Why CGST, SGST and IGST in India and Principle of Subsumation of Taxes

CA Dr Arpit Haldia

Understanding Goods and Services Tax #5: Why CGST, SGST and IGST in India and Principle of Subsumation of Taxes

“Although it would not be the perfect or first best solution to the problems of the present system, reform on these lines would go a long way to remove many of its ill effects and perhaps lay the foundation for an even more rational regime in the future.”

The golden words echoed at the time of suggestion of implementation of VAT in India in The Bagchi Report i.e. the Report on “Reform of Domestic Trade Taxes in India: Issues and Options”, National Institute of Public Finance and Policy, New Delhi in the year 1994 have become the bedrock of reforms in the country and we might call the farsightedness of the authors that India today stands on the verge of its biggest tax reforms in just 22 years from a taxation structure which was archaic, irrational and complex – according to knowledgeable experts, the most complex in the world.

1. Why CGST, SGST and IGST in India in the proposed GST Structure and not a National GST: Principle and reason thereof

It is a known fact that Dual VAT/GST Model has been sought to be brought in place in India. The common thought of people of the country is that why National VAT/GST has been brought instead of Dual VAT/GST and does the lawmaker’s were not farsighted enough about the option of National GST rather than Dual GST. It also appeared to public at large that why when the people of the country with little knowledge about taxation structure could see the benefits of National GST, could the lawmakers who deemed to have the expertise in the subject not see the benefits of National GST in place of Dual GST.

It’s only the half picture that we see. The two models of GST i.e. Dual GST and National GST were both considered in the year 1994 before the implementation of State VAT. After detailed discussion as narrated below Dual GST with independent taxation powers to Centre and State upto a certain part of supply chain with full fledged Credit Mechanism under Excise and State VAT was implemented with an eye on the future for a full fledged Dual GST in the country and National GST was discarded deeming it inappropriate in India.

So what is National GST or Dual GST and what are the merits and the demerits of the same and why Dual GST has been preferred over the National GST. The reason for bringing in SGST and CGST also lies in the same answer as well.

♣ What is National VAT/GST:

The Bagchi Report i.e. the Report on “Reform of Domestic Trade Taxes in India: Issues and Options”, National Institute of Public Finance and Policy, New Delhi described National GST as follows:

“A National VAT – VAT as a National levy implemented through a Parliamentary legislation and administered by the Centre (or the States on behalf of the Centre)replacing both Central excise and sales tax, covering all goods and services, with arrangement for revenue sharing.”

The report further went on to provide that

“A unified system of taxing domestic trade in the form of a national VAT imposed and administered by the Centre would appear to be most attractive from many angles. It would, at one stroke, bring about harmonization and help remove the tax on inter-State trade.”

It would be pertinent here to provide that National GST/VAT is presently in place in Australia, Germany, Austria, Switzerland etc.

• Why National VAT/GST was not implemented and was ill favored by the lawmakers:
  

The big question arises that why the law makers implemented Dual GST Model and National GST i.e. one common GST model was not brought in place in the country.

To understand it better, we would have to consider an hypothetical example wherein entire revenue from the taxes in the country say Rs 5 Lakh Crore revenue is administered and imposed by Centre and which is to be distributed by the Centre between all the States and Centre on an appropriate basis.

One possible scenario in the given situation is that some of the States might get the desired revenue and some would not be satisfied and allegations would then be levied regarding political backlash etc. It could be a harsh reality that leaving aside the States ruled by Political Party ruling the Centre might feel short charged in the entire scheme of distribution of revenue.

It would be appropriate here to refer the observation in “Working Paper GST Reforms and Intergovernmental Considerations in India” for the Department of Economic Affairs Ministry of Finance, Government of India wherein the issues relating to the National GST was summed up as

“The key concerns about this option would thus be political. Notwithstanding the economic merits of a national GST, will it have a damaging impact on the vitality of Indian federalism? With no other major own-source revenues, will individual States become too dependent on collective choices and feel disempowered to act on their priorities? Will it be possible for the governments with such diverse political interests and philosophies to reach a consensus and adhere to it?”

