The indirect tax system in India is extremely complicated with multilayered taxes levied by the Central and State Governments at different levels in a supply chain; the Central Government levying Customs Duty on imported goods, Excise Duty on manufactured products, Service Tax on over a hundred services, Central Sales Tax and the State Governments collecting Value Added Tax (VAT)/Sales Tax, State Excise on a few products, Luxury Tax and Entry Tax/Octroi. Finance Ministers, while presenting the annual budget in the Parliament, keep on asserting the need for reforms to streamline the system.

The reform process in indirect tax has been very gradual, and slow. The first major structural change in excise tariff, Modified Value Added Tax (MODVAT) was introduced in 1986-87. It was based on the recommendation of the L. K. Jha Committee that suggested VAT principles in Indian taxation system to remove cascading effect of ‘tax on tax’. As per the recommendation of the Chelliah Committee in 1991 and the recommendations of the Parthasarthy Shome Committee in 1992-93, Service Tax came into effect from 1994. Budget-1999 was hailed, as it proposed only three rates for Excise Duty in place of eleven and eventually to a single CENVAT rate of 16% by 2000-01.

The Kelkar Task Force (KTF) on the implementation of the Fiscal Responsibility and Budget Management Act (FRBM Act), 2003, mooted the idea of a unified VAT on goods and services. The Twelfth Finance Commission also supported and endorsed the recommendation. The Finance Minister in the budget speech of 2005 had clearly indicated that the most ideal path to be trodden is a move towards nationwide VAT.

Prior to introduction of VAT, unhealthy competition existed between various States to attract investment. Indirect taxation was used as a tool of regional/sectoral development. This led to multiple tax rates, disputes and disparities. These were addressed in a limited sense when a uniform rate of VAT was agreed to. However, uniform rates of tax under the VAT regime was never fully implemented, even today there is distortion on the treatment meted out between two States to the same transaction. With introduction of GST, a larger agenda is to remove such disparity and bring about simplicity in compliance as well as administration, reduced leakages in revenue collection and better coordination between the States and the Centre.

The concept of Goods and Services Tax (GST) at national level was announced in the 2006-07 budget speech and the relevant extract is reproduced below :

“It is my sense that there is a large consensus that the country should move towards a nationallevel Goods and Services Tax (GST) that should be shared between the Centre and the States. I propose that we set April 1, 2010 as the date for introducing GST. World over, goods and services attract the same rate of tax. That is the foundation of a GST. People must get used to the idea of a GST. Hence, we must progressively converge the Service Tax rate and the CENVAT rate.” (para 155)

In the budget speech 2007-08, the Finance Minister reiterated (para 116) :

“I wish to record my deep appreciation of the spirit of cooperative federalism displayed by State Governments and especially their Finance Ministers. At my request, the Empowered Committee of State Finance Ministers has agreed to work with the Central Government to prepare a roadmap for introducing a national-level Goods and Services Tax (GST) with effect from April 1, 2010.”

Introduction of GST at the national level is considered imperative in the context of integrating the countrywide market for accelerating and sustaining economic growth, as is evident from other developing and developed economies.

About 150 countries across the world have introduced GST or Federal VAT in one form or the other. The GST rate in various countries ranges from as low as 5% (Taiwan, Japan) to as high as 25% (Denmark, Sweden, Norway). The average VAT/GST rate in the European Union (EU) is higher at 19.5% than the average Organisation for Economic Cooperation and Development (OECD) countries at 17.7%, Asia Pacific countries 10.8%, or South American countries 14.2%. There is no VAT or GST in Hong Kong, while Bahrain is a tax-free country. In several federations where GST has been introduced, like in Argentina (21%), Germany (19%), Switzerland (7.6%), Austria (20%), Mexico (15%), Australia (10%) and Canada (6%), there have been various combinations of levy and collection by the Centre and the States. For example, in Canada the Federal Government administers uniform tax, the revenue is divided among the participating Provincial Governments according to an agreed formula and some States also impose sales tax at retail level. Australia follows a similar model with revenue collected by the Centre and distributed to the States.

