Preparing for GST in India: The good, bad and ugly of radical tax reform
Enterprises, SMEs, startups, and other businesses should gear up for the GST tax reform
The Goods and Services Tax (GST) law has gone a step further to see implementation by July 1, 2017 deadline. Indian Parliament approved four supplementary pieces of legislation for the historic tax legislation. The Integrated GST Bill, 2017; The Central GST Bill, 2017; The GST (Compensation to States) Bill, 2017; as well as The Union Territory GST Bill, 2017 have been passed despite amendments by Opposition parties. Rajya Sabha too followed suit.
Finance Minister Arun Jaitley has said that the GST, which would bring in a uniform tax regime in India, would prices of commodities “slightly cheaper.” Jaitley also added that the GST rates will also be contingent on whether the specific commodity was being used by a common man or somebody affluent. He also said that once the regime is implemented, harassment of businesses by various different authorities would end and in India there will be one rate for one commodity throughout the country.
Understanding the Goods and Services Tax (GST) and its history
In 1986, Vishwanath Pratap Singh started the tax reform process in India’s indirect tax regime through the introduction of Modified Value Added Tax (MODVAT). The GST would be a comprehensive indirect tax on manufacture, sale and consumption of goods and services throughout India. It will replace the plethora of different taxes that the Central and State governments levy separately. Tax would be collected at each stage on basis of the input tax credit method, in which taxes paid in other states can be claimed.
This would allow registered businesses to claim tax credit to the value of GST they paid on purchase of goods or services in other states as part of their normal commercial activity. Goods and services are not distinguished from one another and are taxed at a flat single rate in a supply chain till they reach the consumer. The administrative responsibility will be with a single authority that will levy tax. Exports will be zero-rated supply whereas imports will be charged the same taxes as those on domestic goods and services—sticking to the destination principle.
Merging various Central as well as State taxes into one single tax will mitigate cascading or double taxation, thus, it will help in facilitating one common national market. It is expected that the simplicity of the tax structure will lead to better and more efficient enforcement and administration. From the point of view of consumers, the biggest advantage will be reduction of overall tax burden on goods, which is estimated at 25–30%.
“Today you have tax on tax, you have cascading effect. When all of that is removed, goods will become slightly cheaper,” said Jaitley, talking about the impact of GST on prices. This introduction of GST will be a major step in the direction of reforms of indirect taxation in the country.
Effect of GST on the common man: Things which may get more expensive
The current rate of service tax is 15% and applicable to most services, excluding the essential services such as ambulance services, cultural activities, certain pilgrimages, and sports events. Under the GST, the rate will increase to 18% which will make services more expensive. For goods such as edible oil, textiles, etc. while the excise duty is nil, the VAT, on the other hand, in several states is 5%. With the GST kicking in, the price of those goods may increase, burdening a common man’s budget. The GST may also make consumer goods like tobacco products, cigarettes, and aerated drinks more costly.
Some other consumer articles that may get costlier include the following:
Mobile bills along with Internet packs
Hotel and restaurant bills
Transportation, including air travel, railways, and cab services
Cigarettes/other tobacco products
Consumer articles that may get cheaper:
Indirect tax on goods is currently high because several articles such as beauty products, consumer electronics, non-luxury automobiles, etc. are levied excise duty of 12.5% and VAT of 12.5–15%. Plus, there are many cascading taxes such as CST, octroi, entry tax, etc. making an article expensive throughout the value chain till product reaches customer. Consequently, for consumer goods, the consumer pays around 25–26% above production cost because of VAT and excise duty. With the GST rollout, in which the rate could be 18%, such goods should get less expensive.
Products that may get cheaper after GST rollout:
Fast moving consumer goods (FMCG) goods such as shampoos, processed foods, chocolates, etc.
Paint, cement, and other construction material
Fan, water heater, air cooler, TV, and other electronic goods
GST effect on industry, startups, and SMES
The GST will be collected at each stage and computed using the input tax credit method, according to which taxes paid on the purchase of goods and services in other states could be claimed. This would allow GST-registered enterprises to cut costs as they would be able to claim their out-of-the-state expenditure during the usual course of commercial activity.
“For instance, if I purchase a product A in some other state, then the duties that I pay there consist of taxes which eventually get added to costs since I cannot claim that tax credit in my home state. Some enterprises may be tempted to evade the system and purchase goods without documentation. But if I am a GST-registered enterprise then I can claim tax credit proportionate to the GST,” said Shashank Dixit, CEO, Deskera, a global leader in cloud technology.
Also, since the GST does not discriminate between goods and services and would tax both at a single flat rate, it will remove the multiplicity of taxes as well as the hassles accompanying their computation, eventually leading to better collections as well as improved participation in the tax net. With businesses saving on taxes and complexities, enterprises stand to gain from the development. Additionally, the step will de-incentivize tax evasion for enterprises and streamline supply chains.
Under the existing regime, big corporates “stock transfer” goods to other states as they have the logistics and infrastructure, thus escape paying tax on interstate movement. But, owing to lack of infrastructure, SMEs and startups are unable to do that and get goods through inter-state sales (instead of stock transfers) and end up paying Central sales tax on them. In this respect, GST brings SMEs and startups at par with big corporates by taxing stock transfers as well.
