MARCH 14, 2012

By Dinesh Kumar Agrawal, AICWA, FCA, Ex-IRS

PRESENTLY, the Central Government is empowered to levy excise duty ('CENVAT') on manufacture of goods and Service tax on provision of services. The State Governments alone are empowered to levy tax ('Value Added Tax' or 'VAT') on the sale of goods i.e. distributive trade. The Central Government has partially succeeded in levying excise duty on distributive trade by adopting 'Retail Sales Price' ('MRP') as basis for valuation under Section 4A of the Central Excise Act, 1944, but the scope of Section 4A is very limited as it covers only about 100 items. Quite a large number of commodities are outside MRP based assessment, and thus, the Central Government is handicapped in levying tax on value addition subsequent to manufacture.

To broaden tax base, a new tax regime 'Goods and Services Tax' ('GST') is proposed which seeks to levy tax on all levels of supplies i.e. manufacture, wholesale distribution and retail distribution. GST will subsume excise duty, service tax and VAT and some other taxes. GST is proposed to have two components i.e. Central GST ('CGST') and State GST ('SGST'). Thus, in nutshell, the Central Government will have revenue from CGST instead of CENVAT and Service tax. As GST will be levied at all levels of supply chain, the Central Government would be taxing even distributive business, thus broadening the tax base. Similarly, credit mechanism will also be available at all levels of supply chain eliminating cascading effect of tax at multiple levels.

GST was expected to be implemented by 2012 but we have yet to see fine prints. Recently, Congress party in the helm at center has been severely beaten in the state assembly elections. There are murmurs of mid-term polls, even otherwise Year 2014 is going to be election year and therefore Central Government is unlikely to unveil GST in this year or next year. Empirical evidences in other countries have shown spike in prices of essential commodities in short term immediately before and after launching of GST like tax systems. GST has also lead to hoarding of goods by public thus resulting in scarcity of essential goods. Therefore, we may have to wait till 2015 for GST.

Considering the delay in introduction of GST regime, the Central Government is expected to implement taxation of services based on a Negative List to pave the way for the smooth transition to GST, and significantly ease the challenges arising out of implementing the GST. Taxation based on negative list of services is certainly a precursor of GST within the existing constitutional framework.

It is possible to implement a precursor of GST under the existing CENVAT regime also with some amendment in the CENVAT Credit Rules, 2004 ('CCR'). Rule 9 of CCR allows a manufacturer, importer, first stage dealer and second stage dealer to issue cenvatable invoices which are considered as eligible documents for the manufacturers and service providers to avail CENVAT credit of CENVAT paid on the inputs. In terms of sub-rule (4) of Rule 9 of CCR, a first stage dealer or second stage dealer is allowed to issue invoice only on pro rata basis. The existing provision is explained below by an example:

In the present scheme, the first stage or second stage dealer has to indicate the actual amount of duty paid by the manufacturer to pass the CENVAT credit to the manufacturer. In this process, although the Government ensures that manufacturer avails only that much amount of credit which has been actually paid to the exchequer, the Government lose out on value addition. Further, it is possible to work out the price charged by the manufacturer by reverse calculating duty amount. Existing scheme works as a deterrent for many dealers who don't want others to know their purchase price, thus breaking credit chain.

Government should allow dealers, with proper safeguards, to pass on CENVAT credit based on the transaction value. Sub-rule (4) of Rule 9 of CCR may be amended to provide that dealers shall be allowed to issue invoice on sale value provided that difference between the pro-rata duty amount and the duty amount in the invoice is paid in cash. This is illustrated below with preceding example:

Peak rate of basic customs duty is only 10%. However, countervailing duty ('CVD') and additional duty ('SAD') adds up the total customs duty to 26.84%. CVD and SAD paid on imported goods could be availed as CENVAT credit by the manufacturer. Traders who supply imported inputs/capital goods to the manufacturers are eligible to issue cenvatable invoices on pro-rata basis. Thus, non-cenvatable duty component on imported inputs/capital goods works out a mere 10.6%. In spite of such small import duty, many traders resort to under-invoicing for the simple reason that they don't want to issue cenvatable invoices to the manufacturers for the fear of revealing actual import price and thus endangering their business. As duty suffered by them is 26.84%, there is greater temptation to resort to under-invoicing. If they are also allowed to pass CENVAT credit based on the transaction value instead on pro-rata basis, the incentive for under-invoicing would be much less. Thus, amendment in Sub-rule (4) of Rule 9 of CCR would also increase customs compliance.

By a simple amendment in Rule 9 of CCR, the Central Government would be able to expand tax base, and garner more revenue by taxing distributive business. This would also ensure seamless flow of credit without any loss. There is no encroachment on States taxing powers as this scheme cannot be construed as tax on sale of goods.

(The Author is Executive Director in Khaitan & Co., Mumbai. The views expressed are his personal views)