JULY 25, 2016

By Dr Shrikant Kamat

IT has been a few weeks since the Model GST law has been published by the Government for comments and feedback from the stakeholders concerned. A lot has already been written and said on the merits and demerits of the new legislation draft and the author doesn't intend to repeat the same observations under this column. However, now that we have some idea of how the new law on GST would look like, it would be interesting to attempt a realistic analysis to ascertain whether GST in its present form would indeed contribute in reducing the costs of all goods and services, consequently increasing the GDP by 2%, as suggested by many economists and experts in this field.

A. Key factors in reduction of cost of goods sold

1. Lesser need for warehousing and storage

It is well known that the current regime under the Central Sales Tax (CST) Act imposes a burden of CST at full rate as prevailing on the goods sold in the origin state when goods are sold inter-state. However, if goods are transferred to a branch in another state or if goods are sold inter-state to a manufacturer or reseller, then such goods are exempt from CST or liable to only 2% CST, as the case may be. This has not only created an artificial barrier to the free flow of goods but has given rise to rampant interstate movement of goods and warehousing of goods at numerous branches thereby increasing the freight, storage and warehousing costs multifold. With a common tax rate across all states, and the recipient of goods likely to be entitled to input tax credits irrespective of whether purchases are made within the state or inter-state, the need for storing goods in large number of depots/warehouses as well as the freight cost linked to transporting the goods to such locations is likely to go down considerably in the GST scenario. If the 1% levy on interstate supply of goods in addition to GST is decided to be discarded ultimately, the benefit on account of savings on storage, warehousing & freight will be all the more significant.

2. Fungibility of input tax credits

Again it is common knowledge that today, a manufacturer or trader in goods is prohibited from using the credit of input VAT or CST paid towards payment of central excise duty. This leads to tax cascading and consequent increase in cost of goods sold to the extent of Currently, goods attract an effective tax rate of 24-25 per cent (including both the central and state levies). In the GST regime, all supplies will be liable to GST implying that the recipient will have credit of CGST, SGST & IGST to set off his CGST, SGST and IGST liability. Further, the Input Service Distribution mechanism will ensure that even SGST paid on input services can be distributed as IGST to manufacturing locations or depots in other States. Also, IGST credit can be distributed as SGST if it is distributed to a business vertical in the same state.Thus, only in exceptional cases, where the State of manufacture/purchase is different from the State of sale of the goods, input tax credit could accumulate otherwise most of the input tax credit would be available for utilisation against output GST liability. Even assuming a standard GST rate of 18 percent, food and beverages would see virtually no price increase and neither would fuel and light, which would be especially important for protecting poor consumers.

3. Reduction in multiple levies

The Constitution Amendment Bill presently placed before the Rajya Sabha proposes subsumption of various Central indirect taxes and levies such as Central Excise Duty, Additional Excise Duties, Excise Duty levied under the Medicinal and Toilet Preparations (Excise Duties) Act, 1955, Service Tax, Additional Customs Duty commonly known as Countervailing Duty, Special Additional Duty of Customs, and Central Surcharges and Cesses so far as they relate to the supply of goods and services and State Value Added Tax/Sales Tax, Entertainment Tax (other than the tax levied by the local bodies), Central Sales Tax (levied by the Centre and collected by the States), Octroi and Entry tax, Purchase Tax, Luxury tax, Taxes on lottery, betting and gambling; and State cesses and surcharges in so far as they relate to supply of goods and services.It would not be difficult to imagine how much the actual cost of goods would come to as a result of cascading of multiple state levies and multiple central levies with severe restrictions on availability of input tax credits inter-se within central levies or state levies. This myriad of levies will disappear when we herald the GST regime with only two levies (CGST & SGST (and IGST that is combination of the preceding two levies)).

