Dual Structure for GST - A Damp Squib or an Evolution in the Reform Agenda

By

S.Sridharan, VAT Consultant

Sridharan has discussed the broad contour of the proposed dual GST and elaborates on the issues and concerns that the dual GST structure should address. He concludes that the effort would be successful only if the tax administration is effectively computerized and the officials administering the legislation at the grass root level are knowledgeable.

For those who were expecting fireworks of a Single unified national GST, the announcement that a dual GST model has been agreed upon by the Empowered Committee of State Finance Ministers would be a damp squib.

Considering the political ground realities and the difficulty in pushing through the required constitutional amendment to implement a Single unified national GST, the dual GST Model, a central GST and a state GST, is the best compromise. A less than perfect dispensation, though not ideal, should be welcomed as a precursor to the ultimate goal of a Single unified national GST.

With a central VAT (Cenvat) and a state VAT already in place, it appears that the proposed dual rate structure would merely fine tune the present system.

For the layman, the excise duty (and allied levies) and service tax would comprise the Central GST; The State GST would comprise of State VAT, State Service Tax (new levy) and few more local levies.

Central GST may not have any significant impact as CENVAT Credit of Excise duty and Service Tax available at present would be continued.

The State GST is likely to encompass local levies like entry tax, Octroi, luxury tax, Entertainment tax, and other cess on goods besides the proposed service tax levy. Input tax hitherto not available on entry tax (in certain States) and other levies is a positive development.

No one size fits all

Different models of GST are implemented across the globe. No one size fits all and each country should design the tax structure that suits its political and business environment. The implementation of the dual GST structure is the most practical decision.

The working group constituted by the Empowered Committee had visited several federal countries where GST has been implemented to gain better understanding of the various GST systems.

The model of GST to be implemented in India would be unique to the ground realities in India, though broadly it appears that the dual GST prevalent in Canada has been considered.

Dr.Shome had observed in an interaction with the industry not to expect a text book structure.

Here are the highlights of the proposed dual GST Structure (gleaned from the press reports) and some concerns and issues.

Rate of Tax

At present, the standard rate of Excise duty is 16% (service tax 12.5%) and State VAT is 12.5% adding up to 28.5%. While it was speculated that the probable tax incidence could be 20- 22%, Dr.Shome has put at rest the possibility of a lower combined GST by observing that one should not indulge in speculation that the GST rates would be radically slashed as demanded from certain quarters of the industry. "Even if the present effective tax rate is kept at the revenue neutral stage, say 28 per cent, what the assesses should look forward to is the transparency and certainty of the structure that could do away with the cascading effect and helping the industry to shore up the competitiveness," he said.

Elaborating on why the tax rates are lower in some countries, Dr. Shome said that voluntary compliance even by large corporations in India was not at the desirable level and that countries that had reduced VAT/GST rates have subsumed many taxes in that framework and tax structure was made linear by doing away with tax breaks.

It is reported that the Centre and the States would fix their respective GST rates after ensuring there would be no revenue loss from the proposed changes.

It is reported that while the Service tax rate under Central GST and State GST would be uniform there could be more than one rate of tax on goods.

Dr. Dasgupta said, "The rates for Central GST and state GST would be prescribed separately, reflecting revenue considerations and acceptability."

What would be the revenue neutral rate of GST

Though Dr.Shome has indicated that the combined GST may be around the present combined rate of 28%, here is an interesting study that the revenue neutral combined GST could be 12% without any exemption on unprocessed food and other essentials like medicines and clothing.

The relevant extract from an article titled "Revenue-neutral rate for GST" By Satya Poddar & Amaresh Bagchi in the Economic Times dated 15/11/2007.

"Here are some basic ingredients of the RNR calculations for 2005-06, the latest year for which the necessary data are available. The total excise/service tax/ VAT/sales tax revenues of the Centre and the states in that year were Rs 134 thousand crore and Rs 139 thousand crore respectively.

Assuming that approximately 40% of the central excise revenues and 20% of the state VAT/sales tax revenues are from motor fuels, the balance of the revenues from other goods and services that need to be replaced by the GST are Rs 89 thousand crore for the Centre and Rs 111 thousand crore for the states, making up a total of Rs 200 thousand crore.

In 2005-06, the total private consumer expenditure on all goods and services was Rs 2,072 thousand crore at current market prices. Making adjustments for sales and excise taxes included in these values and for the private consumption expenditure on motor fuels, the total tax base (at pre-tax prices) for all other goods and services is Rs 1,763 thousand crore.

These values yield a revenue-neutral GST rate of approximately 11% (200 as per cent of 1,763 is 11.3%). The RNR for the Centre is 5% and for the States 6.3%. Allowing for some leakages, the combined RNR could be in the range of 12%. These estimates are by no means precise. Even so, they give a broad idea of the levels at which the rate or rates of GST could be set to achieve revenue neutrality for both levels of government."

"The RNR would, of course, go up if essentials like unprocessed food are left out of the base or taxed at a concessional rate. Assuming that, as the national accounts data show, food constitutes about one-third of the total consumption, the RNR of 12% jumps to 18% if food is totally exempted, and to about 16% if food is taxed at 5%. The RNR rates would be even higher if the preferential treatment were to be extended to other essentials like medicines and clothing.

Tax reforms entail hard choices to be made, which should be based on long-term considerations of nation-building, rather than narrow parochial interests or issues of the day. A tax at 20% with limited base broadening would not serve the needs of fundamental tax reform like GST."

