This answer is quite late in the day – but through this answer, I wish to answer all major questions on GST: what it is, why is it considered a big-ticket reform, what are the provisions of the bill introduced by the NDA government recently in the Parliament, and what are the pros and cons of the bill as also the opposition from states and their reasons, and whether any changes have been made from the bill sought to be passed by the previous UPA government.
However, before jumping in to the technicalities of the GST bill, it is crucial to understand why it is said that GST is a big-ticket reform. To understand this, we go through three images showing different calculations. Figure 1 shows tax calculations in the non-GST era – i.e. when GST is not in force. Please keep in mind that this is not exactly how the taxes were calculated – these figures are more to simplify the understanding of GST.
Figure 1
In this figure:
a) The manufacturer obtains input free-of-cost and adds a value of Rs. 100,with a tax rate assumed to be 10% - thus, the manufacturer sells the product to the wholesale person at Rs. 110, with a tax burden of Rs. 10.
b) The wholesale person in turn obtains the product at Rs. 110 and the value of his output is Rs. 150 – thus resulting in net value addition of Rs. 50 (Value output at wholesale or Rs. 150 minus value output at manufacturer or Rs. 100). With a tax rate of 10% or Rs. 15 on the output value, the selling price is Rs. 165 (150 + 15).
c) The retailer purchases the product at Rs. 165 from the wholesale market and adds a value of Rs. 70 to the product – i.e. the value of output is Rs. 220(Value output at wholesale – Rs. 150 + Value addition – Rs. 70). Again assuming tax rate of 10% on this output value of Rs. 220, the final price for the consumer stands at Rs. 242.
As we can see, the whole chain leads in the sale price of the product being atRs. 242, with the tax burden at Rs. 47 – or about 19.5% approximately. The high tax burden is because tax rate at each end is applied on the value output, not on the net value added. This leads to the situation of paying tax on tax – or compounding of taxes. For example, when the wholesaler adds the tax burden of Rs. 15 at his end and passes it to the consumer – Rs. 15 includes three components:
a) Tax on manufacturer’s earnings (Rs. 100) – Rs. 10
b) Tax on manufacturer’s tax paid (Rs. 10) – Rs. 1
c) Tax on wholesaler’s earnings (Rs. 40) – Rs. 4
Here, the second is actually a tax paid by wholesaler on a tax imposed onmanufacturer – or a tax on tax – which is compounding and adds anadditional burden on the consumer who has to bear the final burden of all taxes. In addition, this system is inefficient because as one can see, the manufacturer’s burden is passed not once but twice on the consumer – once at the wholesaler’s end, and then once at the retailer’s end – so the more the number of people in the chain, the higher is the tax burden on the consumer – this is called the “cascading effect” of indirect taxation.
Now let us look at Figure 2, which looks at the case when GST is introduced. Figure 2 shows the same example and the same tax rate (or GST rate), but the tax burden changes completely.
Figure 2:
In Figure 2, nothing changes at the level of the manufacturer. However, at the wholesaler end, we find that tax is only paid for the value added (Rs. 50) and not for the output value (Rs. 150) – hence, the tax burden is only Rs. 5 and not Rs. 15 as in Figure 1. Similarly, at the retailer level, the tax is only on the value added at the retail level (Rs. 70) and not on the output value (Rs. 220) – a sum of Rs. 7. Hence, the total tax burden in this case is only Rs. 22 – adifference of Rs. 25 from Figure 1. It results in a reduction of the price of the product for the consumer by Rs. 15 from Figure 1 and a tax burden of less than 10%.
Thus, we can see that the introduction of GST makes the product cheaper.
In practice, this system works through the concept called “input tax credits”. This means that when the wholesaler obtains the product from the manufacturer, he also obtains a receipt from the manufacturer or a certified legal document stating that the manufacturer has paid a tax of Rs 10 – therefore, when he has to pay the tax of Rs. 15 on the output value at his end – he shows this legal paper which subtracts Rs. 10 from his tax burden – reducing it to Rs. 5, which he pays as per Figure 2.
Similarly, the retailer obtains tax credit documents from the wholesaler specifying that the manufacturer and the wholesaler have paid their respective taxes – and so has to pay only Rs. 7. The cascading effect of taxes is thus avoided.
But some may ask – well, the taxes have actually reduced on the product – so why this is considered a big-ticket item or reform for governments? For mainly on reason - it is believed as well as observed that a reduction in these cascading taxes increases the incentive for more consumption, leading to higher revenues which compensate for the reduction in tax rates. Hence, nations promote GST. But that is not the lone reason to ask for GST in India. To understand this, we must realize how India's tax system works.
