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The Union government and states will implement a proposed structural revamp of the goods and services tax (GST) in phases, keeping in mind the impact tax rate changes can have on consumption, according to two officials.

The proposed revisions will include pruning tax exemptions, removing anomalies from taxing raw materials and intermediates higher than finished products, and reducing the number of GST slabs, said one of the officials, who spoke on condition of anonymity.

The revisions are currently being studied by two ministerial panels and will entail implementing the tax rate changes needed in the textile industry to correct the inverted duty structure, which have been kept on hold. On 31 December, the council deferred a rate hike from 5% to 12% on several items in the textile and apparel sector, including woven fabrics of cotton, silk and wool, coir mats, apparel and clothing accessories of sale value up to 1,000, which was to take effect from 1 January.

An email sent to the finance ministry seeking comments for the story remained unanswered at the time of publishing.

One major shift in the circumstances favouring implementing further structural changes in GST is the expiry of GST compensation to states in June this year, a major concern for states. That would leave a big gap in state budgets, especially of large state economies, which need to find ways of raising revenue receipts. That makes rate and slab rationalization and revenue augmentation methods agreeable to states. Besides, the Centre’s practise of borrowing from the market to meet the shortfall in compensation for FY21 and FY22 have improved Centre-state relations. The GST Council had, in an earlier meeting, decided to collect the GST compensation cess levied on items like automobiles till March 2026, but the proceeds will be used only to repay the loans taken in FY21 and FY22.

“The main concern of states is the expiry of GST compensation in June. Even though the cess collection has been extended, it will only raise adequate resources for paying back the loans already raised. The only way out is to augment revenue from GST, which can be done in one of two ways. It can be done administratively, or you make your rate structure efficient—that is, remove exemptions, cut duty inversions and reduce the number of slabs," the official said.

The official said many of the duty inversions have already been corrected, and there is a limit to how much revenue augmentation can be done administratively. “Eventually, you have to fix the rate structure. The group of ministers are likely to come out with a road map. They may not want to do everything in one go. It will be phased. But it has to happen. How they sequence, we do not know yet, but there is this realization that they have to do it now. There is no escape," the official said, adding that concerns about private consumption recovery lagging behind other growth drivers will be factored into while finalizing the proposals.

During post-budget interactions with the industry this month, revenue secretary Tarun Bajaj asked business leaders to share their views with the ministerial panels examining GST rationalization. Karnataka chief minister Basavaraj Bommai leads a panel of state ministers on tax rate rationalization, while Maharashtra deputy chief minister Ajit Pawar heads a panel on GST system reforms. The panels are likely to give their reports this month.

Experts believe fewer GST rate slabs will make it easier for businesses. “As we move towards the fifth year of GST, it would be very interesting to see if the rate rationalization committee comes with a recommendation of merging rate slabs so that there are just three rates. This would make it easier for businesses, especially small and medium enterprises. It is also essential to focus on simplifying the compliance process for service providers who have been grappling with multiple-state returns and audit notices,“ said M.S. Mani, partner at Deloitte India.

The second official said that the solution to help states does not lie in extending the GST compensation period beyond June but rather increasing tax collections. “The best way forward is to bring tax rates back to revenue neutrality by removing some of these inversions and exemptions," said the official. He added that the duty correction in the textile sector, which was kept in abeyance, needs to be reversed now. Mobile phones saw duty correction in March 2020.

In the case of ready-made garments, tax incidence in the pre-GST era was about 13.2%, compared to the current levy of 5% GST. Natural fabric has a GST rate of 5%, whereas man-made fibres and yarns are taxed at 18%. This anomaly of raw materials getting taxed at a higher rate than the finished product leads to the accumulation of tax credits in the hands of businesses. Initially, the government had not allowed fabric makers to claim a refund of their unused input tax credit but later relented and allowed refunds in July 2018.

“Input tax credit refunds should not have been allowed on fabric in the first place. It was a political call taken at that time. It should be addressed now," said the official.

The states are given compensation for the first five years of the introduction of GST on the assumed revenue growth rate of 14% on the base year of 2015-16. Compensation cess is levied on luxury and sin items such as aerated drinks, coal, pan masala, cigarettes and automobiles over the peak rate of 28%.

ABOUT THE AUTHOR

Gireesh Chandra Prasad

Gireesh has over 22 years of experience in business journalism covering diverse aspects of the economy, including finance, taxation, energy, aviation, corporate and bankruptcy laws, accounting and auditing.
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