CA Dr Arpit Haldia
Understanding Goods and Services Tax #4: All about Fundamentals of Revenue Neutral Rate
If anything has been associated from the starting with Implementation of Goods and Services Tax in India, it has been Revenue Neutral Rate in GST and its Impact. Till today also, if we have to name the biggest hurdle in the implementation of GST in India, it’s the consensus over the Revenue Neutral Rate. So what exactly is Revenue Neutral Rate and what are the basic fundamentals in arriving at the Revenue Neutral Rate. This article would try to analyze in detail some of the basic principles which form the foundation in working out the Revenue Neutral Rate (hereinafter referred as “RNR”).
The Importance of Revenue Neutrality has been emphasized categorically in the Report by Dr Amaresh Bagchi commonly referred to as Bagchi Report on “Reform of Domestic Trade Taxes in India: Issues and Options”, National Institute of Public Finance and Policy, New Delhi as follows:
“Proposals for tax reform, even when designed on rational principles, are often put aside because of apprehensions of negative implications for revenue. Revenue neutrality thus forms a critical parameter to be kept in view while formulating any scheme of tax reform.”
Thus any tax reform even though based upon rationale principle, first seeks to achieve Revenue Neutrality. Revenue Neutrality broadly can be described as measure to ensure that the proposed revenue reform should not result in negative impact on the existing revenue structure. It seeks to achieve balance and equality between the revenue under the present tax structure proposed to be subsumed under the new law and proposed revenue under the new tax reforms.
- What is Revenue Neutral Rate:
The Report of the Task Force on “Goods and Services Tax Thirteenth Finance Commission” described Revenue Neutral Rate as follows:
“ Since the GST is primarily intended as an exercise in reforming the consumption tax in India and not an exercise for additional resource mobilisation through discretionary changes, the CGST and SGST rates should be such rates which would yield the same revenue as collected from the various taxes which will be subsumed in the CGST and SGST , that is, it should be a ‘revenue neutral rates’ or ‘RNR’)”.
The primary objective for implementation of GST is not mobilization of additional resources but reforming of the prevalent tax structure in India. Revenue Neutral Rate, the name itself suggests the basic meaning of the term and it does not require any rocket science to arrive and define the term.
Revenue Neutral Rate in GST may simply be defined as the tax rate which seeks to achieve and garner similar revenue under the newly implemented tax structure as collected from taxes which are sought to be subsumed and were in force prior to the implementation of the new tax structure. Thus, the basic objective of the Revenue Neutral Rate can described to prevent the newly implemented tax structure having negative revenue implications.
It may also be called an exercise by the States to ensure that their revenue position under the newly implemented law is not worse off than the previously implemented law which the new law seeks to subsume.
Whichever way we see, we can conclude that Revenue Neutral Rate is rate which balances the revenue between the two taxation structures i.e. proposed taxation structure and prevalent tax structure.
- Methodology for arriving at Revenue Neutral Rate
The Method for arriving at the Revenue Neutral Rate has been provide in the Report of the Task Force on “Goods and Services Tax Thirteenth Finance Commission” as follows:
5.19 The RNR for the CGST and the SGST is determined in accordance with the formula-
RNR = R × 100 ÷ B
Where, RNR : Revenue Neutral Rate for the Centre or the States as the case may be;
R : Collection from the Central or State taxes, as the case may be, which are proposed to be subsumed in the CGST and SGST;
B : Estimated Tax base of the GST
The Two key figures in arriving at the Revenue Neutral Rate is the Existing Revenue being collected from the taxes being subsumed and the Estimated Tax Base from which the Revenue is sought to be collected under the proposed tax regime.
The most crucial aspect in the given scenario would be how to calculate the tax base. The Tax Base can be calculated by following methods:
a) GDP adjusted for Exports and Imports
b) Consumption Expenditure from Goods and Services
c) Tax Turnover Method:
As discussed in one of my previous article on Understanding Goods and Service Tax #2: Concept of Origin and Destination Based Taxation, GST is a destination and Consumption Based Taxation. Therefore, all the taxes form part of the cost for the end customer or for the dealer who as per law is not entitled to claim credit of the tax paid under the law e.g. dealing in exempted supplies or covered under composition scheme. The tax paid by the intermediaries dealing in taxable goods and eligible to take credit is allowed as tax credit against subsequent liability and therefore tax paid by the intermediaries is tax neutral as it does not become part of the cost of the supplies until it reaches the end customer.
The tax which adds itself to the cost of the supply is the final revenue for the exchequer and till it is eligible for further credit, it is not added to the cost of the supply. The Tax is added to the cost of the supply only when it reaches to the final consumer or to a person who is ineligible to take credit of the taxes paid earlier.