“After the implementation of the GST, major Central and State taxes will get subsumed. This will reduce multiplicity of taxes, bringing down the compliance cost. Central sales tax will also be phased out,” said a tax official not wanting to be named. Another expert said: “The differential tax regime and tugs of war between the Center and the states results in inefficiencies which include slow transit times, needless red tape and disruption in business climate.”
GST will save India’s industry and businesses from double taxation
The GST would in all likelihood rid enterprises and startups of cascading or double taxation that they most frequently encounter and would enable a comprehensive and integrated national market as a seamless whole. Currently, big corporate houses tend to “stock transfer” goods to other regions and states since they possess the required infrastructure and logistics. Thus, they are able to avoid paying tax on interstate movement. However, startups, SMEs, and small enterprises lack that infrastructure and are unable to do the above. On the other hand, they purchase goods through interstate sales (rather than stock transfers) and have to shell out Central sales tax. In this respect, what the GST has done is to bring startups and SMEs level with big corporate houses by levying taxes on stock transfers as well.
A single tax has other advantages too. After the plethora of Central and State taxes get subsumed, the overall cost of ensuring tax compliance for enterprises would go down substantially. Over time, Central sales taxes too could get phased out. Moreover, taxation has always been a bone of contention between the Centre and the states, leading to intermittent turf wars, sometimes precipitating into slow transit times, red tape and general vitiation of the business climate.
Impact on Enterprises, SMEs and startups in case of faulty GST implementation
Even a tiny change in tax chain leads to a domino effect; we can very well imagine the radical changes that would be brought in by the GST. Startups and new entrepreneurial ventures would be particularly affected as they usually lack the financial and logistic wherewithal. On the other hand, the GST could lead to enhanced supply chain decisions, reduced transportation cycle times, warehouse consolidation, etc.; all of which would eventually lead to better efficiency in startups and SMEs. In order to thrive in this fast-paced scenario, businesses, including startups and SMEs, will need to figure out a number of things: taxes that they need to pay, how tariffs apply, quantum of taxes, suitable software and calculation procedures.
In all this confusion, its best for enterprises to go for automation, that is, calculate taxes through an GST accounting software to avoid any chance of human error—as the smallest mistake could boomerang into an inflated tax bill. This can particularly hurt small businesses that are just starting out. However, if equipped with appropriate technology tools, enterprises can file tax returns properly and can even end up saving taxes.
Additionally, existing tax accounting software will require several modifications to effectively tackle the GST. The enterprise resource planning (ERP) software will have to incorporate several modifications to be GST-compliant since the new law will affect the entire gamut of business activities including manufacture, sale, and consumption of goods and services across India.
Moreover, to be able to benefit from the provisions of the input tax credit feature of the GST (a provision which ensures that taxes paid in other states and regions can be claimed in the home state), multiple modules will be required including destination system, input credit, twin rates, etc. Basic processes such as generating invoices and payroll, meeting new compliance rules, etc. would have to be revisited.
Effect of GST on the federal system of tax collection
Since the GST will be a comprehensive indirect tax on manufacture, sale, and consumption of goods and services throughout India. It will replace taxes collected by Central and state governments. Thus, it will remove service tax, central excise, VAT and other taxes levied locally and by state governments. Those bodies are set to lose a part of revenue.
Consequently, the tax rate for GST might be nominal or zero rated for now to insulate revenues of states from GST impact. Also, the Central government has promised states of compensation for revenue losses that they incur from the date of GST introduction till a period of five years. While experts have voiced concerns of GST eroding Parliament and state’s powers to levy taxes, Jaitley has said that taxation powers will continue to remain with legislatures and will be used on recommendations of GST Council. Under the new tax regime, sovereignty will be shared between Centre and states.
“The GST idea has created a grey area (with regard to power of Centre and states)… Taxes will be jointly imposed by Centre and states, there will be one tax,” Finance Minister Arun Jaitley has said in Parliament.
Losses inflicted on the states due to GST rollout
Well, the Indian Government will pay Compensation. Keeping in mind, the side effects of GST implementation such as wrong cash flow, accounting, etc. there are concerns of investors leaving the country. However, experts say investors won’t leave in a hurry as the Indian economy is resilient and is in a recovery mode with institution-controlled inflation, proper fiscal consolidation, as well as low crude oil prices. Moreover, the Government of India has assured states of compensation for revenue loss for the next five years. It will be effective from the date of implementation. The Indian Government has fixed base year for GST compensation at the financial year 2016.
Importance of GST for developing countries including India
Globally, several countries have experimented and implemented the GST and it has the same concept everywhere. Similar to India, only Canada has dual GST. A main aspect of implementation has been the rate. Canada reduced the rate of GST levy a couple of times after implementation. There were others that were forced to increase it. In Asia, countries such as Malaysia and Singapore have adopted the GST tax structure. Plus, there could an inflationary effect on prices, particularly if the rate is higher than used to be levied earlier. For example, Singapore witnessed an upward trend in inflation (1994) when it implemented the GST. Malaysia adequately coped up with GST implementation.
GST will be the most radical tax reform since Independence
Considered as the most extensive taxation reform after Independence, the new tax law is set to see the light of day soon. Experts say the GST would boost the GDP growth by around 2% and also check tax evasion. India’s Finance Minister Arun Jaitley has assured that the GST Council is working on consensus and gradually all items would come within the purview of this new indirect tax regime, which is expected to ensure a free flow of goods and services throughout India.