GST: Reverse charge mechanism a catch-22 situation for small businesses
Worried about the steadily declining goods and services tax (GST) revenue collection, the GST Council, in a meeting last month, advanced the implementation of the e-way bill for interstate movement of goods to 1 February from 1 April. The government suspects large tax evasion, especially by small and medium enterprises, and feels this would help check it.
The next step to further plug this revenue leakage could be reintroduction of the reverse charge mechanism. Here, large entities are required to pay taxes on purchase from unregistered smaller companies.
In October, the council deferred implementation of reverse charge by six months. According to some media reports and tax experts, the council may take a call on it at its meeting on 18 January.
To put the issue in perspective, the concept of reverse charge is not new. It has been in practice from the time service tax was introduced and was first applied to the insurance sector, say tax experts. It was followed by covering mutual funds under its purview and gradually extending to goods transporters, works contracts, sponsors and brand ambassadors.
In the first two cases, the purpose of tax collection was met to a certain extent because the nature of the industry is such where receipts are few and there are many providers. For the rest, it was implemented because these industries were highly unorganized, add tax experts.
When introduced under GST in July last year, an addition was made. The levy of reverse charge got extended from a few services to all unregistered goods suppliers and services providers falling under the GST ambit.
But it failed to widen the tax base and added to the compliance burden of companies already struggling to adjust to the new tax regime; so, it had to be temporarily shelved.
Despite GST now being implemented for more than six months, businesses continue to grapple with a slew of challenges, raising doubts about the success of the reverse charge implementation at this time.
“The reintroduction of reverse charge on transactions with unregistered dealers would result in businesses having to make process and compliance changes. Some businesses may not want to deal with unregistered dealers; hence, many businesses which are below the threshold may end up taking registration in order to ensure business continuity. Reverse charge is applied on certain transactions in the European Union as well, but in India, it would be preferable to go in for a phased approach once initial hurdles are overcome” said M.S. Mani, senior director (indirect tax) at Deloitte Haskins and Sells Llp.
While the number of registrations might rise once reverse charge is implemented, it would not generate additional revenue for the government because tax paid by the recipient company on behalf of an unregistered supplier will be given as input credit to the former, pointed out Anita Rastogi, indirect tax partner at PwC India. She suggested scrapping of reverse charge on supplies from unregistered dealers at least for the next three-four years.
“Reverse charge on other categories like import of services is fine because it is a global concept to pay tax on imports under reverse charge. Yes, GST tax collections have been lower than anticipated, but in a knee-jerk reaction, if the government rushes with reverse charge just like it is doing with e-way bills, it will only cause more damage,” cautioned Rastogi.
There are, of course, contrary views over the decision.
For instance, Abhishek Jain, partner at EY, pointed out, “One may argue that with just registrations going up, how can revenues get a boost since reverse charge paid will be treated as an input credit? But it should be noted that with more number of smaller entities registering, the turnover of these small firms, which might otherwise be under- reported, can come under the government’s radar and that could boost GST as well as income-tax collections.”
The fact remains, though, that tools like e-way bills and reverse charge will tighten the government’s ability to track transactions, making survival for some small businesses difficult, while increasing the cost of doing business for others.
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