Meeting the challenges of a commom goods & services tax

The prospect of a common goods and services tax (GST) being implemented from April 1, 2008, turns tax-reformers, businesses and governments (both at the Centre and states) euphoric for valid reasons. They all foresee simplification of procedure, lesser tax burden for businesses with credit running along the supply chain, thereby eliminating the cascading effect on prices, and a substantial growth in revenue collection. In short, a win-win situation for all.

However, all these expectations can be belied if the challenges confronting its implementation are not effectively met.

The first challenge comes from our federal structure itself and the sign of a crack in the concept of common GST is already visible. It is significant that the refrain of the Union finance minister about the single GST coming in force from April 1, 2008 was missing in this year’s Budget speech.

It is clear by now that there will be no common GST and that GST for the Centre and the states will run in parallel. Hence, the businesses will necessarily have to deal with more than a single administrative authority for the same goods, like what they have been doing now.

The second challenge emanates from the compulsion of reconciling currently prevalent destination principle with the supply chain credit management under GST that smacks of origin principle. There is obviously a contradiction which needs to be resolved.

To be more precise, under the current VAT system, the movement of goods from one state to the other is taken as export, and since export conceptually is tax neutral, it is the importing state that has a right to collect VAT while the exporting state refunds the tax collected.

This, in short, is the destination principle which currently governs state-VAT, but not Central VAT (Cenvat) which works on origin principle. With the introduc-tion of GST, the state barriers will disappear rendering the concept of import and export in inter-state transactions irrelevant. The only con-necting thread from origin to end would be the credit of GST paid.

In such a system, the destination state is expected to collect net tax on the value added, which is substantially lower than what it collects now under destination principle, thus affecting industrially weaker states like the north-eastern states, Uttarakhand, Himachal Pradesh etc. However, it is technically possible to synthesize the destination principle with the origin principle by allowing end-to-end credit upfront, with back-end revenue adjustment on destination principle through clearing house mechanism. In no country, however, such synthesized system is in place.

Way back in 1985, European Commission (EC) proposed to adopt the origin principle with a clearing house mechanism, but kept its implementation postponed owing to disharmony of VAT rates and governing laws, and consequently the possibility of major distortions in intra-community trade. Nevertheless, we need not be pessimistic about trying a symbiotic approach through innovative automated programmes, thereby setting an example for other countries.

The third major challenge arises from continuance of organised tax-evasion through unaccounted transactions, under-invoicing and credit-frauds under state-VAT and Cenvat.
If GST is not safeguarded by a risk management system, it is likely to create an evasion-prone market that would witness gradual elimination of tax-compliant businesses. We should learn from the experience of other GST-compliant countries in this regard.

On a modest estimate, the UK loses annually over 10 billion sterling pounds of VAT through Missing Trader and carousel frauds, while annual loss of VAT by the EU countries collectively on the same account is roughly estimated as 100 billion euros. In Canada, since the inception of GST in 1991 till March, 2003, about 600 individuals and businesses have been convicted of GST fraud.

In Brazil, the GST experiment has failed for the same reasons. The only long-term solution as a safeguard, as has been envisaged by the EU Commission, is real-time settlement of all VATable transactions. In India, it is technically feasible to put in place a real-time accounting system to raise the compliance level.

The last major challenge of GST comes from the massive expansion of tax base and the resultant demand for additional staff. As for the Centre, once the threshold limit for Cenvat is reduced from Rs 150 lakh to the state level, and dealers and retailers are covered, the assessee base will expand exponentially. Similar expansion is likely in states for reason of inclusion of service taxes in its domain.

It is well-nigh impossible to manage the expanded workload with the existing workforces unless the entire workflow is automated with an effective risk management system.

The question is can we bring about GST on the scheduled date after meeting the above challenges satisfactorily? If we do, India will no doubt set a standard worth emulating.

Source : Economic Times - Gurgaon, Haryana, India, dated 12/03/2008