GST: The next stage of VAT

The Value Added Tax had been introduced with a view to take care of the various anomalies present in the tax structure. In the pre-VAT era, the traders used to juggle with multiple tax regimens – right from procurement of primary material for manufacturing to the final stage until the goods and services were purchased for consumption. This led to problems regarding over-taxation due to Cascading effects of earlier tax regime. This one hand increased the problem of tax evasion; on the other hand it substantially increased the prices for the goods whose processing went through complete documentation as per legal process. This in particular affected the exports sector as they became non-competitive.

Though the VAT addresses these problems, it nevertheless has, since its introduction, presented its own unique set of problems with the powers that be at the State as well as Centre wracking their brains to come up with a mutually acceptable solution. To cite a instance, a number of Central taxes including customs duty, surcharge were excluded from  Central Value Added Tax (CENVAT) while  at the State level  entertainment and luxury taxes (indirect taxes ) were  excluded from VAT. Thus, while VAT did address the cascading effects of taxation a bit, it couldn’t bring the price parity as it could in case of Europe. To address this issue the Asim Dasgupta Committee was formed in 2002 to design the GST.

The GST is considered to be a major improvement over the former system of central excise duty at the national level and the sales tax system at the state level, also the proposed regime was considered a next logical step towards a comprehensive indirect tax reform in the country. It was supposed to unify the taxes concerning goods and services and would have taken care of the problems of the way the tax system had been configured, but due to various political and non-political issues it could not see the light of the day.

One major reason that it is still not implemented in its entirety is due to the lack of consensus among the States and Centre on issues concerning fiscal autonomy at the State level. Another underlying reason till now had been political opportunism, wherein some state governments have joined hands to oppose any move by the opposition political party ruling at center. For other states the reasons are not political alone and have more to do with the financial arithmetic involved as a large number of states do not have any real source of revenue with their dependence on the financial largesse of the Centre.

In addition, GST in India is not an entirely new initiative, but it is to address the implementation problems concerning VAT with the end result of benefits to the economy and smoother functioning. In the present State-level VAT system, there is a problem of what we may call ‘tax overlapping’ between Centre and State taxes. The problem is the residual of Central Value Added Tax or CENVAT on certain commodities remains included in the value of goods to be taxed under State VAT.

As per Indian Constitution, taxes upon goods and services can be classified under three lists, namely Union List, State List, and Concurrent List. Now, certain taxes can be levied either by the Centre or the State. The underlying problem nevertheless is of goods repeatedly being taxed, also called the cascade effect (once by Centre and then by State (the concurrent list ones)). This also adds on to administrative cost. This ‘CENVAT Tax Element in State-level Tax’ needs to be removed. For GST to be effective at the State-level, it is essential that the States should be given the power of levy of taxation of all services. This power of levy of service taxes has so long been only with the Centre. A Constitutional Amendment may have to be made for giving this power also to the States.

As pointed out by Tax Expert Prof. Mahesh Purohit, under the present system of VAT, services should also come under its net. In his words, ‘Historically, India’s indirect tax system is unique given that under the Constitution, the Union government has the authority to impose a broad spectrum of excise duties on production or manufacture while States are assigned the power to levy tax on the sale of goods. Due to this dichotomy of authority under the Constitution, India has been rather slow in the adoption of VAT. Today, India has adopted a model of dual VAT, replacing Union excise duty with CENVAT and sales tax with State VAT. From an economic stand point, there is hardly any difference between the taxation of commodities and that of services. Therefore, under this system of dual VAT, it is of paramount importance that in addition to goods, services also come under its net. The exclusion of services causes many administrative problems and paves the way for evasion of tax.’ GST attempts to rectify that. Under the Goods and Services Tax, each manufacturer needs to pay a GST, which is the difference of the ‘output tax’ and ‘input tax’. Hence, it can be said, GST is a comprehensive value added tax levied on goods and services. Under the GST regime, goods and services will not be differentiated as they move from the manufacturer downwards.

For GST to be effective, it is essential that the States should be given the power for levy of taxation of all services as this power has so long been only with the Centre. A Constitutional amendment will have to be made for giving this power also to the States. (In fact, the most important objective of this new initiative is to amend certain aspects of the Constitution of India in order to make it very clear which objects to be taxed by the States and Centre. Unless such amendments are made it would be difficult to operate GST in an optimal manner).

Recently (on December 19, 2014), a new bill (122nd Constitution Amendment Bill, 2014) has been tabled in the parliament by the NDA Government regarding the changes in provisions of GST as tabled earlier by the previous UPA government in 2011. This Bill replaces the earlier bill, which had since lapsed.

GST also attempts to address the evasion of taxes as it will do away with CST as there would be a continuity in set offs from the manufacturer till the products/services reach the end consumer.  All the taxes would automatically come under the umbrella of the GST. This would, in turn lead to lesser records being maintained (what the government is going to do with the surplus manpower, as a result, can be addressed in another article). A major boost in the arm would be the increased flows of revenues as a result both at the Centre and consequently the State’s share as a result. This will have a favorable impact on the prices of product and would increase the demand for goods and bring benefits to the consumers. Thus GST is likely to bring down inflation for manufactured goods after the initial adjustment phase of 3 years.

Once the production and supply chain costs reduce, it will have an impact on price and availability of raw material leading to lower costs of production and increased efficiency. It is expected that rational GST structure would reduce the production costs by an approximate 10%. GDP growth as a result is expected to increase by 1.4 to 1.6% and would help to aim at the 8 to 9% GDP growth target.

GST at the State level can be justified for the following reasons-

• Additional power for levy of taxation of services for the States
• Removal of the cascading burdens of CENVAT and service taxes
• Inclusion of a number of taxes in the GST

In a nutshell, the GST, once it gets implemented would address the following issues plaguing the economic development:

• Cascading effects of taxation
• Competitiveness of indigenous goods & services
• Fragmentation of market resulting in inefficient production/distribution models
• Economic distortions
• High compliance and administration cost
• High selective tax incidence suppresses demand
• Increases litigation, uncertainty and harassment
• Tax inefficiencies influence policy of protectionism leading to high cost economy

A PAN-linked taxpayer identification number with a total of 13/15 digits would be generated for each tax payer. This would link the GST with PAN-based system for Income tax, thereby leading to greater tax collections as well as data exchange. As a result there will be far greater information sharing between the Centre and the States than it is happening currently.  

The Central GST and State GST needs to be paid to the accounts of the Centre and the States separately and how will each state treat the goods and services tax in the case of flow of products across multiple states is still to be sorted out. Also, the services agenda is still lacking and focus is still on sorting out product related issues only.  In addition a few important sectors like oil and gas, real estate are still out of its ambit and the list of items is still ambiguous.

Finally there is the issue of revenue loss and inclusion/exclusion of state taxes that continues to be key points of discussion in the corridors of power. GST, once it is fully implemented would greatly help to create a single Indian national market in which there is free flow of trade of goods and services. This as a result of the theory of competitive advantage will aid the different states in India to specialize in production and manufacture of services with a distinct cost advantage thereby leading to increased efficiency which will help accelerate the growth engine.

By: Gaurav Bansal