India has a federal system of governance, and the right to impose taxes is given both to central and state governments. Because of the right to impose taxes, both central and state governments also have the right to decide whether documents of manufacturers and/or wholesalers shall be accepted for tax credits or not while deciding on the retail price of the product. In many cases, state governments refuse to accept tax credits for taxes paid by manufacturers and/or wholesalers in other states.
In other cases, they refuse to accept tax credits for taxes paid by manufacturers or wholesalers to the Centre. In both situations, the consumer has to pay higher taxes, since tax is paid not on value added by the retailer, but on the final output value of the product at the retail end. In the example situation we gave, it would mean a tax of Rs. 22 at the retailer end instead of Rs. 7, entailing a higher burden of taxation on the consumer. Sometimes, some products are allowed tax credits but others are not allowed even when all other details are the same.
Because various state governments have their own rules and regulations with regard to accepting tax credits for taxes paid to other governments at different levels, manufacturers, wholesalers and retailers have to keep in touch with the latest rules and regulations formulated in this regard, and maintain a substantial set of machinery to keep up with these rules. This increases the transaction cost of bearing higher taxes – particularly for the manufacturers who want to earn higher profits through higher sales.
In addition, state governments too have to maintain a substantial administrative machinery to ensure that these rules are strictly enforced. All in all, this is a highly cumbersome process. And of course, there is the threat of tax authorities at the state level fleecing people at either of these ends – manufacturers, wholesalers or retailers.
GST simplifies the whole procedure and makes India a single unified market, thereby removing all these complications for people at all ends and making tax collection a much simpler process. It also makes it easier for the administration to certify that the taxes have been paid properly. And for the consumer, it ensures benefit through reduction in prices, incentivizing greater consumption. All in all, GST indeed helps everyone.
In addition, one must note that Figure 2 can be achieved for material products by VAT, but this leaves two loopholes: one, it allows states to decide VAT rates individually in their own territory; and two, it does not cover services which are taxed separately and differently across states. GST addresses this loophole as well and unifies India both in goods and services. In addition, currently different taxes are paid to different authorities at different levels, and it can’t be ensured that the same person is paying taxes to all – ensuring tax compliance is a big headache. GST is expected to address this as well.
With regard to this particular bill introduced by the Modi government in Parliament, it is a constitutional amendment bill and has to be passed not only by 2/3rd majority of both houses of the Parliament (with at least half the house to be present and voting) but also by at least half the state legislatures in the country for it to be ratified by the President and become an Act.
The features of this Act are as follows:
a) The Bill amends the Constitution to introduce the Goods and Services Tax (GST). Now, GST will subsume both the indirect taxes imposed by the Central Government – such as the Central Excise Duty, Central Sales Tax, Countervailing Duty and Service Tax. It will also subsume the state indirect taxes – such as the state Value Added Tax or VAT, Octroi and Entry Tax and Luxury Tax.
b) Under the current arrangement where GST is not yet implemented, goods can be taxed only by the states while services can be taxed only by the Centre. This act will give the central and state governments the concurrent power to make laws on taxation of goods and services.
c) The Centre and states will together implement the uniform GST which will be a “dual” GST – comprising of Central GST and State GST, which shall be legislated, levied and administered by the respective levels of government. The same taxable base will be subject to both GSTs. By subsuming various taxes and simplifying the complicated tax structure, it is expected to reduce compliance costs.
d) Within 60 days of the Act coming into force, the President has to constitute a Goods and Services Tax Council (GST Council) – this council is for the purpose of developing a harmonized national market of goods and services. It will consist of the Union Finance Minister as Chairman, the Union Minister of State in charge of Revenue or Finance, and the Ministers in charge of Finance or Taxation or any other as nominated by each state government.
e) We have already stated that a single system of tax administration will lead to simplification. Since collecting and verifying documents for claiming tax credits across states is an onerous task, only the Centre has the right as per the bill to levy and collect GST on supplies in the course of inter-state trade or commerce. The tax collected would be divided between the Centre and the States in a manner as decided by the Parliament, current laws, and the recommendations of the GST Council. In the 2011 bill introduced by the previous UPA government, the power to decide how to apportion the taxes between the Centre and State was with the Parliament – this power has been given in the 2014 law to the GST Council.
f) The GST council has been given several functions. These include making or giving recommendations on:
- Taxes, cesses and surcharges levied by the Centre, States and local bodies, which can be subsumed in the GST
- Goods & Services which may be subjected to or be exempted from GST
- Model GST laws, principles of tax levy, how to apportion the integrated GST (IGST) obtained through inter-state trade or commerce among states and the Centre, and principles governing the place of supply
- Threshold limit of turnover below which goods and services can be exempted from GST
- Rates including floor rates with bands of GST
- Special rates to raise additional resources during any natural calamity
- Special provision with regard to North-Eastern States (Manipur, Meghalaya, Arunachal Pradesh, Mizoram, Nagaland, Sikkim, Tripura) and other special category states (Jammu & Kashmir, Himachal Pradesh and Uttarakhand)
- Any other matters
The items highlighted in bold are those which were missing in the 2011 bill from the functions of the GST Council.
