The introduction of the goods and services tax (GST) is a critical and long-awaited tax reform, which intends to simplify and rationalise India’s indirect tax regime. The clearance of the The Constitution (One Hundred And Twenty-second Amendment) Bill, 2014 by the Rajya Sabha is a major milestone on the road to the introduction of the GST. Nevertheless, a lengthy legislative procedure is awaited, and there is some uncertainty on whether the GST can be implemented on a pan-India basis from April 1, 2017. Several key variables are yet to be finalised, which are likely to affect the impact of the GST on incidence of tax on goods and services, growth -inflation dynamics as well as ease of doing business. Additionally, a robust IT infrastructure network needs to be set up in time, which is being driven by the Goods and Services Tax Network (GSTN).
What is the GST: The GST would subsume a host of indirect taxes and levies at the Central and State levels,1 with value-added Central GST (CGST) and State GST (SGST) to be concurrently levied on both goods and services at the point of supply. The GST will be levied on all goods and services, except alcoholic liquor for human consumption; GST shall be levied on petroleum and petroleum products at a later date, based upon the recommendations of the GST Council. Additionally, an Integrated GST (IGST) would be levied by the Centre on inter-State transactions of goods and services, as well as imports into India, at a rate that would be similar to the sum of CGST and SGST. SGST would not flow to the Consolidated Fund of India, but go directly to the States. Moreover, CGST and the central share of IGST would be distributed between the Centre and the States.
Benefits of GST: The introduction of the GST regime would create a common market with uniform tax rates across the country. The reduction in the multiplicity of indirect tax rates across States (primarily relevant for goods) would significantly improve the ease of doing business. The GST is also expected to remove product-wise exemptions, broaden the tax base and make the process of providing input tax credit more efficient (both on Central levies, and across State borders), 2 although the proposed, albeit temporary, exclusion of some major inputs such as petroleum and petroleum products, would partly prevent the same. Accordingly, the introduction of a comprehensive GST would reduce the
prevailing cascading effect, with tax-on-tax currently being paid as State levies are imposed atop central levies. Since the GST would be a destination-based tax, dropping of the proposed 1% additional tax to be retained by producing States is appropriate. However, some clarifications are needed to ensure that such benefits are not limited to manufacturing, but also available for the services sector.
Remaining Legislative Procedure: At present, the Central Government levies taxes on the manufacture of goods and the State Governments levy taxes on the sale of goods. Moreover, State Governments are not permitted to tax services, which remain the sole domain of the Central Government. In order for the dual GST (CGST and SGST) to be levied, the Indian Constitution needed to be amended, to enable the Parliament and the State Legislatures to enact laws for levying dual GST concurrently on the same taxable event, namely the supply of both goods and services. Therefore, The Constitution (One Hundred And Twenty-second Amendment) Bill, 2014 (CAB) needed to be passed by both the Houses of Parliament, each with a two-thirds majority. The Lok Sabha (Lower House of Parliament) had cleared the same in May 2015. An amended version of this Bill has now been passed by the Rajya Sabha (Upper House of Parliament), and these amendments would need the concurrence of the Lok Sabha.
However, a lengthy procedure remains before the GST can be introduced. After the CAB is passed by both Houses of Parliament, it would need to be ratified by at least 50% of the State Legislatures, each with a two-thirds majority, and then signed by the President of India, in order for the Constitution to be amended.
Subsequently, three laws need to be enacted for the levy of CGST, SGST and IGST; Parliament would need to enact CGST and IGST laws, whereas each State
Legislature would need to enact the SGST law. Therefore, the likelihood of the introduction of the GST by April 1, 2017 remains uncertain.
Major Pending Issues: The principal source of uncertainty regarding the macroeconomic impact of the GST arises from the fact that the structure of GST rates (low/standard/demerit), and the split between the Centre and States, is yet to be finalised. The structure of rates would influence the prices of and demand for various items, with an impact on sectoral growth, inflation as well as the revenues of the Central and State Governments.
GST Rate: The Dr. Arvind Subramanian Committee report on the Revenue Neutral Rate and Structure of Rates for the GST had assessed that 15% or 15.5% may be an appropriate revenue neutral rate (RNR), which the State Governments have deemed to be too low to protect against revenue losses. Around an RNR of 15-
15.5%, the Committee had suggested a structure of GST rates as follows: a low rate of 12% on goods, standard rate on goods and services of 16.9-18.9%, and demerit rate on goods of 40% and a rate on precious metals of 2-6%.
Table 1: RNR and Structure of Rates for the GST Recommended by the Dr. Arvind Subramanian Committee report
(Goods & Services)
non–GST excise (Goods)
Source: Dr. Arvind Subramanium Committee Report
The CAB allows for the creation of a GST Council comprising the Union Finance Minister (Chairman) and State Finance Ministers. The GST rate/structure would be decided by the GST Council, in addition to providing recommendations on issues such as cesses and surcharges to be subsumed within the GST, exemption list, threshold limits, Model GST laws, etc. It remains uncertain whether a cap on the GST rate would be included in the CGST Bill.
