Taxing times

THE Goods and Services Tax (GST), heralded by a media blitzkrieg that touted it as a “game changer”, was launched on the midnight of June 30. The Narendra Modi government, in keeping with its penchant for drama, decided on a midnight launch at a special session of Parliament, an obvious attempt to draw parallels with the “tryst with destiny” speech of India’s first Prime Minister Jawaharlal Nehru on the eve of Independence in 1947. At the launch, Modi described the GST as a “good and simple tax”, but there is widespread scepticism that the new tax regime would be anything but simple; as for whether it would turn out to be good, there is plenty of doubt about that too.

Missing from the event was the main opposition party, the Congress; M.P.s of the Communist Party of India (Marxist) also chose to stay away, although its former Finance Minister from West Bengal was in attendance. For the Congress, which had only last year allowed the passage of the enabling legislation in Parliament, this was a turnabout of sorts. What explains this? It is quickly becoming clear that there is a continuum in the policies of the Modi government and its overall approach to policy-making that is targeting large sections of the people engaged in small- and medium-scale occupations. Seen from this perspective, the dramatic announcement of demonetisation and its ravaging impact on those engaged in small-scale and informal occupations, including the calamitous impact on agricultural product prices, has a connection to what is likely to happen in the name of the GST.

The GST was always positioned as a tax reform, one which would ease the tax burden, make compliance simpler, reduce the multitude of taxes levied by the Centre and the States by unifying them, and streamline and modernise tax administration. Moreover, the GST system provides for business entities to take “credit” for taxes paid along the supply chain to prevent the “cascading effect” of paying taxes on top of taxes already paid. And, all this was to be achieved without either the Centre or the States taking a hit on their resources. Moreover, this latter objective was to be achieved without impinging on the States’ powers of taxation that are enshrined in the Seventh Schedule of the Constitution and which constitutes what is regarded to be a part of the “basic structure” of the Constitution. This tough balancing act explains the long and arduous road to GST, which began in 2000 (“A killer tax”, Frontline , September 2, 2016).

It was always clear that a major reform such as this required a fair amount of sagacity on the part of the Centre, which, after all, enjoyed lopsided powers of taxation in the Indian constitutional framework; indeed, this explains why the introduction of the Value Added Tax (VAT) was preceded by a long struggle in which the States bargained hard before they ceded the ground that was rightfully theirs under the Constitution. A key problem of the new GST regime is the complication because of the multitude of rates.

Indeed, the government’s slogan, “One Nation, One Market, One Tax”, is misleading because it still does not bring about a unified single tax rate that is applicable on all goods and services across the country. Instead, there are basically rates of 5, 12, 18 and 28 per cent, apart from a zero rate on articles of mass consumption, a 3 per cent rate on bullion and a “sin” cess on articles such as tobacco products.

Moreover, a critical universal input, crude petroleum and its products, which contribute to over one-third of all tax revenues in India, are out of the GST structure.

A senior officer in the indirect tax administration, who has been involved in discussions on the modalities of the GST over the last several years, told Frontline : “The current version of the GST will create serious problems. It is going to result in not only tax evasion but also considerable hardship for small businesses.” Specifically, the multiple rates would increase litigation and lobbying by business entities to shift goods or services into another bracket, he said.

Referring to the tax rate of 28 per cent on tractors (which was reduced to 18 per cent just before the launch at midnight), he said, “There is already large-scale evasion in this business, the high rate would only spur it further.”

Complicated structure

He pointed out that in all internal discussions within the tax administration prior to the Modi government, the proposal was to only have, at the most, two rates of GST—one for raw materials and inputs and the other applicable to goods and services meant for final consumption. “The GST that is now launched suffers from a fatal flaw in design that would become difficult to remedy later,” he said on the eve of the launch.

The design of the GST and its hasty rollout without adequate preparation and capacity building would spur tax evasion of a totally new dimension, this officer said. “Earlier, tax evasion was said to occur because of high tax rates, but now this will happen not because the tax payer does not want to pay but because of his/her inability to incur the cost of compliance,” he said. Already, a cottage industry of sorts has developed, with intermediaries masquerading as “service providers” or “tax enablers” offering solutions to beleaguered tax payers who dread the onset of GST.

Speaking to Frontline on the night of June 30, before the GST launch, a tax official in the Tamil Nadu government, said key elements of the GST Network “are woefully behind schedule”. “The rollout has been very late,” he said and claimed that “we have not yet tested the platform”. More critically, key elements of the software, such as the Application Program Interface (APIs) for the different modules in the platform were made available to the Department “only days before the launch”. The APIs are a key element because they act as a bridge between the different pieces of software that use the platform; in fact, they are essential for GST service providers (GST Suvidha Providers) to access the GSTN (GST Network) platform.

The official’s revelation that the APIs are just starting to be despatched implies an utter lack of preparedness. A software developer familiar with APIs told Frontline that the newer versions of APIs “cannot simply be stitched onto the existing ones”. Any updates would require Suvidha Providers to also suitably modify their software. Otherwise, there is the risk of even a small change causing a major impact on the platform. Referring to the APIs that have just been received in Tamil Nadu, the official said: “We have not even started testing these (APIs). We do not even know what they look like!”

The officer quoted above also pointed out that personnel in the department have been “trained only on dummies, not online,” not even in simulated conditions. Moreover, the department has not completed User Acceptance Testing (UAT) in order to evaluate the system’s compliance with business requirements and to assess whether the system is acceptable for delivery. “In fact, there does not even seem to be a road map to do this,” he said.

