Navigating India’s Goods & Services Tax
By Dezan Shira & Associates
Editor: Nishant Dixit
India has introduced a constitutional amendment bill to enable implementation of a national Goods and Services Tax (GST). The bill was tabled by Finance Minister Arun Jaitely in the Lok Sabha – the Lower House of India’s Parliament – on December 19, 2014, and the GST launch is now expected by April 2016.
The idea of replacing India’s current system of complex indirect taxes with a GST was initially mooted in 2000 by the government of Atal Bihari Vajpayee and then formally introduced by former Finance Minsiter P. Chidambaram in his 2007-08 budget speech. In this article, we analyze how the tax will be structured and implemented.
Advantages of the Goods & Services Tax
The GST, a destination based consumption tax, is expected to simplify India’s tax system and overhaul the way business is conducted. The benefits of the GST for businesses include possible mitigation of double taxation and the cascading effect of the current tax regime, fewer rates, and the creation of a common market. The benefits for government are a broadened tax base and improved compliance that may help boost the economy. Some estimates put the growth effect of a GST at 1-1.5 percent of GDP.
The present system of indirect taxes at both the central and state levels creates multiple problems for business and government. These include cascading taxes on goods, which result when the central government taxes the Central Excise Duty at the time of manufacture and states add entry taxes or taxes at point of sale. Local entry taxes such as Octroi and inter-state trade taxes such as the Central Sales Tax (CST) exert further burdens on businesses. The GST bill proposes a two level Goods and Services tax on the same tax base. The Central GST will subsume the Central Excise Duty and a variety of other central levies while the State GST will subsume the state VAT, Central State Tax, and other state levies.
One of the main problems with the present indirect tax system is related to the inter-state trade of goods. When goods travel through India, they do not travel within a single market. Truckers have to stop at state border points in order to pay state taxes. For instance, between Delhi and Chennai, trucks cross 5 states but 10 checkpoints. According to the World Bank, when combined with the dismantling of inter-state checkpoints, GST implementation could cut freight times by 20-30 percent and logistics costs by 30-40 percent.
The IT system for indirect taxes has its own problems. These include lack of interface between various departments within the same state, lack of good software, and data sharing problems between states and the center. Under the new system, a common nationwide GST portal will provide core services of registration, returns and payments, and accounting of taxes.
The origin of the current system of indirect taxes lies in the Indian Constitution, which gives states and local bodies powers similar to the center when it comes to tax collection. The recently tabled GST bill seeks to remedy this situation by creating a basic legal architecture for GST implementation through a constitutional amendment. Salient features of the legal architecture are as follows:
- Both the center and states will be able to legislate on the GST.
- A Goods and Services Tax Council will be created which will have the Finance Minister as its Chairperson and ministers in charge of finance or taxation or any other minister nominated by each state government as members.
- All Goods and Services will be covered by the GST except alcoholic beverages.
- Petroleum and petroleum products will not be subject to the GST until a date notified on the recommendation of the GST Council.
- The center will collect an additional tax on the supply of goods, not exceeding 1 percent in the case of inter-state trade. This tax will be collected for a period of two years and the Goods and Services Tax Council may recommend the tax to be extended.
Problems in Implementation
India has taken almost a decade to reach an agreement to amend the constitution and pave a way towards the GST. However, migration to the GST is still not assured. The GST arrived on the budget agenda in 2007 and was expected to be implemented by April 1, 2010, but the first constitutional amendment bill was tabled in parliament on March 22, 2011. Disagreements on state compensation between states and the center slowed down the first process.
Although the central government and states reached a consensus on the GST in December 2014, allowing the finance minister to table the constitutional amendment bill, the rate has not yet been decided. Based on 2012 revenue figures, the GST subcommittee of the Empowered Committee of State Finance Ministers has proposed a very high Revenue Neutral Rate (RNR) of 26.68 percent with 12.77 percent for the center and 13.91 percent for the states respectively. An earlier 2013 report from the Finance Commission recommended a much lower rate of 12 percent, with 5 percent for the center and 7 percent for the states.
The threshold limit for the goods and services exemption has not been clarified either, with the GST Council expected to decide the limit once it is formed. There is a difference between central and state government over a threshold for exemption from GST. The center has suggested a threshold limit of INR 2.5 million, while the states have asked for a limit of INR 1 million.
The government’s majority in the Lok Sabha means the constitutional amendment bill will pass the lower house of the Parliament. However, its passage in the Rajya Sabha, the upper house where the government does not have a majority, is uncertain. Moreover, even if the bill passes the Rajya Sabha, it will have to be ratified by at least fifty percent of all State Legislatures. Negotiations over draft bills for the Center GST and the State GST may take considerable time to resolve.
Outlook for the Future
Although model draft laws for GST at both levels are being prepared, they have not been released. According to a February 7, 2015 report by The Financial Express, details about the GST rate, IT system, and model laws should be available by April 2015. Additionally, the Finance Minister is expected to provide a roadmap for the GST rollout during his 2015-16 budget speech.
Despite the uncertainty around the April 2016 deadline for GST, businesses should still prepare for future opportunities and challenges, including supply chain transformation, IT systems, and product pricing. According to Shilpa Goel, International Business Advisory Associate in Dezan Shira and Associates’ New Delhi office, “Businesses must ensure early release of common file formats and assist IT vendors in modifying and releasing updated versions of software that are compatible with the new system. In addition to re-working product pricing, businesses must re-align their sourcing and distribution strategies in view of the changing indirect tax landscape in the country.”
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