There are many shortcomings envisaged in the National VAT/GST which are narrated as below:

a) Centralization Of power to Levy Taxes with the Centre would have taken away the power of the States to levy Taxes: In India, we have multilevel system of Government wherein each government i.e. State or the Centre are separately accountable to the people. This accountability and responsibility requires freedom to do the work and in turn also independent revenues at their disposal. Independent revenue at the disposal of the States cannot be made available to them if they do not have the power to garner revenue on their own and have to depend on someone else for the revenue.

b) National GST would have lead to Centralization and Increased dependence on the Centre: In 1994, if National VAT/GST would have been brought then the States would have to depend for their 70% of the revenue on the Centre as against the then 32% in case of separate legislative powers being delegated to the States for collection of revenue. This overdependence was neither thought feasible at that time and nor in the present times.

c) National GST against the basic principles of Fiscal Decentralization: Implementation of National GST would have gone against the principals of fiscal decentralization which are widely believed to be crucial for the effective functioning of a multi-level system of governance, allocation of resources for public spending according to the preferences of the people and promoting fiscal responsibility at all levels. To promote Fiscal responsibility at all levels of State and Centre and to ensure that the Governments spends what they earn, know what they would earn and enjoy the risk and rewards of the ownership of the taxes, there has to be legislations which promote independent revenue.

d) National GST would have required far reaching and more complex amendment to the Constitution: National GST would have threatened sovereignty of the states and would have brought their sovereignty in jeopardy. Seeing in the present context of the dilly dallying attitude of the political consensus, it would have been next to impossible to ask the States to come to terms of being over dependent on the Centre and pass the Constitutional amendment for National GST. How the diverse and the local political parties would have believed the assurances of Political Parties in the Centre, that they would be given their share of revenue to carry out the work and there would be no political backlash in distribution of revenues amongst all the States whether or not governed by the same political party in the Centre.

♣ What is Dual System of VAT/GST:

Therefore then what was the next best option. The Next best option was Dual GST in India. The dual system of VAT was defined under the Bagchi report as follows:

Dual or Joint System – Both the Centre and the States levying VAT either concurrently or independently, converting their excise and sales taxes into VAT.

Although under National GST/VAT, there was one common tax to be collected but the major short coming of National GST/VAT was that it entrusted the Centre with supreme power for imposition and administration of revenue and threatened the very sovereignty of States.

Thus, lawmakers had while bringing Nationwide VAT/GST ensured that that they inherit the tax structure having common tax rate across the Country in the Dual GST alongwith inherent benefits of Dual GST:

a) The share of the State and Centre should be pre-divided under separate statutes out of the above common tax rate, and

b) There should be concurrent powers of the State and Centre to levy tax on supply of goods and services from starting point to the end point.

The same was highlighted in the Bagchi report as follows:

“While designing a model of dual VAT, it is thus advisable to explore ways in which both the Centre and the States can move their respective excises and sales tax systems towards a system of VAT within the framework of the Constitution and improve their implementation through better legal and administrative structures.”

• Salient features and Comparative Analysis of Dual GST and National GST:

a) Tax rate in Dual GST would be the same as in National GST barring that the Tax Rate in Dual GST would be divided between State Rate and Central Rate and in National GST, there would have been no division in Tax Rate between Centre and the State.

b) Under National GST revenue would be have been imposed and administered by the Centre only and under Dual GST, revenue would be imposed and administered concurrently on supply of goods or services by both State and Centre.

c) The revenue which had to be distributed by Centre amongst the States post collection in National GST would now be distributed in a pre-decided ratio specified in the statute between the State and Centre right at the time of collection from the customer i.e. in present Context CGST and SGST.

d) Both Centre and the State would impose and administer their own share of taxes under separate statutes with provisions similar in both the Statute under Dual GST.

e) The difference between Dual GST and National GST can be summarized in a manner that under National GST there would have been one common tax across the country and imposition and administration of taxes by the Centre alongwith subsequent sharing and distribution of the revenue between the Centre and the States.

