GST- AN OVERVIEW

1. GST- AN OVERVIEW CA DrArpit Haldia FCA, CS, CWA, LLB, Ph.D., DISA, DIRM(ICAI) November 6, 2015

2. Historical Background • State VAT Implemented on Report prepared by National Institute of Public Finance and Policy in 1994 prepared by Dr AmareshBagchi (Hereinafter referred to as BagchiReport)` • The Tax Structure at that time was observed by the Bagchi Report as follows: • “archaic, irrational and complex-according to knowledge Experts, the most complex in World”

3. Historical Background Contd… • Bagchi Report while recommending VAT Observed and clearly laid down that implementation of VAT is only a temporary Solution. • In DOEA Report of March 2009 it was specified referring to observation of Bagchi Report that It would not be the perfect or first best solution to the problems of the domestic trade tax regime in a multi government Framework. However the team felt that this was the only feasible option within the existing framework of the Constitution and would lay down foundation for an even more rational regime in the future.

4. Impediments from the System in place in 1994 • Levy of Taxes at Manufacturer Level/First Sale Point • Exclusion of Services from tax base • Taxation of Inputs and Capital Goods • High Level and Multiplicity of Tax Rates • Taxation of Inter-State Sales and Lack of Harmony in States Sales Tax Systems • Complex Law and Archaic System

5. Taxation at Manufacturer Level/First Sale Point/Exclusion of Services • Base for Excise duty was Production and Base for Sales Tax was Sales or Purchase • They were being levied at one single point i.e. First Sale point of the Goods. • Tax Burden on one Base • Levy of Tax at First Point either on Imports or Manufacturing. • Manufacturing not Easy to Define i.e. Processing, Manufacturing , Marginal Manufacturing

6. Taxation at Manufacture Level and Exclusion of Services and Levy of Tax at First Point • Services were excluded from the Taxation Base • Valuation issues in Sales Tax at First Point: • Do not the Include Distribution Margin and Associated Services. • Forward the distribution functions i.e. Processing and Packaging are contended by the assessee to be not liable to excise • Sales either to related parties or at artificially low prices

7. High and Multiple Tax Rates • High and Multiple Tax Rate • Narrow Base • Tax was Levied at the First Point so as to Tax the Distribution Margin • States then resorted to Levy of Turnover tax, Additional Sales Tax. Surcharge • High Tax Rate also Incentivized Tax Evasion and Exemptions • Increasing Complexities for the Classification of Goods

8. Cascading Effect of Taxation • Every time goods change hands, if tax is levied and no Credit allowed • Results in Multiple Taxation on same Goods • Results in Forward Vertical Integration of the Supply Chain i.e. Direct Sales Offices of the Company • Results in Backward Vertical Integration as no Credit of the Tax paid on Inputs is allowed • Taxation of Capital Goods results acted as hindrance in Capital Investment

9. Cascading Effect of Taxation • Local Goods being Incompetitive with the Imported Goods • Actual Incidence of Tax Not Known to the Consumer paying anonymous amount in the Name of Tax • Incentive results in distortion in Competition B/W New & Existing Unit • Partial Coverage of the Centre and State Taxes

10. Effect of Exemptions in High Tax Rate Scenario • Narrower Base becomes more Narrow • Exemptions to SSI Units: Turnover not crossing the Threshold Limit • Exemptions Granted to Charitable Institutions • Exemptions to New Units in each state encourage relocating of the Unit on Expiry of Time Period

11. Taxation of Inter State Sales • In 1994, 4 High Income States having 20% Population accounted for 45% of Total Revenue of CST • States Having 44% Population accounted for 18% of Tax Revenue • States engaged in undercutting of Taxes to Attract Trade and Industry • Automobiles Taxes at Rate lower than Cereals

12. Taxation of Inter State Sales • Incentive to open branches in each State to avoid CST • Customers in States not having Branches to pay more than other States and Incentive for • Customers move to outer States for Purchases • Multiple Sales in CST results in Cascading Effect of Taxation

13. Taxation of Inter State Sales • Hidden Taxes on Exports • Incentive to Undervalue the Imports to evade tax • Export of Taxes by the Producing States to the Importing States and Extend their Tax Base to citizens of Other States

14. Taxation of Inter State Sales • Argument put forward in Favour of Levy of CST • States need to collect at some to recover the cost of infrastructure and public services • In the absence of a tax on inter-State sales, the location of export industries within their jurisdiction would not contribute to the tax revenues of the exporting State.