Thus in a nut shell, tax base is sum addition of all such situations where tax is finally added to the cost of the supply without any further credit being available of such taxes paid against the subsequent output liability.
a) GDP adjusted for Exports and Imports:
i. GDP of the Country as the starting Point: As a starting point we can take the GDP of the Country. From the above figure, we have to arrive at the value of goods and services consumed in the country on which GST would be leviable as described below.
ii. Addition of Imports and Deduction of Exports to GDP: We would have to add value of Goods and Services Imported during the period to the above base as Tax is leviable on the Imports under the Destination based taxation. Thereafter deduction would have to be provided for goods and services exported out of country as no tax is leviable on exports under the destination based taxation.
iii. Arriving at the Gross base for Goods and Services in India: This figure as arrived above is the total figure for the private consumption, government consumption and the capital formation and the changes in the business stocks. Out of the above figure, we would have to broadly deduct following figures i.e. Government wages, fixed capital formation etc. Once the deduction for the above factors has been made, we are left with the combined base for the Goods and Service in the country on which tax can be levied.
iv. Arriving at the Taxable Base for Levy of Tax on Goods and Services: For arriving at the base at which the tax would be levied, we would have to add intermediary goods or services and capital goods used for exempted supplies including capital goods used in government and agriculture sector for which no credit is allowed. The simple reason for adding these figures is that as the tax paid on the purchase of such goods or services is non creditable, therefore they become the end consumption for such goods and services.
Further, the goods or services exempted from levy of tax and the dealers excluded from the levy of tax due to their turnover below threshold limit would also have to be deducted from the above base as they are not liable under the tax regime.
This would lead us to the estimated tax base under GST for the purpose of Levy of Tax.
b) Consumption Expenditure from Goods and Services: This method provides that the tax base for GST can be arrived at by aggregating the value of goods and services consumed in the country. The method provides that the Private Final Expenditure and Investment and Government Expenditure under the following heads may be aggregated to arrive at the tax base for GST:
i. Private Final Consumer Expenditure(PFCE): This represents all expenditure towards the goods and services by the private households and non-profit organizations. The final consumer expenditure towards private consumption has to be determined under this method.
ii. Government Final Consumption Expenditure (GFCE): This represents the expenditure incurred by the government towards purchase of Goods and Services. This would exclude Salary paid to administrative staff on which no GST would be applicable. Thus salary paid to public administration would not be added to the Government Final Consumption Expenditure.
iii. Gross Fixed Capital Formation: This represents the Investments by Private Household, Businesses and the Government. This includes Investment by Private Households for Construction of Houses, Public Investment by the Government in School, Hospital, Roads etc and Investment of Industries towards Machinery, Equipment and Factory Building. It is expected that Input Credit of the Tax paid on the Capital Goods and Equipment for the purpose of taxable supplies would be available as Input Credit in GST and would be treated as intermediate inputs.
Therefore under this head only Final Expenditure by Private for Personal Housing and expenditure by Industries towards such Machinery, Equipment and Factory Building and Public Investment by the Government towards school, hospital, roads etc. for which no credit is available would be added for arriving at Tax Base.
iv. Arriving at the Taxable Base for GST: Once the three figures are aggregated we arrive at the Gross Value of Goods and Services consumed in the Country. If the Share of the Exempted Goods and Services and the unorganized sector i.e. dealers having turnover upto threshold limit not liable to pay taxes under the new tax regime are deducted from the above figure, we would arrive at the taxable base for GST for the purpose of levy of GST.
c) Tax Turnover Method: This method has been explained in the report on “Revenue Implications of GST and Estimation Of Revenue Neutral Rate: A State Wise Analysis of National Institute of Public Finance and Policy” published in January 2013
“It is possible to estimate GST revenues through “tax turnover” method. Advantage of tax turnover method is that it is based on the data of taxable turnover of goods available with the respective sales tax department of states on goods. As under GST, like in VAT, tax paid on input by a VAT registered dealer would have to be rebated, one has to estimate the inputs eligible for input tax rebate from the tax turnover data. It is also to be noted that inputs eligible for credit will be the taxable inputs alone. Thus, one has to determine not only the input component from the taxable turnover, but also the structure of input used, viz., taxable input and non-taxable/exempted inputs. Another issue that requires attention is the quantification of locally produced inputs and the use of imported inputs within the taxable inputs as they are treated differently in current VAT regime.”
This method requires to calculate the tax base on the basis of the revenue base of various taxes to be subsumed in the new taxes and then adjusting the said tax base of the erstwhile taxes for the factors to be treated differently under GST and arriving at the net base of taxes on which taxes would be levied under GST.
Some of the examples for the adjustments to be made to the current tax base of the prevailing taxes to arrive at the tax base for the proposed tax structure are as follows:
i. Exempted supply being brought into the tax net and any taxable supply being taken out of the tax net,
ii. Eligibility of Input supplies for the purpose of Input Credit against the Output Liability,
iii. Tax paid on inputs for the purpose of Exempted Supplies,
iv. Taxability of Imports to the Territory and Exports out of the Territory to be treated differently in the proposed tax regime as compared to the previous regime of taxation.
Further it would again be appropriate to refer to the following principles which form the cardinal principles of taxation:
a) Destination Based Taxation: The Principle provides that the tax should be levied on consumption and revenue should accrue to the territory where the goods are finally consumed.
b) Principal of Neutrality of Taxation: The Principle provides that the tax should become part of cost for taxable supplies only when it finally reaches to the end customer and till then it should be allowed as a complete pass through and should not become the part of the cost.