In Dual GST, it is proposed that the tax rate would be common across entire country but it would be divided, distributed, administered and collected on predefined terms by State and Centre under separate statues.

Thus, Dual GST is nothing but a balancing act to maintain sovereignty of the States and the Centre.

• Why Dual GST with Concurrent powers to Levy Tax on Goods and Services to State and Centre was not implemented firsthand and why preference was given to VAT with independent powers to State and Centre to levy tax upto certain part of supply chain

Bagchi report although narrated and envisaged full fledged Dual GST but it did not suggest implementation of full fledged Dual GST with Concurrent powers to levy tax on both goods and services by Centre and State in 1994. Instead, they proposed partial Dual VAT/GST with independent levy of taxes with full fledged credit mechanism under State VAT and Central Excise respectively without cross credit being allowed against each other.

The Report narrated the reason for not bringing dual GST with concurrent powers at that time as follows:

“However, effective administration of a concurrent system would call for a degree of coordination between the Centre and the States that is lacking at present and would be difficult to achieve even with the best of intentions.”

The report further went on to provide that

“Apart from the conflicts which it might generate, a concurrent VAT would be seen by the States as an invasion into their tax powers.”

The Final suggestion in the report was:

“Given this background, the only feasible option seems to be a dual system in which the VAT is levied by the two levels of government independently within the existing constitutional framework. This would be possible if the MODVAT now operating through the excise tax system is made into a full-fledged manufacturers’ VAT and the States also adopt a destination-based harmonized system of VAT in place of the chaotic sales taxes operating now.”

In the end it was provided in the report that

“Although it would not be the perfect or first best solution to the problems of the present system, reform on these lines would go a long way to remove many of its ill effects and perhaps lay the foundation for an even more rational regime in the future.”

Therefore in 1994, Dual GST with independent taxation powers to Centre and State upto a certain part of supply chain with full fledged Credit Mechanism under Excise and State VAT was implemented with an eye on the future for a full fledged Dual GST in the country.

• How Dual GST with concurrent powers to Centre and the State to levy taxes on Goods and Services has been sought to be implemented in India post VAT Implementation Era:

From the year 2007, India Lawmakers then strived hard for Nationwide Dual GST with concurrent powers to the State and the Centre to Levy Taxes on Goods and Services simultaneously as envisaged in the report in the year 1994.

The next question arises is what were the things which went in favour of the implementation of Dual GST.

The answer has been given in the “First Discussion Paper on Goods and Services Tax” in India published in the year 2009 by the Empowered Committee of State Finance Ministers as follows:

“Keeping in view the report of the Joint Working Group on Goods and Services Tax, the views received from the States and Government of India, a dual GST structure with defined functions and responsibilities of the Centre and the States is recommended. An appropriate mechanism that will be binding on both the Centre and the States would be worked out…..”

The matter was finally concluded in the Discussion paper as follows:

“India is a federal country where both the Centre and the States have been assigned the powers to levy and collect taxes through appropriate legislation. Both the levels of Government have distinct responsibilities to perform according to the division of powers prescribed in the Constitution for which they need to raise resources. A dual GST will, therefore, be in keeping with the Constitutional requirement of fiscal federalism”.

Thus, Dual GST with pre-divided share of revenue of Centre and State in tax rate and administered and collected on predefined terms specified in separate statues by Centre and State was preferred in India.

2. What is SGST and CGST:

An easy understanding of the National GST and Dual GST would lead us to understand SGST and CGST in a simple manner as follows:

Supposedly, Tax Rate in National GST is 10%. The Tax in National GST would be imposed and administered at the rate of 10% and after collection of the revenue by the Centre; the same would be distributed between the Centre and the States.

However, in Dual GST, the rate remains the same at 10% but the share of the State and Centre would be pre-divided as CGST and SGST supposedly, SGST at 6% and CGST at 4%. This would lead to clear division of the revenue of Centre and State and further both will separately impose, administer and collect their share of revenue under separate statues.

