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GST For India: Reform or Regression?

We are hardly 24 hours away from the launch of GST! Are we ready? Probably not but will we ever be? It is like our exams in school days, more preparatory time seldom resulted in better marks!

Getting back to GST, do you know that Singapore had 3% single rate when it launched GST and that it had exempted financial services from it? Do you know that GST implementation is mostly followed by inflation in short term? By the way, one more interesting fact! New Zealand introduced GST in 1986 with one of the lowest rate but currently is one of the most tax productive nation (GST revenue to GDP).

With more than 160 countries on VAT/ GST, there must be some merit and hence this time there is question more on readiness than on the need of GST (a happier departure from what we witnessed during demonetization). But still we will discuss more on the merits & demerits to arrive at some conclusion on the topic we chose.

So, first, what’s GST?

GST (Goods & Services Tax) is a uniform tax across the nation subsuming numerous central & state level taxes (e.g. CENVAT, sales tax, excise etc.). For example, there would be no Octroi, and hence no queuing up of those lorries at entry points across state borders, free flow of goods in true sense. If you are a number guy, take this…a government study found out that the average Indian lorry spends 16% of its time waiting at checkpoints! Economist in its 6th Aug-2016 article (One Nation, One Tax) summarizes it up well:

‘…the new value added tax (GST) promises to subsume India’s miasma of local & national levies into a single payment, thus unifying the country’s 29 states and 1.3 Billion people into a common market for the first time’

Another important key feature of GST is that it is levied at national level on consumption of goods & services and essentially is a tax on value addition at each stage. (RBI)

A few key features of India GST system:

  1. India will have multi rate GST unlike Singapore, which is single rate GST regime. There are 4 slabs at 5%, 12%, 18% & 28%. The guiding principle of these multi-tier rate was ‘RNR’ / Revenue Neutral Rate’ i.e. a rate at which revenue is preserved at current level
  2. There are a few services which are exempted from GST e.g. services by RBI, services provided by educational institution to its students (till XII) etc. To know more about the rates & exemption, click here
  3. A few items e.g. Alcohol, Petrol have been kept out of GST. The key reason has been states reluctance as these are key revenue drivers for the state & they would not like to share the same with center, at-least not initially. These may be slowly subsumed under GST gradually after the 1st phase stabilizes and the states are comfortable with their revenue generation
  4. Since India is a federated structure with center & states having their own revenue stream from taxes, the same needed to be preserved under GST as well. Hence GST has 3 type of rates, CGST (Central GST), SGST (State GST) and IGST (Integrated GST). IGST is applicable for inter-state movement while the other 2 are for intra-state. To understand this concept and how the tax & input tax credit will be calculated, pls. click here
  5. The backbone for GST administration will be GSTN (Goods & Services Tax Network). It is a IT portal (Gov has 49% stake in GSTN) that will act as the front end of the overall GST IT ecosystem. Individual states or CBEC will have their own systems at back end and linked to GSTN. GSTN will also provide IT enabled services through GST Suvidha Providers (GSPs) for taxpayers. For more clarity on role & function of this Sec-25 company, click here. Below also is a snapshot of role of GSTN (taken from http://www.gstn.org/about-us/)

Next, what reform benefits does GST provide?

  1. Firstly, a uniform rate across the nation (need not be single as we will have slabs based on category) will make life easier from compliance & administration perspective bringing in efficiency & simplicity. This is expected to bring down compliance cost.
  2. Secondly, a simple tax regime can improve ‘ease of doing business’ and has potential to attract large inflows of FDI.
  3. Thirdly, uniform tax rate will eliminate price distortions, which can improve product competitiveness and hence improve export potential
  4. Finally, a consumption driven tax model is expected to increase the tax net and hence lead to tax buoyancy

Economist in its 5th Nove-2016 article (Take It Easy) highlights 3 key benefits arising out of such a tax reform exercise:

‘…Advocates see three great benefits from the tax: the creation of a single market, greater efficiency and a shift of activity into the formal economy’

Several studies have tried to quantify this impact on the country’s economy. While the Economist, 6th August report speaks off boost in economic output by 1-2%, an exhaustive study done by RBI stated:

‘…Although the precise impact is difficult to measure accurately, average growth increased by about 0.7 percentage point following fiscal (including tax) reforms in some advanced economies’

The above is encouraging considering that as per RBI report, the consolidated finances of the state has deteriorated in recent years and breached the 3% ceiling (fiscal deficit) last year (FY1516) for the first time since FY0405.