Impact on demand for goods and services: Depending on the final rates, the incidence of tax on various goods and services would change as compared to the prevailing scenario, as a revenue neutral rate in aggregate would be redistributive across items. The broad expectation is that the standard GST rate would be lower than the aggregate of excise duty, VAT etc. levied on most manufactured goods. Moreover, improved flow of input tax credit would eliminate the cascading impact of taxes, reducing the magnitude of indirect tax levied on various goods and favourably impacting demand. However, the tax base would widen under the GST regime to cover the unorganised sector, protecting the Governments’ revenues. This could also lead to the organised sector gaining an edge in sectors which have a strong presence of unorganised players. The GST rate applicable to services is expected to be higher than the current service tax rate, thereby offsetting the revenue loss from organised sector manufactured goods. However, this may have an adverse impact on demand for services.
Impact on Governments’ revenues: If the revenue neutral rate is appropriate, there should be no revenue losses on an aggregate basis (including the Centre and all the States) following the transition to GST. However, there may be gainers and losers on a disaggregated basis , with consuming-States expected to benefit and manufacturing-intensive States fearful of revenue losses, under the proposed regime. In our view, however, manufacturing-intensive States are also likely to have a substantial volume of service sector transactions. Moreover, higher per capita incomes and urbanisation may be correlated with greater economic transactions getting captured under the GST. Nevertheless, compensation of losses is to be provided by the Centre to the States for five years, which should protect against any medium-term downside to State Government revenues. The formula for calculating the losses suffered by the State Governments has not been decided as yet.
Impact on inflation: In general, the wider availability of input tax credit would bring down the costs of certain goods and services, which would benefit the inflation trajectory. Overall though, the impact of GST on inflation would also be determined by the rates that are imposed on goods and services. A revenue neutral ra te may not necessarily be inflation neutral, given the different contribution of goods and services to the tax kitty , as compared to their weights in the inflation indices such as the CPI and the WPI. For instance, tax incidence on services is likely to go up under the GST regime; however, the WPI does not include services and their weight in the CPI is limited. If the tax base does indeed widen post-GST, a larger number of items (potentially those supplied by the unorganised sector) would attract tax, which would increase their prices and the revenue collections of the Government. Ultimately, the higher Government revenue would be a cost borne by some sections of consumers. This may have an impact on households’ inflationary expectations even if inflation indices do not register a rise based on their static composition.
Going forward, the policy rate required to achieve the inflation target, would be determined by the Monetary Policy Committee (MPC), which is to comprise six members, namely the RBI Governor, the RBI Deputy Governor in charge of Monetary Policy, one office r of the Central Bank to be nominated by its Central Board and three more, to be appointed by the GoI. Differing assessments of the MPC members of the potential inflationary impact of GST may emerge as another layer of uncertainty to be contended with, after the GST regime commences.
Other Issues: Among other things, the GST council is expected to decide the threshold below which GST rates would not be applicable, which would determine the extent to which the tax base expands, subsequent to the introduction of the GST. Additionally, decisions on the threshold related to who has the administrative powers to carry out assessment, scrutiny and enforcement for CGST, SGST and IGST (Central Government or State Government or both), would have an impact on the ease of compliance.
There are some issues that need to be resolved with respect to the application of GST on services. In the prevailing regime, service tax is levied by th e Central Government, and subsequently devolved to all the States (regardless of point of supply of the service) based on the recommendations of the most recent Finance Commission. The apportionment of tax on inter-state transactions of services under the GST regime needs to be clarified, for instance, those on inter-state phone calls or credit card transactions. Another issue to be clarified is whether branches of a corporation need to be registered a s separate entities to identify the point of
supply of services in order to remit the GST to the relevant State Government. Doing so may substantially increase the compliance costs for service sector entities such as Banks, in sharp contrast to the expected improvements in the ease of doing business for the manufacturing sector. Stakeholders’ feedback on the draft GST law would be critical to avoid such missteps.
In addition to the remaining legislative procedures and the pending decision on design, related to rates, thresholds etc., a robust IT infrastructure network needs to be set up in time. A common GST portal for front-end services such as registration, returns and payments to taxpayers is being developed by the GSTN that was incorporated in 2013. The latter is developing the backend IT modules for some States, for functions such as registration, processing of returns, assessment, audit, appeals, etc., while other States have chosen to develop the backend infrastructure themselves. In addition, the State Governments, accounting authorities, the Central Bank and commercial banks are also readying their IT infrastructure for the GST rollout.
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