As the planned implementation date for India’s potentially game-changing Goods and Services Tax (GST) moves closer, important issues still need resolving.
Last Wednesday (19 October), the third meeting of a Council of India’s state and union finance ministers concluded in New Delhi. The topic of discussions – the country’s impending Goods and Services Tax – is the subject of a great deal of attention within India, as well as from foreign investors.
Under India’s existing tax system, goods moving between Indian States are liable to taxes at state borders crossed during transit. As such, a plethora of taxes are levied by India’s 29 individual States and 7 union territories which significantly increases the time and costs of doing business, drives up prices for consumers, and provides potential sites for extortion and corruption en-route.
The intention of the GST is to replace this archaic system with a single indirect taxation regime, along the lines of the Value-Added-Tax (VAT) levied in many countries. The proposal represents a central pillar of Narendra Modi’s drive to create a smoother, cleaner and more competitive business environment in India.
The task of ‘GST Council’ – formed following the passing of a Bill giving legal status to the GST – is to finalise the details of the new regime. The outcome of last week’s meeting, however, exposed the fact that important questions still need to be resolved if the Government is to meet its planned implementation date of 1 April 2017.
The GST: States vs the center
First proposed to the Parliament in 2006, the GST has always been a controversial prospect. This has been apparent during the prolonged debates preceding its eventual enactment. On one level, the tax has been the subject of division between national political parties. When first proposed by the Indian National Congress, the GST was blocked by the then opposition BJP. Since coming to power, the BJP has championed the GST but has faced opposition from the Congress.
The most controversial dimension of the GST, however, is its potential impact on the revenues of Indian States. Under the existing system, most Indian States’ laws establish the taxing right within the place of manufacture. The GST, by contrast, replaces this with a consumption-based model. Understandably, big manufacturing States have been hesitant to support legislation that will carve out, in one stroke, a large chunk of their tax base.
Proponents of the GST have therefore needed to persuade representatives of many States that the revenues derived from consumption within their territories may off-set lost revenue streams. States with large manufacturing sectors, the argument goes, are also likely to have large numbers of consumers to be taxed. Another tactic has been to highlight the significant scope for the evasion of taxes under the current system, much of which would be removed by an effectively functioning GST. As an additional guarantee against potential revenue losses at the provincial level, the GST Bill provides for compensation of States’ lost revenues during the first five years under the new system.
Issues facing the GST Council
On the face of it, these controversial dimensions of the GST were reconciled when, in August, the Indian Parliament eventually passed the GST Bill in August. But questions relating to the impact of GST on individual States continue to complicate the process of finalising the new regulation.
During its first meeting in September, the Council made good progress on several fronts. Agreement was reached, for example, on technicalities such as the turnover thresholds for firms to be covered under the GST, and arrangements for calculating compensation owed to States in case of revenue loss under the new system. Following last week’s talks, however, it is now clear that reaching quick consensus on other areas will not be easy, as the States and the center continue to battle it out.
A key question is the mechanism through which the center will fund its compensation for state governments. The Finance Ministry has proposed a standalone higher rate of tax on ‘luxury goods’ as a means raising the necessary funds. But several States have opposed the notion that the GST itself could be used to fund compensation the revenue losses for which it is responsible, arguing instead that the center should dig into its own pockets to plug the fiscal gap.
Agreement also still needs to be reached on the overall rate structure for the GST. In addition to its proposal for a ‘cess’ on luxury goods, the center has proposed a four-tiered system comprising a lower rate of 4% for precious metals; a threshold rate of 6%; two standard rates of 12% and 18%; and a higher rate of 26%. Under the proposal, services would be taxed at 12% and 18%, depending on whether the service rendered is subject to an abatement. Generally, discussions on the GST rate structure have been divisive. While many Indian States are keen on putting tax rates as high as practicable, as a buffer against potential losses, the center favours lower rates in the interests of avoiding price inflation. Whether States will endorse the proposed structure therefore remains to be seen.
The Council also faces challenges regarding the designation of administrative controls between the center and the States. During its first meeting, the Council decided to grant exclusive control of service tax liabilities under the GST to the center. Since then, however, some States have reneged on the decisions and sought to re-open this question. Similar uncertainties persist regarding control over tax entities with an annual turnover of above Rs. 1.5 crore.
November meetings will be key
Once the GST Council has reached consensus on all outstanding matters, it will not necessarily mean that the deal is done. A final round of implementing legislation will then take place, during which the national Parliament will need to enact laws on the ‘Central GST’ and ‘Integrated GST’, and 29 separate GST bills passed though the respective state assemblies. Meanwhile, the final arrangements of the gargantuan IT infrastructure underpinning the new regime will need to finalised, tested, and state and regional officials trained in its use.
With these next steps awaiting conclusion of the Council’s proceedings, it is clear that rapid progress needs to be made on the issues outlined above if the Government’s target implementation date of 1 April 2017 is to be realised. November is therefore a key month. India’s Finance Minister, Arun Jaitley, has insisted that that agreement on all outstanding matters will be reached in time to allow for implementation by April, and has set 22 November as a target for conclusion of the Council discussions. Some observers, however, are sceptical that this can be achieved. In the first instance, a great deal will depend on the extent of progress made at the Council’s next session on 3-4 November.