GST: Time For The Giant Leap Forward

Resist the temptation to equate revenue shortfall with evasion. That will foster an adversarial tax environment, warns Rohan Shah.

(Image: pxhere)
(Image: pxhere)

The GST Council meeting on Dec. 18, 2019, will likely be the most definitive meeting since the introduction of the goods and services tax. Some of the most important structural issues under the GST laws will be tested and potentially redefined. The precipitative issues which frame the background for the meeting are:

  1. The shortfall in revenue collection;
  2. The modification of the rate structure to address revenue shortfalls;
  3. The payment of compensation to the states;
  4. Issues concerning returns, e-invoices, refunds and the lack of a robust input tax credit mechanism.

The centre has announced its payment of GST compensation outstanding to the states. This issue has hopefully abated and will not resurface. The threat of some states moving the Supreme Court against the centre on the issue of compensation, however, raises some important points of reflection.

The GST Council, which is a showpiece of the power of co-operative federalism—where all decisions to date have been made by consensus—is vulnerable to its first signs of stress. Consensual forums are likely to deteriorate and atrophy when the issues of divergence outrun the issues of convergence. While the GST Council is not strictly a consensual form and has a constitutional voting pattern, it has conducted itself as a forum of consensus, with great virtue.

As revenue collections drop, the greatest challenge to the GST structure is the potential conversion of the GST Council to a forum of divergence, debate and fractious decision-making.

Such a situation must be avoided at all costs. The Centre and states have to continue to maintain the level of statesmanship which has elevated the GST Council to its current enviable position. The downward spiral of the World Trade Organisation is a harsh reality of how forums of transformation can be rendered inert. The members of the GST Council have a duty to preserve the sanctity and sanity of the Council.

The shortfall in the collection of revenues could be attributed to an amalgam of issues, primarily:

  • A low transactional buoyancy in the economy,
  • A fundamental error in the underlying economic and commercial presumptions,
  • Continued procedural and compliance uncertainty, and
  • Evasion through the misuse of credit facilities.

The multifarious causative factors don’t lend themselves to a singular solution. The lack of economic buoyancy is the biggest and most unpredictable factor, the impact of which could well play out for another 12-24 months. The temptation of tinkering with tax rates to address an economic slowdown has a limited ability, at best, to address the issue.

Once this option is adopted, we signal to our industry and global investors, a message that the greater the economic distress, the higher our indirect taxes will be.

Our tax rates have been in a state of churn for two years, where we have seen base rates, followed by a reduction of rates, now followed by an increase in tax rates. This shakes the very foundation of the certainty desired in the tax system. The one-off tinkering or realignment of rates may presently be unavoidable. However, a systemic approach to change tax rates in times of economic challenges is to tread a dangerous path, with adverse mid and long-term consequences.

While evasion is a reality and must be severely dealt with, it would be wrong to attribute evasion as the primary cause of our problems when, in reality, there are some serious structural issues afflicting us.

We must resist the temptation to equate revenue shortfalls with evasion, as that will foster an adversarial tax environment that we cannot risk replicating from the dreaded tax terrorism days.

Universal historical experience indicates that the GST system which works best is where the coverage of taxation is universal, as is the coverage of input credit. We have chosen a different path to our peril.

1. Currently, the GST framework suffers from a non-universal levy with exceptions carved out for petroleum products, electricity, alcoholic beverages, and real estate. This was at the desire of state governments who were sensitive about losing several of their highest revenue-generating opportunities. While such exceptions were critical to the ‘grand bargain’ which gave us our GST, it is widely regarded by global tax policy experts as being a 'fundamental fault' in our GST structure.

2. The agreed exclusions in the basic structure of the GST have been adversely augmented by exemptions and nil-rating. Save and except exports, and, a de minimis threshold for small businesses, there is a strong rationale for replacing exemptions with a minimal levy (0.5 percent or 1 percent) as the product and the assessee are then firmly entrenched in the taxation system. This aids collections, accountability and credit flows.

3. The flow of credit has been restricted on account of transactions that do not suffer a tax, and, credit burnouts under statutory provisions or exemption notifications. The inverted duty structure of some products also poses challenges.

The most far-reaching change that we can make in the GST structure and law is to make the levy of GST universal—except for exports and those below a de minimis threshold—and correspondingly to provide for a complete credit mechanism where every rupee of tax paid in an antecedent transaction is available in the subsequent transaction. This would give us our best chance of addressing our issues of collection, accountability, compliance and plugging evasion. This would also re-align us to our original objective for GST, which was to avoid the cascading impact of taxes and to tax only the value addition in each link of the commercial chain.

The anxiety of the states that they would not be collecting and retaining taxes on the currently excluded products can be addressed through the constitutional amendments and effective treasury management changes in flows between the centre and states. This would ensure that states don’t perceive a sense of loss of revenue or control in respect of the currently excluded products. This would be a huge leap forward in our GST structure, not without its own challenges. Such a leap is imperative, and, is preferable to frequent small steps backward and forward which give the illusion of movement without the reality of progress.

The unending debates and controversy around GST obscure the fact that, to the credit of our lawmakers and bureaucrats, we have a GST which is operational. This has taken decades to achieve. That achievement is getting obscured by certain practical challenges. For a nation which justifiably and deservedly has ambitions of being an economic powerhouse, to have its most critical indirect tax as continually being work-in-progress is not the best advertisement for our $5-trillion economy ambitions.

Rohan Shah is a practicing counsel in the Supreme Court and Bombay High Court.

The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.