The replacement of state sales tax by the value-added tax (VAT) in 2005 was considered a significant step forward in the reform of domestic trade taxes in India.
The state VAT design was based largely on the recommendations of the 1994 report of the National Institute of Public Finance and Policy, led by the late Amaresh Bagchi. In recommending a state VAT, the Bagchi committee report recognized that it was not a perfect solution but was a feasible option within the framework of the Constitution and would lay the foundation for an even more rational regime in future.
The Centre and states have now embarked on implementing this more rational regime, in the form of a dual goods and services tax (GST), to be levied concurrently by both levels of government.
A dual structure would mean that there would be a central GST and a state GST, each levied on a comprehensive base comprising both goods and services. Thus, a transaction would attract both taxes.
Ideally, both taxes should have been merged into a single national GST, with an appropriate sharing of revenues between the Centre and states. However, given the federal structure of the Constitution, a dual GST is a political necessity.
It is essential that the GST laws are harmonized between the Centre and states, and among states. This will simplify compliance, reduce administration costs and improve revenue collections: a win-win for governments and taxpayers.
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There are several dimensions to harmonization—tax base and rates, tax administration and tax legislation, and rules and procedures.
It is essential that the base for the tax covers both goods and services in a seamless manner and is uniform throughout the country. Under the best international models, GST is levied on all supplies, whether of goods, services, real property, intangibles, or any combination of these. Moreover, the tax applies at all points in the supply chain.
The current division of tax base under the Constitution between an exclusive Centre list and an exclusive state list is archaic and no longer tenable in India’s modern economy. The Constitution needs to be amended to give both levels of government concurrent powers to levy tax on all supplies, with the proviso that the state tax would be restricted to supplies for consumption within that state.
Application of tax on a comprehensive base would automatically ensure uniformity of the base between the Centre and states, and across states. Under VAT, states have exercised their fiscal autonomy to deviate from the common base agreed to by a committee of state finance ministers. Such deviations are unfortunate and should be resisted.
As regards the tax rate, two primary tax rates are contemplated—a standard rate and a lower rate applicable to food and other specified necessities. While a lower rate for food may be inevitable on social, economic and political grounds, it runs the risk of seriously compromising the objective of base harmonization.
Currently, the Centre does not levy any tax on agricultural output but the states do. There are, however, significant inter-state variations.
One can only speculate whether a common list eligible for the lower rate would be an easier political compromise than a common base with no such list.
Another element of harmonization is a common set of rules for the taxation of inter-state services—for example, telephone calls and passenger and freight transportation from one state to another.
There are many other services which are rendered or consumed across several states, with no unique place of supply or consumption. Application of state GST to such services requires a common set of rules defining the place of supply where they would be taxable, similar to those defining international exports and imports of services under the current service tax.
A common set of place-of-supply rules will avoid any overlaps or gaps in state taxation of services.
Harmonization of administration is essential to reduce duplication of administration costs, improve enforcement and reduce compliance costs. Currently, there is little coordination among the Centre and state administrations. The GST offers an opportunity for a complete overhaul of tax administration, to make it more efficient and effective.
The governments have agreed to adopt a common taxpayer identification number for the Centre and state GSTs and harmonize the design of tax forms and the reporting and filing periods and procedures.
In addition, it has been proposed that the states collect the Central GST on behalf of the Centre from smaller dealers below the registration threshold of Rs1.5 crore under Central excise. These are welcome features of the GST administration and should be extended to other elements of tax administration.
There are two options for harmonization of tax legislation. First, the core GST legislation could be enacted by Parliament, empowering the states and the Centre to levy and collect the tax by referring to the provisions in the core legislation. This would ensure uniformity in core legislative provisions, allowing the Centre and states the flexibility to set rates within the agreed framework.
The core legislation would include all the definitions, rules defining the taxable consideration, input tax credits, timing of tax payments and adjustments in special circumstances. They would also include tax form design and audit, enforcement and appeal procedures. Harmonization should also extend to the system of tax interpretation and rulings, such as classification of goods and services, determination of taxable consideration and definition of export and import.
This would ensure the setting up of a common rule of law, with the Centre and states having the power to enforce this. The central sales tax (CST) in India provides a useful model for such harmonization.
Although the CST is a Central levy, it’s administered by the states, and the revenue from it goes to the appropriate states. The tax law is enacted by Parliament but the states collect and keep the tax. There can be no better example of harmonization than the conception of the CST model, with the states enjoying the risks and rewards of ownership of the tax.
An alternative model would be to have the Centre and the states each enact their own GST law with identical core provisions. The difference between the two alternatives is cosmetic. The second alternative could be seen to give greater recognition to the states’ fiscal autonomy.
Satya Poddar is tax partner, policy advisory group, Ernst & Young.
This is the first in a four-part series on the goods and services tax.
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