India is at the Cross Road of Major Indirect Tax Reforms
By Nihal Kothari
Posted: 12th September 2014 08:23The present indirect tax structure in India is quite complex. Multiple taxes are levied by the Federal (referred as central) and State governments on tradable goods and services. On imports three different elements of customs duties are levied. Excise duty is levied on domestic manufacture of goods at different slab rates depending on the product. Service tax is levied on provision of services. Sale of goods attracts State VAT which is administered by different States depending on where the sales take place. In addition, there are multiple other levies applicable to certain goods and services such as entry tax, entertainment tax, property tax, profession tax, motor vehicle tax, luxury tax, various cesses etc.
This complex tax structure not only increases the cost of compliance but also add to tax litigation and uncertainly on ultimate tax incidence. The present tax system does not provide full input tax credit on purchases against the output tax liability resulting in cascading impact of taxes on the cost of goods and services. There will be greater adverse impact of cascading taxes on the cost of products and services with long value chain. Thus it discourages value addition. Such partial eligibility of input tax credits apart from artificially increasing the cost of goods and services also encourage enterprises to resort to sub-optimal solutions for reducing tax incidence by tax led structuring of business processes, supply chain models and business structure which otherwise may not be economically efficient.
Consensus on Tax Reform
The compelling need to reform India’s indirect tax structure to improve competitiveness of Indian economy, has been felt by all stake holders including the Central Government and 29 State Governments. Several initiatives had been taken in the past to simplify and rationalise taxes especially during last 10 years but these had limited impact.
In 2007, a major initiative was taken jointly by the Central and State Governments to examine the feasibility of replacing the current multiple taxes by a single national “Goods and Services Tax’ (GST) with inbuilt full input tax credit to simplify the tax structure, eliminate cascading of taxes and enlarge tax base for revenue buoyancy. The basic structure of proposed GST was agreed in 2008 and soon thereafter preparation for change over to GST was initiated. Significant progress has been made finalising the systems, procedures and documentation since then.
India has federal structure of Governance and the taxation powers are divided between the centre and states under the Constitution which cut across supply chain. Hence any major tax reform to integrate indirect taxes need to be agreed by central and 29 State governments and requires amending the constitution. The Indian constitution can be amended only if such amendment is approved by two third members of Parliament and more than 50% of 29 State legislatures. In 2011 a Constitution Amendment Bill was introduced in the parliament to enable replacement of existing multiple taxes by GST. This is pending enactment.
Propose ‘Goods and Service Tax’
Considering the federal structure of Governance the proposed GST will have uniform duel structure under which for each transaction, part of the tax revenue will directly go to the Central Government and part of the revenue will directly go to respective states. This is a unique model. There is broad consensus on the basic GST structure by all stake holders viz Trade and Industry, Central and State Governments and consumers. There is however an apprehension among states on loss of revenue by some states during the initial phase of changeover which may affect their state budget. Some states also feel that uniform GST structure covering all goods and services will take away their flexibility to collect higher tax in case of unforeseen circumstances hence they want some products to be kept out of GST apart from ensuring compensation for any loss of revenue during the initial phase of implementation. These issues are not difficult to be resolved with considering the significant benefits of replacing present complex tax structure. The other issue yet to be finalised is the modality of tax administration especially for small and medium enterprises.
India is at the Cross Road of Mega Tax Reform
India is currently at the cross road of mega indirect tax reform. The Government at the centre has to give high priority to this much awaited tax reform and convince the States to move forward by removing their apprehension of revenue shortfall during transition. Recently held election to the parliament has given clear majority to one political party to form stable government. It is therefore now possible to accelerate the process of implementing GST. This is imperative for the growth and competitiveness of Indian economy. Replacement of existing complex multiple indirect tax structure by uniform single GST will provide significant benefit to all stake holders.
Impact of GST on Different Stake Holders
On Overall Economy
It is expected that India’s economic growth will increase by 1.5% to 2% on implementation of rational GST. GST being one single tax levied uniformly across the country will create single Indian common market which in turn will bring economy of scale. It will increase trade with efficient supply chain. GST will remove economic distortions and will promote indigenous manufacture of goods which in turn will provide more job opportunities to its young population.
GST will remove cascading effect of taxes from the cost of production of good and provision of services. This will make Indian industry more competitive. It is expected that overall cost of indigenous manufacture will reduce by 10% to 15% on replacement of existing multiple taxes by GST.
Tax compliance cost will reduce on simplification of tax structure and introduction of uniform returns/ procedure in all States across India. There will be parity in the tax incidence between Imports indigenous manufacture. In the current tax system total tax incidence on indigenous goods is higher due to imbedded taxes in the cost.
Cost of export production will reduce due to zero rating of all taxes. Hence export will become more competitive. Currently only some of the Central taxes are partially neutralised in the form of refund or exemption.
On Government Revenue
GST will bring buoyancy in tax revenue of central and state governments. Tax: GDP ratio is expected to increase by 2% bringing incrementaltaxrevenue. GST will have built in check on payment of taxes as it is levied on all goods and services at each stage of value addition. Full tax credit is allowed for tax paid on purchase hence no enterprise will buy goods which for which tax is not paid. Tax structure will be simple. These factors will lead to better tax compliance.
Once distortions from existing tax system are removed and common Indian market is created by GST, it will have significant economic saving and reduced tax incidence, which in turn will have favourable impact on prices.
GST will be biggest game changer for all stake holders - Industry, trade, investors, Central and State Governments, and consumers. All stakeholders can benefit significantly from GST provided it is rational and administered properly. Its implementation therefore is keenly awaited.