JULY 25, 2014

By Sumit Dutt Majumder

MUCH has been written about different aspects of the Union Budget in different columns. This piece will deal only with aspects relating to the Goods and Services Tax (GST).

First, let us see what Arun Jaitley the Union Finance Minister said on GST in his Budget Speech.

The relevant portion is quoted below:

"9. The debate whether to introduce Goods and Service Tax (GST) must now come to an end………..I do hope we are able to find a solution in the course of this year and approve the legislative scheme which enables the introduction of GST……"

Many have criticized the Budget Speech for the lack of vision and clarity on a critical issue like GST timelines. But a careful reading of the portion of the Finance Minister's speech quoted above would clearly show that he has made a definitive, unequivocal and positive statement about his resolve to introduce GST. No doubt, there are issues with the States. But the Finance Minister has assured the people as follows:

"9.…… I have discussed the matter with the States both individually and collectively. I do hope we are able to find a solution…..I assure all the States that (Central) government will be more than fair in dealing with them."

It would be grossly unfair to expect a well meaning Finance Minister to say more in terms of specifics on a complex issue like GST when he presents his budget only after 45 days in office as against the normal period of around five months, starting in October.

Therefore what the Finance Minister said about the introduction of GST should be enough to make all the stakeholders pull up their socks and get cracking at finding solutions to the challenges in ushering in the GST.

That brings us to the moot question - What are the challenges? As I have extensively dealt with in my book titled 'GST in India – its travails, tribulations and challenges ahead' the most important challenge, generally speaking, is to bridge the trust deficit between Centre and the States. The Finance Minister has already initiated steps in that direction. He has stated that he has discussed the matter with the States both individually and collectively. Further, he has described the issues as follows:

"Some States have been apprehensive about surrendering their taxation jurisdiction; others want to be adequately compensated." Thus, the intent to resolve the issues as identified during 45 days in office, is loud and clear. These initial steps would definitely go a long way in assuaging the hurt feelings of the States with respect to lack of adequate compensation for loss of revenue in lowering the rate of Central Sales Tax (CST).

Coming back to the challenges in specifies one can identify these as discussed below.

The first major challenge is to get the Constitution amended so as to empower both Centre and the States to levy and collect GST in terms of the agreed Dual GST model agreed by Centre and the States. It may be recalled that for this purpose, the then Finance Minister Pranab Mukherjee had introduced the 115th Constitution Amendment Bill during the Budget session of the Parliament in 2011.

The said Bill was referred to the Parliamentary Standing Committee on Finance for its study and comments. The Committee comprising Members of Parliament from all political parties and led by Yashwant Sinha, then a leading MP from Bharatiya Janata Party submitted its report to the Parliament in July 2013.

In its report, the Committee made an unequivocal endorsement of the Dual GST structure. It also allayed the fears of some of the States about the loss of fiscal autonomy. The major recommendations of the committee are given in brief:

i. The Committee agreed with the clauses of the Bill relating to empowerment of both Centre and States to levy and collect GST, and the constitution of a GST council comprising the Finance Ministers from the States, Union Minister of State in charge of Revenue and chaired by the Union Minister of Finance. However it recommended replacement of the stipulation regarding 'consensus' before every decision of the GST council by 'voting' with appropriate weightage. Further it suggested dropping the provision regarding, setting up of a 'Dispute Settlement Authority' and felt that the GST Council should be able to deal with the disputes.

ii. While agreeing that certain items like Petroleum and Petroleum Products, Alcohol etc. may not be brought under GST at the initial stages, it however felt that exclusion of these critical items from, the ambit of GST in the constitutional provision itself will not be correct. It explained that whenever in future, the States agree to inclusion of these items in the GST, it should be possible to do it without going through the difficult route of Constitutional Amendment.

ii. Recognising that tax on sale of goods is the biggest and most buoyant source of revenue for the States, the Committee recommended for adoption of a system of band with floor rate and ceiling rate so that the States have some elbow room to calibrate the rate of State GST.

iv. Recognising the need to remove hurdles that hinder free flow of trade and reduce compliance burden, the Committee recommended that the 'Entry Tax including Octroi' should be subsumed in GST and that the collection on this count could be distributed to the local bodies.

v. On the issue of compensating the States to support possible revenue losses on implementation of GST, the Committee, while supporting the case of the States, recommended for a built in permanent compensation mechanism in the Constitutional provision itself. For this purpose, it also recommended creation of a GST Compensation Fund under the administrative control of the GST Council.