Therefore while considering the base available for taxation we can simply say that whenever the goods or services are finally consumed or stage subsequent to which no further credit is allowed of the taxes paid at previous stage and the taxes are added to the cost, it would be the tax base on which tax would finally be levied.
- Examples for Arriving at the Tax Base and Revenue Neutral Rate
I would start off with citing simple examples and then moving to some of the more complex examples.
Take an example that following are the Revenue Base of Various Taxes
(Figures in Crores)
| Particulars | Value | Tax Rate | Tax Revenue |
| Sales Tax | |||
| Taxable Goods | 20000 | 10% | 2000 |
| Exempted Goods | 15000 | – | – |
| Aggregate Base for Tax and Total Revenue | 35000 | 2000 | |
| Service Tax | |||
| Taxable Services | 15000 | 20% | 3000 |
| Exempted Services | 5000 | – | – |
| Aggregate Base for Tax and Total Revenue | 20000 | 3000 | |
| Excise Duty | |||
| Taxable Goods | 10000 | 20% | 2000 |
| Exempted Goods | 5000 | – | – |
| Aggregate Base for Tax and Total Revenue | 15000 | 2000 | |
| Aggregate Base for All Taxes and Revenue | |||
| 70000 | 7000 | ||
Below are the various scenarios to reflect how the Revenue Neutral Rate is affected due to the change in Tax Base, inclusion or exclusion of various taxes in the supply chain and inclusion or exclusion of the exemptions.
Scenario I: Sales Tax and Excise Duty are merged into single enactment:
Levy of Sales Tax is an extension of Excise levied at manufacturing stage in the supply chain. Therefore, if both Sales Tax and Excise Duty are merged, then in such case entire taxes levied at any stage i.e. manufacturing or sales from manufacturer to wholesaler and wholesaler to retailer and so on would be allowed as a credit in the supply chain till the last point when the goods are finally sold to the end customer.
i. Assumptions:
a) Exempted goods under excise duty are also exempted for the purpose of levy of sales tax and there are no cross utilization of taxable goods being used in manufacturing of exempted goods.
b) Excise Duty of Rs 2000 Crore being paid on the goods manufactured is not allowed as credit against sales tax. However, since the two taxes are now being merged, therefore any taxes levied by the manufacturer would be allowed as a credit to the Retailer and no part of the taxes would now be required to be recovered as a hidden cost from the customer.
Thus in such case Revenue base for Sales Tax and Excise would be Rs 18000 Crore i.e. (Selling Price to the end customer for final consumption).
ii. Calculation of Revenue Base
| S. No. | Particulars | Amount |
| 1. | Taxable Revenue Base under Sales Tax | 20000 |
| 2. | Revenue Base under Excise not considered as all Taxable manufactured goods are sold as Taxable Goods and any taxes levied at the Manufacturing stage would be allowed as credit at the retail stage. Exempted Goods under Excise are also exempted from levy of Sales Tax (Para a) | – |
| 3 | Excise Duty levied on goods manufactured which was not creditable under previous tax regime against sales tax and was recovered as hidden part of selling price would not form part of selling price and taxes levied at manufacturing stage would be allowed as credit at the retail stage. (Para b) | (2000) |
| Net Revenue Base | 18000 | |
c) Calculation of Revenue Neutral Rate
| S. No. | Particulars | Revenue |
| 1. | Aggregate Revenue from Excise | 2000 |
| 2. | Aggregate Revenue from Sales Tax | 2000 |
| Aggregate Revenue | 4000 | |
| Tax Base as arrived above | 18000 | |
| Incidence of Taxes | 22.22% | |
Conclusion: It can be observed from the above that when the two taxes are merged and one common tax is applied on the entire supply chain of goods, RNR comes to 22.22%. It would be pertinent here to see that previously effective taxation factor was 20% Excise and 10% of Sales being levied on different base and creating a cascading effect.
However, the RNR in the proposed scenario has seen a rise as compared to the previous scenario as there has been a shrinking of the taxable revenue base on account of allowing of the Input Tax credit of the taxes levied at Manufacturing stage against the taxes levied at retail stage. Thus these taxes which were forming part as hidden cost of Sales under the previous regime would not be added as part of selling price for the purpose of levy of taxes. Secondly Exempted supplies have not been brought in the taxable net.
