the only area of indefiniteness. Given the importance of this piece of tax legislation, we will go over the key aspects relating to GST, how it is intended to work, benefits and challenges in its implementation and its implications on Indian economy and business.
Direct and Indirect Taxation
Taxes levied by the government can broadly be classified into two heads: Direct Taxes and Indirect Taxes. A direct tax is one which is collected directly by the government from entities, individual or corporate, on whom such taxes are imposed. For example, individuals are subjected to personal income tax, based on their total earnings for the year, and are taxed at a particular rate based on the tax-band they come under. Similarly, corporates are also taxed at the ruling corporate tax rate, which is around 30 percent in India, on the income they have earned for a particular year. Thus, a direct tax is one where the tax burden cannot be shifted by the taxpayer to someone else. However, an indirect tax, such as excise duty, value added tax (VAT), or goods and services tax (GST), is one which is collected and paid by the manufacturer or distributor of a product, but eventually the burden of tax is borne by some one else, say, the consumer. For example, let us suppose a motor car manufacturer first pays excise duty on the manufactured car as a result of which the cost of the car increases when it reaches the show room. When a consumer purchases the car from the showroom, he eventually pays for the duty component as well, which is included as part of the selling price of the car. Although the manufacturer initially paid the duty to the government, it is the consumer who bears the indirect tax burden.
Taxes are levied by both the central and state governments; which government bears what tax is an issue of constitutional definition and is clearly earmarked. At present, around 30 percent of central tax revenues are further transferred to states, with a greater share accruing to poorer states. An important anomaly also exists in that taxes, both from the perspective of incidence and in terms of rates, manufacturing and services sectors are treated differentially. There are also a host of taxes prevailing in the country; both at the national level and at the state level like octroi, central sales tax, state level sales tax, entry tax, service tax, stamp duty, turnover tax, tax on consumption of electricity, taxes on transportation of goods, etc.
Over the last few years, the government of India has been steadily rationalizing the country's taxation regime to bring them in line with international best practices; direct taxation has received its share of significant rationalization. Indirect taxes have also been rationalized over the last decade and schemes like value added tax (VAT) were introduced. However, implementation of an integrated goods and services tax (GST) is expected to position India's indirect taxation regime in line with global best practices.
History and Current Form of Indirect Taxation
Earlier, till the 1990s there was a burden of 'multiple-point' taxation with the central excise duty and the state sales tax systems. Manufactured products were subject to a series of tax burdens - first before the product was produced, inputs were taxed. Then, the final product was taxed again, which meant tax was calculated even on the earlier taxed component. This resulted in duplicate taxation, referred to as "a tax on tax," creating a cascading effect. Eventually tax payers were subjected to a very high level of tax burden. Such duplication resulted in lower tax collections as there was a reluctance to pay such unreasonable taxes; tax payers chose to evade taxes rather than promptly pay the same.
The Indian government realized this anomaly and introduced the Value Added Tax (VAT) at the central level, originally as MODVAT (Modified VAT) replacing the Central Excise Duty in 1986. In a phased manner, it completed the implementation of CENVAT (Central VAT) by 2002-03. By 2005, services tax was also added to CENVAT and this started emerging as a unified goods and services tax, applied by the Central Government, in the country. Introduction of CENVAT, to a certain extent, addressed the 'tax on tax' issue through a mechanism of providing a set-off on tax earlier paid. Tax compliance and collections also improved due to the fact that set-offs could be claimed only if sufficient proof existed that taxes had actually been paid on inputs.
Introduction of VAT at state levels became more of a challenge as various states were empowered through the Constitution for levying and collecting sales tax, and such tax rates varied vastly between states for the same commodities. The process commenced during 1995. After serious contemplation over the possibility of having a uniform tax rate across states for commodities and at the same time, preserving and accommodating certain state level distinctive differentials, a small flexibility in the rate structure was also agreed upon as a critical need. On this basis, state level VAT was introduced eventually by 2005 with deviations from the agreed VAT rates being very minimal across the states. This resulted in significant growth of tax revenue since the introduction of VAT.
Hence the introduction of VAT, to a large extent, helped harmonization of tax rates across the states and minimized the problem of 'tax on tax' to a certain extent. Then, what is the requirement for replacing VAT by GST? What further benefits will GST bring in?
Benefits of Introducing GST
Tax in the nature of an integrated goods and services tax, attracting the same rate of tax, has already been introduced in many countries the world over. This uniform rate is a fundamental premise of the GST concept. As compared to VAT, GST will result in further benefits consolidating a host of indirect taxes across the country. Benefits of the proposed GST framework will arise out of the following:
•GST is intended to be an integrated indirect tax framework covering manufacture, sale and consumption of goods, as well as services at the national level.