The Committee in its other recommendations and observations highlighted the importance of a robust and seamless IT infrastructure, uniform administrative paradigms, unified tax credit clearing mechanism, harmonized tax structure etc.

(Click TIOL March 18, 2013 - Article titled "Goods and Services Tax – Simply Unstoppable.)

[Click TIOL August 16, 2013 - Article titled Dual GST Hanoz Dur Ast- For Centre 'Ekla Cholorey' beckons]

The Centre accepted most of the Committee's recommendations including those mentioned in foregoing sub-paras (i) to (iv). It however did not agree to have a separate Constitutional mechanism for compensating the States, pointing out that the already existing institution of Finance Commission could take care of this issue. Based on the accepted recommendations, the centre had prepared a Draft Revised Bill and sent it to the Empowered Committee of the State Finance Ministers (EC) for its endorsement. (Please click TIOL October 01, 2013 – Article titled "GST moves on – Revised Bill proposes to use 'DELETE' command for Entry tax, Octroi")

The States however in the Shillong meeting of the EC in November 2013 opposed the views of the Centre in the Revised Bill on following issues:

(a) They insisted on retaining the exclusion clause relating to Petroleum, Alcohol etc. in the Constitution itself.

(b) They opposed subsuming of 'Entry Tax including Octroi' in the GST.

(c) With regard to Declared Goods, the centre has the constitutional authority to declare any goods as being of special importance and ask the States not to impose duty on such goods over a stipulated rate. In deference to the recommendation of the Committee, the Centre had proposed to suitably modify the provision by factoring in the role of the GST council. However, the States demanded to get that authority itself to be withdrawn by Constitution amendment.

(d) The States also reiterated their demand for a formal Constitutional Mechanism for compensating the States for revenue losses they could face after roll out of GST.

With the expiry of the previous Lok Sabha in May 2014, the 115th Constitution Amendment Bill has also died its natural death. Therefore, the first and most daunting challenge for the centre is to take the States on board on all the issues relating to the Constitution Amendment as discussed above, and then present an agreed revised Bill to the current Lok Sabha. This would require vigorous persuasion with the States. On the issue of Petroleum, Alcohol etc., it has to be explained that initially the critical items like Petroleum, Alcohol etc, would remain outside the ambit of GST and will remain so till GST Council decides otherwise. But prudence would demand that this exclusion clause need not be put in the Constitution. Even the all party Parliamentary Committee has recommended so. Secondly, on the issue of Entry Tax, even the said Committee has recommended for keeping the 'entry tax including Octroi' within the ambit of GST. Thirdly, on the issue of 'Declared Goods' the rewording of the law for keeping the GST Council in the loop should take care of the concern of the States. On the issue of compensation, while the Centre may not agree to keep a Constitutional provision, it would have to come out with an agreed foolproof mechanism for compensating the States. This will clear the air and it would be the first major step in driving away the trust-deficit between Centre and the States.

Challenges other than those relating to the Constitution Amendment Bill would be in following areas.

Putting a robust IT infrastructure in place so as to make both Centre and the States interact with it will be a difficult challenge. The GST Net, the SPV that would operate the common GST portal for interaction with all stakeholders including the taxpayers, the Centre and the States has been formed in August 2012. But it has not made worthwhile progress in making it functional, let alone fully operational. Further, at present the IT ability of different States is at different levels. Before GST is introduced, all resources would have to be mobilized to bring all the States on par with each other in IT ability, so that they can effectively interact with the GST Net. Concerns have been expressed on secrecy and security issues and the issues relating to core functions of the department in the context of the GST Net being a private company. Care has to be taken to ensure that the safeguard measures with respect to data security, retention of strategic control by the Government and retention of core function by the Department at Centre and the States are effectively put in place before the GST Net is made fully operational.

Secondly, now that the search for appropriate model for inter-state transaction of goods and services has been concluded with the selection of IGST model, it is now imperative to make it operational on top priority. After all, the treatment of taxation of inter-state transaction is at the heart of the GST design with respect to State's share of GST. GST being a destination based tax, it becomes more critical. The success of a good GST would depend heavily on the success of the IGST model.

Other critical issues that would need to be settled on priority are:

i) Common threshold for goods and services, States GST and Central GST;

ii) Cutoff for composition (compounding) scheme;

iii) Common List of Exemptions – by pruning the current ones for both Centre and the States.

