In a recent meeting of the empowered committee of state finance ministers, certain states demanded a concessional rate for the proposed goods and services tax (GST) for essential commodities, in addition to the merit rate. The Centre has apparently given, in principle, a nod to this structure. Thus, contrary to the initial understanding, we might have at least four different categories of goods under GST; namely, those liable to rates of zero per cent, 1% (precious metals), 8-10% (essential commodities) and 16-18% (merit rate applicable to all other goods and services).
Questions are being raised about whether we can really expect a reformed tax regime which has so many rate slabs similar to the current tax framework. After all, a single-rate GST would have been much simpler to understand and implement without worrying about the classification of goods and services or the need to tweak systems to look up the correct GST rate based on classification. Also, a lower GST rate for select products could mean a higher standard rate in order to achieve revenue neutrality.
However, the multiple-rate structure seems to be a necessity, given the current socio-economic dynamics of our country. To begin with, it would ensure that essential goods currently subject to a concessional rate of tax do not become overly expensive overnight, distorting trade as well as consumer preferences. Take, for instance, steel, one of the building blocks of the nation. If the prevailing 2% Central sales tax (CST) or the 4% value-added tax (VAT) rate on steel increases to an 8-9% state GST, the impact on the infrastructure and manufacturing sectors could be significant. Similarly, a steep increase in the GST rate for commodities such as computers, mobile phones, food items and so on (which currently attract a lower rate of tax) would have a direct impact on most household budgets.
A concessional GST rate would also help to broaden the tax net by including goods which currently don’t attract any tax. Thus, the list of exempted goods can now be pruned by subjecting them to a lower GST rate without causing hardship to industry or consumers.
Internationally, a large number of countries have a lower rate of VAT for essential goods and services. In the UK, while the merit VAT rate is 15%, domestic fuel and power, energy saving materials, residential renovations, etc., attract a 5% VAT. Similarly, in France, a reduced rate of 5.6% is applicable to food, public transport, some pharmaceutical products, etc. There are, however, certain things, which need to be kept in mind. The classification adopted for a lower GST rate should be simple, clear and uniform across all states. This is necessary to reduce unwarranted disputes with tax authorities and the diversion of trade from one state to another.
The lower GST rate should not result in an “inverted duty structure”, which happens when the output attracts tax at a lower rate than the inputs that go into it, leaving the taxpayer with surplus tax credits. Therefore, the goods entitled to a lower GST rate should be carefully selected to avert this problem to the extent possible. There should also be a fallback option in terms of a speedy refund (both in law as well as in spirit) of excess credit, if any.
Also, all competing goods should attract the same rate of GST. For instance, different types of fuel used to generate power should attract the same rate. This would enable industry and consumers to take “tax-neutral” decisions, or decisions driven purely by commercial imperatives or individual preferences, without considering the tax implications.
To conclude, a well-thought-out multiple-rate GST system may actually be desirable for the country—at least for the time being. Once GST is successfully implemented, an attempt can be made to converge the multiple rates into a single unified rate in a phased manner. This could be a win-win situation for both the government as well as taxpayers.
Pratik Jain is executive director and Siddharth Mehta senior manager at audit and consulting firm KPMG. Comment at email@example.com