NOVEMBER 30, 2009

By Nimish Goel, CA & Pritesh Chhajed, CA

Nimish Goel	Pritesh Chhajed

THE First Discussion Paper on Goods and Services Tax (GST) in India was probably released at the right time when the Revenue's indirect tax kitty has dipped by around 13% on a month-on-month basis. The recently released figures indicate indirect taxes collections going down on a year-on-year basis by around 21% for the period April 09-October 09. With the government already putting in place measures to combat widening fiscal deficit, these figures will definitely not assist rather make the things difficult for the government. It is thus, the right time to synergize efforts for reducing this deficit and it was indeed the right time for the government to kick-start discussions on the GST.

Under the current VAT regime, Central Sales Tax (CST) is charged on the movement of goods from one state to another without any possibility to offset it against the VAT/CST liability arising on the subsequent sales. Thus, where a trader in Maharashtra purchases goods from a dealer in Gujarat , the CST of 2 percent charged by the Gujarat dealer on his inter-state sales is not available as credit to the Maharashtra trader. As a result, the CST paid becomes a cost in the supply chain. This non-recoverability factor had forced the industry (particularly consumer products industry) to set up their distribution network with a warehouse facility in almost all the consuming states. This has only increased the logistics and the tax administration cost of the industry.

One of the key imperatives in adopting the GST model in India was to avoid cascading impact of the CST paid on inter-state purchases. Due to the federal structure, it would not have been possible even under the GST model to allow recoverability of state GST (SGST) paid under one state statute against other state's SGST liability. A refund mechanism therefore, seemed to be the only way out.

The First Discussion Paper on GST has introduced an innovative concept of IGST for taxing inter-state supply of goods and services. Under the IGST model, the Centre alone will levy IGST (a sum of CGST and SGST) on all inter-state supply of goods and services. The seller will charge IGST from the customer and pay to the Government. Whilst paying the output IGST to the government (charged from his customer), the seller will be allowed to recover and deduct the input tax credit of IGST, CGST and SGST. To monitor these credit movements, a Central Agency shall be set-up.

The exporting state shall transfer to the Central Government the amount of SGST credit utilized by the seller to discharge his output IGST liability in that state. The inter-state purchaser can recover the entire IGST charged by the seller as input tax credit to set-off against his output IGST (charged on inter-state supplies) and CGST and SGST liability (for supplies within the state). To tax the value addition by the purchaser in his state, the Central Government shall transfer to the destination state the amount of IGST used in the payment of state GST.

To illustrate, if a trader in Tamil Nadu supplies goods worth Rs 100 to a dealer in Karnataka and assuming a rate of 8% each for CGST and SGST, he charges IGST of 16%, i.e., Rs 16 (CGST – Rs 8 and SGST – Rs 8). Assuming some of the goods were also procured inter-state and some were procured locally by the Tamil Nadu trader, his input credit pool was IGST (Rs 6), CGST (Rs 4) and SGST (Rs 5).

To pay Rs16 to the government (collected from the Karnataka dealer), the seller deducts the available credit of Rs15 (6+4+5) from his credit pool of IGST, CGST and SGST and pays the balance (Re 1) in cash.

Under the proposed IGST structure, the Tamil Nadu government will have to transfer Rs 5 (SGST credit) to the Central Government as the Central Government would have only received Rs 11 in the form Rs 6 (IGST), Rs 4 (CGST) and Re 1 in cash. This is based on the destination based principle of taxation. Consequently, the SGST of Rs 5 (already paid to the Tamil Nadu government on procurement of goods by the seller) will have to be returned by the Tamil Nadu government to the Central Agency.

On the other hand, the Karnataka dealer will be able to recover Rs 16 (IGST charged and paid by him to the seller) as input tax credit. This amount of Rs 16 can be used by the Karnataka dealer to set-off his IGST liability (arising on his inter-state supplies of goods and services) and the CGST and SGST liability (arising on his intra-state supplies of goods and services).

If the Karnataka trader further makes inter-state sales of the goods procured inter-state, this chain would continue. However, if the Karnataka trader makes some sales within Karnataka, the Central Agency shall then transfer to the Karnataka government the portion of credit of IGST used for payment of Karnataka's GST liability (arising on sales within the state of Karnataka). For example, where subsequent to the above transaction, the Karnataka dealer makes a sale within Karnataka and charges CGST and Karnataka GST of Rs 3 each, and for making this payment of Rs 6 to the Karnataka government he utilizes the input IGST of Rs 6, then Rs 3 (portion of IGST used for payment of Karnataka GST) shall be credited by the Central Agency to the Karnataka government. This is basically to compensate the Karnataka government for the tax accruing on the portion of sales made within Karnataka.

In summary, the IGST doesn't break the credit chain and at the same time each state gets its share of revenue arising from the value added in that state.

The concept of IGST thus, not only allows a seamless movement of credits throughout the supply chain which is not available under the current CST regime but also does away with the painful refund mechanism which was earlier being contemplated by the Empowered Committee.

From a tax administrative perspective, the dealer merely for complying with the tax provisions would not have to be present in the other state as now the tax on inter-state supply i.e. IGST would have to be discharged to the Central Agency. Further, it would also be interesting to watch out for the tax treatment of inter-state branch transfers, though with this model approach, the fear of credit losses should be dispensed off and thus doing away with the need to plan for credit leakages.

Though, not discussed in the Discussion Paper but anxiously awaited is the tax treatment of inter-state supply of services, the required ground-work in terms of framing the place of supply rules etc seems to have been completed. With the concept of IGST, tax compliances with respect to the inter-state supply of services are also expected to be less cumbersome.