Once these three issues are settled, the policy makers will have a fairly good idea about the Tax Base (Assessee base) which would in turn help in determining the Revenue Neutral Rate (RNR). Like a chain reaction, once RNR is determined, it would be possible to fix the GST rate (s). The GST rates should be same for Centre and the States, except that the Centre has agreed to the States having the discretion for adoption of a system of band with floor rate and ceiling rate for SGST. In my view, the Centre should also keep a provision for similar discretion;- after all, an idea running all throughout has been that the Centre and the States should have similar provisions in the GST regime.

Finalization of the "Place of Supply of Goods and Services Rules" would be the other important issue to be taken up on priority. Since GST is a destination based consumption tax, it is important to know and define the 'Place of Supply'. Thus, the concept of 'Place of Supply' becomes the keystone of the proposed GST structure, particularly with respect to the inter-state transaction of goods and services. Compared to goods, taxation of services is an extremely complex issue. Services being intangible in nature, it is not easily feasible to determine the taxable jurisdiction where services are acquired, enjoyed and consumed.

Other important issues which would also need early finalization are enumerated below:

a) Input Tax Credit (ITC) mechanism

b) Applicability of 'Reverse Charge' mechanism

c) Laying down of Rues, Procedures and related formats for Registration, Returns, Payments, and Refunds etc.

A report on these issues by a committee to the EC in March 2014 would need to be acted upon fast.

d) Finalization of the list of goods and services that are to be outside the ambit of GST, and the list of taxes that are to be subsumed in GST. Without finalization of these issues, tax-base cannot be correctly determined.

Another difficult challenge would be reorganising and restructuring the present tax administrations, both at Centre and the State so as to make it GST-specific. An important aspect that will have to be kept in mind during the process of reorganizing the current tax administrations into CGST and SGST administrations is that both the GST administrations would be technology driven, facilitated by the GST Net. While planning ahead, it would be expected that the administrative structures for the CGST and SGST are harmonious. Both the new administrative structures will have to be in place by the time the legislative actions are completed and the GSTN is fully operational to usher in the GST.

Finally, the controversy regarding dual control over the Small Business has become an irritant in the relationship between Centre and the State. Concern regarding 'rigors of dual control' to be faced by the Small Business led the States to believe that dual control should be there only for large tax-payers over a particular cut-off i.e. Rs. 1.5 crore of annual turnover, and that the States should be the only agency to collect both SGST and CGST below that cut-off, and then transfer the CGST amount to Centre. The Centre protested against such a proposition on many grounds some of which are discussed here.

It was pointed out by the Centre that keeping a section of the tax-payers out of the radar of the CGST authorities will be fraught with revenue risk. One particular risk area of concern would be the issue of fake invoices by a tax-payer under the control of single tax authority, say the State where the centre won't have any control, to a tax-payer under the dual control of both the tax authorities, including the Centre, thus causing substantial revenue loss. A study of VAT frauds detected in VAT compliant countries gives the clear picture of such revenue risks.

Further, verification of Input Tax Credit (ITC) transfer is essential for a destination based Consumption Tax like GST to succeed. For this purpose it is imperative for both Centre and the States to maintain separate administrative control over the entire value chain of supply of goods and services in the two independent streams of CGST and SGST respectively.

Besides the Centre also pointed out that even in the present Central Excise regime, a sizeable portion of the Small Business below the threshold of Rs. 1.5 crore, are already under the Central Excise control for various reasons as explained below.

For example, the first stage and second stage dealers who trade in goods and issue Cenvatable invoices are already under the control of Central Excise. Secondly, a sizeable member of small manufacturers in sectors like Vitrified Porcelain Tiles, Pan Masala, Gutkha, Cigrattes, and Tea etc. are not eligible for SSI exemption of Rs. 1.5 crore. Another section of enterprising Small Business do not avail of SSI exemption because they would like to avail of the Cenvat Credit chain.

Therefore, the basic presumption about all the assesses below the threshold of Rs. 1.5 crore being outside dual control in the existing system is not correct.

Another important consideration is that the power to levy and collect IGST on inter-state transactions will remain with Centre. Consequently, for inter-state transactions the Small Business will have to be under the control of Centre.

Further, in terms of Para 3.2 (viii) of the First Discussion Paper (FDP), the mutually accepted structure of GST has been "Dual GST" with the Centre and the States administering independently the CGST and SGST respectively. Disturbing the agreed position and creating a contentious issue when everyone is looking for an early introduction of GST has no rationale. It also has to be kept in mind that the Indian Constitution underlines the supremacy of Centre over the States on three areas- Defence, External Affairs and Finance. Therefore, the Centre should not be made to outsource its core competency with respect to 'Finance' to the States. Further, GST is a joint venture which has to be implemented with an adequate degree of mutual trust, and more appropriately mutual respect for each other's competence. That is how dual control works in Canada and many other federations.

