Premature GST will drain National Exchequer

Premature GST will drain National Exchequer
By Asish Kumar Raha
(formerMemeber, CBEC, & advocate)


First Discussion Paper on Goods and Services Tax (GST) in India, released by the Empowered Committee (EC) of State Finance Ministers on November 10, 2009, brings out the schematic blueprint of GST with several loose ends.

One distinctive and welcome feature of GST is the concept of Inter-State Goods and Services Tax (IGST), found missing in the prevailing State VAT. It is, no doubt, an improvement over the current practice of treating inter-state transactions as export or import for the purpose of granting refund or levying State VAT sans credit, as the case may be, thus snapping the credit chain the moment the goods cross the state border. The GST template in the Discussion Paper suggests seamless flow of credit throughout the country along the supply chain up to the retail stage and has thus addressed one of the fundamentals of VAT/GST. But to make that concept work satisfactorily, other fundamental requirements needed to be addressed as well. This is where the Discussion Paper is found wanting. Before we examine the shortcomings, let us first discuss the salient features of the IGST model.

First of all, while the threshold of gross annual turnover of Rs 10 lacs, both for goods and services, has been recommended for all the States and Union territories, the tentative decision is to persist with the current threshold of Rs 1.5 crore for Central GST (CGST). Secondly, it has been decided that Centre would levy IGST which would be inclusive of State GST(SGST) and CGST on taxable goods and services, with appropriate provision for consignment or stock transfer of goods and services without paying any such tax. Thirdly, while paying IGST, the inter-state seller can utilize credit of IGST, CGST and SGST. Fourthly, the exporting State will transfer the credit of SGST used in payment of IGST to the Centre for onward transmission to Destination State wherein the importer will claim credit of IGST while discharging his tax liability. Further, it is decided that export shall be zero rated with provision for refund of unutilized credit. Fifth, the Centre will work as a clearing house to verify the claims and inform the respective governments to transfer the funds. Lastly, it is stated that the major responsibilities of IT infra-structural requirement will be shared by the Central Government through the use of its own IT infra-structure facility. The synergy between the States IT infra-structure including TINXSYS and Central IT infra-structure will also be addressed. All inter-State dealers shall be e-registered and correspondence with them will be by e-mail. Consequently, it was hoped that compliance level would improve substantially.

Let us now dwell upon the shortcomings and pitfalls that have been overlooked in the First Discussion Paper.

A. On the need for uniform threshold limit:

Different threshold limits for SGST and CGST, as has been indicated in the First Discussion Paper, will offer serious challenge to synergy and exchange of data between the Central IT System and those of the States. Besides, such divergence will pose insurmountable difficulties for the Centre while implementing IGST model. To be more precise, a State assessee for SGST (with an annual turnover of less than Rs 1.5 lac) will also be a Central assessee for the purpose of IGST only, but it will be deprived of input credit of CGST on account of its turnover being less than the threshold, thus attracting limited cascading effect. Besides, Central Government is not likely to have any trading or manufacturing level data of such non-assessee which will seriously affect e-scrutiny of its IGST Return. Therefore, in the interest of efficient working of the system, it is important that the threshold limit in respect of SGST and CGST becomes uniform.

B. On tax liability upon stock-transfer of goods and services:

The First Discussion Paper suggests that there should be separate provisions for consignment/stock transfer of goods and services, meaning thereby that such consignment/stock transfer should be free of IGST (or any GST for that matter), as otherwise there was no need for separate provisions. This would be fraught with intricacies. The question that would logically arise is who will be responsible for crediting SGST collected in the exporting State to the Destination State. Surely not the Centre if no IGST is levied. If it is the exporting State which will be required to credit the amount directly to the Destination State, a separate procedure is to be contemplated in respect of consignment/stock transfer only. This will add to complication inasmuch as the IT programme pertaining to inter-State transactions is supposed to be developed by the Centre and not the States. Besides, inter-State stock transfer in the absence of e-tracking may end up by snapping the credit chain so far as SGST is concerned. Viewed in perspective, it is, therefore, advisable that stock transfer should also be subjected to GST on deemed value, a concept well known in indirect taxation.

C. On utilization of IGST, CGST and SGST credit:

To enable e-scrutiny of credit utilization, the Return format of the assessee ought to provide for separate column for each category of tax paid, viz. IGST, CGST and SGST and each category of input credit availed of (with opening and closing credit balances). Even though Centre is not responsible for collection of SGST, data pertaining to SGST will be relevant for e-scrutiny of IGST at a macro level. Since inter-State trade is common place, a consolidated Return for central GST (inclusive of IGST and SGST) is advisable rather than going for separate IGST Return.



D. on transfer of SGST credit to the Centre and refund of unutilized credit against exports:

It takes about two years, if not longer, for an exporter to get VAT refund arising from the export of goods to another State. There is no reason for optimism that SGST credit to the Centre in a case of inter-State trade will materialize in a shorter period, particularly when verification process at the end of the exporting State will be far more complex. The following illustration will elucidate the above proposition.

