Taxation policy

For tax harmony?

Print edition : September 04, 2015

An aerial view of the Walayar inter-State checkpost in Kerala's Palakkad district. States are apprehensive about losing revenue following the introduction of a single GST in place of a number of taxes. Photo: K.K. Mustafah

At a meeting of the Empowered Committee of State Finance Ministers on GST implementation in Bhopal in 2012, Finance Ministers (from right) Amar Agrawal (Chhattisgarh), Ajit Singh (Assam), A.K. Rather (Jammu and Kashmir), Sushil Kumar Modi (Bihar), Raghav Ji (Madhya Pradesh), A.K. Walia (Delhi), M. Krishnamurthi (Tamil Nadu) and Kiran Chaudhary (Haryana). Photo: A.M. Faruqui

Enforcing a national market by removing trade barriers through a harmonised commodity tax and reducing the fiscal autonomy of federal institutions is what the Goods and Services Tax system seeks to achieve in India.

AS the economic reforms started in the early 1990s, we started debating the role of the state in creating a single national market. It was perceived that State taxes on commodities, particularly the cascading type of sales tax, created as many markets as there are States and Union Territories in India. Numerous tax rates, exemptions and tax concessions distorted the smooth functioning of markets, it was said. Harmonisation of commodity taxes at the State level, particularly removing the cascading effect and reducing discretion, was initially suggested. Now we are trying to move towards a common commodity tax across the country, even at the cost of removing the States’ autonomy on this important fiscal policy. Prioritising market over political autonomy is a fiercely debated issue in India, and it appears that the political “federal structure” is losing ground to the powerful economic “market”.

The long-drawn process of harmonisation of commodity taxation in India has gone through several rounds of tough negotiations between the Union and State governments since the early 1990s. The amalgamation of commodity taxes of the Union and State governments is in the penultimate stage. A constitutional amendment is essential to empower the Union and State governments to enact goods and services tax (GST) laws and to remove inconsistencies in the Constitution for enacting the GST law. The 122nd Constitutional Amendment Bil, 2014, addresses these issues. The first section of this article deals with the provisions of this Bill, and the sections that follow discuss the possible road ahead in designing and implementing the GST.

The Constitution Act, 2015

The Constitution (One Hundredth Amendment) Act, 2015, (henceforth Act 2015) was presented as The Constitution (One Hundred and Twenty Second Amendment) Bill, 2014, and passed in the Lok Sabha in May 2015. It is now before the Rajya Sabha. The Bill was referred to a Standing Committee of the Rajya Sabha and its report, with dissent notes from the Congress, the Left parties and the All India Anna Dravida Munnetra Kazhagam (AIADMK), was submitted on July 22.

Act 2015 inserts Article 246A, which empowers both Parliament and the State Assemblies to legislate independently on the GST and vests the exclusive power with Parliament to legislate on the Inter-State GST (IGST). It is now clear that Parliament will create a law for the Central GST (CGST) and the IGST, and every State Assembly will create a law for the State GST (SGST). Further, the IGST will be levied on inter-State trade in lieu of both the CGST and the SGST. Therefore, the IGST rate will be a sum of the CGST and SGST rates, with the Union government receiving the CGST part and the States getting the SGST part. In order to make the GST feasible, Act 2015 brings in changes in several articles of the Constitution along with creating a new institution: the Goods and Services Tax Council.

The taxation powers of the Union and State governments are listed in the Seventh Schedule under the categories Union List and State List respectively. Further, the Union government levies service tax using the residual powers vested with it. Act 2015 removes the power of the Union government to levy excise duties on manufacturing of commodities, except petroleum products, and also the power of States to levy State value-added tax (VAT) on intra-State sale of commodities, except petroleum products. The other taxes that are to be removed and subsumed under the GST are the Central Sales Tax (CST) on inter-State trade, entry tax and octroi, entertainment taxes of States except those of local bodies, and taxes on newspapers and the advertisements therein.

Act 2015 also removes all inconsistencies in the various other provisions of the Constitution so that the Central and State governments enjoy independent authority in tax matters, subject, of course, to the approval of the GST Council.

Though there will be a separate IGST for inter-State sale of goods and services, Act 2015 provides for a levy of 1 per cent tax on inter-State sales, which will be collected by the Central government and remitted to the States from where the supply originates. The Government of India will make changes in the list of goods that will be eligible for this specific tax, which essentially is meant to bring the exporting States on board. The definition of place of supply in this context needs to be made clear. The Rajya Sabha panel looking into the issue has suggested that this tax be levied only on inter-State sale to the end-consumer and not on transfer of stocks between States.

The States are apprehensive about losing revenue following the introduction of a single GST in the place of a number of taxes, including sales tax, entry tax, the CST and entertainment tax. But the fact is they have the opportunity to tax production of goods as well as all services, until now the exclusive domain of the Central government. Since the reduction in the general tax rate could also reduce the tax revenue to States, Act 2015 provides for a compensation of loss of revenue to States for up to five years on the recommendation of the GST Council. The Rajya Sabha panel has suggested that this must be ensured. The major and the most contentious provisions in Act 2015 relate to the creation and the functions of the GST Council.

