The government will retain ‘proportionate tax credit’ available under the current Central Vat (Cenvat) system in the proposed Goods and Services Tax (GST) regime. This means the plan to keep items such as some petroleum products outside the GST ambit won’t lead to, as feared, a sharp increase in the overall tax outgo of the firms concerned, even though their ability to utilise input tax credits (ITC) would come down by some extent.

For instance, the proportionate credit system would allow companies in the petroleum business, such as IOC, BPCL, HPCL, Gail and Reliance, to use the GST paid on various inputs — equipment, goods other than crude oil and services — to pay the tax on their outputs covered under the regime.

The petroleum products that have been kept out of GST are crude oil, natural gas, petrol, diesel and jet fuel.

However, naphtha, a key refinery output, will be subject to GST if it is for industrial use other than as feedstock for fertiliser units, where it is tax-exempt even now.
So firms in the refining business can use the ITCs accumulated to pay GST on naphtha meant for industrial use (mainly plastics and synthetic textiles). One of the differences between the present Cenvat system and the GST regime is that in the former the credits can be offset against all output taxes, including excise — now levied as specific duties- on petrol, diesel and aviation fuel, but under GST, ITCs can be used to mitigate only the taxes on outputs covered under GST.

Pertinently, since crude — the most crucial refinery input — is not to be subject to GST, the scope for accumulation of (non-utilisable) credits is limited to that extent.
As for businesses with diesel as an input, however, no credit would practically be available for the input tax paid on it. Such businesses will also be free to use whatever other input tax credits accumulated to meet their output tax liabilities under the proportionate credit system.

What would also impact companies is the difference in tax rates: while the GST rate could be somewhere between 18% and 28%, the median excise duty currently is 12.5% and service tax is 14%. The specific excise duty on petrol is Rs 17.46/litre now and that on diesel is Rs 10.26/litre. Excise on naphtha is 14% (ad valorem).

The idea behind the proportionate credit system is to let firms that produce a wide mix of items, only some of which are covered by GST, to take credit for the GST paid on equipment, inputs and services used in their overall operations to meet the tax liability on outputs. The proportion of GST-paid finished items in a company’s product portfolio to its total turnover would determine how much of taxes paid on input services and raw materials would be available as credit for meeting the GST liability on its outputs.

In case of Reliance, for example, the petrochemical business accounts for about 24% of total sales. That figure is 3% for state-owned IOC and 7% for Gail. So, Reliance’s ability to use ITCs would be that higher than that of PSUs. Of course, there are outputs other than petchem within the GST ambit that these firms, especially Reliance, produce and the input tax credits could be offset against the tax liability on these outputs as well.

As far as downstream plastic and synthetic textile industries are concerned, the exclusion of petroleum products in the initial years from GST would not matter much as their inputs — petrochemical building blocks such as ethylene, propylene and butadiene or polyester input PTA — are subject to GST. They can seamlessly use the input taxes to mitigate their output tax burden on items such as synthetic textiles, paints, soaps and detergents, automobile tyres, fashion accessories, cosmetics etc. The only worry is, some raw material suppliers unable to use ITCs fully could pass on the cost.

The distortion in GST’s design will ultimately go only when crude oil, natural gas, petrol, diesel and jet
fuel are subsumed into the new tax.

To avail of the ITC benefit, companies will have to maintain separate records of GST-paid inputs and services as well as GST-exempt inputs and services used. Records should also specify details of purchase, consumption and inventory.

“Input tax credit in proportion to the ratio of the taxable goods and services (supplied by an assessee) to its total output is inbuilt in the current input tax credit mechanism and the same is expected to prevail even under GST,” said Deloitte India senior director Prashant Deshpande.

The proposed central and state laws on GST would specify the methods of calculating the proportionate tax credit that would be available for companies. The levies such as royalty paid on hydrocarbon are of course not eligible for ITC.