In Pursuit of Knowledge
Indirect Taxes

GST – How it should be ?

Tarun Gulati,
Advocate

Introduction

1. In India there exists a myriad of indirect taxes affecting businesses, common man and the administration alike with the financial costs and burden of administrating the same. Majority of these taxes are in form of consumption taxes levied on the spending on goods and services. Internationally, consumption taxes include, on one hand general consumption taxes, typically Value Added Taxes (VAT and its equivalent, sometimes called Goods and Service Tax – GST) and retail sales taxes and on the other hand taxes on specific goods and services, consisting primarily of excise taxes, customs duties and certain special taxes.

2. The most widespread form of general consumption tax around the world is Goods and Services Tax (GST) or Value Added Tax (VAT) and is levied on the value that is added to a product. Value Added Tax System is based on tax collection in a staged process, with successive tax payers entitled to deduct input tax on purchases and account for output tax on sales in such a way that the tax finally collected by tax authorities equals the VAT paid by the final consumer to the last vendor. These characteristics ensure the neutrality of the tax, whatever the nature of the product, the structure of the distribution chain and the technical means used for its delivery. Such a tax is a destination based tax with the final consumer bearing the final burden of the tax.

Vat in India

3. The concept of VAT is not new to business or consumers in India and the same is being administered in the form of CENVAT for duties on manufacture (Excise duty) and on the services provided (Service Tax) by the Central Government and on the sale of goods as Value Added Tax (earlier levied as Sales Tax) by the State Governments. Though the Central CENVAT provides for deduction of excise duty and service tax paid by a person on the inputs used in manufacture of goods and provision of services on which excise duty and service tax is payable, these taxes are not deductible for the purposes of State VAT and add to the cost of the product and have a cascading effect on the taxes. Further, taxes like entertainment taxes, luxury taxes etc. levied by State are outside the purview of the State VAT and no input credit is allowed for such taxes paid for purposes of VAT. Even between the goods that are subject to VAT, there is no uniformity in rates and mostly goods are taxed at three rates; i.e., 1%, 4% and 12.5% by each individual State with variance in classification of goods that are subject to different rates between the States.

4. Thus, the present VAT in India is an imperfect VAT inasmuch as there is no fungibility between the taxes paid at various stages of a commercial transaction. This variance is mainly due to the federal polity of India wherein areas of taxing powers of the States and the Central Government are specifically demarcated and delineated and each exercises its complete discretion in the specified area of taxation.

5. In order to eliminate the imperfections in the VAT, the Hon’ble Finance Minister in his Budget Speech, 2006 has stated that there is a large consensus that the country should move towards a national level Goods and Services Tax (GST) that should be shared between the Centre and the States and April 1, 2010 was set as the date for introducing GST. To this effect Empowered Committee of State Finance Ministers, representing spirit of co-operative federalism, was formed to work with the Central Government to prepare a roadmap for introducing a national level Goods and Services Tax (GST) with effect from April 1, 2010 Budget.

Division of Taxing Powers and Amendments for Gst

6. In the proposed model of the GST to be implemented in India, it is suggested that it would be a dual GST wherein a State GST and a Central GST would be imposed on the supply of goods and provisions of services and which would be collected by the respective States, each State having its own State GST Code, and the Central Government/Union. The aim is to form an economic union as is represented by the European Union. To implement such a model of GST, changes would be required in the constitutional scheme which provide for levy and collection of taxes in respect of goods and services and distribution of revenue between the States and the Central Government/Union.

7. Part XII of the Constitution of India provides for finance and revenue of the Central Government Union and the States. Article 265 clearly lays down that no tax shall be levied or collected except by authority of law. Thus, not only the levy of tax but also the collection of a tax must be under some authority of law Legislation. Part XI of the Constitution of India distributes the legislative power between the Parliament and the State Legislatures including the power to tax various subjects. Article 246 states that the Parliament has exclusive power to make laws with respect to any of the matters enumerated in List I in the VII Schedule (Union List) and State has power to make laws with respect to any of the matters enumerated in List II in the VII Schedule (State List).

8. Entries 82 to 92 in the Union List enumerate the taxes which could be imposed by a law of Parliament and includes Duties of excise on tobacco and other goods produced or manufactured in India except alcoholic liquors for human consumption and opium and other narcotics [Entry 84]; Taxes on the sale or purchase of goods other than newspapers, where such sale or purchase takes place in the course of interState trade or commerce [Entry 92 A]; Taxes on the consignment of goods (whether the consignment is to the person making it or to any other person), where such consignment takes place in the course of interState trade or commerce [Entry 92B]; and Taxes on services [Entry 92C].

