1. Introduction: GST was introduced in India on 1st July 2017 and in next couple of weeks, this regime will turn 9. The purpose of implementing GST was not only to overcome the prevailing system of multiplicity of taxes and numerous tax-collecting authorities but also to address the rampant frauds leading to loss of billions tax revenue and to simplify the cumbersome compliance requirements.
GST is levied at every stage of sales and the tax credit thereof which is called as input tax credit (ITC) is availed by the recipient supplier to avoid cascading effect of tax incidence on the final customer. Unfortunately, it has been observed during 9 years of the operation of GST that this mechanism has also been greatly abused by the unscrupulous elements. There has been tremendous rise in cases of GST frauds over the years while compliance burden is increasing year on year.
2. Reform is apposite: As per the Indian Government data, during last 5 years alone, there had been cases of tax evasion amounting to INR 7.08 trillion (USD 76.6 Billion) till the year 2024-25, which includes fake GST ITC amounting to a whopping INR 1.79 trillion (USD 19.37 billion) involving more than 44 thousand cases during the period of only 4 years. Broadly, the scams were related to either obtaining dummy GST registrations to avail illegitimate ITC or movement of goods without payment of GST or by issuing bogus invoices or non-payment of GST liability by filing falsified returns or obtaining illegal GST refunds. GST is a testimony to the fact that the inclination for simplification of tax regulations and administration led to loss of government revenue while gradually the complexities kept on creeping in the GST eco-system. The differentiating line between GST vis a vis erstwhile tax regimes has largely become blurred. It also manifested that the time-tested Central Excise laws (also referred as Excise regime or Excise) were indeed focused on keeping in control the loss of tax revenue on the basis various checks and measures, different mode of compliances, and involvement of tax officials at multiple stages of material movement, manufacturing, accounting, and reporting. Excise regime was labelled as restrictive due to huge compliance requirements. But even under the current GST regime, there are still a lot of compliance burden on the taxpayer. The complications remain even after the withdrawal of Excise regime while ITC frauds continue to create havoc. It is worth mentioning that in current GST regime, there are more than 15 million GST registrants in India and the mentioned complexities (with slight variations based on different criteria) are applicable to every tax payer and the government machinery need to monitor all the tax payers. Keeping an eye on such a huge tax base, especially when revenue incentive in the shape of ITC is applicable in most of the cases, is infeasible task and is prone to tax evasion through deceitful activities. It indicates that further tax reform is the need of the hour to rein in the lacunae and to make the tax system more efficient and business friendly while ensuring that the coffer of the government remains shielded from the nefarious exploitations.
3. Alternatives to GST: During the last eighty years, India has witnessed various mode of indirect taxation on goods starting with Central Excise in 1944 to introduction of Sales Tax in 1950s and then implementation of Service Tax in 1993 and lastly VAT in 2000s at the State levels (which replaced Sales Tax in relevant states) before the advent of GST in 2017. Based on experience of these mechanisms of indirect taxation in India and taking into consideration the efficacy of each methodology of taxation, there seems to be two alternatives to the existing GST regime related to tax on goods – Cascading System and Excise and Sales Tax (EST) System – which can aid to elimination of ITC loss while ensuring minimum compliance and limited supervision from the authorities. While Cascading System mandates levy of tax at every stage of sales, EST advocates for levy of excise duty only once at the time of manufacturing and sales tax in cases of sale of goods in cases other than where the excise is leviable. The aforesaid systems appear to be greatly effective against ITC frauds as both envisage no ITC at all. The nature, scope, and benefits of which are discussed hereunder.
4. Cascading System: In this case, the tax is levied at every stage of sales but without any allowance of input tax credit (ITC) to the recipient supplier. It is also called as tax-on-tax system because the tax component in every instance of sale would become part of the taxable value of goods for the purpose of levy. The biggest demerit of cascading system is manifold increase in the price of goods for the consumers. Although cascading of taxes increases government receipts, but it also leads to negatively impact the economic activities due to inflation. Reducing the tax rate appears to be the best bet for controlling the inflated cost of goods.
