Dr. Sanjiv Agarwal

Taxes out of Scope of GST

The state governments are finding it difficult to arrive at consensus on following taxes to be subsumed in GST-

–              purchase tax

–              octroi duty

–              tax on alcoholic beverages (country liquor / IMFL)

–              tax on petroleum products

–              tax on tobacco items

–              stamp duty

–              toll tax

–              passenger tax

–              road tax

–              mining cess / royalty

–              electricity cess etc.

Besides above, there is still no clarity on services- whether both, CGST and SGST would be levied on all services or that centre and states would distribute services amongst themselves or that centre alone will levy service tax on services and then appropriate it amongst  states.

Tax Cascading Effect

The greatest advantage of new GST regime is that it addresses fully the concern of tax cascading. Presently tax cascading is found in both- central and state taxes as the exempt sectors of economy (trade, oil etc) are not allowed to claim any cenvat credit of indirect taxes. It neither happens in excise duty nor in state value added tax. Also, on inter state sales, central sale tax (CST) is collected by the origin state for which no credit is allowed by any Government. It increases cost of production and makes business non-competitive. GST regime shall subsume most of the indirect taxes and will reduce the tax cascading effect to a great extent in entire supply chain. Only the final consumer will not be able to avail or utilize tax credit.

Composite Contracts

At times, it is seen that it is a common practice to have single composite contracts for various works, jobs, services etc such as in case of engineering projects, construction contracts, EPC projects, installation & erection, software and information technology etc. The issue that may arise in GST regime is whether such works contracts be treated as goods or services or as a special class of goods or services for the purpose of levy of GST as these comprise of both the elements of goods and services.

There is a need to simplify the convoluted tax treatment for such contracts and to simplify it, it may be desirable to treat such contracts as services. This would help in simple and reasonable valuation by keeping out such contracts from different classification or valuation if treated as goods. With different threshold limits and GST rates both at central and state level, it will be very difficult to tax and pay tax on such composite contracts. To have a hassle free taxation of such contracts, it could be thought of to treat such contracts as services only. Presently, such contracts are subject to both, VAT or Central Excise duty and Service tax which lead to litigation between the revenue and tax payers as to classification and valuation. One such contentious issue is that of software comprised in a compact disc wherein cost of media or the compact disc is labeled attracts central excise duty and its licence or right to use attracts service tax under intellectual property right service. Unfortunately, the first discussion paper is silent on this issue and it needs to be addressed appropriately. Government will have to specifically provide for such treatment clearly under the new GST regime.

Compensation to States

The discussion paper state that there would be a need for compensation to states by centre during initial phase of implementation of GST as some states would gain while some may loose revenue. Though effect would be made for arriving at revenue neutral rates, it may not be possible to achieve a near revenue neutral situation.

Despite the sincere attempts being made by the Empowered Committee on the determination of GST rate structure, revenue neutral rates, it is difficult to estimate accurately as to how much the States will gain from service taxes and how much they will lose on account of  removal of cascading effect, payment of input tax credit and phasing out of CST. In view of this, it would be essential to provide adequately for compensation for loss that might emerge during the process of implementation of GST for the next five years. This issue may be comprehensively taken care of in the recommendations of the Thirteenth Finance Commission. The payment of this compensation will need to be ensured in terms of special grants to be released to the States duly in every month on the basis of neutrally monitored mechanism.

According to Empowered Committee Chairman, based on the tax compliance in the initial year of GST, possibility of subsuming more taxes could be reviewed under what is called the phased approach to GST. Also, it might not be possible for the centre to compensate all the states for all the losses arising out of loss of revenue, if any. The key to more taxes being included, could therefore, lie in level of GST compliance.

The centre and states are also required to decide on exemptions. Presently more than 300 goods are exempted in Union list and about 100 are exempted under state VAT out of which about 60 are common items in both lists. The exempted goods and services and yet to be finalized.

Supply Chain Impact

The dual GST structure will adversely affect the cost of supply chain, more particularly in manufacturing sector –both for inputs and output. The supply chains could be in relation to procurement of raw material and other inputs and in relation to distribution network for finished goods. The problem areas could be in the form of physical delivery, entry barriers, inter-state movement of goods, imposition of local levies (octroi , entry tax etc), longer transportation time etc. In the proposed GST regime, while we move from origin based tax to consumption based destination tax, entire taxation base would shift to a base where consumption of goods or services takes place. Supply chain would also get affected as even inter-state  transfer or depot stock transfer would be subject to GST without there being actual sale of goods. The discussion paper talks of providing for taxing any branch or consignment transfer. It is feared that longer supply chains would mean more tax compliance and cost attached to it. Companies will, therefore have to revisit and realign their manufacturing facilities, procurement and distribution channels, business processes, sale etc to strike a balance between economic and tax implications. Businesses will have to and should undertaken a complete review and assessment of compliances under GST regime. Now that GST is likely to be deferred beyond  April 2010 dead line , companies  should evaluate the cost benefit in GST regime, based on existing systems and procedures.

IT Infrastructure

After acceptance of IGST Model for Inter-State transactions, the major responsibilities of IT infrastructural requirement will be shared by the Central Government through the use of its own IT infrastructure facility. The issues of tying up the State Infrastructure facilities with the Central facilities as well as further improvement of the States’ own IT infrastructure, including TINXSYS, is to be addressed expeditiously and in a time bound manner.

The major task before the Empowered Committee and the government will be to build up information technology (IT) platform or infrastructure . In my view, the tax information network (TIN) system , built by NSDL for income tax is the right foundation for implementing the GST. It (TIN) already reaches to over a million  entities and this can be easily done. Also, as a preparatory to the exercise, individual states should be merged into  TIN, one by one, at an administrative level while keeping the state VAT distinct from the GST. Once all major states are administratively working on this network, a stage would be set to throw a switch on the appointed date. A strong and robust IT infrastructure is needed as an essential pre requisite  to  address the concerns of inter-state transactions for cross verification and minimal dependency on issuance or production of declaration/ forms.

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