9. Entries 45 to 63 in the State List enumerates the taxes that can be levied by a State and includes Taxes on lands and buildings [Entry 49]; Duties of Excise on alcoholic liquors for human consumption and opium, Indian hemp and other narcotic drugs and narcotics but excluding medicinal and toilet preparation containing alcohol or opium Indian hemp and other narcotic drugs and narcotics [Entry 51]; Taxes on the entry of goods into a local area for consumption, use or sale therein (Entry 52]; Taxes on the consumption or sale of electricity (Entry 53]; Taxes on the sale or purchase of goods other than newspapers, subject to the provisions of Entry 92A of List I [Entry 54]; Taxes on goods and passengers carried by road or on inland waterways [Entry 56].

10. The taxes levied and collected by the State form a part of its revenues and the taxes levied and collected by the Union are distributed between States and the Union on recommendation of Finance Commission. The Constitution of India, however, provides for specific cases for assignment and/or distribution of revenue between the Union and the States in some specific cases as follows:

(a) Stamp duty and duties of excise on medicinal and toilet preparation levied by the Union are collected by the States and are assigned to that State.

(b) Service Tax levied by the Union and collected by Union and the States is to be distributed amongst the Union and the States.

(c) Taxes on sale or purchase of goods and taxes on the consignment of goods are levied and collected by the Union but are assigned to the States within which the tax is levied.

11. As the Union and the States tax different aspects in respect of goods and services, there is a need to amend the Lists so as to empower both the Union and the States to levy and collect the tax on the supply consumption of goods. As seen above, taxation of goods and services constitute a major source of revenue for the States and also for the Union and therefore, the principles for distribution of the revenue under the dual GST would require to be worked out so that the States are not worse off under the VAT system.

Main features of Gst/Vat system

12. As stated earlier VAT is the most common and widespread form of general consumption tax levied across the world. Organization for Economic Co-operation and Development [“OECD”] in its International VAT/GST Guidelines has identified the following core features of a VAT System :

i) Value added taxes are taxes on consumption, paid, ultimately, by final consumers.

ii) The tax is levied on a broad base (as opposed to e.g., excise duties that cover specific products);

iii) In principle, business should not bear the burden of the tax itself since there are mechanisms in place that allow for a refund of the tax levied on intermediate transactions between firms.

iv) The system is based on tax collection in a staged process, with successive tax-payers entitled to deduct input tax on purchases and account for output tax on sales. Each business in the supply chain takes part in the process of controlling and collecting the tax, remitting the proportion of tax corresponding to its margin; i.e., on the difference between the VAT paid out to suppliers and the VAT charged to customers.

v) Value added taxes are also neutral towards international trade according to international norms since they are destination based (even if the rule might be different for transactions made within federations or economically integrated areas). This means that exports are zero rated and imports are taxed on the same basis and with the same rate as local production. Most of the rules currently in place aim therefore at taxing consumption of goods and services within the jurisdiction where consumption takes place. Practical means implemented to this end are nevertheless diverse across countries, which can, in some instances, lead to double or involuntary non-taxation, and uncertainties for both business and tax administrations.

Desirable features of a dual Gst in India

13. An ideal GST would be a pan-India single rate tax on all products and services with uniformity in classification and place of supply rules. However every GST/VAT is subject to the local needs and sensitivities and internationally VAT systems differ on one or the other count. For example, in the European Union, each Member State’s VAT law must comply with the VAT Directive 2006/112/EC which provides a framework for EU VAT. Each Member State is provided the flexibility in implementation of VAT law and to that effect there are different rates of VAT in different member States; in New Zealand, the GST exempts certain items from the levy of tax.

14. The desirable features of the GST can be seen under the following heads:

Levy of tax

15. It is proposed that Centre and States will separately legislate, levy and administer a Central GST (CGST) and State GST (SGST) respectively.

16. Being a Dual GST, one can expect that both the Centre and the States will tax all supplies of goods and services, to CGST and SGST respectively. There is an alternative notion vis-à-vis the taxation of services per which there will be separate lists of the services to be taxed by the Centre and the States respectively, and accordingly, a service will be taxed to either CGST or SGST. The corollary to this scheme is that each taxable service will have to be defined, rather than the tax applying under a comprehensive coverage of services with a negative list, as was being talked of earlier. If this situation were to arise, the classification of services will become crucial. Moreover, the present issues vis-à-vis coverage under a particular taxing entry may continue. In such a situation, the allocation of services between the Centre and the States is expected to be linked to administrative convenience vis-à-vis monitoring and collection, and States would be likely to tax services which are performed locally (perhaps including some services presently taxed by the Centre).