GST Council

The GST Council has to be constituted by the President of India within 60 days of the commencement of Act 2015. It shall consist of the Union Finance Minister as Chairperson and the Union Minister of State for Finance or for Revenue as a member. It will have all the Finance or Revenue Ministers of States and Union Territories with legislatures as members. One of these State Ministers will be elected as its Vice-President. With a quorum of 50 per cent of the members, the council shall decide on issues with three-fourths majority in a voting pattern that gives one-third weightage to the votes of Union Ministers and two-thirds to the votes of State Ministers. In its dissent note, the Congress wants to reduce the concentration of power with the Union government, hence its suggestion to reduce the weightage of the Union government to one-fourth and increase that of the State governments to three-fourths. A vacancy in membership for any reason shall not affect the functioning of the council.

The GST Council shall decide on the following matters:

(1) The taxes, cesses and surcharges levied by the Union, State and local governments are to be subsumed under the GST. Already, Act 2015 has mentioned certain taxes to be subsumed under the GST.

In due course, the GST Council will decide to subsume more taxes or products under the GST. For instance, the industry lobby is for subsuming both excise duty and sales tax on petroleum products as that will considerably reduce the cascading effect and increase input tax credit to business units.

(2) Tax rates, exemptions of specific goods, special rates during times of natural calamities and special provision for the north-eastern States.

To simplify the tax system, a single rate for all goods and services would be fine, but that would be at the cost of losing the progressivity of the tax structure. Similarly, bringing most of the goods and services into the GST net would help reduce the overall tax rate and avoid unnecessary breaks in the chain of tax credit. This is difficult to achieve.

(3) The threshold limit of turnover for business enterprises to come under GST registration.

This is another political issue with lots of economic implications. Small traders and producers form a vocal lobby in electoral politics in all States. A higher threshold level would leave a large number of potential taxpayers outside the tax net. This may also create a substantial difference in prices if the value addition at the last retail level is high in trade. In the case of manufacturing, it will break the tax credit chain if there are too many small-scale industrial units providing inputs to large and organised enterprises.

(4) Writing the model GST law, principles of levy, apportioning of the IGST, the principles that govern the place of supply and creating a dispute settlement system are the other important tasks. The council should complete these within a reasonable time period. If the tax laws and the administrative system to collect tax are determined by the GST Council with the objective of harmonisation of commodity taxes in the country, there will be little need for Parliament and State Assemblies to debate them. The AIADMK objects to reducing the sovereignty of the Central and State governments by giving the GST Council all powers, but harmonisation will essentially lead to that.

While deciding on the issues listed, the GST Council will be guided by the principle of harmonisation of commodity taxes. This can be achieved provided tax laws, tax rates, exemptions, the process of tax administration and the input tax credit system are uniform across the States and the Union government. A complete and sophisticated information technology (IT) strategy is essential for achieving the objectives of the GST. This strategy is provided by the GST Network.

GST Network

The Empowered Committee of State Finance Ministers constituted a committee under the chairmanship of Nandan Nilekani, who was then the chairman of the Unique Identification Authority of India (UIDAI) under the second United Progressive Alliance (UPA) government. The committee published a report on the “IT Strategy for GST” in 2010. Thereafter, the GST Network (GSTN) was instituted as a Section 25 (not-for-profit) private company on March 28, 2013. The shares of this company are held by the Union government (24.5 per cent), all the States and two Union Territories with legislatures (together owning 24.5 per cent), LIC Housing (11 per cent), ICICI Bank (10 per cent), HDFC Ltd (10 per cent), HDFC Bank Ltd (10 per cent), and NSE Strategic Investment Corporation Ltd (10 per cent). The total paid-up capital is Rs.10 crore.

The major services that the GSTN will provide are registration of traders, filing of returns, and managing payment of tax revenue to governments. The GSTN is supposed to establish a complex network of traders, tax authorities in the Central and State governments, banks, the Reserve Bank of India (RBI) and other government organisations such as the Ministry of Company Affairs and the Comptroller and Auditor General of India, with whom the tax data will be shared for better vigilance and monitoring.

All GST returns will be filed electronically by every trader, big or small. The tax authorities, banks and the Reserve Bank of India (RBI) will process all the documents electronically for smooth transfer of tax revenue between traders and governments and across governments in the case of cross-border trade. Therefore, a common accounting software and tax-return-filing system will be created and it will be used by all the stakeholders, particularly traders and the tax authorities. This requires not only common tax laws but also codes for various goods and services, tax rates, exemptions and accounting systems. Further, the GSTN carries the assurance that there will be a single challan for the payment of three types of the GST—the CGST, the SGST and the IGST. Therefore, digitisation of all tax documents is essential for faster processing and reconciliation of tax information.