4.1 Reduced tax rates: One of the best ways to address the ill effect of cascading tax burden is to lower the tax rate on those products which entail the requirement of multiple chains of wholesalers and retailers to match the existing tax rate. For example, if the current tax rate is 18%, then the same could be broadly brought in the bracket of 5% to 7% to factor the supplies made by the wholesalers, retailers, etc., to match the final incidence of tax on goods.
However, there are challenges to such arrangements. As a means of tax optimization, the manufacturers or wholesalers may indulge in opting for vertical integration to reduce the tax impact on their goods to achieve competitiveness and may eventually device a system to directly supply the goods to the ultimate customer. Though this would cause to reduction in supply chain but would also usher in increase of economic activities because the reduction in cum- tax price to the final consumers would create demands and consequently boost government income. This will also help address the issue of avoidable middlemen costs which usually results in unwanted increase in prices of goods at the hands of the ultimate consumer. Lest there are short tax receipts, the government can, as an add-on measure, apply such slightly higher rate of tax as needed to meet the projected revenue targets. Though this technique is good as a forethought but it entails a detailed analysis in terms of study of existing tax rates of all the goods and volume of revenue generation vis-à-vis potential reduced tax rates while securing there is not loss to the exchequer. Ensuring that sufficient checks and measures are put in to ward off any scope for excessing tax burden on the ultimate consumer is a must and seems very challenging to foresee and may lead to drastic fluctuations in revenue earnings.
5. EST System: Another more pragmatic method is to implement combined Excise and Sales Tax System (EST), wherein there would be inclusion of better attributes of both erstwhile tax regimes – Excise and Sales Tax mechanisms. While the application of Excise will be confined to only the manufactured goods, Sales Tax would cover the sale of all goods other than the manufactured ones. The Excise regime in India, which was in operation prior to implementation of GST, was indeed an innovative concept, having its root in Netherlands and initiated during the British rule in India. It was a novel approach to tax the goods not the time of sale but at the time of manufacturing i.e. the taxability of goods accrues once the goods achieve the status of being manufactured irrespective of the incident of sale. Initially, only salt was subjected to Excise Duty (ED) and later all the goods were brought under the excise net. Application of ED on manufacturing act was possible because, unlike services which are intangible in nature and difficult to differentiate, goods were easy to differentiate and identify in many parameters for instance, manufactured or traded; raw or semi-finished or finished; and in terms of quality, quantity, volume, size, shape, etc. ED was applicable upon completion of manufacturing act i.e. the goods were treated as manufactured once it transforms to have separate identity, usage and marketability independent of the inputs that went into manufacturing thereof. The crux was evolution of a new product which became dutiable under the Central Excise Act, 1944.
This system kept on evolving and culminated in 1986 when the new concept of MODVAT (Modified Value Added Tax) was introduced, which was a mechanism for the recipient B2B registered manufacturer to avail the input tax credit of ED paid on input goods for manufacturing goods which would be chargeable to ED, called MODVAT credit. Initially, it was levied on select goods and later extended to all the commodities. Going further, this facility was extended to capital goods, which are employed for conversion of inputs goods into processed goods but which does not itself become part of the finished products such as machinery, equipment, accessories, apparatus, etc. The objective for allowing ITC was basically to eradicate prevalent tax-on-tax scenario because the goods were first subject to ED at the hands of the supplier of inputs, then at the end of manufacturer as ED and then at further supply chain till the goods reached the end customer. Similarly, the ITC on capital goods was allowed basically to reduce the amortized cost of such goods factored in the sales price. All these levies used to keep on adding in the final sale value leading to the price of goods getting exorbitantly high at the hands of the final users. It is quite evident that Excise in India was a time-tested regime having gone through more than seven decades of continual improvements in the administrative practices, implementing variety of measures based on years of experience in dealing with the taxpayers.