17. It is desirable that there is uniformity between the classification of goods and services between Centre and State on one hand and between the States on the other hand so that there is clarity and certainty of the levy of tax and disputes as to appropriate classification of goods (especially where different rates are going to be prescribed for different items) and eligibility of goods and services to take input credits can be avoided.

Taxable person

18. The taxable person for the purposes of GST should be any individual, partnership, company, corporation or any other person which supplies taxable goods and services in the course of business.

19. Presently certain threshold limits are provided under the Central Excise Law as SSI exemption, under Service Tax Law as threshold limit of receipts up to ten lakhs and also under VAT law. The proposed GST should also contain provisions to provide that if the annual turnover of a person is less than a certain limit (the threshold), the person does not have to charge GST on its sales. It is also desirable that the threshold limit remains uniform across the States.

Coverage of taxes and Vat rates

20. CGST will almost certainly subsume Central Excise duty, service tax and the additional customs duties. The State GST (SGST) will almost certainly subsume VAT and perhaps also entry tax (at the State level) and luxury tax. In order to avoid the multi-State taxation and prevent cascading taxes, it is desirable that all other taxes like entertainment tax, luxury tax, entry tax are subsumed in the proposed GST model.

21. There appears to be a large scale consensus that some goods (most notably petroleum products and alcoholic liquor) be kept outside the purview of GST Though such a position derogates from the principle of value added tax, such a position may be unavoidable in view of the strong political will and revenue considerations of the States and the Central Government. Such products are likely to continue to be charged to the specific levies that they presently attract.

22. CST is an origin-based tax, and is therefore antithetic to a destination based tax such as GSTCST should therefore be abolished on the switchover to GST. It is with the switchover to GST in mind that the rate of CST was reduced from 4% to 3% in 2007 and then further to 2% in 2008.

23. The coverage of GST in terms of the goods and services on which the taxes are levied should be broad based and the exemptions should be less and by way of exceptions. A broad-base of tax ensures that the rates are not high and the revenue of the State/Centre is not compromised.

24. In case different rates are going to be prescribed for different goods and services, as under the present VAT legislation, being standard rate ranging between 8% and 12.5%, a normal rate for goods of mass consumption at 5% and rate of 1% of precious metals, it is desirable that uniformity is maintained in the classification to ensure certainty in taxes and ease in taking input credits,
Taxable Event

25. Presently, for each of the existing indirect taxes that the Centre and States levy, the relevant legislation specifies the taxable event, which is the trigger for the levy of the tax, and the collection mechanism. Under Central Excise, for example, the taxable event is manufacture, whereas the trigger collection is removal from the factory [see Wallace Flour Mills Company Ltd. vs. CCE – 1989 (44) ELT (SC)]. For service tax, the taxable event is the provision of services, though service tax only becomes payable after consideration for the services has been received [see CCE, Vadodara-II vs. Schott Glass In Pvt. Ltd. – 2009 (14) STR 146 (Guj.)], except for transactions between associated enterprises. Similarly for VAT/CST, the taxable event is a sale (transfer of property) of goods, though for deemed sales taxable event can be the delivery of goods (as in the case of hire purchase or installment payment transactions).

26. Internationally, in a GST system, the taxable event is a supply. In the UK, for instance, a support includes all forms of supply done for a consideration, and any supply that is not a supply of goods is supply of services. The distinction between goods and services has implications in terms of their ‘place of supply’ and ‘time of supply’ (commonly referred to as the ‘tax point’). The time of supply rules determine when a supply is treated as having taken place, and the tax is payable per the due date for the period which the tax point occurs. The criteria applied include the following, viz, delivery of goods, performance of services, invoicing (advance or post supply) and receipt of consideration. The UK also allows for payment as per a cash system (instead of accrual) if the turnover is below a specified limit, which changes time that tax becomes due.

27. It is expected that in the CGST and SGST legislations, the taxable events will be the sale of goods and the consumption of services.

28. It is expected that the definitions of goods and services in the GST legislations will incorporate mutual exclusivity, and the present issues on overlap of taxes will come to an end.

29. The key effects of the changes vis-à-vis taxable event and tax point at an operating level should as follows:

i) With Central Excise duty getting subsumed into CGST and SGST and the concept of manufacture ceasing to have significance, the need for section and chapter notes in the Central Excise tariff specifying certain processes as amounting to manufacture will no longer arise. Similarly, the third Schedule to the said Tariff will no longer apply. The Tariff may itself be done away with, depending upon how the Governments decide to set out the rate structure.

ii) The concept of job-work will undergo a significant change - internationally, the activity of work on another person’s goods is treated as a service. If this principle is followed, GST will apply on conversion charges as a supply of services, contrary to the present position (under the taxing entries of Business Auxiliary Services and Packaging Services).

iii) The change in the taxation of services will arise from the fact of separate lists of services to be taxed at the Central and State level, respectively.

iv) The change in the taxation of sales of goods will be linked to the changes in the definitions of deemed sales.