Selective Concessions/Exemptions to continue

While a linear tax structure with few exemptions would be ideal, the GST structure is likely to continue with sector specific concessions and exemptions.

On sector specific concessions, Dr.Shome observed that shades of policy interventions is a fact of life and we have to weave such positive suggestions in the framework and that by 2010, we will have a structure that will overhaul all taxes into one, of course with some exemptions.

Likely Levies under Central GST

The central taxes likely to be subsumed under GST are central excise duties and allied levies and service tax.

Dr.Dasgupta is reported to have observed that the Government is likely to impose an excise duty over and above the GST on alcohol, tobacco products and petroleum products

Likely Levies under Central GST

State taxes likely to be subsumed under GST are value added tax or sales tax, luxury tax, octroi, entry tax, electricity tax taxes on lotteries, betting, gambling and purchase tax.

State entertainment tax is likely will be abolished and it will come under services in GST.

It is also reported that the states want liquor and crude products to be outside the purview of GST.

The GST regime may not subsume all taxes and several taxes like road tax, passenger tax, stamp duty and toll tax will be kept beyond the ambit of GST.

Service Tax under GST

Service Tax is levied at 12.36% (inclusive of Education Cess) per cent tax on around 100 services.

States do not levy or collect service taxes at present, but get a share from the Centre's collections. It is now proposed that states will keep the entire collection from 33 services from this year.

States would tax another 44 proposed new services, collect and appropriate as part of compensation for central sales tax phase-out in 2010.

Since there would be issues on taxing cross border services it is expected that the State GST would only include services that are essentially of "Local Nature"

It is reported that Service tax rate under Central GST and State GST is likely to be uniform.

It is possible that the rate of service tax may be increased in 2008 budget to align with the proposed peak rate of tax under Central GST.

Integration of Local Levies under State GST - A Welcome Initiative

Though State Service Tax proposed to be levied on 44 new local services would add to the cost, a redeeming feature is that Input Tax Credit would be eligible on the State Service Tax and a host of other levies like Entry Tax, Electricity Tax, and Luxury Tax etc that would be integrated under State GST. Of course, the service should qualify as an eligible Input Service.

No Cross Credit of Central and State GST

Cascading of Taxes would continue as the dual GST structure does not provide for fungibility of tax credit between the Central GST and State GST.

Dr Parthasarathi Shome, Advisor to Union Finance Minister said that in the dual Goods and Service Tax (GST) at the Central and State level, input tax credit would be allowed only at one chain and no carry forward of the credit from one chain to the other would be allowed. The structure would only address the cascading effect only in the respective chain and not in the parallel one.

In the absence of cross credit of input taxes between the two levies under dual GST, the much hyped intention of eliminating cascading of taxes and provision seamless input tax credit would appear a distant dream.

The 11th Finance Commission headed by Dr.Kelkar would also take into consideration the likely impact of the proposed implementation of GST on Centre-State revenues. It is hoped that the Finance Commission would examine the possibility of enabling fungibility of tax credit between the Central GST and State GST.

Tax Base for Dual GST Levy

Though nothing has been explicitly said on the tax base of for the State GST, Dr Dasgupta is reported to have observed that the dual GST Structure would ensure that there is no double taxation and it would help trim the present cascading effect of tax to benefit industry and consumers.

Does it mean that the levy of Central GST and State GST would be on the same tax base as only this can help trim the present cascading effect of tax? At present States levy VAT on the sale consideration inclusive of Excise Duty.

Taxation of Interstate Sale

With the phase out of CST by 2010, the concern is that would CST sale be zero rated or would it be considered an exempt sale.

The subtle difference between the two options is that if the Inter State Sale is Zero rated, the dealer would get Input Tax Credit, if the Inter State sale is an exempt sale, Input Tax Credit cannot be taken.

Expectations/Issues from Dual GST

Some essential prerequisites that would make the exercise of dual GST meaningful are

• Dematerialization of Form C and Form F

• Single return for Central GST and State GST

• Uniform State GST legislation

• Uniform procedures and return formats

• Tax administration should be facless

• Will States continue to refund unutilized Input Tax Credit?

I am sure the list would be longer. We would have answers when the final proposal is unveiled.

Formal Recommendation to Centre by December End

Dr.Dasgupta has said that the formal final report would be sent to the Centre by end December,2007 and as Dr.Shome observed it is the political masters who would to take the call on GST.

Challenges Ahead

Though I apprehend that the administrative machinery may not gear up to the challenge of creating the necessary infrastructure by 2010, it is not impossible.

The essential prerequisite is the large scale computerization of the State Administration to facilitate e filing of returns, monitoring of returns, mapping of interstate sale.

No meaningful risk management system can work without efficient tax administration software. If the procedures and formats are not uniform across States, normalization of data would be difficult and it is hoped that the States agree on uniform procedures retaining only the powers to selectively grant concessions on rate of tax based on local political and business exigencies.

An efficient computerized system becomes all the more important as Inter State sale would be exempt. The process of issue of Form C /F should be dematerialised and monitored online.

Another important aspect is proper training of both the Central GST and State GST officials on the law and procedures.

I am sure most of you would have come across instances of Service Tax officials and the State VAT officials being not very conversant with the provisions of law. Best talent should be attracted to Government Service by matching Industry level compensation. Success of any progressive legislation depends entirely on the quality of manpower administering the legislation particularly at the grass root level.

Let us look forward to a Practical GST, though truncated!

(The author is a Madurai based indirect tax consultant. Email: sridharan@stvat.com)

04/12/2007