•CENVAT, in its current form, does not include several taxes which are levied separately such as additional customs duty, surcharges, etc. Further consolidation is thus required and hence the requirement for GST. Moreover, with the state level VAT, there are still many indirect tax components that are yet to be converged into VAT. This includes luxury tax, entertainment tax, etc. GST is expected to achieve this.
•More importantly, the CENVAT element is further taxed under the state VAT, duplicating the tax burden; in that sense, the 'tax on tax' component on the CENVAT element is still not eliminated in totality. In the proposed GST, such cascading effects of CENVAT as well as service tax are removed with set-off, and a continuous chain of set-off from the original producer's/service provider's point up to the retailer's level is established; this reduces the burden of all cascading effects. This is a critical improvisation in GST, which VAT lacked.
•As an outcome of removing the cascading effect on CENVAT, the burden of tax under GST on goods is expected to generally fall, being a positive driver for manufacturers, consumers and the industry, at large.
•There is also expected to be revenue increases for both the centre and the states, primarily through widening of tax base and possibility of a significant improvement in tax-compliance.
How does the proposed GST system work?
The tax burden on GST is applied across the entire 'value chain'; incidence of tax on entities is proportional to the value addition at each point. Let us take the example of a detergent manufacturer (see figure). Assuming a packet of this detergent is sold at Rs.380 in the retail stores, the GST on this packet of detergent is uniformly applied across the detergent manufacturing 'value chain'. By 'value chain' we mean, the process of raw materials being supplied to the manufacturer (by the raw material supplier), finished detergents supplied in a 'bulk' form to the whole sellers (by the manufacturers) and the packaged detergents being supplied to the retailers (by the whole sellers), and finally, the consumers purchasing the final packaged detergent at the retail stores.
The example illustrated in the figure shows that at the first stage the raw material supplier, who supplies raw materials worth Rs.200 to the manufacturer, has already paid GST of Rs.20. The manufacturer processes the raw materials and adds total value to the extent of Rs.50 (process value addition Rs.40 and profit margin Rs.10) and sells the bulk detergent to the whole seller at Rs.250. The manufacturer will then pay a GST on output of Rs.250, which will amount to Rs.25 (GST rate of 10 percent on Rs.250), but will get to set off a GST credit of Rs.20 (10 percent on Rs.200) thus paying a net GST of Rs.5. Similarly, as illustrated in the figure, the whole seller and the retailer will each pay a net GST of Rs.10 and Rs.3 respectively. In total, the raw material supplier, manufacturer, whole seller and the retailer, all put together, pay Rs.38 as GST, on the value additions along the entire value chain, from supplier to retailer, after setting off taxes paid at earlier stages. Hence, GST is a tax which has an incidence of tax burden only on the component of 'value additions' at each stage, and a supplier at each stage is permitted to set-off the earlier payment, through a tax credit mechanism.
What are the challenges in introducing GST?
•Given the current state level VAT variations, there are challenges in securing unanimous consent on the rate of the integrated GST; hence this is yet to be finalized. It is not only a matter of rate, but the states have to let go the powers of levying many forms of taxes, which will henceforth be converged into the proposed GST. Such loss of powers/ state revenues have turned out to be a major hurdle for securing unanimous approval from the state governments in implementing GST.
•The GST would have two components; a central component and a state component. The rates applicable for the central and the state components are under consideration by the expert committee. However, all other aspects are expected to remain uniform, as far as possible.
•As regards the proposed rate of GST, the task force of the 13th Finance Commission (TFC) has prescribed a GST rate of 12 percent; the states are refusing to accept this. Many other bodies that are working, in parallel, to come up with a rate have prescribed numbers that are different; one such rate is 11 percent for the state component, and other agencies establish an incremental rate of around 6 percent to 9 percent to cover the central GST component alone, taking the consolidated integrated GAST rate much above the 12 percent recommended by the TFC.
•There is likely to be significant loss of revenue to the state and the central governments on account of GST implementation; an equitable formula that will share this loss also needs to be mutually agreed upon.
Given these complications the implementation date needs to be finalized; it is unlikely to be 01 April 2010, as earlier committed to by the finance ministry. Stiff resistance has also been encountered from the opposition; the Bharatiya Janata Party (BJP) is opposing the implementation of GST on the grounds that sufficient discussions need to take place with all the stakeholders (central government, state governments, industry federations and academia) in order to ensure that interests of all are protected.
Overall, it is going to be a really tall task to design and implement an integrated goods and services tax framework that will be in line with international best practices, and at the same time, will take care of the unique complexities of the Indian central and state legislations. We have moved forward significantly in this initiative, but, when we would be in a position to actually implement this in entirety still remains a key question!