15. Taxation of Inter State Sales • Any value addition means extra income in the hands of residents which means more spending of this income on consumer goods. • This enhanced spending expands sales tax base of the producing States and, thereby, contributes to their revenues. • It is for this reason that countries are prepared to let exports leave their boundaries free of any domestic taxes. If zero tax makes sense for exports to other nations, it should make equal sense for exports to other States.

16. Competition Amongst the States for Tax Revenue • Competition in Tax Rates • At one Time Orissa Reduced the Tax Rate on TV from 16 percent to 4 percent and correspondingly Increased Tax Rate on basic food items from 0 to 4%. • Revenue loss occurring to States from consumers purchasing goods from outside the State has sought to be offset from Levy of Entry Tax

17. Suggested Reforms • Extend the Tax Base to Retail Stage • Bring Services in the Taxnet • Enlarging the Tax Base by Inclusion of services and Extending the Tax Base to Retail Stage would result in lowering of Tax Rates • Removal of CST • Entire System was required to be overhauled with narrow base, multiplicity of rates, selective exemptions and ambiguous laws facilitate and encourage tax avoidance and evasion

18. Historical Background Contd.. • MODVAT Implemented W.E.F. March 1, 1986 • Complete CENVAT Allowed in the Year 2002-03 • Service Tax Added to CENVAT in 2004-05 • VAT Introduced w.e.f. 2004-05 in Various States of the Country • VAT implemented in Rajasthan April 1, 2006

19. Historical Back ground Contd.. • Implementation of State VAT Eliminated Following Inconsistencies • Removal of First point Tax • Uniformity in Tax Rates • Reduction of Harmful Tax Competition amongst States • Lessening of Tax Cascading Effect • Reduction of CST from 4% to 2%

20. Historical Background Contd… • Implementation of CENVAT • Application of CENVAT at Fewer Rates • Fewer Classification Disputes • Reduced Tax Cascading Effect • Implementation of Service Tax • Broadened Tax Base • Implementation of Negative List to Reduce Tax Litigation as Suggested in Report Submitted by DOEA in March 2009 • No Standardized Nomenclature of Service such as HSN

21. Issues in the Present Scenario of Tax Structure • Constitutional Issues which do not allow Centre and State to Levy Tax on a Comprehensive Base • On All Goods and Service • At all points of Supply Chain

22. Issues in the Present Scenario of Tax Structure • Exclusion of Services from the Power of the States to Levy Taxes • Traditional Distinction Between the Goods and Services has become obsolete i.e. Goods and Services being offered in Bundle • Neither State and Nor Centre can tax Bundle Services in a Comprehensive Manner resulting in controversies • Exclusion of Tax on Services results in Narrow Base of Goods for the States to Earn Revenue resulting in Higher Tax Rate

23. Issues in the Present Scenario of Tax Structure • Reasons for Cascading Effect of the Present Tax Structure • Exempt Sectors Not allowed to claim any Credit for CENVAT, Service Tax and VAT Paid on Inputs • CST Collected by the Origin State and No Credit being allowed by the Destination State • Estimate for CANADA, estimated that One Third of the total Collections in CENVAT and 35-40% of Total Collections in VAT estimated to be Non-Creditable • No Credit allowed for Centre and States Taxes amongst themselves

24. Issues in the Present Scenario of Tax Structure • Multiple Tax Rates • Complex Classification of Goods • No Concrete Basis for determination of Tax Rates with Lowest Tax Rate to Luxurious Goods • Not Conducive for Lower Determination Cost with dealers finding it hard to determine Tax Rate and Consumers being Completely Unaware