Seen in this context of gross underpreparedness, Finance Minister Arun Jaitley’s announcement, made just before the launch, that industry and trade have time until September to file returns for July is but an admission of failure, not the magnanimous gesture that he appeared to portray it to be. But even if the platform is rolled out smoothly, there are fundamental problems with the design, which impose a heavy burden on the weakest link in the Indian business environment—small- and medium-sized units.

The GST system that has been launched requires each and every transaction made by a business unit to be “matched” with every single purchase or sale, what is termed as a “match” of invoices. For this, a business entity has to “know” the GSTIN (GST Identification Number) of the counterparty before it does the transaction; and, even more onerously, the business unit is responsible for the counterparty’s action insofar as it must ensure that this is reflected in the counterparty’s entries in the system.

The owner of a small hardware shop in Bengaluru told Frontline: “Normally a transaction happens once the buyer and the seller agree on the product and its price, but now I have to not only sell my product but also ensure that the purchasing party conforms to the new regulations.”

The apprehension that the GST’s flawed structure would result in increased tax evasion is echoed by this dealer. “The new rules impose not only costs in terms of systems (computerisation and personnel familiar with accounting systems to operate them) but also the sheer risk they expose traders to which are completely outside their control,” he said. “It is for these reasons many would simply avoid the system altogether,” he remarked.

The tax officer quoted earlier said the system of matching invoices is “completely unique to India”. “Nowhere in the world do they have a system like this, which requires parties to match invoices; they are usually self-declared for the purpose of settling tax credits,” he said. Most countries simply require business units to file a consolidated statement of invoices with their counterparties.

Matching of invoices

“Invoice-based matching would lead to great hardships for businesses, especially small ones.” It would require a trader to be familiar with the specific HSN (Harmonised System of Nomenclature) code for each commodity. “How does the administration expect small traders to know the HSN code for every single commodity they are dealing in?” asked the tax officer.

Wider consultations and the study of best practices the world over would have ensured a better design. Greater attention to detail would have been possible, said an officer, referring to the fact that the tax rate and the method of its imposition need to take into account the nature of the supply chain. “The bullion trade, for instance, is characterised by a short supply chain, in which the link between the manufacturer and the final consumer does not normally happen through a distributor.” In trades such as this, the supply chain is short, implying limited physical movement of goods that can be inspected, leaving greater scope for tax evasion. “We had suggested that in trades with short supply chains a compounded tax based on turnover ought to be levied, but obviously bullion traders carry more clout,” he quipped.

Small units’ burden

While these may be the daily hazards small units will face, they do not end here. There is also the burden of filing multiple returns, which, according to tax experts, may be at a minimum of 49 over the course of a financial year. Contrast this to the two returns that needed to be filed earlier by those filing returns for service tax during a year.

To make matters worse, the higher costs of compliance—not just financial but in terms of increased capacity that is necessary to cope with the demands of the new system—have a bias against smaller units.

The sheer economic cost is one aspect of the problem, as demonetisation has demonstrated so dramatically since November 2016. Just as “going digital” was not a costless and painless option for small and informal enterprises, coping with GST is likely to impose similar pain in the immediate short term. Many units may turn unviable in the short term, unable to cope with the demands of the new regime.

But things could turn out worse for even those who manage to survive the first wave of the onslaught under the new regime. This pertains to the logical structure of the GST in which transactions are in a chain. Since tax credits can be claimed for taxes paid down the line, many small business units would need to be GST-compliant simply in order to survive. This is because larger units that source from small businesses would demand that the small ones be GST-compliant so that they are able to adjust tax credits against their tax liabilities. The small units that are unable to do this will be simply cast aside. This perhaps explains why captains of industry have been unabashed admirers of GST. This is because big business sees GST as a means of uprooting competition from the smaller units or at the very least putting pressure on them. These are still early days, but it would not be surprising if the GST regime paves the way for greater consolidation through takeovers and mergers and acquisitions following bankruptcies of small and medium enterprises.

The nationwide agitation of small-scale traders and businesses in cities and smaller towns across the country—in Delhi’s Chandni Chowk, in Surat, in Ghaziabad and elsewhere—points to simmering unrest. The fact that the government decided, only hours before the Parliament session, to reduce the GST rate on fertilizer even as the country is reeling under extreme agrarian distress is likely to be interpreted not as an act of magnanimity but as utter lack of sensitivity for the weak. If demonetisation was widely seen as a gross example of the Modi government’s obsession with the optics of a spectacle, the GST has reinforced that impression.

The imposition of GST, portrayed as a revolutionary reform, ought to have been preceded by a respect for the democratic character of the polity. This would have meant wide-ranging consultations with economists, especially experts in public finance, besides chartered accountants, lawyers and a genuine cross section of business interests, instead of just its creamy layer. In short, a dialogue with all “stakeholders”, that much-abused term that is fashionable in cbusiness and government circles, would have perhaps resulted in a better structure. Even if it had not sorted out all problems, the dialogue would have ensured at least the goodwill of all those involved. Such an approach would also have sanctified the notion of reform as a continuous process, not merely an event to be showcased.

The senior tax official quoted earlier told Frontline that the entire structure “has been crafted by the bureaucracy without building into the tax regime valuable inputs that would have been made available by expertise outside government”. This, and a more sagacious approach, in which the Centre’s tax-take was not the only motive, may have resulted in a simpler structure.

“If States’ apprehensions of lower revenues post-GST had been assuaged through legal guarantees, they may have been willing to agree to fewer slabs,” he pointed out. Moreover, the flaw in the design arises from the fact that the GST rates have been arrived at merely by subsuming existing State and Central taxes and levies. “A proper GST would have been arrived at if the government, in partnership with the States, had gone to the drawing board with the intention of working out a fresh design,” he argued. “Instead,” he said, “we have a slapdash approach.” “How can this be termed revolutionary?” he asked.