 

So, with so many benefits to count, are there any challenges worth it?

GST, as a concept, does not pose any challenges and is known to usher in tax transformation. For a country like India, it has the potential to resolve the cacophony of so many different taxes.

The challenge is in the effectiveness of the implementation. The key reasons for worry are:

  1. IT readiness. This primary concerns the GSTN and its associated IT infrastructure. This is reflected in the concern raised by Harpreet Singh, Partner KPMG in an article in FT, 26th Jun’17: “Right now it is all about IT-readiness. Companies might not even be able to file their first invoice on July 1. There is a lot of mess right now — the first few months are going to be chaos (Financial Times, India faces chaos over Modi’s tax code revolution). The present Government can hardly afford a mess especially after what we have experienced during demonetization, especially since one can expect large volume of transactions across the country on this network
  2. A higher multi-tier GST rate structure: This may have several impacts. Firstly, a high rate can be deterrent to tax compliance, leading to efforts towards avoidance, under reporting, non-remittance of tax collected by traders to Govt, false refunds etc. Secondly a multi-tier rate can partially eat away the ease which GST promises to bring in and can lead to manipulation of goods category to attract lower tax rates. Hence there are chances of regressive impact in short term
  3. Short to medium term inflationary impact & drop in consumption: The impact on inflation is well documented from the experience of Australia, Singapore post GST implementation. Such inflation impact also dents consumer confidence who will need time to adjust their consumption. THIS CAN BE A BIG CHALLENGE FOR AN ECONOMY WHICH IS YET TO RISE FROM THE DOUBLE WHAMMY OF DEMONETIZATION & NPA! For a refresher on how badly consumer confidence was beaten earlier, click here
  4. Dispute resolution: Since this is a new concept & there will be implementation challenges, one can expect disagreements & disputes to arise between center & states, taxpayer & tax authorities & so on. A proper governance mechanism will be required to add teeth to the overall program

 

Now let’s come to financial services:

  1.  The tax will increase by 2.5% from the current levels. GST will be at 18% for all financial transaction services. Singapore had kept it exempted from GST
  2. Since GST will follow a federated structure, the financial services institutions/ banks must register with all the states where they have physical presence. This will be a onetime painful activity as earlier they used to have one registration at the central level. This actually goes against the ‘ease of doing business’
  3. GST is administered at consumption point and hence the ploughing of the customer transaction tax to the right state for a financial institution will be a little tricky as customers are mobile. Possible the only feasible solution will be to go by the permanent address of the customer
  4. Interest payment will remain exempted as it also not under service tax earlier. The GST council note states exemption of ‘Exemption: ‘Services by way of— (i) extending deposits, loans or advances in so far as the consideration is represented by way of interest or discount (other than interest involved in credit card services) …

 

Conclusion

GST is surely a great tax reform for our country but as the proverb goes ‘once burned, twice shy’, people will be worried after a harrowing demonetization experience.

The slow credit growth, banking capital quality challenges, lower than expected GDP growth, hardly any growth in employment and sagging customer confidence can withstand only that much!

While the next 3 months will give lot of clarity on whether the apprehensions are true or not, for the coming days we pray that technology can support this transformation and we see a smooth progression to ‘GST way of life!’

 

Sources

https://rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=40437 (GST implementation to have far reaching implications for the Indian Economy RBI releases State Finances: A Study of Budgets of 2016-17, May 12-2017)

The Economist (http://www.economist.com/), Articles as quoted above

http://www.mof.gov.sg/Policies/Tax-Policies/Goods-and-Services-Tax

India faces chaos over Modi’s tax code revolution, FT

www.gstn.org/

http://www.gstcouncil.gov.in/

https://cleartax.in/s/what-is-sgst-cgst-igst

Image sourced from www.cbec.gov.in

 

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