Similarly, Sales Tax (ST) has also its root in 1950s, when it was first introduced in the state of Tamil Nadu before being implemented in the other States. This was applied on pure sales transactions and was applicable on the cum-excise duty price of the goods. Likewise, Central Sales Tax (CST) was collected by the central government on sale of goods where there was a movement of goods between the borders of two or more states. ST and CST were levied in addition to ED.
The attributes of the proposed EST system are discussed below separately for Excise and Sales Tax after considering the beneficial aspects of the old tax systems:
5.1 Reincarnation of Excise: As a better resort, the concept of Excise could be reintroduced to levy the tax right at the manufacturing stage itself on all the goods which conform to the requirements of being treated as manufactured. The erstwhile Excise regime was based more on manual documents and hard records, filing of largely person-based returns and refund claims which were infested with rampant human errors and were subject to error-prone audits, scrutiny and investigations resulting in lack of achieving revenue efficiency. Such infirmities would be eliminated by taking optimum advantage of technological advancements taken place during the period of last ten years, such as electronic filing of returns with all electronic checks and measures in place, advanced analytics, systemized matching tools and generation of actionable intelligence, the revolutionary benefits of Artificial Intelligence (AI) and risk-based audits and scrutiny.
There is a famous saying by Thoreau that “There are a thousand hacking at the branches of evil to one who is striking at the root“. It aptly applies here that instead of surveillance of the movement of goods down the supply chain till it reaches the end customer which encompasses the length and breadth of the entire country involving hundreds of districts and thousands of villages, the authorities will have to be confined only to the registered manufactories, to ensure compliance, examine the movement of goods to and from the factory on random sampling basis, by means of modern technological apparatus to help curtail any clandestine movement of goods through enforcements such preventive checks, anti-evasion moving squads and periodical audits and investigations of the factory and books of accounts.
A few finer points of Excise are discussed as below:
5.1.1 SION: Standard Input Output Norm (SION) needs to be the back bone of this system. This will have to be prepared, verified and submitted by manufacturers for approval of the authorities. A percentage of process waste to be allowed in calculation of input content in output goods especially in case of specified goods such as plastics, rubber, metal, wood, etc. This will automatically freeze the ITC involved in output goods without being available as set-off. Any deviation will get highlighted and stipulated tax thereon would stand applicable. It is pertinent to note that the lack of SION reporting has led to many frauds taken place recently and could not be noticed instantly.
Recently, the Great Biryani Scam (or the Great Biryani Audit) was reported, amounting to INR 7 billion (USD 75.74 million) of estimated sales suppression by innumerable restaurants. It is a glaring example of imperils of simplification. It was revealed that almost 27 percent of the restaurant supplies were not at all reported for the purpose of payment of taxes (both direct and indirect) and the same was noticed only upon focused investigation of this sector in a specified geography alone. Had SION been in place and mandated for periodical reporting with the authorities, the tremendous mismatch of inputs with outputs would have exposed and alerted the authorities on the real time basis preventing loss of revenue to the exchequer and would have acted as a deterrent for the others as well.
5.1.2 Valuation: The manufacturers to have well recorded valuation matrix for all the goods manufactured by them duly considering every input, input services, and amortized cost of capex (wherever applicable) with quantity, quality, and value in the calculation prior to pricing of the final product. This valuation matrix to be duly filed with the authorities for their perusal and approval. The core purpose of having valuation of all the goods is to ensure that none of the intrinsic value of goods skips taxable value. This would eradicate any scope for undervaluation or overvaluation of cost of acquisition of inputs. It is worth mentioning that had valuation matrix been mandated for business as a compliance measure, majority of GST frauds (See Para 2. and Para 5.1.1.) could have been averted or caught immediately on filing of the periodical returns.
