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Determining GST rates calls for cutting the clutter
November, 17th 2009

The discussion paper on GST, released by the Empowered Committee of State Finance Ministers last week, turned out to be a damp squib, disappointing industry and the Centre alike.

Other than the concept of integrated goods and service tax (IGST) for inter-state transactions, the paper offers very little no mention of classification of goods or an exempted list, no plan for phase out of exemptions, no measures to prevent deviation by states from agreed rates, no monitoring machinery, no mechanism for settling disputes and so on. The paper has only reiterated what we knew: that there will be a central GST (CGST) and a state GST (SGST).

And that on goods, there will be four rates at the state level a 0% for exempt goods, a nominal rate (perhaps 1%) for precious metals, a concessional rate for goods of basic importance, and a standard rate.

The paper has also proposed that states continue the exempted items list they have under value added tax (VAT) at least in the initial years. Effectively then, the SGST will be the current VAT with a new nomenclature. For services, the discussion paper has proposed a single rate.

The GST structure at the Centre is yet to be known. The Centre will perhaps make its mind known after the Thirteenth Finance Commission, chaired by Vijay Kelkar, comes out with its recommendation on GST.

No one disputes the compulsion driving a dual GST structure, although a single GST would have been ideal. Indias Constitution allows fiscal federalism, and asking states to give up their power to levy taxes is impossible.

However, given the experience with the implementation of VAT, a smooth rollout of GST will be challenging. A lot of work needs to be done. Amendment to the Constitution and enactment of a GST Act at the Centre and states may be the easiest of the tasks ahead.

Most importantly, the tax base need to be finalised. That is crucial for finalising tax rates at the Centre and state level. The larger the base and fewer the exemptions, the lower can be the rates.

And, as Central Board of Excise and Customs member Sumit Dutt Majumdar observed at a recent PHD Chamber conference in New Delhi, exemptions need to be brought down to the minimum in a phased manner, from a level of more than 300 at present. Scrapping exemptions in one stroke is impossible. Pruning the list requires consensus among states, a political decision. Moreover, the list needs to be common across states to prevent trade diversion.

Alongside, the states must decide on a common threshold for exemption from tax. Under VAT, the threshold varies from state to state. In the North East, where businesses are small in size and fewer in numbers, the threshold is Rs 2 lakh while in many others, it is Rs 5 lakh. The discussion paper proposes to raise this to Rs 10 lakh. Will all states come on board? Unlikely, unless they are compensated for loss of revenue.

Thats where the Finance Commission would come in. There is also demand that the threshold limit at the Centre for excise (currently Rs 1.5 crore) and services (Rs 10 lakh) be raised. Again, that is a difficult decision, given the revenue implications. The CBEC has rightly said that it does not want a hasty decision.

These concessions are being sought on the pretext of easing the burden for the SME sector. But as Mr Majumdar noted, the solution lies in simplifying procedures, rather than in giving concessions.

These include common registration and return forms for CGST and SGST, e-filing and doing away with physical verification. Schemes for composition/compounding too may find very few takers only those who do not want to avail credit for taxes paid on inputs.

States must agree to keep the threshold low and the list of exempted item small to bring all into the tax net, allow better use of credit for tax paid on inputs and reduce cascading effect.

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