The Hindu Business Line : The bumpy road ahead

The Goods and Services Tax regime due to be in place by2010 is essential. The need for such a reform in a nation thatwants to provide a more conducive environment for businesscan hardly be overstated. But a lot needs to be done to getthere, say PRATIK JAIN and SIDDARTH MEHTA.

Although the transition to a Goods and Services Tax seems to be underway in India, this year's Union Budget cast little light on its structure and other fundamental issues related to this critical tax reform. The silver lining, if any, is that the proposed reduction in the rate of CST, along with the Finance Minister's statement about the satisfactory progress in preparation of the roadmap, may be taken as an indication of the Governments commitment to switch over to the GST within the set deadline.

Since the 2010 deadline is inching closer, there was some hope that the Finance Minister would unveil the GST rate slabs, and initiate the process of realigning existing tax rates. The reduction in excise duty from 16 per cent to 14 per cent could possibly figure as an effort towards such realignment but some analysts feel the cut was no more than a booster shot for consumption and manufacturing activity.

Since the Indian GST is a hybrid model involving a State as well as Central GST, perhaps the Union Budget was not perceived as the appropriate forum for unveiling its roadmap. Be that as it may, the transition to a GST regime will overhaul the indirect tax regime significantly by aligning it to global standards.

BRIEF HISTORY

The need for such an alignment of tax regimes has been long acknowledged but the actual transition to it was first expressed by the Finance Minister in his Budget speech of 2006-2007. The following year, the Finance Minister once again signalled India's commitment to the proposed transition. An empowered committee of State finance ministers set about evolving a roadmap for its realisation.

Extensive deliberations on the roadmap proposed by the Empowered Committee later, the State finance ministers finally reached a consensus on a `dual GST' model. This would entail a Central and State-level GST. The Central taxes likely to be subsumed under GST are excise duty, Central sales tax and service tax, whereas State GST would subsume VAT and other local taxes.

GLOBAL EXPERIENCE

The world over, some 120 countries follow the GST model; however, apart from India, the only two other countries to have adopted the dual GST model are Brazil and Canada.

Implementing such a hybrid poses challenges, given the limited global experience to learn from. But such difficulties as may arise do not water down the suitability of the dual GST structure, given its unique political and economic dynamics.

India can adopt the best GST practices followed across countries while formulating a model suitable to its federal status. While the debate continues, it is important to realise that given the parallel systems of indirect taxation at the Centre and State levels, a lot more still needs to be done before the realignment process is complete. In the absence of a gradual and continuous realignment, tax rates may witness drastic changes in the run up to the 2010 deadline.

The GST regime will witness a significant departure from the existing indirect tax regime in several areas. For instance, unlike the current regime, dual GST is expected to give States concurrent powers to levy service tax on a specified list of services. These are likely to include services provided by private educational institutions, unaided health institutions and hospitals, amusement parks and notaries that certify legal documents.

These services are part of the compensation package offered to States for the loss of revenue suffered on account of the CST phase out taking place in light of the proposed transition to GST. Another vital change would be in tax incidence that is likely to fall at the point of sale as against the multiple taxable events under the current regime.

For instance, excise duty is levied on the manufacture of goods even though it is payable at the time the goods leave the factory. Further, service tax is levied on the provision of taxable services, which is also payable as advance payments; while for other levies such as VAT the taxable event is not linked to the receipt of consideration. Thus, while all the taxable events would fold as one under GST, related administrative and procedural issues still need to be tackled. For instance, would a factory undertaking only stock transfers and not executing any sales be liable to be registered under GST?

As mentioned earlier, there is still no clarity on the tax rates likely to be adopted under the GST system. Although the Empowered Committee has set up a panel to work out these important aspects, the final report is yet to be released.

Judging from media reports, there are indications that the framework of dual GST would embody multiple slabs of taxes for goods, but a single rate for services within a State.

The Finance Ministry has hinted that unlike Japan and Singapore, which have a low tax rate, viz.5-7 per cent, GST in India is likely to be applicable at a moderate rate since tax leakages and exemptions in the country make a low tax rate rather unviable.

Although a moderate GST rate is being perceived as the key to its successful implementation, it cannot be achieved in the absence of a broadened tax base. Critics of a moderate tax rate argue that a higher compliance rate warrants a lower tax rate.

Although nothing conclusive on the probable GST rates likely to be adopted in India is available in the public domain, a study of the global VAT rates suggest that most advanced nations have adopted a GST rate of 17-20 per cent.

Besides the rates, other fundamental issues also warrant clarification. For instance, the treatment of inter-State transactions post the CST phase-out is one grey area. To enable the industry to plan long-term business operations with more certainty, the government needs to clarify the treatment and credit mechanism governing such transactions sooner than later.

Similarly, the reduction, restructuring or phasing out of the current tax exemptions under the GST regime, crucial as that is to keep rates at moderate levels, should be undertaken in a measured and gradual manner.

STATE-LEVEL CHANGES

At the provincial level, the biggest challenge lies in obtaining a consensus amongst States to abolish the multiple local taxes that have emerged over the years. Abolishing such multiple levies would permit the GST regime to introduce its primary objective; a simplified tax regime with no cascading impact.

Further, the domain of each State would also need to be defined clearly through `place of supply' rules, to ensure there is no ambiguity between different States regarding taxability of the same transaction. The power of States to tax services void of well defined place of supply rules would lead to perennial litigations over jurisdictions of various states especially in cases of services that have an inter- State spread.

TO SUM UP.

Even though the transition to GST may not be as smooth and hasslefree as the stakeholders may like, the regime would enable businesses to be driven purely by commercial imperatives and not on the basis of applicable indirect taxes. For a nation that wants to provide a more conducive environment for business, the necessity for such a reform can hardly be overstated.

(The authors are Director, Indirect Tax and Senior Manager, Indirect Tax at KPMG respectively.).