25. Issues in the Present Scenario of Tax Structure • Existence of Exemptions • Breaks the Supply Chain • Determination of Transaction being a Transaction of Sale or Transaction of Services • Eg. Softwares, Works Contracts, Building Contracts, Application Downloads

26. Objective of Tax Reforms • Wide Tax Base to cover all items of Goods and Services and Dealers • Reduction in Cost of Implementation of Tax Structure by Simplification • Harmonization in the Tax Levied by the Centre and the State • Neutrality Principle of Taxation • Principle of Destination Based Taxation

27. Objective of Tax Reforms • Degree of Fiscal Autonomy to Centre and States as power to Govern and Raise Revenue go together • Dual GST Preferred over other Models • Centre and State retain the power to enact the Tax • Enjoy the Risk and Reward of the Ownership • Be accountable to their Constituents • Able to us Tax as an Instrument for Social or Economic Policy

28. Objective of Tax Reforms National GST not preferred over Dual GST because of the Fiscal Autonomy Issues as Follows • Control over Tax Rates is necessary for achieving the sub-national Governance • Revenue Sharing may become subject to Social and Political Considerations • Deviation from Benchmark of Destination Based Taxation possible • Too Much Centralization of Powers as also feared in Bagchi Report

29. Revenue Neutral Rate under GST • Poddar and Bagchi Report (2007) suggested RNR under GST of 12% with the exception of Motorfuels to attract Supplementary Levy. • Constraints in a Lower RNR • Pressing Calls for Exemptions • Taxation of Food including Agriculture Products • In 2005 Food accounted for one-third of total Final Consumer Expenditure

30. Revenue Neutral Rate under GST • Food includes grains, cereals, prepared meals, snacks, Fruits and Vegetables • Taxation of Foods articles in VAT ranges from mostly being Exempted to generally being Taxed at 4-5% and in Few Cases at the Maximum Tax Rates • Taxation of Agriculture or Farm Produce • As per DOEA Report 2009 Food being provided total Exemption raises the RNR from 10-12% straightaway to 18%, Lower Rate of Food takes the RNR to 16%

31. Origin and Destination Based Taxation • Tax can be levied on two Principles • Origin Based Taxation: Where the goods or services are produced or transaction is originated • Destination Based Taxation: Where the goods or services are consumed i.e. Consumption Tax

32. Four Possible Alternatives to Tax Trade between two Jurisdictions • Goods to be taxed in both states, giving rise to double taxation. • Goods would not be taxed in either state therefore gives imports an advantage over domestic production. • Goods are taxed only in the state of origin i.e. Origin Based Taxation or • Goods are Taxed only in the state of destination i.e. Destination Based Taxation

33. Example of Origin Based Taxation • Transaction: A in Gujarat produces the goods and sells the goods to B in Rajasthan, • State in which Tax is levied and Collected: State of Gujarat • The revenue in the case of origin based taxation should accrue to the place, where the goods or services are produced and not to the State where they are consumed.

34. Example of Destination Based Taxation • Transaction : A in Gujarat produces the goods and sells the goods to B in Rajasthan, • Tax in Such case should be levied and Collected: State of Rajasthan • The revenue in the case of destination based taxation belongs to the place, where the goods are finally consumed and not to the State where the goods are produced.

35. Taxation of Exports • Origin Based Taxation: Exports would always be taxed in the origin based taxation as tax under this principle is levied on goods or services produced in the territory. • Destination Based Taxation: Exports would not be taxed and would be zero rated in the territory as tax is levied in the territory where the goods or services are finally consumed.

36. Taxation of Imports • Origin Based Taxation: Imports would not be taxed in the territory where they have been imported for consumption • Destination Based Taxation: Imports would be taxed in the territory where they have been imported as they would be consumed in that territory.