The benefit of one common tax cannot be seen unless the revenue base is widened i.e. exempted supplies brought into tax net or lowering of the threshold limit etc, keeping a large base under exempted supplies or outside the purview of the new tax regime would only enhance the Revenue Neutral Rate. The same can be understood under the next scenario as provided below:
Scenario II: Sales Tax and Excise Duty are merged into single enactment and all the exemptions under both the enactment removed and brought into taxable net:
If the entire exempted sector both under Sales Tax and Excise are made taxable and are brought into taxable net then in such case erstwhile revenue base of Rs 18000.00 Crore cited in Scenario I would increase by Rs 15000.00 Crore i.e. sales price of tax exempted goods to the end customer to Rs 33000.00 Crore. This is also the selling price of the goods to the end customer and as exempted supplies in Excise merge into the revenue base of Sales Tax therefore they would not be added separately for the purpose of Revenue Base.
i. Assumptions:
a) Excise Duty of Rs 2000 Crore being paid on the goods manufactured is not allowed as credit against sales tax. However, since the two taxes are now being merged, therefore any taxes levied by the manufacturer would be allowed as a credit to the Retailer and no part of the taxes would now be required to be recovered as a hidden cost from the customer.
b) Calculation of Revenue Base
| S. No. | Particulars | Amount |
| 1. | Taxable Revenue Base under Sales Tax | 20000 |
| 2. | Revenue Base under Excise not considered as all Taxable manufactured goods are sold as Taxable Goods and any taxes levied at the Manufacturing stage would be allowed as credit at the retail stage. | – |
| 3 | Excise Duty levied on goods manufactured which was not creditable under previous tax regime against sales tax and was recovered as hidden part of selling price would not form part of selling price and taxes levied at manufacturing stage would be allowed as credit at the retail stage. | (2000) |
| 4. | Sales Price of Exempted Goods being sold to End Customers for end consumption | 15000 |
| Net Revenue Base | 33000 | |
b) Calculation of Revenue Neutral Rate
Revenue Neutral Rate in such case would see steep downward correction which would be worked out as follows:
| S. No. | Particulars | Revenue |
| 1. | Aggregate Revenue from Excise | 2000 |
| 2. | Aggregate Revenue from Sales Tax | 2000 |
| Aggregate Revenue from the Excise and Sales Tax | 4000 | |
| Tax Base i.e. Selling price of goods to the end customer for final consumption | 33000 | |
| Incidence of Taxes | 12.12% | |
Conclusion: The Main mantra of merging of taxes and lowering of the tax rate is to widen the tax base, remove the exemptions and improve compliance. This is the same concept which has been contemplated for the purpose of applicability of GST i.e. to merge the supply chain under one tax right from the inception to the delivering to the end customer and to reduce the exemptions to bare minimum.
Thus, the RNR which was 22.22% in previous scenario came down to 12.12% by removing exemptions and the combined tax rate and incidence which was as high as 20% in excise and 10% in sales tax separately comes down to 12.12%.
However, in the given scenario Service Sector is yet to be merged and the same has been contemplated in Scenario-3.
Scenario III: If Service Tax, Sales Tax and Excise Duty are merged into one single enactment and all the exemptions under the enactments are removed and brought into taxable net:
i. Assumptions:
a) Entire exempted services of Rs 5000 Crore are being rendered to consumer for final consumption and is not being rendered to any intermediary in the supply chain.
b) Out of the total taxable Services of Rs 15000.00 Crore, Services of Rs 10000.00 Crore would be rendered to the end consumers and no credit of the taxes paid would be taken for the same and rest of Rs 5000.00 Crore would be rendered to the an intermediary in the supply chain who would be availing credit of the taxes paid.
c) Out of the Total Taxable sales price of Rs 20000 Crore, Rs 1000 Crore is towards the recovery of Service Tax paid on input services used in manufacturing or selling of goods for which no credit has been allowed. There is a hidden recovery of Rs 1000 Crore as part of selling price whereas under GST all input taxes would be allowed as credit against the output liability.
d) Out of the Total Value of Taxable services received of Rs 15000 Crore, Rs 1000 Crore is towards the recovery of Sales Tax paid on goods used in rendering of services for which no credit has been allowed. There is a hidden recovery of Rs 1000 Crore as part of selling price whereas under GST all input taxes would be allowed as credit against the output liability.
e) Excise Duty of Rs 2000 Crore being paid on the goods manufactured is not allowed as credit against sales tax. However, since the two taxes are now being merged, therefore any taxes levied by the manufacturer would be allowed as a credit to the Retailer and no part of the taxes would now be required to be recovered as a hidden cost from the customer.
It would be appropriate here to mention again that wherever the goods or services are supplied in a supply chain to an intermediary availing tax credit, such intermediate taxes would never be added to the tax base and revenue would be earned by the exchequer in the taxable supply chain only when the goods are sold to the final consumer.
That would mean that revenue base would only increase by Rs 15000.00 Crore out of the total service tax base of Rs 20000 Crore i.e. services rendered to the end customer.