Direct and Indirect Taxation
Taxes levied by the government can broadly be classified into two heads: Direct Taxes and Indirect Taxes. A direct tax is one which is collected directly by the government from entities, individual or corporate, on whom such taxes are imposed. For example, individuals are subjected to personal income tax, based on their total earnings for the year, and are taxed at a particular rate based on the tax-band they come under. Similarly, corporates are also taxed at the ruling corporate tax rate, which is around 30 percent in India, on the income they have earned for a particular year. Thus, a direct tax is one where the tax burden cannot be shifted by the taxpayer to someone else. However, an indirect tax, such as excise duty, value added tax (VAT), or goods and services tax (GST), is one which is collected and paid by the manufacturer or distributor of a product, but eventually the burden of tax is borne by some one else, say, the consumer. For example, let us suppose a motor car manufacturer first pays excise duty on the manufactured car as a result of which the cost of the car increases when it reaches the show room. When a consumer purchases the car from the showroom, he eventually pays for the duty component as well, which is included as part of the selling price of the car. Although the manufacturer initially paid the duty to the government, it is the consumer who bears the indirect tax burden.
Taxes are levied by both the central and state governments; which government bears what tax is an issue of constitutional definition and is clearly earmarked. At present, around 30 percent of central tax revenues are further transferred to states, with a greater share accruing to poorer states. An important anomaly also exists in that taxes, both from the perspective of incidence and in terms of rates, manufacturing and services sectors are treated differentially. There are also a host of taxes prevailing in the country; both at the national level and at the state level like octroi, central sales tax, state level sales tax, entry tax, service tax, stamp duty, turnover tax, tax on consumption of electricity, taxes on transportation of goods, etc.
Over the last few years, the government of India has been steadily rationalizing the country's taxation regime to bring them in line with international best practices; direct taxation has received its share of significant rationalization. Indirect taxes have also been rationalized over the last decade and schemes like value added tax (VAT) were introduced. However, implementation of an integrated goods and services tax (GST) is expected to position India's indirect taxation regime in line with global best practices.
History and Current Form of Indirect Taxation
Earlier, till the 1990s there was a burden of 'multiple-point' taxation with the central excise duty and the state sales tax systems. Manufactured products were subject to a series of tax burdens - first before the product was produced, inputs were taxed. Then, the final product was taxed again, which meant tax was calculated even on the earlier taxed component. This resulted in duplicate taxation, referred to as "a tax on tax," creating a cascading effect. Eventually tax payers were subjected to a very high level of tax burden. Such duplication resulted in lower tax collections as there was a reluctance to pay such unreasonable taxes; tax payers chose to evade taxes rather than promptly pay the same.
The Indian government realized this anomaly and introduced the Value Added Tax (VAT) at the central level, originally as MODVAT (Modified VAT) replacing the Central Excise Duty in 1986. In a phased manner, it completed the implementation of CENVAT (Central VAT) by 2002-03. By 2005, services tax was also added to CENVAT and this started emerging as a unified goods and services tax, applied by the Central Government, in the country. Introduction of CENVAT, to a certain extent, addressed the 'tax on tax' issue through a mechanism of providing a set-off on tax earlier paid. Tax compliance and collections also improved due to the fact that set-offs could be claimed only if sufficient proof existed that taxes had actually been paid on inputs.
Introduction of VAT at state levels became more of a challenge as various states were empowered through the Constitution for levying and collecting sales tax, and such tax rates varied vastly between states for the same commodities. The process commenced during 1995. After serious contemplation over the possibility of having a uniform tax rate across states for commodities and at the same time, preserving and accommodating certain state level distinctive differentials, a small flexibility in the rate structure was also agreed upon as a critical need. On this basis, state level VAT was introduced eventually by 2005 with deviations from the agreed VAT rates being very minimal across the states. This resulted in significant growth of tax revenue since the introduction of VAT.
Hence the introduction of VAT, to a large extent, helped harmonization of tax rates across the states and minimized the problem of 'tax on tax' to a certain extent. Then, what is the requirement for replacing VAT by GST? What further benefits will GST bring in?
Benefits of Introducing GST
Tax in the nature of an integrated goods and services tax, attracting the same rate of tax, has already been introduced in many countries the world over. This uniform rate is a fundamental premise of the GST concept. As compared to VAT, GST will result in further benefits consolidating a host of indirect taxes across the country. Benefits of the proposed GST framework will arise out of the following:
•GST is intended to be an integrated indirect tax framework covering manufacture, sale and consumption of goods, as well as services at the national level.