Illustration:

X (manufacturer of tyres) in State A receives his inputs from States B, C and D and sells his finished product (tyre) to Y (car manufacturer) in States E and F on payment of IGST after availing of credit of IGST, CGST and SGST. Y transfers the cars to Z (dealer) in State G on payment of IGST after availing of credit of IGST, CGST and SGST. The cars are eventually sold to consumers in State G.

In this illustration, SGST credit will have to be transferred in the first instance by States B, C and D to the Centre for transmission to State A, and then by State A to the Centre for States E and F, and thereafter States E and F to the Centre for State G. Since there is no mechanism yet to e-capture transaction level details, it would be extremely difficult for the exporting States to verify facts from the aggregated data captured from the Return and to satisfy itself that the SGST credit utilized by the exporter was in fact deposited to its Treasury. Secondly, if A is yet to receive SGST credit from B, C or D in full via the Centre, A will have its justification to withhold the payment to the Centre for States E and F. Thirdly, the fear that once the SGST credit is transferred to the Centre, it would not be possible for the exporting State to get back the amount even if investigation proves that the credit was fraudulently availed would deter the latter from transferring SGST credit to the Centre without thorough scrutiny and verification.

In the event of understandable delay in the transfer of SGST credit to the Centre from the exporting State, which may go beyond two years, there are only following two possibilities. Either the Destination State will starve of revenue or the Central Exchequer will bear the cost, having undertaken to meet the revenue deficiency of a State after GST has been introduced. On a rough but reasonable estimate, about 90% of the transferable SGST credit is likely to remain outstanding in the first two years, and if the Centre is to bear the brunt of it, Hon’ble Union Finance Minister should be prepared to accept sharp depletion of revenue on account of systemic failure.

As regards refund of unutilized credit of SGST against exports out of India, the First Discussion Paper does not throw any light. It is, however, not difficult to foresee insurmountable difficulties for exporters to obtain such refund for want of clarity as to which State will be responsible for granting refund in a case where IGST has been levied but goods have not been consumed in the Destination State for reason of its export out of the country.

E. On the Centre working as a Clearing House:

The Clearing House concept to administer inter-State GST was earlier conceptualized and proposed for implementation in member countries in 1990s by the European Commission (EC) following origin principle. But it was eventually given up owing to absence of an effective IT system in member countries to capture transaction level data in real time. When internal fiscal frontier in the EU countries was removed in the early 1990s, the European Commission proposed that each country levy tax on exports to other member States, and the importing member then allow full credit for that tax against its own VAT. Under a Clearing House arrangement, the importing country would then reimburse the exporting country for that credit. Consequently, revenue in each country would be exactly the same as under Zero rating exports. The GST model proposed by the Empowered Committed in the First Discussion Paper is based on destination principle and that explains why the transfer of credit will be in the reverse direction, i.e. from the exporting State to the importing State.

Be that as it may, an effective IT system to capture transaction level data was recognized by European Commission as sine qua non for effective implementation of borderless GST system. There is no valid reason why we should think otherwise in respect of IGST. It is pertinent to mention in this regard that on the Recommendation of Ramanan Sub-Committee, the Empowered Committee of the Finance Ministry headed by Dr. Parthasarathy Shome recommended development of an electronic self-regulated invoice capturing module for credit accounting, which, however, could not be implemented for administrative and technical reasons. It is time to re-visit and to put into effect the said recommendations in the interest of successful implementation of GST in India. If GST is introduced before IT system to capture transaction level data is in place, there is every possibility of gross abuse of the system by some unscrupulous traders, thereby raising the price of compliance too high to be competitive.

F. On substantial improvement of compliance level owing to IT infra-structure:

Realistically, neither the Centre nor the States have an IT infra-structure in place, which is capable of meeting GST requirements of credit accounting and doing e-scrutiny of the Returns filed. The existing Automated Central Excise and Service Taxes (ACES) Module is a little more than dematerialized Return with aggregated data that would be quite inadequate to address the issue of inter-State credit accounting or to detect credit fraud. It has taken nearly 4 years to commission ACES. Obviously ACES needs to be replaced by a much more effective IT credit-accounting GST module which would capture transaction level data, if not in real time, at least off line. What is needed is a realistic projection of time for development of the said IT system with wide area network and appropriate server back-up and the introduction of GST may be deferred till then unless we are desperate to introduce a half-baked taxation system to invite chaos.

Incidentally, the experience of GST compliant countries, even with their strong IT infra-structure, is not at all encouraging, so far as tax evasion is concerned. On a modest estimate, the UK loses annually over 10 billion sterling pounds of VAT through Missing Trader and carousel frauds while other EU countries collectively lose about 100 billion Euros annually on same account. In Canada, since the inception of GST in 1991 till March 2003, about 600 individuals and businesses have been convicted of GST fraud. On a modest estimate, tax evasion in India may work out to 40% of the total CENVAT collected by the Centre and considerably higher in States. Given the above background of lack of effective IT infra-structure and the adverse experiences of western countries and India as well regarding level of tax compliance, we do not find any ground for optimism that GST per se will substantially improve compliance level. On the contrary, a lax system may be enough to sap the growth and vitality of compliant Indian industries and businesses.