5.1.3 Nature of transaction: There would be only two kinds of customers in this mechanism– First one belongs to the manufacturers procuring inputs directly from registered suppliers for the purpose of manufacturing final product, and the other one would be the ultimate consumers whom the manufacturers sell directly. Wherever more agencies, e.g. dealers, stockist, etc. are involved in the supply chain, then the dealers margin need to be factored in the price of the goods at the manufacturer’s level itself. No further levy would be charged by such dealers on their invoice. In exceptional cases, if the subsequent dealer’s margin exceeds the agreed amount due to any reason, they may pay the differential amount of tax directly to the government without affecting the final price of the goods. This will push the dealers to either stick to the predetermined margins or negotiate the same before the issue of invoice by the manufacturer. The input suppliers who are supplying the goods to the manufacturers would not charge any tax but will only mention the amount of tax in the invoice purely for the purpose of generation of E-way bill for in-transit movement of goods and for future references. This will aid as evidence of value of goods in case if any future objections are raised by the authorities. The recipient manufacturers to account for all the inputs received by them and file return containing all the details including the amount of sales tax not paid by the input supplier. The dealer to supply the goods at the same price as received from the manufacturer to the retailers or to the ultimate customer.
The concept of Maximum Retail Price (MRP), as prevalent under Excise regime, can be reintroduced to avoid excessive price charge by the dealers. Appropriate checks and measures at dealers’ end could be devised and dealers’ return to contain the reconciliation of their sales with the receipts from manufacturers.
This mechanism serves as broad guidelines while sector-wise or product-wise requirements to be tweaked via appropriate notifications/circulars to suit the compliance needs.
In the event of dealer is not directly supplying the goods to the ultimate customer or serving as a stockiest or when there are multiple chains of retailers involved in the value chain, then it would be difficult for the manufacturer to envisage the final price of the goods at the time of invoice generation. Though for heavily organized sectors such as automobile, heavy machinery, durable goods, etc., it is possible to ascertain the price at the hands of the ultimate customer, but in case of goods having insignificant value or having no distinct identity and capable of duplication, especially where the manufacturers are small set up entrepreneurs, it would not be feasible for them to have control over the supply chain from the perspective of final price to the customer. Moreover, there could be innumerable manufacturers making same product competing in the same market and controlling price at manufacturer’s end would not be practical from marketing point of view. In like situations, sector-wise bifurcation can be made to segregate such manufacturers based on criteria such as price, market, volume, etc. On such goods, the tax rate can be relatively kept lower as compared to the goods where final sell price is available at the manufacturer’s end. Lower tax rate would not only make further suppliers less prone to tax evasion but would also result in commensurate reduction in administrative cost for the government.
Yet another criterion, for instance, turnover of the manufacturer, could be considered for determining the tax rate based on the levels of turnover during a financial year. Authorities can estimate the revenue generation target for a respective sector and devise tax strategy accordingly.
A blanket ITC allowance till the last point of sale makes life easier for the authorities, but that is neither basic nor sole purpose of the tax administration. Other than ease of administration, revenue safeguarding, ease of operation for entities involved in supply-chain and correct price at the hands of the customer are far more prominent to make the economic wheel run smoothly.
5.1.4 Captive-Consumption: Wherever any intermediary manufactured goods get generated during the manufacturing of the desired final product, the manufacturer may issue a self-invoice with 110% of the cost of production as captive consumption for further manufacturing activities. Such value to be factored in the price of the final product for sale. Valuation method preferably CAS-4 Standard could be followed depending on suitability. This practice was enshrined under the Excise provision also.
5.1.5 Manufacturing Timelines: As per the current GST regime, goods attract payment of tax at the hands of the input supplier and ITC is availed by the manufacturer. But in the proposed EST system, the payment of tax on inputs goods would get deferred till the manufacturing stage when it becomes payable by the manufacturer on the finished goods and not on individual inputs, the value of which gets factored in the manufactured goods. However, to avoid indefinite delay in realization of government dues, a timeline can be affixed within which the goods to be manufactured and applicable ED to be paid to the government. In the event where the goods could not be manufactured within the timelines due to any reason, the amount of tax contained in the input goods to be remitted by the manufacturer to the government upon exhaustion of the given time limits. Such details are to be duly captured in the periodical returns to avoid double ED payment.
The foregoing points may need further modifications, customization based on nature of goods, marketability, volume, and complications as per the requirement of issues faced during and post implementation of this EST system.
