July 21, 2010 may be one of the most important dates in history of tax reforms in India.

In a rather unexpected move, in his speech before the Empowered Committee (EC), the Finance Minister not only unveiled the Central GST, he made all possible efforts to persuade the States to support the introduction of GST w.e.f April 1, 2011. 

Centre conceded to the States demands on a multiple rate structure for goods, with a standard CGST rate of 10 % and lower rate of 6 % for select products.  It was unrealistic to expect the States concurrence of a single rate structure, to start with.  Taxation in India has significant socio-political ramifications and the society is not mature enough to accept a common tax rate structure on everything, from luxury watches/ cars to items of mass utility such as salt and sugar.  Having said that, the advantages of a single tax structure are many and one should try to achieve that over a long term.

While the FM did not comment on the items that would be entitled to such concessional rate, a reasonable guess could be that 6% would apply to all or most of the goods which currently attract 4% / 5% VAT (such as industrial inputs, capital goods, IT products, pharmaceutical products, etc.).   In general, if this proposal is accepted by the States, the cumulative GST rate of 12% would not be bad, as a lot of products which attract 4% / 5% VAT are liable to excise duty at 10.3%, resulting in effective tax of around 15%. 

The standard rate of 10% CGST and SGST each would translate into effect rate of 20% for all other goods.  This again would be good news for many industry verticals (such as FMCG, Consumer durables), where the effective tax incidence currently is in excess of 20%.  The 20% rate also compares well with international benchmarks, with UK at 17.5%, Germany at 19%, China at 17%, and so on. 

However, for few products, the impact could be adverse as well.  This would be particularly the case, where the products are currently exempt from excise duty and are subjected to VAT at a concessional rate of 4-5%.  Take mobile phones for instance, which are subjected to an effective rate of 5-6%.   If the effective rate of tax suddenly increases to 20% or even 12%, it could again revitalize the grey market for these products, which has shrunk considerably over the years. 

It may be worthwhile to consider a lower rate (say 4-5 percent) for some of these products and then gradually align the rates with other products over a period of time.  Off course, this would mean a complicated tax system but it would certainly be closer to reality and more acceptable to businesses.

One would ask that if another slab of lower rates is introduced, then who would compensate the Government for the loss of revenue? It is therefore necessary that tax base is significantly broadened.  In this context, the proposal to prune the list of existing excise exemptions (currently over 300) to align it with the existing VAT exemptions (around 99) is helpful. 

Expansion of tax base on services and increase in effective tax rate to 16% (assuming States agree to 8% State GST) would also yield some additional revenues. 

The Centre has also proposed a lower threshold of INR 1 million, as opposed to the States earlier demand of INR 1.5 crores.  Though initially it may disappoint small dealers (especially the SSI units currently availing excise exemption), it is an important move towards widening the GST net. 

Induction of Dr. Nilekani for building the IT infrastructure is also a welcome move.  However, given the limited timeframe available, the level of IT preparedness at the time of transition may be a matter of concern.  The industry would hope that the GST regime would be technology-enabled, with provision for initiatives such as e-invoicing, e-audits etc., in addition to e-filings.

The draft of the proposed constitutional amendments has also been given to the States for their feedback.  There are indications of States resistance on some of these proposals, specifically the one for setting up the GST counsel to be chaired by the FM, with seeming wide ranging powers to determine the rates and structure of GST.  Many States view this as a dilution of their fiscal autonomy and the issue has the potential of becoming a major hurdle in timely introduction of GST.  This would need serious consultation between Centre and State in coming few weeks and I suspect that the final proposals would be somewhat different from the existing ones.

Overall, the Central Government seems to have put GST back on the fast-track mode, and the efforts to make it happen on time are apparent. 

As a result, we are much closer to GST than we thought earlier.  April 1, 2011 certainly is a possibility and delay, if any, may not be beyond few months.

Yes, we will not have a perfect GST to start with.  However, if the choice is between perfection and existence (of the new tax system), I would definitely go with the latter.