This is the reason why Dual GST in the form of CGST and SGST has been sought to be brought in country. The Common Tax Rate as decided would be split between CGST and SGST which would be nothing but pre-divided share of the revenue between the Centre and State administered separately and collected and deposited simultaneously under separate revenue head.

3. Why IGST on Inter State Supply of goods and services:

The goods or services consumed in the Country are either Imported from outside the Country or manufactured or provided within the Country. The goods manufactured or services provided with in the country are further divided between Intra State Trade and Inter State Trade.

Under the proposed Dual system of Taxation, it is suggested that CGST and SGST would be concurrently levied on Intra-State supply of goods and services. However there was still a gap on the transactions involving Import of Goods and Services from outside the Country and Inter State Supply of Goods and Services.

Thus with a view to bring the taxation of goods and services imported from outside the country or transactions involving Inter State Supply of Goods and Services at par with the taxation of Intra State Transaction of supply of goods and services, there was requirement of levy of tax equivalent to CGST and SGST. The said levy has been suggested in the name of IGST which is nothing but equivalent sum of CGST and SGST to levy tax on Inter State Supply of goods and services and Import of Goods and Services from outside the country.

Levy of IGST on Import or Inter State supply of goods and services and levy of CGST and SGST on Intra State supply of goods and services would ensure that all transactions whether being Import of Goods or Services in the country from Outside India, Inter State Supply of Goods and Services and Intra State Supply of Goods and Services would be levied with similar rate of tax i.e. either concurrently under CGST and SGST or under IGST (which is equivalent to CGST and SGST).

The Next issue was if IGST is levied on Inter State Supply of Goods and Services or Import of Goods and Services in the country, Input Credit should be allowed to the dealer of Importing State of the Taxes paid in IGST. The allowability of the Input Credit of taxes paid under Import or Inter-State Supply of Goods and Services was a mandatory condition for the full fledged Dual System of GST in India. Therefore, concept of collection and administration of IGST was proposed to be brought in place on following principles as follows:

a) Under the destination based concept the imports are generally liable to tax in the consuming territory equivalent to the taxes being levied on the goods and services produced in that territory. Therefore under proposed model of GST in India, all goods and services which would be imported from outside India would be liable to tax equivalent to CGST and SGST.

b) One of the salient features of destination based taxation is that the revenue of the goods or services consumed should accrue to the Importing State so that the importing state may allow the credit to the dealer of the taxes paid earlier. If the revenue of the taxes paid earlier is not transferred to the importing state, then in such case it would not be possible for the importing state to give credit of the taxes paid earlier.

c) Therefore, under the proposed Indian Model of GST particularly with respect to the Inter State Trade of goods and services, power to levy and collect tax has been given to the Centre under the nomenclature of IGST. IGST would be collected in the exporting state.

d) The Government intends that GST should be destination based and the revenue collected and levied by Central Government under IGST should be transferred to the Importing State, to the extent importing state gives credit to its dealer of the tax paid in the exporting State as IGST.

e) Therefore, there were two options one either the exporting state to transfer the credit directly to the importing state to the extent credit allowed by the Importing State to the dealer of the importing state of the taxes paid in the exporting state as IGST or second was someone to act as an agency for transferring the amount to the importing state so that the credit may be allowed by the importing state to the dealer of the importing state of the taxes paid in the exporting state as IGST.

f) The government has preferred the second option and then came out with IGST which is nothing but the tax which would have been levied and collected by the Importing State in ideal destination based taxation equivalent to CGST and SGST but would now be levied and collected by the Central Government. The mechanism of sharing of revenue between the states and the centre would be laid down by Parliament in a manner so that no state suffers loss of revenue. Through this mechanism the government has tried to ensure that the revenue accrues to the importing state and destination based taxation can be implemented in a modified manner.

Thus, this is how CGST, SGST and IGST were proposed to be brought in the entire scheme of Taxation in GST in India. Once we understand the basic principles of why and how CGST, SGST and IGST have been brought in the country, it would be fairly easy to understand the input credit mechanism amongst IGST, CGST and SGST.