In addition, the GST council shall also deliberate upon the modalities based on which disputes arising out of its recommendations shall be resolved. The GST Council shall also decide upon the actual GST rates on various types of commodities.
g) An interesting aspect is that in the 2011 bill, the presence of only 1/3rd of members was required to constitute the Quorum – this has been increased to half in the 2014 bill. Also, while the 2011 bill talked about every decision of the GST council to be taken with consensus of members who were present, the 2014 bill clearly lays out that every decision of the GST Council should be approved by at least 75% of weighted votes – with the Centre having 33% of weighted votes and the states combined having 67% of weighted votes.
This has been recently opposed by the Uttar Pradesh government though – which wants to increase the share of states to 75% weighted votes.
h) Disputes had arisen between Centre and States on many counts. One such point of contention was with regard to the compensation to be paid to states by the Centre on account of loss of revenue in the initial years. The 2011 bill had no provision for any compensation. The Standing Committee in 2013 had suggested that a GST Compensation Fund be set up and operate as an automatic, built-in mechanism for compensation to states to address their revenue loss concerns.
The 2014 bill has partially incorporated this mechanism by stating that Parliament, on the recommendations of the GST Council, can provide for compensating states for revenue losses arising out of implementing the GST – but only up to a period of 5 years. The compensatory revenue package will allow the Centre to reimburse 100% of the revenue loss for the first 3 years, followed by reimbursement of 75% of loss in the 4th year and 50% loss in the 5th year.
i) Another major point of contention between the Centre and the States was with regard to bringing petroleum products and alcohol within the purview of GST – the issue was that many states obtained substantial revenues by imposing higher taxes on these goods, and they felt that a uniform rate of taxation across the country would lead to lower tax rates in their territory, leading to a loss of revenue for them. The 2011 bill had addressed this concern by exempting crude oil, diesel, petrol, natural gas, ATF (aviation turbine fuel) and alcohol consumed by humans out of the purview of the GST Bill.
This had been opposed by supporters of GST as they felt that removing these commodities out of GST would take away a major impact of the reform measure. The 2014 bill arrives at a compromise – alcohol has been kept out of the purview of the GST, while the other goods are under the purview of the GST Council, which shall decide whether and when GST shall be levied on these goods.
j) Under the 2011 GST Bill introduced by UPA, a separate dispute settlement authority had been created to address disputes between state and central governments with regard to any loss in revenue or any measure affecting the harmonized tax structure. A detailed structure of the constitution of the authority had also been laid out.
However, based on the recommendations given by the Standing Committee in its report in 2013, the 2014 bill has deleted the provision that created this authority, since it would override the supremacy of Parliament, state legislatures and the GST Council. The GST Council has been given the powers to work out modalities to resolve these disputes instead.
k) An interesting measure is that with regard to levying tax upon entry of goods or on inter-state trade, the 2011 bill allowed states to tax such entry of goods into a local area for use or sale only to the extent levied by a Panchayat or municipality – this provision has been deleted.
However, other provisions – be it on the power of state governments to levy taxes on intra-state trade of petroleum products and alcohol, on the taking away of taxing power on advertisements except for those published in newspaper and broadcast by radio or TV, and on replacing the entry on luxuries (incl. taxes on entertainment, amusement, betting and gambling) with taxes only on entertainment and amusements to the extent levied and collected by a Panchayat, Municipality or a Regional/District Council – all these have been kept in the 2014 bill in the same way as they were in the 2011 bill.
l) With regard to the levy of excise duties – the 2011 bill gave the Centre the power to levy excise duties on goods manufactured or produced in India only with regard to petroleum products and tobacco and tobacco products. It also omitted taxes on services and on sale/purchase of newspapers and newspaper advertisements. This has been retained in the 2014 bill as well.
In terms of pros – there are many. The bill certainly achieves the objective which a model GST would to a substantial extent – removing the cascading of taxes, simplifying tax collection and tax administration which could help reduce tax compliance, improving incentives for consumers to consume more and hopefully leading to greater tax collections, reduced taxation-related costs at all levels from manufacturers to state governments to wholesalers and retailers etc.
The cons would be that a separate tax is being sought to be introduced for manufacturing states though it shall be only up to 1%, and the fact that goods important in terms of earning revenues but also in terms of their impact on economy and society – petroleum products and alcohol have been kept out of the GST. This leaves the option to use these as cash cows for state governments and reduce the impact of GST on an overall basis - and may possibly increase the revenue-neutral rate (RNR) that is charged on all other commodities included in GST - since these products could have been charged at a higher rate to allow lower taxes on other commodities.
(Rakesh Iyer,
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