It is everybody's case that the Small Business should not face any hardship under the new GST regime. There are ways to meet that end. With the IT infrastructure, the GST Net in place, the basic functions like Registration, Payment after self assessment and filing of returns would be done electronically and there will hardly be any physical interface (control) with the Small Business.

Further, interface with the Small Business can be based only on risk parameters, which has to be identified jointly by Centre and the States based on their independent inputs. The mitigating administrative measures for the Small Business may also include the following:

i) Registration by a single agency for both CGST and SGST without manual interface;

ii) No physical verification of previous entries;

iii) No pre deposit of security;

iv) Simplified Return format;

v) Longer frequency of Return filing and

vi) Minimised compliance requirements like audit, inspection etc.

As for the logistic difficulties of approaching two tax authorities- Centre and State, when physical contact becomes imperative, an idea can be to draw inspiration from the principle of Large Tax-Payers Units (LTUs), and make the taxmen from both Centre and the respective State to sit under one roof. These can be called Small Taxpayers Units (STUs) and housed in each of the State capitals and other cities or towns of commercial importance. The details regarding setting up of STUs can be worked out. The STUs alongwith the mitigating administrative measures discussed above can alloy the apprehensions about the rigors of dual control over the 'Small Business'.

There is another important perspective which cannot be ignored by the Union Finance Minister. This is with respect to the problem of 'surplus' in the cadre strength of Central Excise and Service Tax employees that might happen if the proposal is accepted. A ball park estimate suggested that the Centre's tax base in the Dual GST regime with threshold of Rs 25 lakhs and with Dual Control would be around 22.50 lakhs. But with Centre's control (dual) only over the cut-off of Rs. 1.5 crore as suggested by the States, the tax-base would come down to 8.50 lakhs from 22.50 lakhs. This is because around 92% of Service Providers have a turnover up to Rs 1.5 crore. If the proposal of the States is accepted, around 92% of the current tax-base of Services Providers will be outside Centre's control. Given the added consideration that the administering of GST will be technology driven, thus reducing the manpower requirement, there may be 'surplus' in the cadre strength of Central Excise and Service Tax employees which may not be a desirable proposition.

In light of the foregoing discussion on various aspects of the proposed Dual Control over a cut-off of Rs 1.5 crore of annual turnover and single control by the States below the said cut-off, it would be a better proposition – technically, structurally and administratively to allow both Centre and the States to perform their sovereign functions of levy and collection of GST in their respective jurisdictions in the scheme of Dual GST as envisaged originally. Briefly said, the jurisdiction to levy, collect and administer the CGST and IGST by the Centre and SGST by the States should not be tampered with in the new GST regime. The motto should be Dual Control over the entire value chain in GST with minimum hardship to the Small Business.

One last point. The Economic Survey has inter-alia proposed that the Centre should aim at introducing atleast Central GST as a precursor to a full-fledged unified GST regime. In this context the Survey has commented - "Once Central GST is implemented and the information technology system for it has worked, (revenue) estimation risk will be lower and it will be easier for the Centre and States to move to GST". The Economic Survey basically suggests the decoupling of the CGST and SGST instead of the current model of dual GST.

It may be recalled, I had written thrice before in this column in the context of endless negotiations between Centre and the States, suggesting that it was time for Centre to plan its own GST. My articles as follows may be referred to:

a) July 15, 2013 – "Tale of endless negotiations and unsettled key issues – Time for centre to plan its own GST!"

b) August 16, 2013 – "Dual GST Hanoz Dur Ast – For Centre, 'Ekla Cholo ray' beckons!'

c) November 26,2013 – "Wheels of GST chariot in reverse gear – 'Blame it on Rio' err General Elections!"

However, in the changed scenario I won't now recommend for my previous proposal. Having spent so much of time, and with the signals of trust-deficit between Centre and the States getting bridged, this is now the time to go ahead with full fledged Dual GST simultaneously at Centre and all the States. Shaktikanta Das, Revenue Secretary has also been reported to have said to Business Standard (18th July 2014) that 'the Centre wants a complete solution instead of starting with a Central GST as suggested in the Economic Survey.'

Summing up, the challenges ahead for introduction of GST are enumerated below at one place.

