India’s states have taken another step in indirect tax reform by agreeing to a common classification of all merchandise sold within the country, which is expected to curtail state governments’ ability to abuse their taxation powers and strengthen the move towards a common market while potentially reducing related litigation.
State finance ministers agreed “in principle” to a common classification, the so-called harmonized system of nomenclature (HSN), of merchandise at a meeting in New Delhi on 30 November, said a senior official at the finance ministry, who did not want to be identified. Once a common HSN is in place across India, individual states largely lose the power to play favourites as a change in classification needs a national consensus.
The groundwork on HSN was carried out by the Thiruvananthapuram-based Centre for Taxation Studies, a not-for-profit autonomous institution floated by the Kerala government.
HSN classification is done by creating schedules of digits, and commodities with similar functions are grouped in each schedule. Once all merchandise sold in the country has a common classification, and tax rates are fixed for all classifications, the domestic market moves towards uniformity.
Currently, in the absence of an HSN, the same product is taxed at different rates across states, leading to problems for traders. For instance, a digital camera has a value-added tax (VAT) of 4% in Andhra Pradesh and Maharashtra, while most other states levy a 12% VAT on it, said one tax practitioner, who didn’t want to be identified. The difference in VAT rates on digital cameras is largely on account of differences in classification, the tax practitioner said.
HSN is expected to be introduced in the current VAT framework. Once India moves to the goods and services tax (GST) system in April 2010, the common HSN is expected to be an integral part of a smooth transition.
“Classification (in a GST framework) is desirable, and part of a move towards a common market and simplicity,” said S.B. Gupta, tax adviser at Federation of Indian Chambers of Commerce and Industry, an industry lobby group.
“A common HSN will ease the process of GST implementation,” added Pratik Jain, director at audit and consultancy firm KPMG.
The introduction of GST will see states fixing a uniform tax rate on merchandise and services, which when coupled with HSN, will largely remove the fragmentation of markets in the country.
A switch to a common HSN across states is also expected to provide more stability to businesses by reducing the discretionary taxation powers of states.
When state governments have the discretionary power to change classifications of merchandise, and consequently move them to different tax brackets, lobbying assumes importance, said a tax consultant, who did not wish to be identified.
With more transparency in the system on account of a common HSN, disputes are expected to come down. HSN’s introduction “will avoid litigation”, predicted Jain.