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The way ahead for goods and services tax
January, 16th 2018

The six-month goods and services tax (GST) journey so far has seen technology, procedural compliance and policy withdrawals as speed breakers, but no serious roadblocks are in sight. The rate reductions, and alignments that were done by the GST Council have aided acceptance by various stakeholders. At the moment, the small businesses within the composition scheme are at the traffic light, which continues to be amber for them.

In the 200 days of the GST regime, the consumer hasn’t yet benefited as he ought to have, the taxman is struggling to come to terms with loss of control and authority, the businesses are getting used to the system, while small businesses are finding it difficult to cope with the new indirect tax regime and its attendant consequences. In general, the business-to-consumer segment is running well; the business-to-business sector continues to have hiccups.

With the GST set-up, the technology piece is still clearly struggling, while the procedural and compliance part is better than what we started off with.

In short, the system is up, transitional glitches have eased to a large extent and now some internal inconsistencies—essentially in the nature of attendant issues—are surfacing which will get evened out as we complete the first full cycle. The next 200 days, in terms of policy, should focus on restoring the reverse charge mechanism (RCM), putting in place a modified composition scheme with some form of input tax credit available (a model is suggested below) and restarting the e-way bill. These are the three short-term measures. But even prior to that is setting up the technology and design in order to make it simpler and more robust.

In the medium-to-long term, the big measure that will take GST to next level in terms of effectiveness and change its dynamic vis-à-vis price formation at the retail level is doing away with the maximum retail price (MRP) system.

The big surprise of the first 200 days is that a big producer state like Maharashtra has already made up for the revenue loss; even as the tax collection from “goods” is down, it has been more than made up by the “services” part. The consuming states, which were expected to be major gainers, are still falling short of revenue. This is more of a transition issue rather than a structural one. As such, the total need for compensation will not only be less but also limited to a period of less than five years. At least, that is how one reads the trends till now.

These trends may require the GST Council to revisit the compensation scheme but more importantly, the compensation account; if it is in surplus or has it gone into a deficit?

Post-this, a revisiting of the slab will be in order. If indeed the compensation requirement is less, the multiple rate slabs ought to converge sooner. More than rate cuts, the focus should be on how the two middle slabs of 12% and 18% will converge to 14.5% sooner than later. Along with this, the number of commodities attracting 28% will have to be, and will be, trimmed.

The other area that needs to be sorted out is that of exports, especially the embedded taxes. We have to move away from an ad hoc solution to a proper mechanism.

There seems to be some evidence that more than the growth of gross domestic product (GDP), GST seems to be having an impact on the structure of GDP. This needs to be studied as it will have long-term macroeconomic consequences.

Actually, a big issue that is impairing the efficacy of the GST regime is that the small businesses are bearing a disproportionate burden in accounting for transactions from the unregistered segment. While technically RCM is required, the GST Council can help ease the small businesses into this system over time.

However, what should be on top of the policymakers’ agenda is how to make GST attractive and relevant for the composition dealers. This is critical. As of now, dealers having a turnover up to Rs1.5 crore have an option to adopt the composition scheme in GST where they have to pay 1% composition tax in the case of traders, 2% in the case of manufacturers and 5% in the case of restaurants.

An area that needs to be sorted out is that of exports, especially the embedded taxes. We have to move away from an ad hoc solution to a proper mechanism.
No input tax credit is allowed to composition dealers and they are also not allowed to raise GST invoice enabling the buyer to take input tax credit. In the absence of availment of input tax credit, registered dealers are reluctant to make purchases from these composition dealers as compared to the purchases from registered dealers where they are in a position to get input tax credit.

This has destabilized the supply chain and also affected purchases by registered dealers from the composition dealer. In the present scenario of GST, the composition dealer is neither eligible to get input tax credit even if he is buying from a registered dealer on a regular GST invoice nor is he allowed to raise GST invoice showing charge of GST equivalent to the composition rate.

The purchases of registered dealers from the composition dealers involves a hidden component of tax equivalent to the composition rate, which is ultimately paid by the composition dealer. But the buyer cannot take input tax credit for the same due to the embargo placed by the statute.

If a scenario is created to address this invisible part of tax charged by the composition dealer, the transactions between the composition dealer and the registered dealers for sale and purchase could be restored. Thus, if a registered dealer is allowed to pay that hidden part of composition tax through RCM, the registered dealer can become eligible to take input tax credit of the equivalent amount without disturbing the treatment given to the composition dealer as per the existing GST legislation.

The composition dealer shall, however, have to be exempted from payment of composition tax on such turnover which he makes with the registered dealer paying tax on an RCM basis.

For this purpose, changes shall have to be made in the statute as under:-

i) Section 10 has made composition levy subject to section 9(3) and 9(4) of the central GST/state GST Act which allows RCM only to the specific categories on supply of goods or services or both. This further implies that the class of dealers do not fall within the scope of section 9(3) and 9(4) of the SGST/CGST Act. In case the mechanism has to be adopted, necessary amendment in the relevant section 9(3) needs to carried out so as to include class of dealers in the section.

ii) If composition dealer is to be allowed to avail the option for being part of or remain out of the proposed scheme, necessary amendment needs to be carried out in section 9(3) of the SGST/CGST Act, since the section mandates that RCM cannot be optional. The relevant portion of the section which makes it mandatory in case of notified categories of goods and services is reproduced here as under:

“Section 9 sub section 3 “The Government may, on the recommendations of the Council, by notification, specify categories of supply of goods or services or both, the tax on which shall be paid on reverse charge basis by the recipient of such goods or services or both and all the provisions of this Act shall apply to such recipient as if he is the person liable for paying the tax in relation to the supply of such goods or services or both”.

iii) This facility has to be made available at the composition rate instead of the normal scheduled rates as envisaged under the GST legislation. For making it possible, the necessary provision has to be incorporated in section 9 (3), which enable the recipient of supply from a composition dealer to pay tax on that supply at the rate of composition.

iv) Amendments in GSTR-4 and other corresponding rules have to be made to allow the composition dealers to reflect details of supply made to registered dealers on an RCM basis as discussed above.

Once freed from resolving these issues, the short-term calibration of rates and pruning the list of commodities in the sin goods category, the long-term issue that the GST Council needs to deliberate on is the relevance of an MRP system—an anachronism from the control raj days— in a GST regime.

The MRP system was relevant in a pre-liberalized economy operating with producer taxation. The producers would work out the costs and margins of its distribution chain and allocate that within the MRP.

Now it is a consumption tax, with final payment of tax at the last stage. Here, it becomes an anomaly to have an MRP. It overdetermines the system. The result in the last three months has been that GST is being charged over and above the MRP!

It is time to examine if it is right or even the mandate of the manufacturer to set the price at which a product will be sold to the end user. For in doing so he decides the profit margin of the retailer, which in the current system may end up harming the consumer. Under GST, the MRP is more likely than not to create a retail price collusion as it becomes the de facto uniform price.

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