India - One step closer to GST

The recent decision of the Uttar Pradesh Government to implement VAT (Value-Added Tax) has brought a nationwide Goods and Services Tax (GST) regime closer to reality. UP was the last State to adopt VAT, holding out on the ground that VAT will cause inconvenience to traders and may lead to a loss of revenue. These concerns have been proven to be unfounded by the experience of States that have adopted VAT. Revenue has increased in these States and the taxpayers have not comp lained of the tax compliance regime being burdensome.

In the Budget session of 2006, the Finance Minister, Mr P. Chidambaram, had announced that India will have GST by 2010. Given India’s federal structure and the constitutional provisions regarding a State List and a Union List for taxation, there is likely to be a Central GST and a State GST.

Empowered committee

Involvement of State governments hence is a sine qua non for evolution of the indirect tax system in India. The empowered committee of State finance ministers which was constituted for enabling the transition from sales tax to VAT will continue to play a role in effecting the transition to GST as well.

Among the many things Mr Chidambaram can be credited with, is giving the empowered committee a substantial say in articulating the future indirect tax system of India. This is essential if the path-breaking tax reform, that GST requires, is to happen.

The road to GST entails evolving a consensus, constitutional amendments and well-defined Central and State laws for implementing the tax on goods and services. At a broad level, the key issues in this would be combining the taxation of goods and services and securing agreement over the taxing powers of the Union and the States.

If we ignore the challenges of combining goods and services taxation as also those of division between taxing powers of the Union and the States, substantial challenges still remain. If every State enacts its own legislation, the empowered committee would need to ensure uniformity of regulations.

Under the VAT system a semblance of uniformity prevails due to the adoption of the rates of 0 per cent, 1 per cent, 4 per cent and 12.5 per cent on various categories of goods across all States, with higher rates applicable to alcohol, fuel and a few other commodities. However, tax systems are not complicated merely by multiplicity of rates; they get complex because of the rules defining taxable values and credits. It is here that despite the present-day VAT, significant work would have to be done by the empowered committee to bring around 31 States on common ground.

This is a mammoth task and is illustrated by the present state of VAT laws in the States in which significant variations have crept in despite the Central Government assisted empowered committee providing a common platform for evolution of VAT. Variations across States in provisions governing tax credit of capital goods and differences in taxing works contracts are a good place to begin.

On the issue of credit of capital goods, the statute and rules of Delhi allow credit of capital goods in three tranches spread over three years. The law further says that in the case of stock transfer or clearance of exempted goods, proportionate credit needs to be reversed.

The lack of a clear definition of ‘proportionate credit’ gives rise to differing ways of computing tax credit reversals in line with differing interpretations. Also, spreading the capital goods credit over three years implies that stock transfers and sale of exempted goods over three years will impact credit reversals.

On the other hand, if one looks at Haryana, the entire credit of capital goods can be taken in one go and hence the proportionate credit reversals eat into the capital goods credit only as long as it remains unutilised.

In Maharashtra there is no need of a credit reversal on capital goods in the event of stock transfers or sale of exempted goods. If a manufacturer or a large scale-retailer sets up a multi-locational business across these three States, he has to configure his tax accounting system differently for different locations.

The legal position on tax credit of capital goods need not differ from State to State since the use of capital goods does not depend on the State in which it is located. A nationwide State-level GST should bring in uniformity of tax treatment of such transactions.

In the case of works contracts, the statute and rules of the States provide for deductions of amounts expended towards labour and like charges, for arriving at the taxable value. In case the dealer is unable to maintain records of amounts expended towards labour and services, there is a schedule of percentage deductions which can be applied by the dealer.

Different States have prescribed differing percentages for similar items of work. So while in Delhi a deduction of 25 per cent is available for ‘fabrication and installation of plant and machinery’, in Karnataka a deduction of 15 per cent is available to ‘installation of plant and machinery’. The differing wordings in the rules leave scope for interpretation while the significant rate differential makes the system non-uniform across States.

Similarly, while the ‘construction of railway coaches on undercarriages’ supplied by the railways is amenable to a deduction of 30 per cent in Karnataka, the same item of work has a deduction of 20 per cent in Delhi. There will always be some differences in tax regimes of different States depending on their revenue requirements and the choice of businesses that they want to encourage. However, such differences should be exceptions rather than the norm across all States.

If States’ goods and services taxation is to achieve a national character so that a truly national market emerges within India, uniformity of tax treatment of common economic activities is inescapable. Concerted effort needs to be made in this direction by the Central and State governments.