1) Bridging the trust-deficit between Centre and the State,

2) Amendment of Constitution for empowering both Centre and the States to levy and collect GST. For their purpose a Constitution Amendment Bill, agreed by both Centre and the State, will have to be placed before the Parliament sooner than later. Issues where there are differences of views between Centre and the States are as follows:

(a) The states want exclusion of items like Petroleum, Petroleum Products, Alcohol etc. from the ambit of GST to be embodied in the Constitutional provision itself.

(b) The States do not want 'Entry Tax including Octroi' to be subsumed in GST.

(c) The States do not want 'Purchase Tax' to be subsumed in GST.

(d) The States demand withdrawal of Centre's authority with respect to 'Declared Goods' as enshrined in the Constitution.

(e) The States demand a formal Constitutional Mechanism for compensating the States in the cases of revenue losses they could suffer after roll-out of GST.

3) After amendment of the Constitution, the Centre and the States will have to draft a model GST law, based on which the Centre will place the CGST Bill in the Parliament and the States will place SGST Bills in the respective State Assemblies.

4) The other main challenge would be to put a robust IT infrastructure in place by making GST Net fully operational, while at the same time ensuring that the safeguard measures with respect to certain concerns of the Central Board of Excise and Customs relating to Data Secrecy, Data Security, and Strategic Control are implemented effectively.

5) The IT ability of different States will have to be brought on par so that they can effectively interact with the GST Net and also among themselves and the Centre.

6) Treatment of taxation of inter-state transactions being the heart of the GST design, the chosen IGST model will have to be put in practice on priority.

7) Determination of Tax Base, Revenue Neutral Rate (RNR) and the GST rates on finalization of threshold, 'cut-off for composition scheme' and common list of 'Exemptions' .

8) Finalisation of important issues as follows:

(a) "Place of Supply of Goods and Services Rules" – important in the context of inter-state transactions.

(b) Input Tax Credit (ITC) mechanism

(c) Applicability of 'Reverse Charge' mechanism.

(d) Laying down of Rules, Procedure and related formats for Registration, Returns, Payments and Refunds etc.

9) Reorganising and Restructuring the present tax administrations, both at the Centre and the States so as to make it GST-specific.

10) Dual Control over the entire value chain of GST independently by Centre and States with respect to CGST and SGST respectively with minimum hardship to the Small Business through mitigating administrative measures.

The challenges are daunting- but not insurmountable. It has been realized by the people of India that a time bound introduction of the GST will surely help in building an integrated national market for goods and services, and will reduce the cost of doing business, and that it will bring down the prices as well. Further it will boost up investments thus contributing in increase in GDP. The apprehension of the States regarding loss of fiscal autonomy has been allayed by the all party Parliamentary Committee, while making an unequivocal endorsement of the Dual GST structure. The fear of the mineral rich originating States regarding the loss of revenue to the destination States can be allayed by increasing royalty on minerals. The loss of revenue by a manufacturing State because of the State GST getting accrued to the destination States can be taken care of by a suitable mechanism of compensation.

Let us see what our political leaders are saying on the issue of introduction of GST. The Union Finance Minister, Arun Jaitley, has given enough indications in his post-budget interactions with the media that the Government is serious about introducing the long-delayed GST. He even said that the GST that he is going for may not be the 'best GST' to start with, but it would be a 'good GST'. Nirmala Sitharaman, the Union Minister of State for Finance and Commerce has said to Times of India that the discussions with the States are intensive and in friendly atmosphere, and that there is definite progress on the issue of GST, and that the discussions are moving towards greater consensus. Saurabh Patel, the Gujarat Finance Minister has told Business Standard that Gujarat is not opposed to GST; but being a manufacturing State which has put lot of money in infrastructure, they would be losing State GST to the destination states and therefore their revenue should be protected. Amit Mitra, the West Bengal Finance and Industry Minister has told Times of India that the most important thing is confidence building in the States so that they can rely on the Centre's words. Finally, Abdul Rahim Rather, the Jammu and Kashmir Finance Minister and Chairman of the EC have told Times of India that he is hopeful that the GST reform would be unveiled soon.

In the background of these positive statements from our political leaders of different parties, the challenges of GST as spelt out in details in this article, howsoever daunting it may look, can be overcome, provided all the stakeholders join their hands and work together in the ultimate interest of the country in a spirit of cooperation. And, I sincerely believe that this will happen in next two years time.

(The author is the former Chairman of the Central Board of Excise and Customs and author of the book titled "GST in India – its travails, tribulations and challenges ahead.")