Why reverse charge mechanism must stay

The recent proposals to amend GST rules include one to dilute the reverse charge mechanism (RCM). While many industry lobbies as well as tax consultants want this feature scrapped altogether, the Centre rightly has not acceded and is considering a staggered implementation of RCM.

The reverse charge clause is the most powerful check that had been inserted into the regulations by the architects of GST. It provided that registered persons should pay the tax on reverse charge basis on goods or services purchased from unregistered persons.

Those against it argue that the amount of tax collected through this route is negligible and hence it can be done away with to help smaller players. But that is a myopic view.

The intention of RCM was to check tax evasion and expand tax the base through self-policing by taxpayers. The first few months of GST rollout witnessed sharp expansion in indirect taxpayer base mainly due to the presence of the reverse charge feature. Scrapping this feature will lead to the tax base shrinking again. The Centre can instead implement RCM in a staggered manner over two years, starting with larger companies. Very small enterprises with turnover of less than ₹10 crore can be left out of this clause.

Expanding tax base

This effect of the RCM provision was visible on two fronts during the GST rollout, around July 2017. One, all the larger companies ensured their suppliers registered on the GSTN. Buying from unregistered buyers would mean that the buying entity would be liable to pay the tax.

While the buyer could claim input tax credit on the tax paid, the additional work involved in paying tax under reverse charge acted as a deterrent, making companies coax their vendors to on-board the GSTN.

The other impact of RCM was that smaller vendors who wished to supply to larger clients, voluntarily registered on the GSTN. They were afraid that if unregistered, larger clients might spurn them.

Surprisingly, many small businesses that buy from larger businesses also opted to register under GST, despite being below the GST threshold, in order to claim input tax credit.

The Economic Survey 2018 has some interesting numbers that show that the tax base had expanded after the implementation of GST. It noted that as of December 2017, there were 98 lakh unique GST registrants. Once double-counting under the old system was adjusted, there were 34 lakh new registrants under GST, indicating a 50 per cent jump.

The voluntary compliance elicited by features such as RCM resulted in about 17 lakh registrants who were below the threshold limit registering on GSTN. It is obvious that RCM has already played a part in expanding the tax base.

Staggered introduction

Small businesses as well as tax consultants have, however, been lobbying for retraction of the RCM provision altogether. Due to the hue and cry, it was initially postponed to September 2018. But now the Centre proposes that it would be applied only on a certain class of taxpayers.

The Centre can consider implementing RCM in a staggered manner, over 2-3 years. Since smaller companies have been complaining about lack of resources and funds for complying with RCM, it might be a good idea to apply reverse charge on larger companies, with turnover above ₹100 crore, initially.

After a year, the turnover threshold could be lowered to ₹50 crore, and after two years, to ₹10 crore.

Larger companies have already adjusted their processes to account for the RCM provision and hence may not find it too troublesome. With time, mid-sized companies too would be able to adapt to RCM. Tiny units can be kept out of RCM altogether.

Shouldn’t be scrapped

If the threat of RCM is removed, the entities that registered under GST last year could de-register, thus shrinking the tax base. The good done in the first few months of GST rollout will be undone. Scrapping RCM will also halt the shift of entities from the unorganised to the organised segment; that was touted to be one of the long-term benefits of GST.

Retaining RCM will not only help expand the tax base but also improve transparency by making available data on the unorganised segment to the Centre. This data can be used to formulate policies for this segment.

By asking taxpayers to check if their vendors are registered and paying tax on time, the workload on the tax department reduces significantly. Given the shortage of manpower in the revenue department, the limited resources can be used to go after large tax-evaders, leaving the internal checks such as RCM, to do the rest.

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