ii. Calculation of Revenue Base
| S. No. | Particulars | Amount |
| 1. | Taxable Revenue Base under Sales Tax | 20000 |
| 2. | Revenue Base under Excise not considered as all Taxable manufactured goods are sold as Taxable Goods and any taxes levied at the Manufacturing stage would be allowed as credit at the retail stage. | – |
| 3 | Excise Duty levied on goods manufactured which was not creditable under previous tax regime against sales tax and was recovered as hidden part of selling price would not form part of selling price and taxes levied at manufacturing stage would be allowed as credit at the retail stage. (Para e) | (2000) |
| 4. | Service Tax Levied on Service used as Input Services in Goods on which credit was not recoverable under previous tax regime and was recovered as hidden part of selling price. It would not form part of selling price as all taxes levied in supply chain would be allowed as credit in GST. (Para c) | (1000) |
| 5. | Sales Price of Exempted Goods being sold to End Customers | 15000 |
| 6. | Revenue Base under Service Tax of Rs 20000.00 out of which 15000.00 being rendered to end customers for final consumption would be part of Final Tax Base and Rs 5000 being rendered as intermediary in the supply chain would not be considered as part of Tax Base as it would not be towards private final consumption expenditure and taxes levied would be allowed as Credit against the Final Output Liability thus not bringing any additional revenue to the Government. (Para a and b) | 15000 |
| 7. | Sales Tax Levied on Goods used as Input for rendering services on which credit was not recoverable under previous tax regime and was recovered as hidden part of selling price. It would not form part of selling price as all taxes levied in supply chain would be allowed as credit in GST. (Para d) | (1000) |
| Net Revenue Base | 46000 | |
iii) Calculation of Revenue Neutral Rate
RNR in such case would be worked out as follows:
| S. No. | Particulars | Revenue |
| 1. | Aggregate Revenue from Excise | 2000 |
| 2. | Aggregate Revenue from Sales Tax | 2000 |
| 3. | Aggregate Revenue from Service Tax | 3000 |
| Aggregate Revenue from Excise, Sales Tax and Service Tax | 7000 | |
| Tax Base i.e. Selling price of Goods and Services to the end customer for final consumption | 46000 | |
| Incidence of Taxes | 15.21% | |
Conclusion: It can be observed that when all the three taxes are merged and one common tax is applied on the entire supply chain of goods and services, RNR comes to 15.2%.
It would be pertinent here to see that previously effective taxation factor was 20% Excise, 10% Sales Tax and 20% Service Tax being levied on different base and creating a cascading effect which would now be reduced to 15.2%.
The Increase of Revenue Neutral Tax Rate as compared to Scenario-2 has been on account of merging of the Service Tax which was previously taxable at a higher rate of 20%.
However in the given case, entire sector has been brought under the taxable net, which is not the case in practical scenario as there are always certain exempted sectors in the tax structure which deal in both taxable and exempted supplies as Inputs. The same has been discussed in Scenario-4.
Scenario IV: If Service Tax, Sales Tax and Excise Duty are merged into one single enactment and exemptions under the enactments are partially removed and brought into taxable net:
i. Assumptions:
a) Exempted goods under excise duty are also sold as exempted goods in the sales tax therefore selling price of the goods sold to customer for final consumption would be equivalent to the tax base of Exempted Goods under Sales Tax i.e. Rs 15000 Crore.
b) Entire exempted services of Rs 5000 Crore are being rendered to consumer for final consumption and is not being rendered to any intermediary in the supply chain.
Therefore the tax base for the exempted goods and services would be Rs 20000 Crore (Rs 15000 Crore of exempted goods and Rs 5000 Crore of exempted services) being rendered to the customer for final consumption.
c) Considering 50% of the tax base under the exempted goods and services is exempted i.e. Rs 10000 Crore and balance Rs 10000 Crore is brought under the taxable net.
d) Out of the 10000 Crore exempted from levy of taxes, it has been assumed that taxable goods and services of Rs 7500 Crore would be used as Input. No input Credit would be available on the taxable goods and services used as input for Exempted Supply. This 7500.00 Crore would also be added to the tax base as tax would be added to the cost of the supply and no further Input Credit would be available of the taxes paid earlier.
e) Out of the Total Taxable sales price of Rs 20000 Crore, Rs 1000 Crore is towards the recovery of Service Tax paid on input services used in manufacturing or selling of goods for which no credit has been allowed. There is a hidden recovery of Rs 1000 Crore as part of selling price whereas under GST all input taxes would be allowed as credit against the output liability.
f) Out of the Total Value of Taxable services received of Rs 15000 Crore, Rs 1000 Crore is towards the recovery of Sales Tax paid on goods used in rendering of services for which no credit has been allowed. There is a hidden recovery of Rs 1000 Crore as part of selling price whereas under GST all input taxes would be allowed as credit against the output liability.
g) Excise Duty of Rs 2000 Crore being paid on the goods sold is not allowed as credit against sales tax. However, since the two taxes are now being merged, therefore any taxes levied by the manufacturer would be allowed as a credit to the Retailer and no part of the taxes would now be required to be recovered as a hidden cost from the customer.
h) Out of the Total Taxable Services of Rs 15000 Crore, Services of Rs 10000.00 Crore would be rendered to the end consumers and no credit would be taken for the same and Rest of Rs 5000.00 Crore would be rendered to the an intermediary in the supply chain who would be availing credit of the taxes paid.
It would be appropriate here to mention again that wherever the goods or services are supplied in a supply chain to an intermediary availing tax credit, such intermediate taxes would never be added to the tax base and revenue would be earned by the exchequer in the taxable supply chain only when the goods are sold to the final consumer.
This would mean that revenue base in point (i) would increase in case of taxable services by Rs 10000.00 Crore i.e. services rendered to the end customer as any taxes levied on the service rendered to an intermediary during the supply chain would be allowed as a credit and would be a complete pass through and would not be added to the cost of the goods or services.