4. Principle of Input Tax Credit availability between CGST, SGST and IGST inter-se

• Input Tax Credit of the taxes paid under CGST against SGST and vice versa: The basic requirement of implementing CGST and SGST under Dual GST through different statues in the country was to maintain the revenue share of the State and Centre and to maintain their sovereignty along with minimum dependence on each other for revenue. Thus, in situation where such complex are the relations and mechanism between the State and Centre and entire mechanism of National GST had to be modified to Dual GST on account of such complex relationship, then in such case the question of allowing credit of the taxes paid in CGST against SGST and vice versa would not arise at all.
  

If the Inter credit of SGST and CGST would have been made allowable, then Dual GST would have been nothing but National GST and it would have been better to bring National GST rather than Dual GST. Thus, Credit of the taxes paid in CGST against SGST and vice versa is not allowable on this basic principle.

• Inter Credit of IGST against both CGST and SGST: The principal reason for implementation of IGST was to allow seamless credit of the taxes paid in the exporting State to the dealer of the Importing State via Centre acting as a clearing mechanism. Thus when the intention of implementation of IGST has been to allow credit to the dealer in the importing State of the taxes paid in exporting State, then the principle follows that the credit of IGST should be available against both CGST and SGST without any restriction.
  

There should be no bar on adjusting Taxes paid in IGST against both SGST and CGST otherwise it would be resulting in cascading effect and entire concept of GST being lost. That is why IGST would be fully creditable against both CGST and SGST.

5. Principle for Subsumation of Taxes

The subsumation of Taxes has been a part of much debate since the thought of implementation of GST has come to the fore in India. Various studies have provided different taxes to be subsumed in GST. The clarity over the subsumation of the taxes is yet to emerge under the Law. Although, 122^nd Constitutional Amendment Bill had been passed in Loksabha and it provides the details of the taxes to be subsumed but the report of the Chief Economic Advisor has again thrown the cat amongst the pigeons. The determination of the subsumation of Taxes can directly be linked with the Revenue Neutral Rate under the GST. Wider the Tax base, Lower is the Revenue Neutral Rate. For the Tax base to be wider, it is required that more taxes be subsumed under GST.

At the outset, it would be appropriate here to refer to the principles which were narrated in the “First Discussion Paper on Goods and Services Tax” in India published in the year 2009 by the Empowered Committee of State Finance Ministers for subsumation of taxes.

“(i) Taxes or levies to be subsumed should be primarily in the nature of indirect taxes, either on the supply of goods or on the supply of services.

(ii) Taxes or levies to be subsumed should be part of the transaction chain which commences with import/ manufacture/ production of goods or provision of services at one end and the consumption of goods and services at the other.

(iii) The subsumation should result in free flow of tax credit in intra and inter-State levels.

(iv) The taxes, levies and fees that are not specifically related to supply of goods & services should not be subsumed under GST.

(v) Revenue fairness for both the Union and the States individually would need to be attempted.”

The Task Force Constituted for 13^th Finance Commission for Report on Goods and Services tax agreed to the above principles.

For understanding the principle of subsumation of taxes, it would be appropriate to mention the admitted facts which would be a great help in understanding why and how the taxes would be subsumed in GST:

a) GST would provide concurrent powers to both State and Centre to levy taxes simultaneously on the entire supply chain. Thus all the indirect taxes presently levied by the State and Centre anywhere in the supply chain of goods and services and in whatever form would be subsumed in GST.

b) GST would be levied on both supply of goods and services. Thus, all taxes levied by State and Centre on the supply of goods and services from import/ manufacture/ production of goods or provision of services at one end and the consumption of goods and services at the other would be merged in the new levy.

c) GST would subsume only the taxes levied by the Center and State in the supply chain on supply of goods and services thus all the taxes levied by Local Authorities and taxes levied by Centre and the State other than taxes on goods and services would not be subsumed in GST.

d) Both State and Centre would be forgoing their present revenues with the implementation of GST, therefore revenue fairness and balance amongst the states and centre for distribution of taxes would have to be maintained.

e) There should be no cascading effect of the taxes paid and subsumation of taxes should result in free flow of tax credit in Inter State and Intra State Trade as narrated above.

