Goods and services tax: Place-of-supply rules need more clarity
January, 20th 2015
India’s progression towards a goods and services tax (GST) regime appears imminent with the introduction of the GST Constitution Amendment Bill in Parliament last month. The Bill enables both the central government as well as state governments to levy a GST on the supply of goods, supply of services or supply of both. While deliberations appear to be on with respect to various aspects of GST design, including rate, threshold, exemptions, a crucial aspect that needs to be finalised are the parameters for determining the ‘place of supply’ of goods and services for GST levy. While news reports indicate that draft rules have been framed, they are yet to be released to the public.
From what we know so far, under GST, a Central GST as well as a state GST is expected to apply on every intrastate supply of goods and services in India. Further, an integrated GST or IGST, which is a combination of Central GST and State GST, is expected to apply on cross-border supply of goods and services into India (i.e., imports) and within India (i.e. inter-state supplies).
With respect to inter-state supplies and imports, the ‘place of supply rules’ are expected to determine the state which can stake claim to the state GST component built into IGST.
As the place of supply rules are expected to be different for goods and services, in this first part of a two-part series, the discussion is centred on the cross-border taxation of goods into and within India.
GST essentially seeks to replace an origin-based tax levy currently prevailing in India, with a destination-based tax levy. Under the current system of taxation, goods manufactured in a factory in Maharashtra and sold to a customer in West Bengal shall require payment of central sales tax on the sale in the state of Maharashtra. Under GST, it is expected that, IGST shall apply on the sale with the state GST revenue accruing to the state of West Bengal. Further, as against central sales tax, which is non-creditable and, therefore, a cost in the supply chain, full credit is expected to be available in respect of GST paid on inter-state sales.
While this seems a minor transition in the point of taxation, it can be expected to throw up compliance challenges for a manufacturer selling goods to multiple states across the country.
By way of illustration, currently, when goods are sold from Maharashtra to West Bengal, Haryana, Karnataka, central sales tax on all these sales shall be payable in Maharashtra at a uniform tax rate. However, under GST, in the same example, the seller in Maharashtra could well be required to pay an IGST identifying each of the destination states. Simply put, a seller of goods today can conduct his business by only being aware of the tax rate in the state of his operation or supply; however, under GST, it is possible that a seller supplying goods to 20 states may well need to have a knowledge of the prevailing rates as well as GST provisions across all those 20 states. On a related matter, GST is set to apply on ‘supply of goods’; however, the term ‘supply’ is yet to be defined. There is, therefore, some apprehension that even a stock transfer of goods to a branch or an agent could attract GST as a ‘supply of goods’. While such a levy may enable GST credits to flow with the goods, its impact on compliances (i.e., reporting of IGST payment to multiple destination states) across multiple supplies as goods flow through a complex and elongated supply chain would need to be evaluated.
Further, while IGST on inter-state supplies is set to be levied and collected by the central government, as to how the relevant state shall assess and enforce the state GST component, basis its provisions, from a supplier in another state is currently unclear. Irrespective of the manner of collection, unless a standard IGST rate is mandated for inter-state supplies, every seller of goods may well be required to build into its systems the GST rates and provisions across the nation—a Herculean task for any business. An alternate approach would be for the IGST to be paid by the buyer of the goods in the destination state (i.e., under a reverse charge mechanism) with the supply being zero-rated in the state of origin—similar to the model used in the European Union with respect to its intra-community supplies across European countries. However, this model would require a robust refund mechanism of the tax credits to the seller as the GST credits would not move along with the goods in this case.
Similar complexities possibly await importers of goods under GST. Currently, import of goods are subject to the levy of a basic customs duty and countervailing duties in lieu of excise and sales tax. While basic customs duty is expected to continue as is, the countervailing duties are proposed to be subsumed under GST. In effect, the import of goods is expected to attract IGST and the place of supply rules are expected to determine the relevant state which shall derive the state GST revenue built into IGST.
Currently, the rate of all customs duties including countervailing duties is uniform across the country. However, a rate arbitrage in IGST rates could necessitate businesses to evaluate the state of import of goods under GST with a view to leverage on a lower GST rate. It is also currently unclear if the GST rate shall stand determined by the initial port of import or final destination of the goods. For example, if goods are imported by a company in Haryana through Delhi, a key point of determination would be whether IGST shall be payable based on the state GST rate prevailing in Delhi or Haryana?
Another aspect to be addressed is whether the IGST component shall stand administered by the customs authority at the stage of import as is currently being done or by the GST authority at a later stage? The customs and trade compliance function is typically defined and divorced from the tax function in most organisations. Administration of IGST by the GST and not customs authority could require an integration of the customs and tax functions at the organisational level.
In the overall backdrop of GST being a creditable destination-based tax, the GST Constitution Amendment Bill has proposed the levy of a 1% ‘additional tax’ on interstate supply of goods for a period of two years, possibly to compensate central sales tax revenue loss to states in the initial years. This tax is expected to be levied by the Centre and appropriated to the state of origin of the goods. The impact of this proposed levy (expected to be non-creditable tax cost) on the supply chain for procurement and distribution of goods also requires simultaneous evaluation.
Possibly a single sale shall entail payment of taxes both to the state of origin as well as destination during the initial years requiring compliance systems to gear up for the same.
While additional tax levy should stand confined to interstate supplies of goods, given that imports are proposed to be treated at par with inter-state supplies with regard to GST levy, there is some debate on the applicability of additional tax on imports as well.
Evidently, the lawmakers have their work cut-out in terms of addressing some of these complexities in framing an IGST law for taxing cross-border supply of goods. It is also time now for organisations to evaluate the potential impact of some of these aspects on their business operations and engage with the government in a dialogue to address and resolve the same.
Overall, the aspect of place of supply is complex and requires many aspects to be factored and clarified. The issues, in fact, are more complex in the context of a service provider and part two of this series seeks to address the same.