However, when the goods are supplied to an intermediary who is exempted from levy of tax although he would not be collecting any taxes from the customer on supplies made by him but any supplies made to him by any taxable person would be revenue earned for the exchequer as he would be the end point for the purpose of claiming of Input Tax Credit up until the entire supple chain upto him. All taxes charged and collected from the exempted dealer would be revenue to the exchequer as he would not be availing any credit of the same and supplies mde by him would be exempted from tax.
ii) Calculation of Revenue Base
Thus Revenue Base in such case would be as follows:
| S. No. | Particulars | Amount (Crore) |
| 1. | Taxable Revenue Base of Sales Tax :Supply of Taxable Goods to End Customer | 20000 |
| 2. | Excise Duty levied on goods manufactured which was not creditable under previous tax regime against sales tax and was recovered as hidden part of selling price would not form part of selling price and taxes levied at manufacturing stage would be allowed as credit at the retail stage. (para h) | (2000) |
| 3. | Service Tax Levied on Service used as Input Services in Goods on which credit was not recoverable under previous tax regime and was recovered as hidden part of selling price. It would not form part of selling price as all taxes levied in supply chain would be allowed as credit in GST. (Para f) | (1000) |
| 4. | Erstwhile Exempted Goods now brought under Tax Net @ 50% of Rs 15000 Crore (Para c) | 7500 |
| 5. | Supply of Taxable Services to the End Customer (Para i) | 10000 |
| 6. | Erstwhile Exempted Services now brought under Tax Net @ 50% of Rs 5000.00 Crore (Para c) | 2500 |
| 7. | Taxable Input of Goods and Service Used in rendering of Exempted Supply of goods and Services (Para d) | 7500 |
| 8. | Sales Tax Levied on Goods used as Input for rendering services on which credit was not recoverable under previous tax regime and was recovered as hidden part of selling price. It would not form part of selling price as all taxes levied in supply chain would be allowed as credit in GST. (para g) | (1000) |
| Aggregate Revenue Base | 43500 | |
When we compare the two tax base as provided in Scenario -3 and Scenarion-4, we can conclude that any value addition made by the exempted sector has been taken out of the tax net and value addition upto the point where it uses taxable inputs is only added to the tax base. The Exempted Supplies under above examples was Rs 10000 and Rs 7500 worth of taxable inputs was used by the exempted sector.
| Reconciliation of Tax Base in Scenario-3 and Scenario-4 | |
| Tax Base in Scenario-3 (entire supplies were taxable with no exemption) | 46000 |
| Less: Value of Exempted Sector in Scenario-4 | 10000 |
| Balance Taxable Sector | 36000 |
| Value Addition of the Taxable Sector towards the Exempted Sector against which no credit would be allowed to the Exempted Sector | 7500 |
| Tax Base in Scenario-4 | 43500 |
iii) Calculation of Revenue Neutral Rate
Revenue Neutral Rate in such case would be as follows:
| S. No. | Particulars | Revenue (In Crore) | |
| 1. | Aggregate Revenue from Excise | 2000 | |
| 2. | Aggregate Revenue from Sales Tax | 2000 | |
| 3. | Aggregate Revenue from Service Tax | 3000 | |
| Aggregate Revenue | 7000 | ||
| Tax Base i.e. Selling price of Goods and Services to the end customer and Cost of Taxable Input of intermediary who further supplies exempted goods and Services | 43500 | ||
| Incidence of Taxes | 16.09% | ||
Conclusion: It can be compared from the scenario-3 that the effective tax rate has risen from 15.2% to 16.1%.
This is the effect of exemptions being provided in the Taxation Structure that tax burden from one kitty is shifted to another kitty and although the tax revenue remains the same but the effective tax rate for the consumer increases manifold.
In the above backdrop, now it would be much easier to understand how Revenue Neutral Rate would be calculated under GST Regime as follows:
- Methodology Provided in Reports of Department of Economic Affairs for arriving at Revenue Neutral Rate in GST in India
It would be appropriate here to refer the calculation of Revenue Neutral Rate in “Working Paper GST Reforms and Intergovernmental Considerations in India” for the Department of Economic Affairs Ministry of Finance, Government of India released in the month of March 2009 wherein it was stated that
The following excerpt given in the report of Department of Economic Affairs is the part of famous study of Bagchi and Poddar (2007), the very first study in India on the Revenue Neutral Rate in GST. This would give an further insight to us of how to calculate Revenue Neutral Rate.
“Here are some basic ingredients of the RNR calculations for 2005-06, the latest year for which the necessary data are available. The total excise/service tax/VAT/sales tax revenues of the Centre and the States in that year was Rs.134 thousand crore and Rs.139 thousand crore respectively. Assuming that approximately 40% of the central excise revenues and 20% of the state VAT/sales tax revenues are from motor fuels, the balance of the revenues from other goods and services that need to be replaced by the GST are Rs 89 thousand crore for the Centre and Rs 111 thousand crore for the states, making up a total of Rs 200 thousand crore.