Cross-Border Transaction in Goods – Imports and Exports

30. Whereas the switchover to GST will not principally affect the customs provisions, there will be a significant change in the taxation of cross-border transactions in goods, on account of the additional customs duties getting subsumed into the Central GST (CGST) and the effects of the switchover to a destination-based tax system on the VAT laws.

Imports

31. Under the current tax system, high seas sales and inextricably linked sales (both of which are commonly described as sales in the course of import) do not attract a levy of State VAT. Such sales may not continue to remain tax-free at the State level if States begin to tax imports, per the destination principle. It may be relevant to note the Canadian precedent on sub-national taxation of imports in a Dual GST system, which is that a distinction is made between non-commercial imports and commercial imports. Non-commercial imports are taxed by the States on the basis of the place of residence of the importer and commercial imports do not attract a State tax because of issues with determining the place of consumption, and because the tax would be creditable. The same principle may also be adopted in India.

32. With the additional duties of customs getting subsumed into the CGST, the 4% tax cost that service providers suffer will no longer apply. However, if the services are taxed under separate lists by the Centre and States, fungibility of credit will be required for the CGST to not become a tax cost.

Exports

33. It is a settled proposition that taxes should not be exported. Therefore, the exemption / refund mechanisms currently in operation to zero rate the exports must continue under the Dual GST also.

Cross – Border Transaction in Services & Place of supply rules

34. Two basic principles on which there is general acceptance across the world is that internationally traded services should be taxed according to the rules of the jurisdiction of consumption, and that the burden of the tax should not lie on taxable businesses except where explicitly provided for in the legislation. The UK (as per the EU legislation) taxes services based on place of supply rules, as per which the place of supply of a service is determined, and tax is only applicable if the place of supply is the UK. Australia applies a test of connectedness, whereby a service is taxed to Australian GST if it is performed in Australia or by a permanent establishment in Australia or is linked to a supply in Australia. Canada taxes services provided or deemed to be provided in Canada, as per the tests specified for different services; Services provided from abroad by non-residents and used for business are not subject to reverse charge.

35. The Indian service tax legislation applies to the whole of India, including India’s EEZ and Continental Shelf. A service provided by a person “belonging” outside India and received by a person “belonging” in India could also be liable to service tax under the reverse charge mechanism, depending upon the criterion applied to connect the service to India, viz, that the immovable property in relation to which the service is provided is located in India, or that performance of the service is in India, or that the recipient is located in India. The same criteria are applied to treat a service as exported, and therefore not liable to service tax. However, additional conditions regarding use outside India and foreign exchange earning apply, which arguably give rise to an inequitable position. The recent decision on the stay application of Microsoft Corporation (India) Pvt. Ltd. vs. CSI New Delhi – 2009-TIOL-1325-CESTAT-Del has reopened the question of what constitutes use outside India by considering the secondary use of the service (beyond the contract in question), and holding that notwithstanding the criteria for determining exports, performance would determine the place of use.

36. The dual GST thus, must provide for the Place of Supply Rules that is common between the CGST and SGST to ensure uniformity of taxes. The Rules must clear the doubts that have arisen regarding export of services that have arisen since 2005. The arguably arbitrary basis on which the services have been categorized to apply the 3 criteria can be expected to be replaced by a more service character- specific destination principle. In the UK, for example, the linkages in the place of supply rules include supplier location, recipient location, place of performance, and relation to land, in addition to specific rules applying for select services. Further, use and enjoyment apply to certain services to shift the place of supply. The aforesaid scheme is set out towards achieving the goal that the tax should apply as per as the destination principle, and remain creditable to businesses.

37. Exported services should be zero-rated in keeping with the principle of not exporting taxes.

38. It would be helpful if the reverse charge provisions are only triggered after a threshold level. Alternatively, foreign service providers may be given an option to register under the Indian GST provisions, similar to the present provisions for non-resident dealer under VAT for administrative convenience and to eliminate cascading of taxes.

Inter-State Transactions

39. Currently, the inter-State movement of goods is taxed under the Central Sales Tax Act, 1956 and the State from which the movement of goods commences collects the CST on inter-State sales, and no input tax credit of this CST is available to the buyer. The seller in the said origin State can utilise any VAT input tax credit availed by him to discharge his CST liability, per the VAT provisions of the origin State.

