India’s GST Reform
At the stroke of midnight on June 30 2017, India launched one of the most far reaching reforms in its tax structure since independence. The introduction of Good and Service Tax (GST) is meant to enforce the principle of ‘one tax one nation’, by subsuming the multiplicity of indirect taxes levied at different levels. The hope is that the new tax structure will curtail red-tape, plug leakages and pave the way for a fully transparent indirect tax regime.
The GST is a step forward from the earlier Value Added Tax (VAT). It may be recalled that VAT was levied on any increase in value of an article at each stage of it production or distribution. VAT was not applicable on services while GST is applicable on both goods and services. The government has categorised most goods and services into four tax slabs with rates of 5, 12, 18 and 28 percentage while some essential goods are made exempt from tax. Businesses are now required to collect taxes based on the above rates for an array of goods and services under a code called the harmonized system of nomenclature (HSN).
India has implemented a dual GST model, where the Centre and the States together levy tax on a common tax base. The tax levied by centre on intra-state supply of goods and services is called Central GST (CGST) and that to be levied by state is termed the State GST (SGST). The tax levied on inter-state supply of goods and services is administered by the centre and called Integrated GST (IGST). With GST, the entire accounting system is online.
Implementing GST was a mammoth task and the success of reform would be based on how quickly it is able to resolve the major problems it threw up, viz., complicated tax structure that can create distortions, onerous compliance procedures that have created working capital stress in many smaller companies, and technical glitches in the GST network (GSTN). The complexity from multiple tax rates increases confusion in classifying products into various categories especially when the subcategories of products fall into different tax slabs under the harmonized system of nomenclature. This makes filing tax return complicated.
GST may also have hit the informal sector hard by transforming accounting and tax filing standards. Micro, small and medium enterprises (MSMEs) were at the forefront in expressing dissatisfaction with GST. Many of these enterprises operated in the informal economy and anecdotal evidence suggests that many got away by paying a fraction of the taxes they were actually liable to pay. The new tax regime has not only compelled them to fall into the tax ambit but also increased their tax compliance cost. Earlier, filing taxes was done manually without requiring much of professional assistance. With the implementation of GST, a lack of awareness and the challenge of adapting to a fully computerised tax system has been stressful. Hiring professional accountants and buying new accounting software equipped to handle GST has increased operating costs for many small businesses.
For example, it is mandatory under GST for a business unit operating in only one state to file a minimum of 37 returns (it was 13 pre-GST), i.e., at the rate of three per month plus one annual return. If the business operates in more than one state the number of fillings will increase accordingly, e.g. when operating in three states the number goes up to up to 111 returns a year. Further, larger companies are unlikely to entertain non tax-compliant MSMEs as the former would not be able to claim input tax credit. In this context, the proposed reverse charge mechanism that makes a purchaser liable to pay taxes on procurement from unregistered suppliers, and the invoice matching principle wherein input tax credit can be claimed only when the purchase invoice matches with the sales invoice uploaded by the supplier (evidencing GST paid by the supplier) would make things more difficult for small businesses.
The objective of GST is “transaction-level reporting to assess value chains for better compliance, widen tax base and effective credit matching for focused non-intrusive limited audits.” This objective can be achieved if business units especially MSMEs understand the tax filling procedure. Noncompliance with the filling procedure will only hurt their cash flows.
The government is committed for smooth transition of tax structure and has been taking necessary remedial measures. To simplify the GST process, the government is slowly rationalising the multiple tax structures. Recently the GST council undertook a major rationalisation exercise by cutting tax rate of 177 items from 28 percent to 18 percent, leaving only 50 items (the so-called demerit goods) in the highest tax slab. The government has also hinted that depending on revenue buoyancy there may be scope for further rationalisation of rates.
Responding to the compliance burden of businesses (especially the small and medium enterprises and exporters) the GST Council has allowed continuation of some of the pre-GST era incentive schemes. The stringent supplier and buyers invoice matching practise has been suspended for now. The council also suspended the reverse charge mechanism that makes big businesses responsible for tax filings for items sourced from smaller units till the end of the current fiscal year. Besides, the Council has taken series of steps including reducing late payment fees and simplification of forms to encourage voluntary compliance. For business with aggregate turnover of up to Rs1.5 crore, returns are now required to be filed only on quarterly basis thus easing the burden of compliance.
The GST Council will introduce the e-way billing system from February 1, 2018 to make electronic permits compulsory for inter-state movement of goods. This will replace the transit pass system followed by individual states. As for intra-state movement of goods, states have time till June 1, 2018 to implement the national e-way bill system. The council is also considering inclusion of real estate and petroleum products in the GST framework. Also, to ensure that the recent reductions in GST rates are passed on to the final consumer, the government has formed a national anti-profiteering authority (NAA).
Implementation of a comprehensive reform like GST was always going to be a challenge. Indeed, when the Indian government was getting ready to roll out GST, we saw many stories in the media about the unhappy fate befalling governments in other countries that implemented GST. It was pointed out that because of its initial inflationary tendencies, governments implementing GST across the world had either lost the next elections or performed poorly. In Canada, the Prime Minister Kim Campbell of the Progressive Conservative Party lost the 1993 national elections after implementing the GST which proved deeply unpopular with the electorate. In Australia, the John Howard government was somewhat more fortunate, narrowly returning to power in the 1998 election soon after implementing the GST. In most countries, implementation of GST has led to higher inflation. Even Singapore saw a spike in inflation in 1994 after the introduction of GST.
In India, while the teething troubles appear to have been taken care of by the government, there are many issues and concerns that remain to be resolved. Our current GST framework is still a work in progress. However, it is true of all structural reforms that one must undergo pain in the initial stages in order to reap benefits in the long run. The global experience shows that advantages from GST have invariably offset the disadvantages within a short period of time. India will, eventually, be no different.
V.P. Nandakumar MD & CEO of Manappuram Finance Ltd.
Board Appointee to the Lions Clubs International Board of Directors.
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