GST: The Final Frontier

The following discussion is largely based on the talk and follow up discussion by Mr. K Balamurugan, Indian Revenue Service, Customs & Central Excise. He provided a candid view of GST, its origins, implementation, and challenges. We also discussed about the impacts on the manufacturing sector. This discussion is preceded by the previous interview and would provide a holistic view on where GST stands in the taxation structure of India.

GST: The journey so far

GST is the much-needed fiscal reform needed in the country. Many opponents of GST give the argument that it is a regressive tax, effecting the poor as well as the rich. However, studies have shown that indirect taxes could be the best way to bring tax equality. The split of tax revenue in India is 50-50 between direct and indirect taxes [data]. The long-term aim is to push this more towards the realm of indirect taxes. This step promises to increase the governments tax revenue.

The foundation of GST was laid down in 2007 by Mr. Chidambaram. The initiative had a twofold story the DTC (Direct Taxes Code) & GST (Goods and Services Tax). While the former has died a political death, the latter promises to shine presently.

There is a plethora of indirect taxes in India, there is VAT, customs, central excise, service tax and many more. GST envisions to unify them under one umbrella. It will be a value-added tax, at every point of value addition.

The concept is not new to the world. It dates to 1950’s [data]. In the 1960’s the success of VAT was evangelized by IMF and lead to widespread adoption. Over 150 countries have adopted indirect taxes in one form or the other. There is however a dark side to this story. In every country where GST was introduced, the immediate impact was a dip in growth and political instability. Almost every party which bought out these changes in their respective country, lost power soon after.

Thus, it is a great challenge for the central government to make this shift. This problem is further aggravated by the conflict in interests of different state governments. Take for example Karnataka, a state which has invested heavily into developing manufacturing capabilities and receives tax revenues on business originating from its state. As per GST, all the tax in for of production tax and cross border transport is gone and the state in which the product is sold will be collecting the net taxes.

The major debate on reaching a consensus on this bill is thus the revenue sharing between different states and centre. It has been stipulated that the centre will compensate the state for lost revenue over a period of 5 years to bring them into the boat.

GST: Benefits

Industry Consumers
Multiplicity in tax removed, e.g. octroi Simple tax structure
Double taxation while crossing state borders will be avoided Effective tax lowered (removal of double taxation)
Enhanced mobility of goods leading to common national markets Taxation will occur as the good moves through its supply chain
Simple and uniform tax Uniform prices
Fewer tax exemptions for PSUs and defence manufacturers. Transparency
Greater transparency and equity for the manufacturing sector leading to a level playing field. Increase in employment to support GST implementation

GST: Challenges

Indian constitution 101st amendment act paved the way for implementation of GST under the GST council. It also brings with it a mandated deadline of September 2017 when states will stop receiving tax revenues if they are not through GST. This fact has led to different states and political parties resolving their issues on revenue sharing in the past few months at a fast pace.

The biggest challenge to GST implementation is Invoice matching. As and when a good moves through the supply chain from manufacturer -> warehouse -> wholesaler -> retailer -> end customer; the invoice number will move with the good and will be tracked at each point of value addition. At every point of transaction, the invoices will be matched to enable tax credit transfers which will make evasion difficult.

To perform this humongous task, it calls for a solid IT infrastructure. Introducing GSTN (Goods and Services Tax Network), a 49-51 split organization between Infosys and GOI. Currently, about 60% of the project is complete and work is going on at a fast pace. GSTN network will check and make sure that only after the taxes are paid on a good, that the corresponding tax credits will be passed on to the manufacturer.

This will ensure greater tax discipline among traders and India’s tax to GDP is bound to increase because of this. However, for a section of retailers who were avoiding taxes, this would come as a huge blow and may cause public unrest. It is believed that the GST fiscal reform would take a 10-year stabilization period and would see an initial dip in growth. The burnt will be the highest in the year 2019 and thus, GST has also now become a political bet.

Leading account keeping software vendor, Tally has come up with GST match facility on its systems. In a broad sense, the accounting and tax filing practice will become easier and give a boost to MSMEs by reducing middlemen and improving transparency via automatic returns facilitated by GSTN.