In 2005-06, the total private consumer expenditure on all goods and services was Rs.2,072 thousand crore at current market prices. Making adjustments for sales and excise taxes included in these values and for the private consumption expenditure on motor fuels, the total tax base (at pre-tax prices) for all other goods and services is Rs 1763 thousand crore.
These values yield a revenue neutral GST rate of approx. 11% (200 as percent of 1763 is 11.3%). The RNR for the Centre is 5% and for the states 6.3%. Allowing for some leakages, the combined RNR could be in the range of 12%. The Centre excise duty rates have been reduced substantially (the standard rate reduced from 16% to 10%) since 2005.”
If we refer to the formula given above for calculation of Revenue Neutral Rate then 200 Thousand Crore would be the “R” i.e. collection of the Central or State Taxes which are proposed to be subsumed in the CGST and SGST.
The Total Private Consumer Expenditure after making adjustments for the goods outside the purview of GST and making the expenditure pre-tax, we arrive the variable “B” i.e. Estimated Tax Base of GST of Rs 1763 thousand Crore.
Thus the Revenue Neutral Rate would be approximately 11% and within a band of 10-12%.
- How Exemption to a particular sector affects the Revenue Neutral Rate in GST:
It would be appropriate here to refer the calculation of Revenue Neutral Rate in “Working Paper GST Reforms and Intergovernmental Considerations in India” for the Department of Economic Affairs Ministry of Finance, Government of India released in the month of March 2009
The following is an example given in the report of the Department of Economic Affairs that how exemption provided to food could seriously affect the Revenue Neutral Rate in GST. How lower RNR in GST would be hard to achieve if a complete exemption or a partial exemption is provided to the food sector in GST. The particular scenario of Food Industry has been provided that if no exemption has been provided to Food Industry, RNR in GST would be 10-12% and if complete exemption/partial exemption is provided to food Industry, result of the same would be as follows:
Facts about the private final consumer expenditure towards Food Sector :
In 2005, data, food accounted for one-third of total private final consumer expenditures. For those at the bottom of the income scale, it doubtless accounts for an even higher proportion of total expenditures and incomes. Taxing food could thus have a major impact on the poor. By the same token, a complete exemption for food would significantly shrink the tax base.
Scenario 1-Complete Exemption to food sector from levy of tax:-
a) RNR to Jump to 18%:
The alternative of exempting food altogether (or zero rating) would not be any better. First, the revenue neutral rate would jump from 10-12% to 18%.
b) Effects of Such Exemption and Higher RNR of 18%-
“While the poor would pay less tax on food, they would pay more on other items in their consumption basket.
The higher standard rate would, in turn, lead to pressures for exempting other items (e.g., medicines, books, LPG, and kerosene ).
Third, it could preclude unification of the tax rate on goods with that on services, which are currently taxable 12.36%. Imposition of tax rate at 18% on hitherto exempt services (e.g., passenger travel, health, and education) would encounter significant political resistance.
Fourth, one cannot expect any improvement in taxpayer compliance at such high rates. To the contrary, greater visibility of the Centre tax at the retail level could have a negative impact on compliance.
Thus, an exemption for food has the potential to totally unravel the simplicity and neutrality of GST.”
Scenario 2- Taxation of food sector at Lower Rate i.e. 5% :-
a) RNR to Jump to 16%:
“One could consider a lower rate for food, instead of complete exemption. If the lower rate were to be 5%, the revenue neutral standard rate (based on 2005 rate structure) would be pushed up to 16%. This may be a reasonable compromise, provided all other goods and services are made taxable at the single standard rate of 16%. “
b) Effect of Lower Rate of Taxation on Food
“The risk is that the lower rate for food would become the thin edge of the wedge which would create irresistible demands for the opening the door wider.
An important question is the definition of food that would be eligible for the lower rate. To keep the base broad, and limit the preference to items of consumption by the lower income households, the lower rate should be confined to ‘unprocessed’ food items (including vegetables, fruit, meat, fish, and poultry). Its scope can be further restricted by excluding from the preference food pre-packaged for retail sale. . This definition would not be without problems, especially where the processing value added is small. For example, if wheat were taxable at 5% as unprocessed food, but flour taxable at 16% as processed food, it would encourage consumers to buy wheat and then have it processed into flour.”
Thus we can see from the above that if complete exemption is provided to the private final consumer expenditure on Food then in such case, RNR at the rate of 10-12% would jump to 18%. If we apply the above examples, then its not hard to understand why the RNR jumps to 18%. The same can be understood as follows:
a) Where no Exemption from levy of tax is allowed to the food sector:
Estimated Revenue from GST: Rs 12
GST Tax Base : Rs 100
RNR = 12/100 i.e. 12%
b) Where complete exemption from levy of tax is provided to the food sector:
Estimated Revenue from GST: Rs 12
GST Tax Base : Rs 67:-If one third of the revenue base is exempted from the levy of GST, then in such case the GST Tax Base on which tax would be levied reduces to 67 i.e. 100-33.
RNR = 12/ 67 i.e. 18%
Revenue Neutral Rate in the given case would be 18% as describe above.
