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Discuss GST Hot topic in India today

I think that it is time today to discuss Goods and services tax its formulation and implementation by 2010.Practitioners should come forward on this topic.


Goods and Services Tax (GST) is a part of the proposed tax reforms that center round evolving an efficient and harmonized consumption tax system in the country.
Presently, there are parallel systems of indirect taxation at the central and state levels. Each of the systems needs to be reformed to eventually harmonize them.

In the Union Budget for the year 2006-2007, Finance Minister has proposed that India should move towards national level Goods and Services Tax that should be shared between the Centre and the States. He has proposed to set April 1, 2010 as the date for introducing GST. World over, goods and services attract the same rate of tax. That is the foundation of a GST. The first step towards introducing GST is to progressively converge the service tax rate and the CENVAT rate.
January 03, 2006

The discussion on tax reforms in the coming months will centre round evolving an efficient and a harmonised consumption tax system in the country.

The prime minister himself has suggested that we should move towards a harmonised goods and services tax. Calibrating such a co-ordinated indirect tax reform in an environment where the states value their autonomy dearly is not easy.

Given that we have parallel systems of indirect taxation at the central and state levels, each of the systems needs to be reformed to eventually harmonise them.

Thus, central excise duty should be converted into a full fledged manufacturing stage VAT on goods and services and the states sales tax systems should be transformed into a retail stage destination based VAT, before the two are integrated by striking a "grand bargain" to harmonise the two systems.

At the central level, considerable progress has been made by converging widely varying tax rates and extending input tax credit to convert excise duties into a CENVAT.

Although on paper full tax credit is supposed to be given for the prior taxes paid on both goods and services, in terms of actual operation, much remains to be done. Besides, to transform this into a manufacturing stage VAT on goods and services requires considerable reforms.

Transforming CENVAT into MANVAT requires further simplification and convergence of excise duties, which, inter alia, also requires conversion of specific duties into ad valorem, with the exception of a few items such as cigarettes.

It is also important to broaden the base of the tax. Almost 40 per cent of the revenue from excise duties is collected from petroleum products alone and this concentration, particularly on a predominantly intermediate good creates severe distortions. It is also necessary to get rid of area-based exemptions and exemptions to small-scale industries, and rationalise concessions on exports.

A necessary reform is the extension of the scope of service taxation to all services and its merger with CENVAT. VAT on goods on services should apply to all services with a small exemption list and a narrow negative list.

Once the service tax is made general, it may be merged with CENVAT to have a common exemption limit and tax rate. After broadening the base by removing exemptions to small-scale industries and area-based exemptions, and general taxation of services, the revenue-neutral rate of tax could be worked out.

A rate of 12-13 per cent at the manufacturing stage would be equivalent to about 10 per cent retail VAT.

Admittedly, the replacement of cascading and narrow based sales taxes with VAT is the most important tax reform in independent India. The major gain from the tax has been to simplify the tax system considerably.

There is need to further simplify and rationalise the system and the Empowered Committee would do well to address them. This includes confining the number of items in the 4 per cent category to basic necessities, and shifting the "inputs", currently taxed at 4 per cent, to the general tax rate.

In fact, the general rate itself could be brought down to 10 per cent from the prevailing 12.5 per cent. In any case, taxes on all inputs will be credited under VAT and taxing the so-called "inputs" at a lower rate only reduces tax compliance.

The real gains from the reform will accrue only when the tax is extended to all the states and tax credit is extended to inter-state transactions. Hopefully, the states that developed cold feet last year will gear up to the reform task this year. A more formidable challenge lies in abolishing the central sales tax.

It is important to finalise the methodology of relieving taxes on inter-state transactions to make the tax system destination-based and build the information system to administer the levy.

The method of zero-rating transactions at the point of inter-state sale on the lines followed in the European Union has found favour in much of the discussions. However, it requires considerable preparation, particularly computerisation, to ensure that the items eventually zero-rated by the exporting state pay the tax in the importing state.

There can be other models requiring pre-payment of the tax by the importers before the tax is zero-rated in the exporting state, but that would add to the compliance cost.

Abolishing the CST will entail loss of revenue to the exporting states and they will certainly demand compensation. The only way possible to permanently compensate exporting states is to give the states additional tax powers.

The time is opportune to return the power to levy VAT on sugar, textiles and tobacco products. But, it should be clear that the levy on tobacco products should be only at the general rate and sumptuary powers of the levy will continue with the centre.

In addition to the above three items, it is also necessary to give the power to levy service taxation to states to make it a retail stage destination based GST.

There can be two methods of sharing the service tax powers. One is to give the states concurrent powers. This would, create some difficulties in the case of all-India services such as railways and telecommunications.

The sale of service to a registered dealer in another state will entail a treatment similar to that of goods and there are no problems.

However, when the inter-state sale is to a final consumer, it is necessary to define the rules of apportioning revenues. Although this may not be entirely destination-based, some operational rules will have to be evolved as in Canada.