If one is able to understand the basic theory behind the above principles, it would be easy to understand that why particular taxes are proposed to be subsumed in GST. There are certain areas which require further consideration and are the point of debate.

6. 122^nd Constitutional Amendment Bill passed by Loksabha provides following taxes to be merged in Goods and Services Tax

• Central Indirect Taxes and Levies to be merged

a) Central Excise Duty,

b) Additional Excise Duties,

c) Excise Duty levied under the Medicinal and Toilet Preparations (Excise Duties) Act, 1955,

d) Service Tax,

e) Additional Customs Duty commonly known as Countervailing Duty,

f) Special Additional Duty of Customs, and

g) Central Surcharges and Cesses so far as they relate to the supply of goods and services.

• State Indirect Taxes and Levies to be merged

a) State Value Added Tax/Sales Tax,

b) Entertainment Tax (other than the tax levied by the local bodies),

c) Central Sales Tax (levied by the Centre and collected by the States),

d) Octroi and Entry tax,

e) Purchase Tax,

f) Luxury tax,

g) Taxes on lottery,

h) betting and gambling; and

i) State cesses and surcharges in so far as they relate to supply of goods and services.

If we refer to the above list of the taxes to be subsumed in the GST, all these taxes are directly relatable to the supply of goods and services and fall in the supply chain from the point of procurement of the raw material to the consumption of the goods and services by the end customer. Further, all these taxes are being presently levied either by the State and Centre.

The report of the Task Force on Goods and Services Tax popularly called as the 13^th Finance Commission also provided to merge the following taxes under GST as follows

Since all taxes on goods and services, levied by the Centre or the States, should be subsumed in the GST, the following other taxes levied by the States on goods and services should also be subsumed:

i. Stamp duty;

ii. Taxes on Vehicles;

iii. Taxes on Goods and Passengers; and

iv. Taxes and duties on electricity.

However, the suggestion seems to not have been accepted by the Lawmakers and the above taxes have been kept out of the subsuming of the taxes.

7. SIN Goods: To be or not to be in GST Purview:

It has been provided in the “Report on the Revenue Neutral Rate and Structure of Rates for the Goods and Services Tax (GST)” presented by the Committee formed for presenting report on the Revenue Neutral Rate in GST dated December 4, 2015 that

“At the same time, the exceptions—in the form of permissible additional excise taxes on sin goods (petroleum and tobacco for the Centre, petroleum and alcohol for the States)—will provide the requisite fiscal autonomy to the States. Indeed, even if they are brought within the scope of the GST, the states will retain autonomy in being able to levy top-up taxes on these “sin/demerit” goods.”

The reason for high and additional taxation of the said goods is because of the fact that goods like alcohol, tobacco etc. are treated as demerit goods or sin goods under Taxations laws in India. Thus, as a measure to generally discourage their use by the common public, high tax-rate is proposed on the supply of these goods.

It would be worth mentioning here alcoholic liquor for human consumption has been kept out of the levy of goods and services tax. The said goods would not be under the purview of GST and would be taxed by the State and the Centre separately.

Petroleum and Petroleum products would not be subjected to the levy of Goods and Services Tax till notified date on the recommendation of the Goods and Services Tax Council. Further, they would continue to be in Entry No. 84 of List I to the Seventh Schedule to the Constitution. This entry would be enabling the Centre to levy taxes under Excise duties on Petroleum and Petroleum products manufactured or produced in the Country. Further these products also find a place in Entry No. 54 of List II to Seventh Schedule which enables States to levy taxes on the Intra-State sale of Petroleum and Petroleum Products.

Further, Tobacco and Tobacco products although falling within the purview of GST but manufacture or production of Tobacco or Tobacco products would be subjected to an additional levy under excise duty under Entry No 84 of List I to Seventh Schedule to the Constitution by the Centre.

Note from the Author: This series of articles on Goods and Services Tax would be an effort to put forward a detailed view of the subject. The series would make an effort to analyze the intricacies and details about Goods and Services Tax. It would be an effort to narrate the issue to have an understanding on the subject.

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