Conclusion: This is the effect of providing Exemptions to a particular sector and that’s how the Revenue Neutral Rate would increase If further exemptions are granted to other Industries and Sectors. This was quoted as just an example to showcase the effect of exemptions on Revenue Neutral Rate.
- Result of various studies being carried out in India for arriving at Revenue Neutral Rate in GST:
| S. No | Particular | RNR |
| 1. | Bagchi and Poddar Report(2007) | 10-12% |
| 2. | Report of the Task Force on Goods and Service Tax: Thirteenth Finance Commission | 11% |
| 3. | National Institute of Public Finance and Policy | Approx:-27%
|
| 4. | Report by the Chief Economic Advisor submitted on the issue of RNR in GST (as per reports available) | 15-18% |
- Factors Affecting Determination of Revenue Neutral Rate:
We can conclude that for the purpose of determination of Revenue Neutral Rate in Taxation following are the relevant considerations and the variations in the Revenue Neutral Rates may be on account of the following major factors:
a) Tax Base
b) Exemptions from the Taxes under the Proposed Tax Regime and
c) Multiple Tax Rates
Each of the above factors have a direct relation with the Revenue Neutral Rate.
a) Tax Base: Larger the Tax Base, Lower would be the Revenue Neutral Rate. More persons would be covered under the tax net thereby resulting in tax being spread and shared between large number of taxpayers. However, a smaller tax base would lead to higher Revenue Neutral Rate.
b) Exemptions from the Taxes under the proposed Tax Regime: Higher the number of Exemptions, higher would be the Revenue Neutral Rate. Further as a direct impact of higher exemptions and higher Revenue Neutral Rate, it would only lead towards more pressing calls from other sectors to come under the exemptions as they would feel that why they should borne the burden of the taxes. On the contrary, if the exemptions are fewer and taxes are applicable on all the taxpayers as per common practice, there would be lesser call for exemptions.
The Report by Dr Amaresh Bagchi commonly referred to as Bagchi Report on “Reform of Domestic Trade Taxes in India: Issues and Options”, published by National Institute of Public Finance and Policy in 1994 highlighted the fact that how distortions in terms of exemptions force even the honest taxpayer to resort to unethical means:
“This lack of neutrality in the application of tax creates distortions in production and distribution channels, and creates inequities in the application of tax to competing firms. Such distortions and inequities force even otherwise honest dealers to resort to activities that are unethical or in contravention of the law.”
Thus not only higher tax rate but other factors also call for lower exemptions and common base for all the tax payers.
c) Multiple Tax Rates: Multiple Tax Rates forces taxpayers covered under Higher Tax Rates to press for calls to cover them under the Lower Tax Rate. Any such pressing call and resultant change has the effect of a particular category being shifted to lower tax rate and Revenue Neutral Rate or General Rate of Tax applicable on common Tax Payers being raised to cover the revenue loss.
The Report by Dr Amaresh Bagchi commonly referred to as Bagchi Report on “Reform of Domestic Trade Taxes in India: Issues and Options”, published by National Institute of Public Finance and Policy in 1994 highlighted the fact
“For example, in its 1993 budget, Orissa reduced the sales tax rates on motor vehicles, earth moving equipment, TVs and other electronic goods from 6 per cent, 16 per cent and 16 per cent respectively to a uniform 4 percent, largely in response to competition from neighbouring States. At the same time, the tax on certain basic food items was proposed to be increased from zero per cent to 4 per cent to compensate for the revenue loss from the rate cuts. Punjab has been obliged to reduce its sales tax rate on motor vehicles to 3.5 per cent while taxing cereals like rice and wheat at 4 per cent because of the tax rates prevailing in the Union Territory of Chandigarh.”
Multiple Tax Rate and Tax Payers covered under Higher Tax Rates leads to distortions amongst the taxpayers. Multiple tax rates should be avoided so as to have a common tax rate for all and all the taxpayers subjected to principle of Neutrality of Taxation without discrimination being made any of the tax payers.
Conclusion: It would be appropriate to conclude that the proposed Revenue Neutral Rate in GST should be covering a broader tax base, lesser exemptions and a uniform tax rate to the extent possible. This uniform Tax Rate would not only be less but also would create lower number of classification disputes and higher compliance from the taxpayers. Higher Tax Rate and Inequality amongst the taxpayer forces the Taxpayers towards evasion as narrated above in the Bagchi Report. The need of the Hour is to determine Revenue Neutral Rate in GST which is acceptable to all.
In my view, if the Principle of Neutrality in Taxation is followed in letter and spirit in the destination or consumption based taxation, it can result in a Revenue Neutral Rate which would be an ideal rate in GST. A broad Based GST Revenue Neutral Rate with lower Exemption and Lesser classifications is what we all need.
Note from the Author: In the Next Article, I would dwell upon the principle of Reverse Charge Mechanism and how the same becomes the very core for Implementation of Goods and Services Tax. This article was supposed to cover Reverse Charge Mechanism but due to relevance in the current scenario, issue of Revenue Neutral Rate was covered.
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.
Very Helpful Article