In a city like Bangalore where 30 thousand businesses are registered but only 6 thousand filing their taxes, GST brings a promise of widening the tax net and could potentially lead to lower tax rates in the future. All the data regarding businesses will be stored on the cloud and brings with it data security issues.

It is important to note that many sectors are free from the ambit of GST and it is not so uniform as it was promised to be. Road taxes, real estate stamp duty, liquor taxes and taxes on petroleum products will continue to persist on their own. With the amendment act hanging with the deadline of September 2017 and the recent fiasco of demonetization effecting the economy; it has indeed become a tricky way ahead for GST.

This shift will force firms to change their strategy in terms of distribution. New business agreements will be framed among various parties of the supply chain taking into consideration the implications of GST. The whole exercise was championed by the multi-national companies who wanted simpler tax reforms. Will the investments now rise as we move ahead with GST? Will the supply chain get smarter and integrated and be fuelled by credit growth? Will the honest retailers who pays his taxes on time be incentivized by the manufacturers? Only time will tell.

The Indian Tax Story

The following discussion is largely based on the talk and follow up discussion with Mr. Sibichen K Mathew. He is an Indian Revenue Service (IRS) cadre and working in the Income Tax Department. He is of the belief that the country should abolish all kinds of taxes one day, especially GST which is a regressive tax (i.e. everyone in the population would come under its ambit).

Taxes in India: Case in Point

Taxes originated in the medieval ages with the advent of wars between tribes and nations. To continue their massive war campaigns, every nation used this instrument. Even in India, the origin of tax comes about from the colonial rule and the tradition has continued till date. Historically, it is easy to see why taxes are looked down by the people of the nation as something which is unjust, unfair, and biased.

There are multiple factors as to why we dislike taxes so much. During the British rule, it was a tool of repression. It has been politically and sociologically moulded in the following years leading to its present state.

While in the European nations, taxes have a certain degree of social reciprocity meaning the taxpayer can see the benefit coming back to him. The situation in India is completely different with the general notion on tax being a welfare scheme for the less able. Once you cough out the money, just forget about it. The limited accountability of the government in terms of its expenditure of taxpayer’s money further aggravates this problem.

Once you keep this existing notion in mind and look at tax regulations, it all boils down to simple application of game theory. The penalties are so lax and the chances of getting caught dramatically low, why should one pay taxes. Let’s just follow the norm and evade like a pro.

Income Tax Collection: Now and next

qThe effective tax base of India is pathetically low. The government’s aim to increase tax revenues and is looking at innovations in the taxing process to achieve its aim. Tax payment, in the language of the IT dept., can be treated as a national good. Like any other good, it follows a supply demand curve. Further introspection shows that the tax revenue should follow the Laffer’s curve.

wThe objective is to reach this peak, where tax rates are lower than current but the tax base has widened.

IRS has limited resources and must be selective in perusing cases of tax evasion. An implication of the situation is the plethora of amnesty schemes announced every other year.

Here in lies the challenge and a prospective solution in the form of digital payments. The current regulations which stops cash payments above 3 lakhs give a great boost in this direction. This allows the IT Dept. to create a 360-degree profile of every PAN card holder and use non-intrusive and non-invasive methods to keep defaulters at check. A special mention of the PMO office to push these reforms through.

To illustrate the importance of this step, take the net yearly seizures by the IT dept., a miserly figure of 3000. The limited manpower calls for innovative steps to solve this problem. Digitization not only increases transparency, it also brings down the cost of tax collection. Gone are the days of making rounds of IT office, now you can e-file your returns from the convenience of your home or office. This has an added benefit of bringing down corruption by removing the middlemen from the process.

The nation is ready for a leapfrog in the prevailing tax culture. To further strengthen this move, a low rate of tax (say 5%) should also be applied to agricultural income and religious institutions. This would promote transparency and plug the leaks in the tax net which occur via these activities, i.e. the practice of fund transfers into these instruments to evade taxes.