When the nationwide goods and service tax rolls out on July 1, it is likely that micro and small enterprises will under-report their yearly income. Firms might do so to stay in the Rs 20-50 lakh bracket so that a low tax rate of 1-2 per cent applies to them.

Increased compliance under GST will benefit firms in the long run by providing them access to cheaper capital and lower input costs, in the short term, the switch from the unorganised to organised sector will make them less competitive.

GST, in its current proposed form, exempts small businesses below Rs 20 lakh from registering for the GST network (GSTN) unless they want to avail of the benefits of input credit. Small businesses, according to GST, will be in the Rs 20-50 lakh bracket.

Analysts say a number of businesses with turnover above Rs 50 lakh could resort to under-reporting their income to pay lower taxes.

“You may have cases where small businesses will try to evade the system. Say, there is a family owned business worth around Rs 90 lakh annual income. It may try to pass off as two separate businesses owned by family members, each worth Rs 45 lakh, just to pay lower taxes under the GST,” said Abhishek Rastogi, partner, Khaitan and Co.

“People will continue to try to game the system, like they do now. However, as upstream compliance improves, the number of such businesses under-reporting income will decline. In the long term, such a move will be detrimental for enterprises whose only source of competitiveness is tax evasion,” said Neelkanth Mishra, India equity strategist with Credit Suisse.

According to the latest annual report (2015-16) of the ministry of micro, small, and medium enterprises, there are estimated to be about 51 million MSME businesses, employing more than a 117 million people, and having a combined fixed asset value of nearly Rs 15 lakh crore. Nearly 55 per cent of such businesses could be a part of the unorganised sector.

Businesses making a switch to the organised sector would, in the short run, become less competitive with the rise in compliance costs, the analysts said.

However, formalisation will eventually be beneficial.

“Entering the formal sector under the new GST regime can provide smaller businesses access to cheaper capital as well as legal recourse in case of disputes,” said Mishra.

“Under the GST you will see a situation wherein most of the registered entities will only want to do deal with other registered entities because of reverse charge,” said Rastogi.

The purpose of the reverse charge is to increase tax compliance and revenues.

The concept is already present in service tax. In the GST regime, reverse charge may be applicable for both services as well as goods. It will have to be paid by the receiver of goods or services. In case an unregistered dealer sells or supplies to a registered dealer the registered dealer has to pay the GST on the supplied good or service.

“Hence, registered businesses will not want to deal with those entities still in the informal sector. Non-compliance by small businesses, or any efforts to stay out of the organised sector, will only hurt their business over a period of time,” Rastogi said.