For instance, we need to provide nationwide input tax credit for the CGST, and this is possible only if tax returns are filed electronically. A similar process is required for the SGST, too, as a trader who buys a product from other States should claim input tax credit, against the IGST he or she paid, from the SGST he or she would pay on the subsequent sale. This is all the more complex and can only be addressed through an electronic system of clearing of such credits between governments. Similarly, the tax paid through bank challans must be transferred to governments through a dedicated RBI channel, and this also requires a strong IT solution.

There will be a single tax number for each trader, which will be used to pay all the three GSTs. The trader would pay the CGST and the SGST separately to the Union and State governments respectively because cross-tax credit is not possible: that is, one cannot claim credit from the CGST for payment of the SGST. After paying the GST separately to the Union and State governments, the trader will file a single GST return. This system enables concurrent auditing and processing of tax appeals. Therefore, the IT strategy would require all tax departments in the Union and State governments to use the same IT platform that is used by taxpayers.

If the tax laws, the system of tax administration, the filing of returns, and financial technology are common for both the Central and State governments, the tax administration system of either the Centre or the State governments could become redundant. For instance, when tax laws and rates are common for State governments and the Central government, tax administrations in these two governments cannot interpret tax laws differently. Therefore, the tax audit by the State and Union tax administrations should not lead to conflicting results. This would ultimately make one of the audits redundant as interpretations and laws and rules will be the same across Central and State governments.

In this regard, a committee in the Finance Ministry is looking into the IT preparedness of the tax authorities at the Centre and in the States. It is also reviewing the preparedness of taxpayers, particularly the larger ones, through consultations with trade associations. Further, the committee is looking into various other aspects of implementing the GST, such as integrating the different GSTs and training the stakeholders, that is, both traders and taxmen.

Issues raised by States

Several States have, from time to time, depending upon the political equation with the Central government, raised several issues concerning the design and the implementation of the GST. Though State governments have been given the authority to legislate on the GST, such tax laws must be approved by the GST Council, which is guided by the principle of tax harmonisation. Therefore, all tax laws and related issues will be decided at the GST Council, and its recommendations will be ratified by the State Assemblies. Of course, the States can use the council as a forum to debate and decide their issues, but the fact that “tax harmonisation” is the guiding principle means that State-specific issues cannot be addressed adequately.

The Empowered Committee of State Finance Ministers instituted a study to calculate the Revenue Neutral Rate, which is a rate that would not reduce the tax revenue of States from the existing level. This was conceived to be around 27 per cent. Many think this is too high, and the committee, under the chairmanship of Arvind Subramanian, Economic Adviser to the Finance Ministry, is looking into the issue with the sole objective of reducing the GST rate without adversely affecting the revenue potential of States. Meanwhile, the Rajya Sabha panel advocated that a rate in the range of 14 per cent to 20 per cent be selected.

The GST Council will decide on the quantum of loss and period of compensation, and this process is likely to be prolonged as every State is sure to clamour for larger compensation and the Central government may put a cap on such compensation. Another contentious issue before the proposed GST Council will be the creation of a dispute settlement system. It is not clear which of the disputes this system will address. If there is a dispute between the Central and State governments and between the various State governments, then it should be resolved in the GST Council itself. If it is between taxpayers and the tax authorities, then the existing system, which starts with adjudication by the appropriate higher-level tax authorities in the Central and State governments, and thereafter the courts, can continue with appropriate changes in the existing tax dispute settlement systems. The original Bill suggested a judicial-level dispute settlement system, but it was removed on the recommendation of the Lok Sabha’s Standing Committee on the Bill.

The institutional mechanism of the GST appears to have a parallel in the World Trade Organisation (WTO). The Ministerial Conference in the WTO creates trade-related regulations and a dispute settlement system within it that resolves disputes between participating nations on the basis of the laws created by the stakeholders earlier in the Ministerial Conference. Here, too, the GST Council, with the member-States and the Central government, will draw up the GST laws and create a dispute settlement system.

The WTO has been accused of taking away the sovereignty of nations on trade-related issues, and the GST Council will face the same charge. Both these institutions work to institute a rule-based regulation of the market economy with little discretion for elected representatives in their forums.

Barry R. Weingast, a political scientist in Stanford University, conceived the idea of the “market preserving federalism” in 1995. One of its main characteristics is the establishment of a common market for products and factors that would foster competition between sub-national governments in providing local public goods and services. “The failure of the common market condition creates pathology in which sub-national government becomes a de facto ‘national government’ within its jurisdiction…. Trade barriers short-circuit inter-jurisdictional competition…” he says.

Enforcing a national market by removing trade barriers through a harmonised commodity tax and reducing the fiscal autonomy of federal institutions is the “market preserving federalism” in India.

R. Srinivasan is Associate Professor, Department of Econometrics, University of Madras, Chennai.