The alternative is to share only the services of regional spread with the states, but this would neither bring in substantial revenues to the states nor enable proper levy of the GST at the state level.

Once we have separate central and state VAT systems, the next step is to work on the harmonised GST at the Centre and a piggybacking levy by the states.

Given the prevailing rate structures, on average both could levy the tax at 10 per cent. This will allow complete input tax relief and reduce the compliance cost considerably. But to achieve the "grand bargain", the states have to agree and this can be done only when their fiscal autonomy is ensured.

This can be a long-term objective, but certainly within the realm of feasibility if both the Centre and states act responsibly.

The author is Director, National Institute of Public Finance and Policy.
The proposed model for the general goods and service tax is not likely to be based on the recommendations made by the Kelkar committee and the tax committee for the 10th-Five Year Plan headed by Parthasarthi Shome.

It is also expected that the GST rate will be at 20 per cent or more.

"The suggestions made by the Shome committee and the Kelkar committee are restricted to the Concurrent List and would require extensive constitutional amendment. Since the deadline for GST is 2009-10, we are trying to see how best we can introduce the GST within the existing framework," an official said.

The matter was discussed at a meeting convened by Finance Minister P Chidambaram last week. Ministry officials said a draft paper on the proposed outline for the GST was likely to be ready within the next one month.

Officials said efforts would be made to try and have the GST rate comparable to the international GST rate of 20 per cent.

"At present, the effective value-added tax at the level of the states is around 17 per cent (inclusive of the excise duty on manufactured goods and the central sales tax), while the excise duty is 16 per cent. Hence, the combined tax at the Centre and the states is 33 per cent. This has to be brought down to 20 per cent, which could entail a huge revenue loss for the government," an official said.

In its report, the Kelkar committee had mooted new legislation called the Indian Goods and Services Act to replace the Central Excise Act, and the service tax levied under the Finance Act 1994. The new legislation would provide a well-defined negative list of goods and services for exclusion from the tax net.

It had also recommended that the central GST liability should be based on the in-voice credit method ie. allow credit for tax paid on all intermediate goods or services on the basis of in-voices issued by the supplier.

The Shome committee, in its report, had said the value-added tax on services should be fully integrated with the VAT on goods, both in its design and administration, with an appropriate mechanism to set off service input tax against goods output tax and vice-versa.

"A destination based, invoice credit method, dual VAT -- one at the central level and another at the level of states -- comprising both goods and services could be envisaged by the end of the 10th Plan," the report had said.
A roadmap to goods and services tax

D.K. Srivastava

The Centre may have to bring down the service tax rate under CGST from 12 per cent to 10 per cent. In order to preserve the autonomy of the States, the core SGST rate should be taken as a floor rate.

Bharat Matrimony

Continuing fiscal and tax reforms in India have already prepared the ground for a high growth economy. The revised estimates of growth rate of 9 per cent for 2005-06, 9.2 per cent for 2006-07, and estimates that this momentum will be maintained in 2007-08 are welcome news.

To sustain this heady growth performance over a longer period, we need to complete the process of indirect tax reforms leading to a comprehensive goods and services tax (GST).

Following announcements by the Union Finance Minister that GST may well be in place by April 2010, we can expect the Budget 2007-08 not only to spell out the course but also to take the first few steps.

In a modern economy, separate taxation of goods and services is not viable. Value added in the production and sale of many products require inputs both of goods and services, which may be bundled indistinguishably. Beginning with the early nineties, much has already been achieved on the road to reforming our indirect taxes. Four critical steps remain. First, the central sales tax (CST), currently being levied at 4 per cent, needs to be abolished. Secondly, we need to determine a suitable GST rate, which should be much lower than the sum of core rates of Cenvat at 16 per cent and State VAT of 12.5 per cent, which relate to the taxation of goods. Thirdly, States need to be enabled to tax services and the service tax rate should be same as that for goods. Fourthly, the Centre should be enabled to tax value added in the case of goods up to the retail stage.

These changes would lead to a comprehensive and unified system of taxation of goods and services. As we have a federal structure, the task is not so straightforward.

Reforming the CST

The final reform of the CST lies in its abolition. The tax is levied by the Centre but collected by the State Governments who are allowed to retain the revenue proceeds. It was introduced at the nominal rate of one per cent.

Under pressure from the State Governments, the CST rate was progressively increased to 4 per cent. Over time the CST has become an important source of revenue for some States that are known to be `producing' States. While the tax accrues to the producing States, it is paid by the citizens of the consuming States. As such, the CST has been a vehicle of tax-exportation violating the principle that the tax should accrue to the jurisdiction where the final consumption takes place. The total revenue under the CST is estimated to be Rs 19,345 crore in 2006-07 as per the Budget estimates. Some of the major States such as Maharashtra, Gujarat, Karnataka, Tamil Nadu, Haryana, and Andhra Pradesh have a comparatively high share in this revenue. Considering Rs 20,000 crore as the potential revenue under CST for the current year, a decline of 1 percentage point in the CST rate would involve a loss of about Rs 5,000 crore, and the individual annual losses for the States could range from about for Rs 170 crore for West Bengal to Rs 550 crore for Maharashtra. Part of the loss would be made up by increase in the tax base.

