GST: Getting stuck (in) trepidation

As India is surging ahead to become a developed economy from the present status of ‘under-developed’,  the need for an efficient and transparent pan-India indirect tax regime is increasingly becoming a necessity. The plan to replace the existing central excise duties and state sales taxes with a more modern Goods and Service Tax (GST) is a step in the right direction. But after reaching a point close to unfolding the new tax regime from the beginning of next financial year, the implementation of GST appears to have received another setback with many states opposing it fearing loss of their autonomy to levy taxes.

At this juncture when the ongoing joint efforts by the Centre and states to push forward the pace for introduction of the much-talked about GST has gathered momentum, with both sides making sincere efforts to narrow down their differences, the growing apprehensions among states about infringement on their fiscal autonomy is, no doubt, posing a major hurdle in the path of putting in place the new tax regime.

The GST, which seeks to subsume indirect taxes like Central Excise and Service Tax at the central level and the Value Added Tax (VAT) and other local levies at the state level, was first scheduled to be introduced with effect from April 1 this year. But it missed the deadline as both centre and states could not resolve their differences on various knotty issues.

Now, though both the sides in principle have agreed to put in place the new tax regime with effect from April 1 2011, some major hurdles still remained to be crossed. One relates to evolution of a mechanism that will address the concern of states losing their fiscal autonomy and loss of revenue by switching over to new tax regime.    

The other relates to a still more complex problem of evolving modalities for fixing the rate of taxation and threshold limits. The Empowered Committee of State Finance Ministers (ECSFM), which met recently to discuss the draft of the Constitution Amendment Bill for putting in place the GST, concluded that the draft in the present form would “infringe upon the financial autonomy” of states and, was therefore, not acceptable.

No meeting point

States apprehend that the draft Bill seeks to provide the Centre with veto powers over indirect tax matters pertaining to states. As the Chairman of the ECSFM and the West Bengal Finance Minister Asim Dasgupta says “the proposed draft Constitutional Amendment Bill on GST in its present form is not acceptable to the states.”

States, in principle, are against infringement on their financial autonomy and have certain reservations on the draft bill’s provisions for the GST Council and the GST Disputes Authority.

It is learnt that the draft bill envisages that the GST Council, which is proposed to be final authority to fix the tax rate, will be headed by the Union Finance Minister. Besides, the draft Bill is understood to have proposed that the Union Finance Minister would have veto powers on matters relating to state subjects. However, Finance Minister Pranab Mukherjee has clarified that he has no intention of becoming the “Super Finance Minister” and interfere with the State GST. GST will see the light of the day only after the proposed Constitutional Amendment Bill on GST is finally approved by two-third majority of both Houses of Parliament and then ratified by two-thirds of 28 states.

The Congress-led UPA government does not have the two-third majority in both Houses of Parliament. Similarly, a large number of states are being ruled by the main opposition BJP as well as Left Parties. Until and unless there is a broad national consensus on all sensitive aspects of the GST, it will be difficult to put it in place.

In another significant development Mukherjee in a bid to push forward the process for introduction of the GST has proposed a dual rate of GST for goods in the initial two years. He proposed that in the first year there will be a lower rate of 12 per cent (6 per cent each by the Centre and states) and a standard of 20 per cent for other goods (10 per cent each by the Centre and the state.) Service tax was proposed at 16 per cent.
As per the revenue share proposal the GST will have two components— Central GST (CGST) and State GST (SGST) and revenue will be equally divided between the Centre and states, while both states and Centre will levy service tax at the same rate.

In the second year the standard rate will come down from 20 to 18 per cent while the lower rate will remain at 12 per cent. The third and final year will achieve standardisation of the GST rate at 16 per cent for both goods and services.

Very high rates

Given the division of taxation powers between Centre and States under the constitution and being conscious of the fact that neither of them would like to part with their powers, it is being overwhelmingly felt by trade and industry that the dual taxation system could be the only feasible option to start with but in the long run a single pan-India GST would be the ideal solution.

 As per a study, more than 140 countries have national level GST and the dual tax system is in existence only in few countries like Canada and Brazil.

Though trade and industry have welcomed Mukherjee’s proposal for GST for the initial years, most of them feel the tax rates are on the higher side. As the FICCI President Rajan Bharti Mittal says “we feel the proposed standard rate of 20 per cent with 12 per cent for essential goods in the first year are somewhat on the higher side. The Thirteenth Finance Commission (TFC) has recommended a combined rate of 12 per cent (5 per cent CGST and 7 per cent SGST).”

“What is being planned to achieve in the third year could have been a good rate to start off in the first year—16 per cent instead of 20 per cent with a lower rate of 8 per cent for merit goods instead of 12 per cent,” Mittal suggests.    Though other apex chambers of trade and industry have more or less welcomed the dual GST in the initial years they admit in private that the proposed tax rates are on the higher side.

Leading tax expert Satya Poddar, Tax Partner, Ernst & Young says “Rates proposed by Mukherjee are far higher than the revenue—neutral rates in the range of 12 per cent were anticipated by the industry and were recommended by the TFC. He proposes to address the upward bias in the rates by lowering them, but only gradually over the next three years.”

Tax payers would be sceptical of such promises given the international experience of rates always moving in the opposite direction, he says. Many tax experts feel that a tax rate of 20 per cent at the retail level would not be popular and might lead to widespread tax evasion.

Experts also feel that Mukherjee’s GST rate structure with most inputs taxable at 16 per cent or 20 per cent and output taxable at 12 per cent would lead to inverted duty structure where inputs credits always exceed output taxes.

Industry is also apprehensive that a separate tax rate of 16 per cent for services (as opposed to a maximum of 10 per cent now) would give rise to classification disputes and complexities in applying the tax to mixed supplies of goods and services such as car repairs and work contracts. The overwhelming apprehension is that the GST at high rates would encounter significant consumer resistance, especially at the retail level and would give rise to pressures for exemptions and lower rates for a variety of goods and services as is the position under the current regime, which is replete with exemptions and concessions resulting in complications in tax administration.

The GST should be designed in such a way that it should improve the efficiency and productivity of the economy and thereby international competitiveness, facilitating a common market, reducing cost of indigenous goods and services through better economies of scale in manufacturing and by reducing supply chain cost.

Therefore it is imperative to have a moderate GST rate.