While the Centre is targeting an April 2016 deadline for implementation of the Goods and Services Tax (GST), many states have taken steps derailing even the Value-Added Tax (VAT) system. Satya Poddar, tax partner, Policy Advisory Services, EY, in an extensive conversation with Sunil Jain, explains how states are ill-prepared to implement GST and why a 27% rate is not workable at all. Excerpts:
Do you think GST can be rolled out with the 27% rate proposed, keeping out petroleum and liquor in the beginning but bringing them into the GST fold once it settles down?
The way to ensure compliance is to start with a tax at a low rate. At the 27% rate, the compliance for GST would be very poor, for two reasons. First, at such a high rate, retailers will not invoice a sale to the customer because no customer would take an invoice and pay the tax. So, the standard refrain of the retailer would be, “If you don’t invoice, it is fine”. This way, the whole system breaks down. Second, the rate is proposed at 27% because states are refusing to broaden the tax base. This leads to distortions in competition. Take, for example, chocolates. When these are taxed at 27% and some other food items have a zero-tax rate, there will be arbitrage; people will do everything to hide the sales of taxable products and classify these under the exempt categories. Go to a kirana store selling chocolates, biscuits and rice; it would never record the sales of taxable products. Thus, an easy way of avoiding tax is provided if the dealer has a mixed inventory of taxable and non-taxable products. Consider cooking oil. It is taxable at a low rate or exempt in some states, but if it is sold as hair oil, a cosmetic, it is taxable at 27%. There are court cases on it. Marico, which sells coconut oil, has moved the Supreme Court. The rule is that if oil is sold in a container of less than 100 ml or 200 ml, then it is treated as hair oil. But if the container holds more than 200 ml, then it is treated as cooking oil. Imagine the arguments a kirana guy will have with the consumer while selling different volumes of the same product from the same shelf!
In order to bring the rate down, you have to broaden the base. Rolling out the GST with a rate of 27% will lead to a vicious circle, where even that 27% rate will not be able to give you revenue neutrality.
But wouldn’t dealers, who are not part of the tax base now, be incentivised to get into the tax net by the virtue of the GST offering seamless input credit on value addition based on invoices at every point of sale?
That is the way it should have been right now, under VAT. But it is not so because states are not enforcing it properly. Their computerised systems are defective or incomplete. More importantly, the tax rate is quite high. Even at the 14.5% that states levy now, they are not able to collect the tax.
Are you saying VAT buoyancy has reduced because states are not able to collect it efficiently?
Exactly. Besides, some states are taking retrograde steps, such as collecting the tax only from the manufacturer. Punjab is collecting VAT from the manufacturers, at the first point of sale. A month ago, UP announced that rather than collecting the tax from the vendor when he makes a sale to customer, the customers will now be required to deduct the tax. So, when you sell me the goods for R100 with R14 as tax, I am supposed to pay R114 to you and you send R14 to the government. But you are not sending R14 to the government, and perhaps you are sell the goods to me for R112. Now, UP has brought in the rule that the customer is supposed to withhold the tax and pay the same to the government. Then, many states are denying input tax credit for goods sold. In the beginning, input tax credit was denied only when a stock transfer of goods was made from one state to another, which attracts no CST. The states’ argument was that if a company avoids CST by way of stock transfer, then they would deny 2% of the input tax credit on sales made within the state on which VAT is payable. But now, states like Tamil Nadu, Karnataka and even Gujarat have increased the amount of credit that is denied on inter-state sales and even in local sales. Tamil Nadu denies input tax credit to the extent of 5%.
VAT payable to a government is the output tax minus the input tax. Now, these states say that VAT is the output tax minus the restricted input tax deduction. And restricted input tax deduction means no credit up to 4% of the tax. The moment input tax credit is restricted, there is no longer a VAT. The worse thing is when input tax is collected and no input tax credit is given. Then, it becomes a turnover tax; and VAT was designed to get rid of the turnover tax. Nothing destroys an economy like a turnover tax. When the customs union was formed in the EU, the first thing they did was to get rid of the turnover tax and replace it with the VAT.
How accurate is the tax base that is under consideration by various panels?
There are three data sources for calculating the tax base. One is the national accounts data, aggregate consumer expenditure in the national accounts. The second method, which the Finance Commission taskforce (chaired by Arbind Modi) on GST used, is based on the turnover declared for corporate income tax. You can infer the VAT base from this and make some adjustments for exports and imports. The third method is to take the declared turnover for the VAT on goods and declared turnover for service tax. The National Institute of Public Finance and Policy’s (NIPFP) number is based on the third method. But, the Finance Commission taskforce relied on income tax data as it is comprehensive on turnover because there is no distinction between exempt goods and taxable goods or exempt services and taxable services. Based on that, the taskforce came up with a very low revenue-neutral rate (RNR) for GST, of less than 12%. The taskforce computed the tax in three different rates and took the average rate from the three methods, which came to 11.3%, and then rounded it off to 12%. I find this the most respectable method. The NIPFP has used the third method, which is fine, provided you are collecting data only on the taxes paid and declared. But both the VAT and service tax systems have massive exemptions. Even the negative list of services, those that are not taxable, has about 100 items. Previously, the positive list of taxable items had about 100 items. The VAT also has many items in the negative list. The initial list had 29 items. The VAT base could be as small as 50% of what should be the actual base! The same is true for the service tax base as well.
The states have not made any serious attempt to broaden the base, except for adding one or two items such as textiles and sugar. In fact, the (proposed) rate is going up now because it has to compensate for the states’ revenue loss on CST and VAT, which will lead to a higher rate than the rate today (of existing central and state taxes).
The disagreement between the Centre and the states on inclusion of petroleum products in GST is on the account of denying input tax credit at the intermediate stage, such as to a refinery. It is not about denying credit for the taxes paid on a finished petroleum product, which can be an input for other businesses, say for an airline buying jet fuel and not being able to use that credit for meeting its final tax liability…Yes. It is at the intermediate stage where tax-cascading is the most significant. Even if states are allowed to levy the supplementary taxes, these can only be levied on the finished products, but not on the required industrial inputs.
Wouldn’t it solve states’ revenue loss issue if the Union government compensates them for supplementary taxes?
The Centre can compensate states permanently, as is being demanded now. But it is refusing to give a permanent compensation by including a provision for it in the Constitution. Second, states can protect it by having the right to levy entry taxes. That is what Maharashtra is fighting for.
You don’t see the possibility of starting GST with a 27% rate and then gradually reducing it?
GST can never get started with a 27% rate because compliance would be very poor at this rate. It will be a non-starter. Second, I can guarantee a 27% GST will not give you the revenue that states get today. Because of poor compliance, states will start losing revenue dramatically.