37. Present Practice in India for Taxation of Imports and Exports • Destination based taxation • Import of Goods or Services: Levy of different types of Import Duty and Tax in case of import of services from outside the country in the form of Reverse Charge Mechanism. • Exports of goods or services to other countries from India: Zero Rated i.e. taxed at zero rate and any Taxes levied are refunded to the Exporters

38. Issues arising in Destination Based Taxation • Taxes administered, levied and collected by one single Government i.e. either National or State Government: • In case of a Multipoint Taxation Structure wherein tax is administered, levied and collected by a single government i.e. National or State, entire revenue accrues to that government only.

39. Issues arising in Destination Based Taxation • Taxes administered, levied and collected by Different State Governments: • In case of Inter-State movement of goods or supply of services from one state to another and tax is administered, levied and collected by different State Governments, issue arises for levy of tax and subsequent credit of the tax paid with regard to the inter-state movement of goods or supply of services.

40. Destination Based Taxation Vs Origin Based Taxation • Non-cumulative character of the VAT :-Tax paid in previous stages is recovered, • In a destination-based environment, though, items shipped from one state to another are not subjected to VAT, so no recovery is needed. • This requires VAT must be removed from products leaving the state and then added upon entry in the importing state, at the importing state internal rate.”

41. Destination Based Taxation Vs Origin Based Taxation • Recovery mechanisms only apply to inter-state trade if the states are subjected to the origin principle. • If taxes are levied at the time of export of goods or services from one state to another, it would be origin based taxation which would tend to move towards destination based taxation provided the revenue is transferred by the exporting state to the importing state.

42. Principle of Neutrality in Taxation • Tax on laptop is 5% and desktop computer is 14.5%. being closed substitutes of each other • Services obtained from a service provider in India is charged with service tax at the rate of 14% and same services procured online from a service provider from outside India, not chargeable to tax.

43. Principle of Neutrality in Taxation • Excise duty is leviable on Manufacturing Cost out of the entire selling price. Products having high distribution margin face a relatively low excise than goods wherein cost of production is high and distributor margin is low. • Inter-State Trade: Trade Off Between CST Sales and Consignment Sales

44. What is Principle of Neutrality • Tax be a uniform percentage of the final retail price of a product, regardless of the supply-chain arrangements for its manufacturing and distribution; • ·Tax on inputs be fully creditable to avoid tax cascading; and • ·Tax be levied on the basis of the destination principle, with all of the tax on a given product/service accruing in the jurisdiction of its final consumption.

45. What is Principle of Neutrality • Full right to deduct the Input Tax through the supply Chain to avoid the cascading effect of taxes • Businesses in similar situations carrying out similar transactions should be subject to similar levels of taxation. • VAT rules should be framed in such a way that they are not the primary influence on business decisions.

46. What is Principle of Neutrality • Close substitutes should not be taxed at very different rates—to avoid leakages and distortions. • With respect to the level of taxation, foreign businesses should not be disadvantaged nor advantaged compared to domestic businesses in the jurisdiction where the tax may be due or paid.

47. What is Principle of Neutrality • Due to the anti-cascading effect, the number of times a product is traded before reaching the final consumer or how much of the value is added at what stage in the production-distribution process are of no consequence under a VAT • Other things remaining the same, the tax liability does not vary as between corporate and non-corporate entities, or between integrated or specialized units

48. What is Principle of Neutrality • To ensure foreign businesses do not incur irrecoverable VAT, governments may choose from a number of approaches. • System of applying for direct refunds of local VAT incurred; • Making Supplies VAT Free; • Enabling refunds through local VAT registration; • Shifting of the responsibility on to locally registered suppliers/customers; and • The granting of purchase exemption certificates.

49. What is Principle of Neutrality • Specific administrative requirements for foreign businesses should not create a disproportionate or inappropriate compliance burden for the businesses.

50. Proposed System of Taxation • Two Tier Structure • CGST • SGST • Covering all transactions of Centre and State • To be Implemented through Multiple Statutes (One for CGST and SGST for Every State)