Goods and Services Tax (GST) :

In the present framework of taxation of goods and services, the Central Government levies tax on goods at the manufacturing level, while the States levy tax on goods at the point of sale. The Central Government in 1999 constituted an Empowered Committee of State Finance Ministers to lay out the roadmap for the GST. The Empowered Committee in consultation with the Central Government has constituted a Joint Working Group (JWG) in May 2007. It is currently taking into consideration the global models in operation, in order to come out with a unique formula to satisfy India’s diverse needs. The report to the ministerial panel is likely to be submitted by September this year.

Through Entry 84 of the Union List of the Seventh Schedule of the Constitution of India, read with the new Entry 92C of the Union List, as inserted by the Constitution (Eighty-eighth Amendment), the Central Government now has the power to levy tax on a tax base comprehensively extending over all goods and services and going up to the final consumer. This amendment also mandates that the power to collect this levy will vest both in the Central and the State governments.

GST is proposed to be implemented by year 2010. Its final form is envisaged to be a comprehensive value added tax on goods and services i.e., taxes on all goods and services within a State at a single rate facilitating compliance. Though the precise nature of the national VAT or GST is yet to be arrived at, it aims at removing tax distortions that exist today. The movement towards a consolidated and integrated GST is seen as adherence of the indirect tax reform to the principles of trust, best international practices, simplicity, transparency, stability and service coupled with the use of information technology as reiterated in KTF Report. It would aim at encouraging an unbiased tax structure that is neutral to business processes, business models, organisational structures, product substitutes and geographical locations.

Under this system, all other existing taxes (except Income Tax and the Property Tax) would cease to apply. An integrated national GST will mean integration of taxes and duties on services and goods at both the State and the Central levels.

Salient features :

Particularly, in the last two years, the Central and State Governments have taken significant steps in this direction. The goal is to complete these discussion and law-making efforts by December 2008. And then shift the focus to State-level administration. At first, individual States would be merged into the Tax Information Network (TIN) at an administrative level, while keeping the State VAT distinct from the Central GST prior to implementation. The JWG is also deliberating on the kind of administrative machinery and procedure for revenue collection.

As a step towards rationalisation, the system will contain provision for seamless input tax credit throughout the supply chain. Manufacturing firms would get credit for the purchases of inputs including services.

• It is necessary to make a built-in control mechanism and to ensure tax compliance, since input tax credit is allowed at the next stage only if the supplier from whom goods or service is purchased issues tax-paid invoice.

• The system needs to take advantage of information technology and bring the indirect tax laws and procedures at par with the best international practices and thus, encourage compliance and minimising complexities.

• GST would significantly improve the competitiveness of indigenous goods and services. The nation without tax barriers will facilitate economy of scale in manufacturing and reduce the supply chain cost.

Keeping in view the objective for the introduction of GST, tax experts are univocal on three options, namely :

• One, the Centre will have complete power to levy and collect tax and will distribute it to States according to a pre-defined formula.

• Two, a dual levy, one at the Central and another at the State with a common base; and

• Three, dividing the right to tax goods between the Centre and the States.

Various models have been designed and a few suggested by experts are as follows :

Ever since the idea of a GST was placed by KTF, a widely-held presumption has been that GST will be a single VAT to be levied nationally, replacing both the CENVAT and the VATs now being levied at the State level.

The Kelkar-Shah Model suggested implementation in four stages to the GST effort: establishing IT systems, building the Central GST (by consolidating Central Excise, Central Service Tax, and VAT on imports), the political effort of agreeing on “a Grand Bargain,” and administrative efforts at the state level (interaction with the States).

