The so-called sin products, such as alcohol and tobacco, are singled out for taxation at high rates in virtually all jurisdictions around the world. The high rates serve the double purpose of yielding extra revenues to the government and discouraging consumption of such products, which are harmful to health.
In India also, these products attract high and multiple taxes in the form of excise duties, licence fees, cess, inter-state import and export fees, and bottling fees. Should these products then be left out of the ambit of the goods and services tax (GST)? If not, how would the tax be structured for them?
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The blueprint for GST prepared by the empowered committee of state finance ministers suggests that, following the current practice under the state value-added tax, or VAT, these excisable products, including petroleum, would remain outside the scope of GST. While the reasons for this treatment are not fully articulated, it is contrary to international best practices and warrants reconsideration.
Their exclusion from GST would mean that manufacturers and producers of the excluded products would not be able to claim a credit for GST paid on capital equipment, raw materials and other inputs acquired for use in their production. This would lead to tax cascading and other economic distortions which GST is designed to eliminate.
It would also create complexity in administration and compliance. For example, a restaurant serving alcohol with meals would be required to split the charge for alcohol, and apply GST to the balance of the invoice. If the restaurant were to buy a refrigerator for storing alcohol as well as fruits, vegetables and other food items, it would be required to apportion the use for storing alcohol and reverse the credit claimed for the refrigerator.
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One possible reason for their exclusion could be the taxation of these products at rates substantially higher than GST rates. However, application of GST does not mean a reduction in their overall tax burden. The international practice is to apply excise duties on such products over and above the standard GST. The excise duties can be set at an appropriate level to yield desired revenues from the sector, regardless of the GST rate.
Thus, if the total effective tax rate on a product is to be 50%, and the standard GST rate was 15%, the excise duty could be set at approximately 35%. The exact rate would vary depending on the trade level (manufacturer or distributor) at which it was to be levied.
A second reason for their exclusion could be to limit their taxation at the production stage, where the collection of tax could be better monitored and enforced.
GST applies at all points in the supply chain and there is a risk of significant leakage if the collection of taxes on such highly taxed products is shifted to smaller dealers and retailers. Again, such risks can be managed by leaving the application of the excise duty at the production stage, while collecting GST at all points in the supply chain. In the example above, the bulk of the revenues would come from the 35% excise duty, which would be collected at the first point of sale, which could be the sale by the producer or, in the case of imports, by the distributor or importer.
A third reason could be to deny the input tax credit in respect of such sin products when they are acquired as business inputs for entertaining clients or owners and shareholders. Under GST, businesses are allowed to claim a credit for the tax paid on the purchase of the products acquired as raw materials or other inputs for further manufacturing and processing or for resale. However, it may not be appropriate to give credit for the tax paid on sin products such as alcohol and tobacco when they are acquired for entertainment.
This concern can be met in two ways. First, if the total tax on the products is split into an excise duty and GST, no credit would be allowed for the excise duty. A credit is to be allowed for only GST paid on the inputs. Second, even the credit for GST can be denied, except where these products are acquired as raw materials or for resale. Many countries disallow credit where tobacco or alcohol is acquired for entertaining business clients or for use by business owners or employees. Similar restrictions apply to credits in respect of meals, sports, entertainment, diesel, petrol and automobiles.
Yet another reason for the exclusion of these products from GST could be to keep their taxation within the exclusive domain of the states. This reason is applicable mainly to alcohol.
Currently, the powers for regulation and taxation of alcohol are vested exclusively in the states. By bringing alcohol within the ambit of GST, both the states and the Centre would be empowered to levy tax. States may be reluctant to accept this jurisdictional encroachment by the Centre.
But GST will entail substantial realignment of taxation powers, allowing both levels of government concurrent powers to tax all goods and services. States will be empowered to levy tax on services, and the Centre would be allowed to levy tax beyond the stage of manufacturing at all points in the supply chain. There is little justification to exclude certain sectors or products from this arrangement. The power of regulation of alcohol could still be left to the states, while allowing the Centre and the states concurrent taxation powers under this arrangement.
Full benefits of GST may not be realized if it is not levied in a comprehensive manner to all goods and services. Tax compliance in both the tobacco and alcohol sectors is far from satisfactory, and leakages are believed to be substantial.
Extension of GST to these products would reduce tax cascading and allow enhanced tracking of their movement, greater transparency in their taxation, and improved tax compliance: a win-win situation for the economy and the governments.
Satya Poddar is tax partner, policy advisory group, Ernst and Young.
This is the last in a four-part series on the goods and services tax.
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