GST affords an opportunity to get rid of antiquated monitoring devices such as inter-state check posts which do not result in any improvement in tax collections, but cause a significant loss in increased transportation costs!
The introduction of the goods and services tax (GST) is being viewed as one of the key moves to “create a seamless national common market for our farmers, artisans and entrepreneurs” (2009 manifesto of the Congress party). This means that there would be free flow of goods and services throughout India, and that the tax burden on a product would be the same regardless where it is produced in India.
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Currently, there are two hurdles that dealers encounter in free movement of goods within the common market of India. First, inter-state sales of goods are currently liable to the Central sales tax (CST) which is a central levy but administered and collected by the states. CST is collected by the seller from the purchaser and remitted to the origin state, i.e. the state from where the goods are originally dispatched. This tax is over and above the VAT applicable in the state to which the goods are shipped, and makes the overall tax burden on goods acquired from other states higher than goods acquired locally within the state.
Second, many states have set up check posts to monitor inter-state movement of goods. In concept, there is nothing wrong with the check posts if they serve the purpose of ensuring proper compliance with the laws of the land. In practice, they are an archaic and ineffective method of monitoring inter-state movement of goods. Physical inspection of goods at inter-state borders becomes a means of harassment and an extra source of income for those managing the check posts. They lead to higher transportation costs, and inefficiencies in the design of supply chain.
The blue print for the GST already endorsed by the governments stipulates that both Centre and state GSTs would be levied on the basis of the destination principle. Under this principle, the application of tax is restricted to goods and services which are destined for consumption within the boundaries of the taxing jurisdiction. Thus, exports would be free of both Centre and state GSTs. The Centre GST would apply uniformly to all domestic sales within India, whether inter-state or local.
Inter-state sales, on the other hand, would be subject to tax in the state to which the goods are shipped. They would not be subject to any tax of the state from which they are shipped. Thus, there would be no levy of a tax like CST, which is levied in the state of origin.
A set of rules will be needed to define the place of destination of the goods and services supplied, i.e., the jurisdiction in which they would be taxable. For goods, such rules already exist under the CST legislation and could be readily adapted for the GST. Generally, the place of destination could be defined as the place where the goods are made available to the buyer or the state to which the goods are shipped.
New rules would need to be developed for defining the place of destination of inter-state services. These rules could be similar to those for defining international exports and imports of services. As services do not entail physical movement from one state to another, their destination is generally defined to be the place where the recipient/customer is located.
Another important requirement would be an effective and practical mechanism for enforcing compliance with those rules. It is now generally recognized that check posts are not a good mechanism for the GST. What are the alternatives?
While the details are still awaited from the empowered committee of state finance ministers (EC), one mechanism under consideration is to require the vendors to collect the destination state GST on inter-state supplies of goods and services and deposit the tax directly in the account of the destination state. Thus, the vendors would collect tax on all of their domestic sales (i.e., other than exports) – destination-state tax on inter-state sales, and local tax on all other sales.
The tax collected and remitted by the vendor in the origin state would then be creditable to the purchaser in the destination state under the normal rules, i.e., if it relates to inputs for use in making taxable supplies. It would be identical to the tax collected and remitted to local dealers within the destination state.
The dealers would file a monthly return for their inter-state sales, indicating sales made to different states and the tax deposited. This mechanism is similar to that for the CST, the only difference being that CST is remitted to the origin state whereas the GST would be remitted to the destination state.
Under this system, there would be no need for border controls, such as the check posts that are antiquated and ineffective in any case. The application of the Centre GST to all domestic supplies would automatically serve as an audit control under this system. Since all supplies, whether inter-state or intra-state, would be reported for the purpose of the Centre GST, the aggregate turnovers reported for the state GSTs must equal the total turnover reported for the Centre GST.
Although dealers can misclassify the turnover to different states in order show a higher turnover in the states where the GST rate is lower, this can be effectively countered if the tax base and rates are harmonized across the states.
Another valuable tool for the monitoring of inter-state transactions is the Trade Information Exchange System (TINXSYS), which was developed at the behest of the EC as an automated data system on all inter-state sales, replacing the manual data capture system based on C forms and CST returns filed by dealers. TINXSYS can be used for verification of sales reported by inter-state dealers and for matching this information with the accounts of the buying dealers.
The method of taxation itself provides an in-built mechanism for monitoring inter-state trade. All sales would be deemed to be taxed in the origin state, unless the sale is an inter-state sale on which tax is paid to the destination state. Buyers in the destination state who are GST registrants would have a strong incentive to ensure that the vendor properly applies the destination tax, which would be available to them as credit against their output tax in the destination state. Otherwise, the goods would be subject to the tax of the origin state, which would not be creditable in the state of destination.
One issue with taxation of inter-state supplies as per the destination tax principle is whether the destination state can enforce payment of tax by the dealers who are not residents of the destination state. States should be able to take action against dealers regardless of whether they are established in the destination or not. However, in case the states are not able to enforce the law against such dealers under the current legal system, Parliament could enact suitable enabling provisions to permit such action.
Satya Poddar is a Tax Partner, Policy Advisory Group. Ernst & Young