In addition, the State Governments are likely to be allowed to levy State VAT at the rate of 4 per cent on imports. This would be comparable to the countervailing duty that the Centre levies on imports. There is also a proposal to exclusively assign revenues from a select set of services to the States as part of the compensation. All signs are that the first steps towards abolishing the CST will be taken in the 2007-08 budget.

Achieving the Long Run GST rate

Achieving the desired overall GST rate decomposed into its Central and State components is a more difficult task. Both tiers of governments have to jointly bring down the overall tax rate, which at present amounts to 16 per cent and 12.5 per cent on the respective tax bases of the Cenvat and State VAT as far as manufacturing and sales of goods are concerned. While the tax rate on goods can come down, that on services, which is at 12 per cent may have to be incrementally uplifted to bring it closer to the long term desired norm.

The suggestion of the Kelkar Committee to aim at a 20 per cent combined GST rate seems to be a suitable target as it compares well with some of the international GST rates. The highest GST rates are in Sweden and Denmark at 25 per cent. Countries at the higher end of the tax rate are Iceland at 24.5 percent and Finland at 22 per cent.

At the lower end, Switzerland, Japan, Thailand and Singapore have GST/VAT rates at 5 per cent or marginally above. Most countries have GST/VAT rates that are less than 20 per cent. For example, in the UK the VAT rate is 17.5 per cent, Spain 16 per cent, Russia 18 per cent, France 19.6 per cent, and Germany 19 per cent. Canada is a federal country where both the federal and provincial GST rates are charged. The combined incidence of federal and provincial rates varies between 6 per cent and 14 per cent.

Central, State Components of GST

There has been a debate on whether we should go for a completely centralised GST, or agree to a State GST. A centralised GST provides harmonisation of tax rates and exemptions by definition. On the other hand, an exclusive State level GST takes state autonomy to the extreme and calls for external harmonisation efforts apart from reducing Centre's capacity of equalising transfers in a country characterised by extreme disparities.

In the medium term, with a view to preserving our federal structure, a system of concurrent taxation consisting of a State GST (SGST) and a Central GST (CGST) seems to be a viable option. One critical question is determining the component tax rates of CGST and SGST keeping in mind the benchmark for the overall tax rate. If the equation of pre- and post-devolution accrual of resources is not to be disturbed as this, in broad terms, has been stable for long years, we may have to settle for almost equal levels for the two components, that is, 10 per cent each. In 2006-07, as per estimates the States are expected to raise about Rs 1,60,000 crore under the State sales taxes and the total revenue of the Centre under the Union excise duties plus service tax comes to about the same as shown in the graph.

This suggestion differs from the recommendation of the Kelkar Committee, which had suggested a division of the 20 per cent GST rate where 12 per cent is for the Central GST and 8 per cent for the State GST. The Twelfth Finance Commission (TFC) had also observed that the 12:8 ratio in favour of the Centre can increase the vertical imbalance in the system.

Administering the Concurrent GST

While the indirect tax system converges to a GST, there is also the issue of reshaping administration of the Centre and State Governments to cater to its implementation. The Centre's administrative capacity vests with the Central excise department whereas the States have a larger capacity in the form of States sales tax establishments. It would be ideal to use both in the implementation of GST. Some areas may have to be exclusively assigned for the central establishment like the taxation of services of an inter-State nature. Services that are retailed may be taxed by the state administration.

In all cases, taxes will have to be collected under two columns pertaining to CGST and SGST. The levy and sharing of tax revenues where extensive inter-State transactions are involved would also cause some problems. However, with the help of IT systems and effective compilation and processing capabilities, it should be possible to handle these problems without much difficulty.

From 2007-08, the adjustments needed may be: one, downward adjustment in the core Cenvat rate to lower than 16 per cent. Secondly, States should be extended the power to levy service tax, which can go up to 10 per cent. Concurrently, the Centre should have the extended power to capture value added up to retail stage under Cenvat.

Finally, the Centre may have to bring down the service tax rate under CGST from 12 to 10 per cent. In order to preserve the autonomy of the States, the core SGST rate should be taken as a floor rate. States if they so desire can raise their state-specific SGST rate above the floor.

However, in an integrated market, competition will ensure that the SGST rates do not diverge unduly. High growth years are the best years to undertake structural reforms in taxation, because growth absorbs most of the initial revenue shocks. It creates a virtuous cycle as tax reforms enable sustained high growth, which facilitates the absorption of initial revenue shocks.

The author is Director, Madras School of Economics. The views expressed here are his personal views.

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