• The KTF model envisions the GST to be levied at a rate made up of two components, one the Central part (CGST) and the other, the States part (SGST). The key features are that there would be three rates apart from ‘zero’ viz. a standard of 20% (12% for the Centre and 8% for the States), a lower rate of 6% and a maximum rate of 20%. Exemptions would be few and limited mainly to food, medical care, education, residential housing and certain financial services. The collection is only by the Centre. The task force proposed a ‘Grand Bargain’ between the two levels :

  • Both levels will have concurrent but independent jurisdiction over a largely common tax base and the tax at both levels will extend to final consumers covering both goods and services.
  • The existing Octroi/Entry Tax, Central Sales Tax, States Sales Tax, Stamp Duties and other cascading taxes and fees will go.
  • Both levels will have power to fix the rates, but there would be one rate for all States and rate setting will be coordinated between the two levels.

Bagchi-Poddar Model also envisages a combination of Central Excise, Service Tax and VAT to make it a common base of goods and Service Tax to be levied both by the Centre and the States separately and collection by both the Centre and the States.

Key issues :

The Prime Minister recently mentioned that calibrating such a co-ordinated indirect tax reform in an environment where the States value their autonomy so dearly, is not an easy task. First and foremost, for the States the power to levy Sales Tax constitutes to be the most important authority at their command. Taking it away will grievously reduce their fiscal autonomy. It will make them even more dependent on the Centre than they are at present and reduce them to mere spending agencies with little responsibility for raising what they spend. Sharing the revenue from a tax is no substitute for sharing the tax power.

Rough computations indicate that the proportion of tax revenue raised by the States in the total tax revenue of the Government (Centre and States combined), which stands at around 33% at present, would come down to barely 15% or so.

The Government is seized with the challenges for introduction of GST and these include issues relating to Constitutional provisions, tax collections vis-à-vis revenue sharing, the threshold limit, the overall level of rates, the type of rate structures, development of a common market and successful operation of TINXSYS (Tax Information Exchange System). In addition, preserving the federal character by protecting and balancing the present and future revenue potentials and safeguarding the interest of less developed States with lower revenue potential has to be taken care of.

It would be desirable to have procedural clarity, ab initio for efficient administration at the field level with the States. Audit has to be a joint endeavour, but each authority should have the power to institute audit in cases selected by them. Trust and coordination between the Centre and States’ tax authorities would however be essential for smooth implementation of the system.

An independent quasi-judicial body to enforce agreements between the Centre and the States and among the States, may have to be constituted with appropriate authority for resolving problems/disputes in the interest of smooth functioning of the system. The Constitution also provides for creation of such a body under Article 307.

The method of zero-rating transactions at the point of inter-State sale on the lines followed in the European Union has found favour in much of the discussions. However, it requires considerable preparation, particularly computerisation, to ensure that the items eventually zero-rated by the exporting State pay the tax in the importing state.

The Shome Committee recommended that the centre ought to levy the tax and allow it to be collected by States. In that scenario, the collection procedures through States need to be clearly stated.

The tax reforms are aimed at improving tax to GDP ratio, expanding the taxpayer base, making tax administration more efficient, taxpayer-friendly and increasing voluntary compliance resulting in India’s economic liberalisation and GST implementation will hopefully do just that.

The reform process, aimed at streamlining the indirect tax system that was initiated in 1986 with MODVAT for manufactured goods, seems to culminate with the introduction of GST in 2010. It envisages unified tax structure for the whole country, replacing multiple taxes. It is certainly a bold step that is in coeval with the international trend. The path however is strewn with hitches and the authorities need to proceed with pragmatism, taking into consideration aspirations and compulsions of the States. The sincere intent of the Government is evident and it is relevant to quote the Finance Minister in his Budget 2006-07 speech :

“Over a hundred years ago, a restless young man in his quest for the core of all spirituality admonished his fellow men in the following words : ‘We reap what we sow. We are the makers of our own fate. The wind is blowing; those vessels whose sails are unfurled catch it, and go forward on their way, but those which have their sails furled do not catch the wind. Is that the fault of the wind ? . . . . We make our own destiny.’ Those are the immortal words of Swami Vivekananda. Let us believe in our destiny, let us make our future.” (para 179)

GST in the long run, it is believed, would improve India’s competitiveness, increase the tax-GDP ratio by at least 2% and accelerate economic growth. It will be a boon to all sections of society, as India takes the common market structure.