4. Lower compliance costs

An obvious extension of multiple levies as stated above would be the requirement of multiple tax payments and compliances at State level and Federal level. This not only necessitates having a compliance team handy but also requires businesses to budget for a high cost for such compliance (including the manpower costs and IT software costs). With just CGST & SGST to replace the plethora of central and state levies, compliance costs would also automatically get streamlined although for the first few months of the new regime, there could be need for stringent monitoring of GST compliances across each State.

5. Clear provisions on valuation, place of supply and point of taxation leading to reduction in disputes and consequent costs of litigation

If one goes by the catena of cases under the current regime on federal and state level indirect levies on goods in respect of various aspects such as valuation or the jurisdiction to charge and collect tax or the point at which the tax can be charged, the potential for interpretation and resulting disputes with tax authorities is limitless. This is likely to change in the GST scenario which clearly relies on objective provisions on valuation, place of supply and time of supply (point of taxation). This could considerably reduce litigation in the longer term, even though the possibility of litigation on these issues cannot be ruled out in the initial years even in the GST landscape.

B. Key factors in increase in cost of services provided

1. Increase in compliance costs

As far as service providers are concerned, today they are just concerned with payment of service tax (unless they are providing services that also require supply of goods and consequent charging of VAT in the invoice) and that too can be undertaken from a single office if it holds a centralized registration though business is transacted from multiple locations across India. However, this will change completely in the GST regime when each office providing service to the customer or receiving service (in case of liability under reverse charge) will have to obtain registration in the State in which such office is located. This will impose an additional burden of compliance on the service providers which is presently non-existent. Certainly, costs associated with this will add up.

2. Ambiguity on place of supply and valuation likely to give rise to disputes and consequent increase in litigation costs

Given that service, being an intangible, on many occasions, is difficult to track, so far as its originating point, supply point and consumption point are concerned. In the GST scenario, the respective State Governments are likely to jostle with each other for claiming jurisdiction to tax a particular service, based on the provisions in respect of place of supply in respect of inter-state supply transactions. The fall out of this nudging between states would be in the form of demand notices that could be raised on the unsuspecting assessee (‘taxable person', in GST parlance) by State and Central GST Authorities. Disputes on jurisdiction to charge and collect GST could witness a peak for a few services such as Banking, Telecom, Transportation, Courier, etc. which require supply of services over multiple territories and very often, continuously.

3. Multistate levy could create a lopsided structure of accumulated input tax credits in originating States vis-a-vis a drain on cash flow in supply States

With the place of supply rules in the Model GST law virtually handing over the power to charge and collect GST to the receiving State in respect of services, except in cases where it is not possible to trace the location of the recipient or where specifically it has been provided that place of supply will be the place of business of the service provider, the state where the service originates (usually the place of business of the service provider) could witness a sizeable accumulation of input tax credits (CGST, SGST and IGST). Eg. If the supply is from State A to a person who is located in State B, then place of supply will be State B and the supply will be liable to IGST. So far so good. But if services are received where place of business is generally located, then input tax credit will also get accumulated at such place of business. If supply is however made from another office of the service provider that doesn't receive too many input services but only supplies output services, it will require to pay its GST liability in cash unless the other office receiving services is able to seamlessly distribute input tax credit. This could give rise to bottlenecks and consequent drain on cash flows at certain supply locations.

Overall, there seems to be a consensus amongst economists and experts that price of services will go up in the short to medium term in the GST regime. Even the Report on the Revenue-Neutral Rate and Structure of Rates for the Goods and Services Tax tabled in the Parliament in December 2015 by the Chief Economic Advisor to the Government of India is conspicuously silent on the impact of GST on price of services. It seems there is considerable uncertainty on the services front and to be on the safer side, service providers are likely to increase the price of their services by 3 – 5% to factor the negative impacts of GST in the short term.

With services contributing almost 60% to the India's GDP, it is difficult to foresee how a tax that will negatively impact services will help curb inflationary trends in the first few years of GST implementation. The economists helping the Governments certainly seem to have their hands full.

(The author is Head – Indirect Taxation, JMP Advisors Pvt. Ltd.& the views expressed are strictly personal.)