Goods and Services tax – What’s in store?

With the roll-out of what has been touted as the biggest and most ambitious tax reforms that the country has ever seen, there has been widespread apprehension about what the Goods and Services tax entails for the economy.

Despite the Government’s constant claims that the GST will be beneficial, and boost the GDP of the country by 1-1.5%, many speculations have been doing the rounds about its immediate inflationary effects.

In order to gain some perspective and to understand the GST, it is first relevant to go over the basics of the erstwhile tax regime. Previously, separate taxes were levied on goods and services. Service tax was charged on the provision of services; excise duty on manufacture of goods and Value added tax/Central sales tax on the sale of goods. Further, various states levied additional taxes such as entertainment tax, entry tax, octroi etc.

The GST seeks to integrate most indirect taxes and create a single tax chargeable on the supply of goods and services alike, to create one single market. This distinction between goods and services was imperative to be done away with, as under the previous regime, service tax paid on input services could not be used as credit to set off output VAT/CST liability arising on the sale of goods.

To further elaborate, let’s take a hypothetical example of a shoe retailer. Suppose the retailer pays:

• Rent to maintain his show room amounting to INR 115, (Rent of INR 100 + Tax of INR 15 at the rate of 15%);
• He also buys shoes from a wholesaler for INR 84 (Shoes at INR 80 + Tax of INR 4 at the rate of 5% VAT)
• Then he subsequently sells shoes to his customer for INR 105 (Shoes at INR 100 + Tax of INR 5 at the rate of 5% VAT)

In the example illustrated above, in the earlier tax regime, the shoe retailer could only set off VAT against VAT, which were both taxes on sale of goods. Hence, INR 4, paid as input tax could be utilized as credit and INR 1 would have had to be paid in cash to the government. However, no credit would have been available for tax on services hence the the 15% tax on rent would be directly added to the cost of goods sold by the retailer.

On the other hand, in the GST regime since there is one single levy, even tax paid on services such as rent will be available as credit to the shoe retailer on sale of goods. Hence, in the case illustrated above, the amount of credit available for set off would increase to INR 19 which would ideally reduce the final cost of the product sold.

With the above concept in mind, lets now move on the the rate structure proposed by the Government under the GST regime. In order to ensure that the government doesn’t lose out on income from tax collection, supply of goods and services is to be taxed under ‘revenue neutral’ rate slabs of – 0%, 5%, 12%, 18% and 28%, with some exceptions like precious metals and diamond which are taxed at a different rate. Generally speaking, these rates are higher than the rates under the earlier regime. Hence, the tax payable by the end consumer is bound to increase.

This increase in tax is justifiable only if the ultimate burden on the customer would not increase and this in-turn will be possible only if all businesses pass on the benefit of additional credit available to them by way of reduction in cost.

As explained above, in principle, cost of goods is estimated to reduce, but the picture is only half complete.

The GST puts into effect an anti-profiteering clause which mandates companies to transfer the tax benefits arising due to increased credit, to their customers by way of reduction in price. However at present, there is no mechanism in place to calculate such reduction in prices.

This means, that as of today the fall in prices completely depends on voluntary compliance on part of the price setters. To be honest, this seems like a long shot, at least in the initial phase. With nothing to ensure a reduction in price, coupled with an increased tax rate the expected rise in inflation seems to be valid.

In my view, it is clear that in principle, the GST will substantially reduce the process cost of businesses by providing a seamless flow of credit between goods and services. However, it looks like the rushed implementation and the absence of an anti-profiteering mechanism, will prove to be a speed-bump in realizing the long-term benefits associated with it.