40. As stated earlier that CST may be abolished and the concept of determining when a sale or purchase takes place in the course of inter-State trade or commerce, or outside a State would become irrelevant.

41. The GST provisions should include place of supply rules to determine where a sale is deemed to take place and accordingly which State will have the right to tax the sale. If international practice (as in the EU, for example, which operates as a tax federation) is followed, sales in the course of inter-State trade are likely to be zero-rated in the State of origin and taxed in the destination State on ‘Import”. However, consensus seems to be building for the alternative scheme whereby the origin State will collect the tax, which will be credited to the account of the destination State and for which the buyer in the destination State will get a tax credit.

42. Taxation of inter-State supply of services is a vexed issue and no consensus appears to emerge with regards to the same. In EU, VAT on services is paid at the place where the service has been supplied. This is most often, but not always, is where the service supplier is established. The trader in those cases account for VAT on his services in the Member State where he is established, applying the VAT rate of that country. Depending on the nature of the service, VAT may need to be paid in another Member State than that where the supplier is established. This is for example the case with services connected to immovable property.

43. The rules applied in EU appear similar to the one applied in India. As the services would be taxed on consumption basis, the Place of Supply Rules in relation to the services would gain importance so as to decide the taxation of services.

Exemptions

44. The legislations for each of the principal taxes that will get replaced on the transition to the GST regime (viz, Central Excise duty, service tax, and State VAT) provide for exemptions from the duty/tax in various situations. Outside of the de minimis exemptions, the exemptions can broadly be categorised into area based exemptions, end-user based exemptions and product or sector specific exemptions. It is well accepted that exemptions in a GST are distortionary, and affect the free flow of tax credits. Therefore, in principle, exemptions should not continue on the transition to GST

45. In the GST regime, concept of manufacture will lose significance as the taxable event changes to supply, and therefore the exemptions for job work and captive consumption will disappear. However, keeping in view the region based needs and the promotion of various goods, exemptions would continue under the GST regime. Such exemptions are likely to get converted into deferral schemes or operated through a refund mechanism so as not to disturb the value chain.

Transitional provisions

46. It is imperative that the GST provides for the transitional provisions to ensure a smooth transition to the GST regime without undue hardship to the businesses. One issue in this regard is the treatment of the accumulated credits. In the present indirect tax regime, credit of taxes paid on antecedent transactions are allowed under the CENVAT mechanism at the Centre level and as per the StateVAT provisions on input tax credit at the individual State level. These credits correspond to pre-incurred tax payments, and will become sunk cost for business unless accumulated credits remain utilizable upon migration to the GST regime. Neither the CEN VAT provisions nor any State VAT input tax credit provisions place a time limit on utilization of tax credit. It is well settled that credit which has accrued to an assessee cannot be expunged. Therefore, the transitional provisions of the GST laws need to provide for the migration of all accumulated tax credits of CENVAT and VAT. The system for migration of accumulated credits should also allow the transit of credit without restricting it to goods lying in the stock.

Tax Administration, Authorities & Dispute Resolution

47. The dual GST regime that is sought to be introduced would be governed by two concurrent laws; i.e., CGST legislation by the Central Government and the SGST legislation by the State Government. Thus, it is but obvious that there would be two set of authorities (including adjudicating authorities) that would have jurisdiction over the assessee. The assessee would also need to comply with the two set of legislations in terms of returns and other formalities.

48. Though it would be ideal to have common authorities that assess and adjudicate the issues relating to GST under both the CGST and SGST; in case such a position is not possible, there should at least be a common authority at state level so as to ensure that there are no difference and diversity on the interpretation between the entries and provisions at State level.

Conclusion

49. The move towards the GST/pan-India VAT is desirable and expected to bring value to the way we do business in India. It would further make the Indian indirect tax scheme more comprehensible to international businesses that are familiar with such systems in their respective countries and see India as favourable destination for setting up industries and businesses.

50. In order to gain the full benefits of the GST it is imperative that the following are achieved:

The diversity and complexity of the taxation in India, that is often used as a tool of social control or to provide incentives to particular sector or product, and the varying needs of various States that presently enjoy autonomy in taxation of goods, also cannot be lost sight of while adhering to the task enforcing the GST. It is imperative that the ideal aspects of a VAT System are brought in harmony with the practical needs and difficulties in the Indian context. It is but obvious that some glitches would arise when a new system is introduced; it is equally obvious that the same would be addressed to with discussions on white paper, draft legislations, the roll out of the GST and the practical experience of businesses.

[Source : Paper presented in two days National Tax Conference held at Nagpur on 2-3 October, 2009]