•CENVAT, in its current form, does not include several taxes which are levied separately such as additional customs duty, surcharges, etc. Further consolidation is thus required and hence the requirement for GST. Moreover, with the state level VAT, there are still many indirect tax components that are yet to be converged into VAT. This includes luxury tax, entertainment tax, etc. GST is expected to achieve this.
•More importantly, the CENVAT element is further taxed under the state VAT, duplicating the tax burden; in that sense, the 'tax on tax' component on the CENVAT element is still not eliminated in totality. In the proposed GST, such cascading effects of CENVAT as well as service tax are removed with set-off, and a continuous chain of set-off from the original producer's/service provider's point up to the retailer's level is established; this reduces the burden of all cascading effects. This is a critical improvisation in GST, which VAT lacked.
•As an outcome of removing the cascading effect on CENVAT, the burden of tax under GST on goods is expected to generally fall, being a positive driver for manufacturers, consumers and the industry, at large.
•There is also expected to be revenue increases for both the centre and the states, primarily through widening of tax base and possibility of a significant improvement in tax-compliance.
How does the proposed GST system work?
The tax burden on GST is applied across the entire 'value chain'; incidence of tax on entities is proportional to the value addition at each point. Let us take the example of a detergent manufacturer (see figure). Assuming a packet of this detergent is sold at Rs.380 in the retail stores, the GST on this packet of detergent is uniformly applied across the detergent manufacturing 'value chain'. By 'value chain' we mean, the process of raw materials being supplied to the manufacturer (by the raw material supplier), finished detergents supplied in a 'bulk' form to the whole sellers (by the manufacturers) and the packaged detergents being supplied to the retailers (by the whole sellers), and finally, the consumers purchasing the final packaged detergent at the retail stores.
The example illustrated in the figure shows that at the first stage the raw material supplier, who supplies raw materials worth Rs.200 to the manufacturer, has already paid GST of Rs.20. The manufacturer processes the raw materials and adds total value to the extent of Rs.50 (process value addition Rs.40 and profit margin Rs.10) and sells the bulk detergent to the whole seller at Rs.250. The manufacturer will then pay a GST on output of Rs.250, which will amount to Rs.25 (GST rate of 10 percent on Rs.250), but will get to set off a GST credit of Rs.20 (10 percent on Rs.200) thus paying a net GST of Rs.5. Similarly, as illustrated in the figure, the whole seller and the retailer will each pay a net GST of Rs.10 and Rs.3 respectively. In total, the raw material supplier, manufacturer, whole seller and the retailer, all put together, pay Rs.38 as GST, on the value additions along the entire value chain, from supplier to retailer, after setting off taxes paid at earlier stages. Hence, GST is a tax which has an incidence of tax burden only on the component of 'value additions' at each stage, and a supplier at each stage is permitted to set-off the earlier payment, through a tax credit mechanism.
What are the challenges in introducing GST?
•Given the current state level VAT variations, there are challenges in securing unanimous consent on the rate of the integrated GST; hence this is yet to be finalized. It is not only a matter of rate, but the states have to let go the powers of levying many forms of taxes, which will henceforth be converged into the proposed GST. Such loss of powers/ state revenues have turned out to be a major hurdle for securing unanimous approval from the state governments in implementing GST.
•The GST would have two components; a central component and a state component. The rates applicable for the central and the state components are under consideration by the expert committee. However, all other aspects are expected to remain uniform, as far as possible.
•As regards the proposed rate of GST, the task force of the 13th Finance Commission (TFC) has prescribed a GST rate of 12 percent; the states are refusing to accept this. Many other bodies that are working, in parallel, to come up with a rate have prescribed numbers that are different; one such rate is 11 percent for the state component, and other agencies establish an incremental rate of around 6 percent to 9 percent to cover the central GST component alone, taking the consolidated integrated GAST rate much above the 12 percent recommended by the TFC.
•There is likely to be significant loss of revenue to the state and the central governments on account of GST implementation; an equitable formula that will share this loss also needs to be mutually agreed upon.
Given these complications the implementation date needs to be finalized; it is unlikely to be 01 April 2010, as earlier committed to by the finance ministry. Stiff resistance has also been encountered from the opposition; the Bharatiya Janata Party (BJP) is opposing the implementation of GST on the grounds that sufficient discussions need to take place with all the stakeholders (central government, state governments, industry federations and academia) in order to ensure that interests of all are protected.
Overall, it is going to be a really tall task to design and implement an integrated goods and services tax framework that will be in line with international best practices, and at the same time, will take care of the unique complexities of the Indian central and state legislations. We have moved forward significantly in this initiative, but, when we would be in a position to actually implement this in entirety still remains a key question!
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