As a nationwide Goods and Services Tax (GST) is scheduled to roll out w.e.f. 1st July 2017, investors seem to be concerned about the potential impact on India Inc because the complexities involved in the GST design. Despite repeated claims by government representatives about their preparedness to handle a smooth roll out, their practical implications are being pondered over.
The new tax system requires three filing a month plus an annual return – a total of 37 filings – for each of India’s 29 states in which a firm operates. Because there are multi-billion transactions taking place monthly, pan India, one can only fathom the magnitude of filings that need to be uploaded periodically. The new tax mandates every firm to upload their monthly invoices to a portal that would match them with those of their suppliers / vendors. This is necessary for the firm to claim input credit. This also means that incrementally firms may refuse to solicit business with unregistered businesses because such businesses being able to furnish the appropriate tax numbers. This is expected to bring several, hitherto unregistered, businesses into the tax net; thereby improving tax compliance and bringing transparency and shoring up public finances at the same time. That said, this also necessitates an overhaul of such firms’ accounting systems and calls for fresh investments into people and technology. For a country like India, in which a large part of the economy thrives on cash transactions from smaller businesses, such investments into skilled people and technology could significantly dent their margins threatening their survival. As also, since manufacturers are responsible for compliance across the supply chain, they need to ensure that the suppliers / vendors they do business with are equally compliant. While the government has given some time for firms to be GST compliant and liquidate pending inventory, the potential collateral damage of the new tax system is anyone’s guess. While over 160 countries have adopted universal tax system like GST/VAT, their experiences have been varied. While some countries have seen inflation spiralling in the year following the implementation of GST (only to moderate later), some other countries have had to reduce such slabs to boost their economies.
We need to concede the fact that for a vast and complex economy like ours, a smooth and uninterrupted implementation of such an ambitious program can and WILL prove to be very challenging. That said, which structural change hasn’t? All said and done, GST implementation is our country’s biggest tax reform (since independence) and is expected to bring millions of unregistered businesses into the tax net, thereby boosting government revenues and, hopefully, the country’s sovereign profile.
While on this subject, I came across a recent report (reproduced as hereunder) by the Reserve Bank of India, which I found quite informative
Reserve Bank of India – May 2017 report
The Reserve Bank of India (RBI) brings out an annual publication entitled “State Finances: A Study of Budgets” which analyses the fiscal position of state governments based on primary state level data. From 2005-06 onwards, this report has been structured around a special theme of topical relevance. The current report’s theme is the goods and services tax (GST).
The salient features that emerge from the analysis of state finances in the report are:
• The GST is likely to strengthen cooperative federalism and have far-reaching implications for growth, inflation, public finances and external competitiveness in the Indian economy, drawing on the evidence of significant efficiency gains revealed in empirical evaluation of the implementation of VAT in 2005.
• The GST is likely to bolster states’ revenue and anchor fiscal consolidation without compromising on expenditure quality.
• Seamless implementation of GST is contingent upon a robust dispute resolution mechanism and a sound information technology (IT) infrastructure.
• From a medium-term perspective, the GST assumes significance in the context of the debt sustainability of states and the evolving contours of state finances.
While we reproduce Section 3 hereunder, to highlight what select countries have experienced, you may read the complete article here (pages 20-33)
Section 3. Select Country Experiences
(i) New Zealand – The GST was introduced in 1986 as part of a comprehensive tax and welfare reform when the economy was in crisis. Initially, GST was introduced at a rate of 10 per cent which was subsequently raised to 12.5 per cent (1989) and further to 15 per cent (2010) to mobilize higher revenue while removing distortions in the tax structure (IMF, 2015a). This eventually led to the adoption of GST at a single rate with almost no exemptions. With a standard rate lower than in most other OECD countries but without almost any exemptions, New Zealand is one of the highest tax productive nations (highest GST revenue GDP ratio) among the OECD countries (IMF, 2015a).
(ii) Canada – The GST was introduced in the form of a multi-level VAT in 1991 replacing manufacturers’ sales tax. GST was levied on supplies of goods or services purchased in Canada and included most products, except certain essentials such as groceries, residential rent, medical services, financial services and exports. The system of input tax credit ensures that the value added at each stage of the supply chain is taxed only once thus avoiding cascading. The introduction of GST led to new processing operations and techniques to verify the accuracy of the returns submitted by small entrepreneurs and multinational corporations (Sherman, 2009). Since some of the Canadian provinces impose their own sales tax besides the GST, it creates price distortions in the economy (IMF, 2015a).
(iii) Singapore – The GST was introduced in April 1994 at 3 per cent, along with a reduction of direct and other indirect taxes (Zhou, et al, 2013) to make it acceptable to the public and to minimize the inflation impact. Additionally, the government committed not to raise the tax for the next 5 years which was an important step in reviving consumer spending. Thereafter, rates were raised gradually, although it remains one of the lowest rate globally with favourable implications for trade competitiveness (Yin, 2003). To compensate for the regressive nature of GST, Singapore has introduced a GST compensation scheme which provides support to the needy and underprivileged.
(iv) Australia — Although first mooted in 1975, GST was implemented in Australia 25 years later on July 1, 2000 through the passing of the Goods and Services Tax Act, 1999 (Zhou, et al, 2013). Australia imposed a 10 per cent tax on goods and services and replaced a range of existing taxes – the wholesale sales tax (WST), debit tax, financial institutions duty, and stamp duty on shares, leases, mortgages and cheques. The GST is collected by the federal government and redistributed to the six states and two territories according to the amount recommended by the Commonwealth Grants Commission (CGC) on the basis of the principle of horizontal fiscal equalization (HFE). The aim is to achieve equality in the provision of services and infrastructure; however, it often causes friction between the states when the GST revenue is divided (Zhou, et al, 2013). Several exemptions (viz., basic foods, some education and health services, childcare, and religious and charitable activities) and low standard GST rate at 10 per cent have, however, led to low GST revenue productivity from a tax collection standpoint (IMF, 2015a).
(v) Malaysia – One common reason for implementation of GST in both Singapore and Malaysia is the large expatriate work force in these countries who benefit from economic growth but are exempt from income tax. Furthermore, Malaysia’s shadow economy was estimated at 30 per cent which represents a vast scope for tax revenue (Zhou et al, 2013). Although the idea of introducing a consumption based GST has been on the table since 1989, it was introduced only in 2015 after intensive debate on its potential merits and shortcomings. Lingering doubts on the country’s preparedness for the introduction of GST led to some delay in its implementation even though the standard rate (at 6 per cent) is relatively low compared to the VAT rates in other ASEAN countries. After introduction of GST, the cost of doing business in Malaysia has reduced as the tax burden has been transferred from manufacturers to consumers. A generous list of exemptions and very low rates, however, lowers revenue productivity in terms of tax collection (IMF, 2015b).