One of the key objectives of GST reform is to have seamless taxation of both goods and services. In markets today, goods, services, and other types of supplies are being packaged as composite bundles and offered for sale to consumers under a variety of supply-chain arrangements.
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Under the current division of taxation powers in the Indian Constitution, neither the centre nor the states can apply the tax to such bundles in a seamless manner. Each can tax only parts of the bundle, creating the possibility of gaps or overlaps in taxation.
Currently, the Centre levies the service tax which applies to the provision of taxable services and the states levy the VAT on sale of goods. However, in spite of several judicial pronouncements by the Supreme Court, there is lack of clarity in the definition of goods and services. Increasingly, taxpayers are being asked to pay both taxes, which is fundamentally contrary to the division of taxation powers in the Constitution between the Centre and states.
Advancements in information technology and digitization have blurred the distinction between goods and services. Under Indian jurisprudence, goods are defined to include intangibles, e.g., copyright, and software, bringing them within the purview of state taxation. However, intangibles are often supplied under arrangements which have the appearance of a service contract.
For example, software upgrades (which are goods) can be supplied as part of a contract for software repair and maintenance services. Software development contracts could take the character of contracts for manufacturing and sale of software goods or for rendering software development services, depending on the roles and responsibilities of the parties.
The so-called ‘value-added services (VAS) provided as part of telecommunication services include supplies (e.g., wallpaper for mobile phones, ring tones, jokes, cricket scores and weather reports), some of which could be considered goods. An on-line subscription to newspapers could be viewed as a service, but online purchase and download of a magazine or a book could constitute a purchase of goods.
This blurring also clouds the application of tax to transactions relating to tangible property. For example, disputes have arisen whether leasing of equipment without transfer of possession and control to the lessee would be taxable as a service or as a sale of goods.
Another major reason for taxation of both goods and services under the GST is to enhance the buoyancy of State tax revenues. With the growth in per capita incomes, services account for a growing fraction of the total consumer basket, which the states cannot tax. With no powers to levy tax on incomes or the fastest growing components of consumer expenditures, the states have to rely almost exclusively on compliance improvements or rate increases for any buoyancy in their own-source revenues.
In designing the GST, the following aspects have to be considered:
First, GST would work only if there is single tax on all supplies and not if two separate taxes are levied on goods and services. Further the tax rate should be the same in both instances. If the tax rates differ, one would then again be left with confusion in applying the tax to composite supplies containing both goods and services.
This would require amendment to the Constitution, giving concurrent powers to both Centre and states to tax goods as well as services. The Centre does already have powers to tax services. This power has to be extended to the states as well.
In the past, consideration has been given by the empowered committee of state finance ministers to dividing services into certain categories for purposes of the GST, e.g., those subject to direct taxation by the states (the would be local services such as dry cleaning, beauty salons, and repairs and maintenance), and those on which the tax would be levied by the centre with appropriate sharing of revenues with the states.
This would breach the principle of seamless taxation of goods and services. It would perpetuate the confusion that currently prevails in defining goods and services. Moreover, the division services into various categories would become an added source of complexity.
To apply the State GST to services, rules would be needed to define where inter-state services, such as telephone calls, and passenger and freight transportation from one state to another, would be taxable. Under the destination principle of GST, goods and services are taxable in the state where they are consumed, not in the state from where they are supplied. For inter-state services of this type, it is arguable whether consumption takes place in one state or the other.
This issue also arises under national GST in defining tax-free exports of services. International policies vary from country to country. For example, in Canada, place of taxation for telecommunication services is dependent on the origin, destination, and billing address of the service. The service is taxable in the province where two of these three attributes are present. In Europe, all international passenger transportation by air is tax free, where as rail travel is taxable on the basis of distance travelled in a given jurisdiction.
Similar rules could be adopted for purposes of State-level taxation in India. They appear complex and could entail difficult negotiations among the states and union territories. However, once agreed, companies providing such services should be able to adapt their accounting and invoicing systems to apply the tax according to the rules. Whatever the rules, they have to be uniformly adopted by all of the states to avoid any gaps and overlaps in taxation.
If the above issues are taken care of, a uniform GST would eliminate the litigation arising owing as a result of taxation of goods v. services. The threat of double taxation would also be precluded.
Satya Poddar is Tax Partner, Policy Advisory Group, Ernst & Young.