5.2 Reintroduction of Reformed Sales Tax: Sales Tax was prevalent in India since late 1950s, albeit not as a single tax but individual states of the federal system used to levy separate sales tax, while ED and CST were parallelly levied by the Central Government. States had their own rules, regulations, and administrative bodies to regulate ST and had their own judicial set up till the stage of Tribunals or Tax Boards for redressal of any tax disputes. Multiplicity of statutes made business way too complicated because a supplier engaged in inter-state movement of goods had to cope up with regulations of respective states wherever they were supplying the goods. The biggest demerit of this system was cascading impact of taxes on the final consumer and it was the primary reason for the introduction of VAT in India in the early 2000s.
The reformed Sales Tax regime needs to be made applicable on not all the goods but only on those goods where ED is not applicable i.e. non-manufactured goods such as imported goods, goods existing prior to operationalization of EST system, goods not satisfying the definition of manufacturing, etc. This system should be implemented centrally across all the states and should have one single law to administer the same. This will avoid double taxation or cascading of taxes and steer clear of multiplicity of regulations. The purpose of inter-state supplies would be only to establish the jurisdiction and the place of provision of goods to determine the tax revenue which is attributable to the destination state of consumption and not the state of origination. There will be no availability of ITC on the goods to the recipient registered entity. In event of inter se supplies between importers, wholesalers and retailers, the price from the originating dealer to include the subsequent dealers’ margin (as mutually agreed between the parties) for payment of sales tax. This will make the middlemen to act as an intermediary in the process of sale instead of being a buyer or a seller and would only raise their service invoice towards their commission charges to the supplying dealer.
Hence, only the value addition of the respective supplier would be added to the price of goods but would not result in cascading burden of taxes as the tax will be restricted only on the amount of value addition i.e. commissions, till the goods finally reaches the ultimate consumer. Valuation to be done for the purpose of obtaining the final price to make sure correct payment of sales tax, basically to discourage undervaluation. Taxes suffered but not paid are to be paid back in those cases where there is undervaluation or in cases where the sales are made at Nil value such as sample, free supplies, etc.
In cases where the price at the original dealer cannot include the commission of the subsequent dealers when such dealers would be issuing their own invoices with payment of sales tax, the tax rate can be relatively kept lower to ensure that the final price at the customer end does not get huge impact of cascading effect of taxes. This will also help reduce the tendency to evade payment of taxes by the suppliers and would induce them to devise ways to trim the multiplicity of channels or reduce commission to secure lesser price impact at the customer end to help remain competitive in the market, while the tax revenue would get generated at every such transactions for the government.
6. Rationale for EST as superior to GST: There are following reasons which amply substantiate that the proposed EST system would take care of all the major infirmities faced under the current GST regime –
6.1 Decrease in tax transactions: As there will be no further levy of tax on manufactured goods post removal from factory gate, there will be tremendous reduction in multiple incidences of payment of taxes. Same is the case with Sales Tax as no set off would be available. Such taxations from the government perspective were non-value added as these were mostly available for set off by the recipient supplier.
6.2 Ease of compliance – The multiplicity of complex compliance requirements stems basically due to involvement of money in the supply chains in the shape of payment of taxes and ITC thereof. Reduction in payment of taxes and subsequent availing of ITC would automatically make compliance easier, stress free and would be more of an academic exercise because any inadvertent errors or inaccuracy will at least not have pecuniary repercussions for the taxpayers. And subsequential levy of interest and penalties, which otherwise would have become applicable, gets automatically extinguished.
6.3 Reduction in litigations – Tax disputes, in most of the cases, have its root in the allegation of revenue infringements. Once revenue angle itself is gone or drastically minimized, the scope of disputes and ensuing protracted litigations across various levels of appeal, covering multiple judicial bodies, become greatly diminished. Consequently, the judicial forum will be left with only quality litigious areas such as classification, interpretation, question of law, legislative intent, etc., to dwell on.
6.4 Mitigation of fraudulent practices – Deceitful inclinations will take to its heels once the scope of unfettered ITC itself is gone. As a corollary, there will be no more incentive for opening multiple fictitious registered entities, generating millions of dummy invoices, and filing fake returns, availing illegitimate tax credits, and applying for spurious refund claims.
6.5 Minimum Government, Maximum Governance – The reduction in tax transactions, litigations and fraudulent practices will commensurately decrease the requirement of enforcement and administrative machinery while the fiscal goals would remain intact. Government machinery which was otherwise forced to involve in firefighting the fraudulent activities would get channelized in adding further value to the scope of betterment of tax administration.
6.6 One GST law – As sales tax would be levied centrally on trading of all non-manufactured goods, irrespective of location of goods across all states and union territories, it will eventually help avoid chaos and complicated compliances. Currently every state has its own GST Act and Rules.
6.7 Curtailment in complex reconciliations – The existing GST returns excessively involve reconciliations related to liability and ITC and matching concept of taxes paid by the supplier and ITC taken by the recipients. Even after around 9 years of implementation of GST, and application of automations, there still is huge loss of tax revenue because of infirmities or lacunae in returns. While the fraudsters run away with illegal ITC credit utilization or refunds, the genuine ones find themselves entangled in reconciliation ordeals, which was employed by the administration to plug the loophole, making the exercise look like collective punishment. Such tremendous reconciliation requirements would be drastically curtailed and would become more user friendly.
6.8 Elimination of stakeholder issues – There are plethora of cases involving demands from the taxpayer due to supplier non-compliances. Usually garnishee notices (A government mechanism to obtain its dues directly from the stakeholders who owe the amount to the defaulting taxpayers) and subsequent demands are issued to the taxpayer due to default by their stakeholders, who are mostly the suppliers who were non-compliant. Also, there are plenty of cases referred to various high courts via writ for redressal from recovery of ITC from genuine recipients due to retrospective cancellation of GST registration of the suppliers. The provisions are stacked against the recipient to ensure that the GST liability is duly discharged by the supplier before availing the ITC, which leads to issue of demands for such matters which are beyond the control of the taxpayer. In the recent case of McLeod Russel India Ltd Vs, the Union of India, the Gauhati High Court read down the given provision which puts onerous burden on purchaser for supplier’s default, asking the CBIC (Central Board of Indirect Tax and Customs) to formulate a practical solution to relieve the difficulties faced by the tax payers. All such issues would vanish once the crux of the issue i.e. ITC would be abolished.
6.9 Eradication of multiple set of tax heads – There are huge number of cases filed in constitutional courts for redressal on inadvertent payment of liability in different tax head. In Ocean E Mart Vs State of UP, the Allahabad High Court had to intervene to quash the demand issued purely on the ground of payment of tax in different tax head. Such disputes are like proverbial ‘the mountain laboured and brought forth a mouse.’ The tax administration can always apportion the revenue between various states and centre based on place of supply of goods. Once the condition of multiple tax heads itself is removed, the controversies stemming from this matter would disappear.
Conclusion: Reintroduction of EST regime would be a progressive step as it will retain all the better attributes of current developments in tax administration and enforcement, while weeding out all the demerits. As we can observe that the former Excise and Sales Tax systems were bereft of e-governance measures such as extensive use of electronic tools based on technological advancements and AI driven software at the disposal of the tax administration. With rapid technological advancement, e.g. availability of AI tools, availability of advanced tax reconciliation software, real time surveillance and evidence of movement of goods through RFID systems, CCTV and other such supervision techniques at factories and other important locations across country, the success of EST is possible which will eradicate the current inefficiencies and resultant time-consuming compliance burden, increase in litigations and loss of revenue for the authorities. This will help boost the economic activities as leakage of revenue would be avoided leading to help the government reduce commensurate percentage of tax rate to match the planned revenue generation from indirect taxes. These would culminate in reduction of tax burden on the consumers via reduction in final cost of purchase, which would result in leaving more money at the disposal of the consumer catalysing in the growth of economic activities.
Author Bio
