GST 2.0

With the motto of ‘One Nation, One Tax,’ the Goods and Services Tax, introduced on July 1, 2017, is undoubtedly a significant milestone in India’s journey. The economy has witnessed several unprecedented changes since then: the Indian taxpayer base has almost doubled from 66.25 lakh to 1.28 crore; there has been a large increase in voluntary registrations, etc.

However, far from a fool-proof plan, in the face of a pandemic, rising inflation, inefficiencies within the system, and centre-state tensions, reform is high on the agenda. 5 years into this regime, the 47th meeting of the GST Council held in Chandigarh on the 28th and 29th of June 2022 ended with Union FM Nirmala Sitharaman setting forth all the new GST reforms.

In this week’s article, we review the recommendations of the GST Council, enquire into their relevance and address a few crucial questions.

Firstly, a brief overview of significant changes:

Recommendations of the GST Council can be broadly categorised under the following 4 domains:

Rate rationalisation –
In its interim report, the GoM on rate rationalisation, headed by Karnataka CM Basavaraj Bommai, proposed correction of the inverted duty structure and removal of exemptions. Their detailed report on a potential tax slab merger and rate rationalisation is expected in the coming three months.

The Inverted duty structure anomaly, prevalent in many industries (a situation in which inputs are taxed at a higher rate than finished goods) had been resulting in the loss of crucial working capital for firms and simultaneous, an input tax credit accumulation for the government. However, correcting it is bound to result in higher prices for consumers on items such as printing/drawing inks, LED lamps, solar water heaters, finished leathers, etc.

Among services, 18% GST shall be levied for the issue of cheques.

Pre-packaged and pre-labelled food items such as wheat flour, puffed rice, etc, which were exempt, will now be taxed at 5%. Items sold loose or without labels, however, will continue to be exempt. Further, refund of accumulated ITC would not be allowed on goods like coal and edible oil.

Previous exemptions on hotel and hospital room rents have also been removed. On the other hand, GST rates have been lowered for medical appliances.

According to the GST data reviewed by EY, as many as 46% of current shares of goods and services fall in the 18% GST bracket while 37 items are attracting the highest GST rate of 28%, down from 228 in July 2017.

System reforms –
In 2021, tax authorities detected GST evasion of Rs. 40000 crores, largely on account of fake invoices and fraudulent ITC claims.
To identify these sources of GST evasion and to plug revenue leakages, extra measures for physical verification at the time of registration for high-risk taxpayers including biometric authentication and real-time monitoring of bank accounts, have been recommended.

Movement of gold and precious stones –
States may voluntarily track the intra-state movement of gold and precious stones through the generation of e-way bills under the GST regime.

Gambling –
A proposed uniform 28% tax on casinos, horse racing and lotteries shall be taken up more extensively in the next council meeting to be held in Madurai this August.

According to the officials, these compliance checks and rate adjustments would generate an estimated Rs. 15,000 crores in revenue in a year.

What has triggered this move of the Government?

The Centre and the states together rack up taxes worth only about 17% of GDP, as per the Economic survey, which is inadequate to sustain the nation’s growth. Further, the generation of fake bills by firms to avail of ITC, widely prevalent malpractice, among other leakages has kept collections below the Rs. 1 lakh crore mark for most quarters.

Though recently there have been record GST collections, (Rs. 1.68 crores in April 2022), the euphoria is partially unfounded. It must be kept in mind that massive collections have been driven by high inflation, tightening of compliance by the government, the surge in imports and an uptick in high-ticket consumption post-pandemic. In fact, the weighted average tax rate has dropped to 11.6% from the initially recommended rate of 15.5%.

Additionally, the large number of tax slabs adds to the complexity of the regime which was intended to be easily comprehensible, and thus an improvement from its predecessor.

Therefore, reform in the existing tax structure is imperative. Part of that is reflected in GoI’s intention to gradually shift from 4 rate slabs (i.e., 5%, 12%, 18% and 28%) to just 2.

What about the rate hikes’ impact on already high inflation?

GoI’s push for rate rationalisation and correction of the inverted duty structure would naturally result in a spike in the overall price level, but nonetheless, as FM Sitharaman pointed out, they are required to counter ‘inefficiencies’ in the value chain. The tourism industry in non-metro cities is likely to be affected the most, with a 12% tax being levied on hotel rooms priced under Rs.1000/day. Though retail inflation based on CPI won’t be as affected, a rough estimate suggests that these rate hikes could amplify the raw inflation figure by up to 0.3% points from August onwards. This is a key concern for policymakers, already grappling with higher global commodity prices and a Fed-induced worldwide rate hike.

What makes GST a federal flashpoint?

Prior to the implementation of the GST, states used to get taxes directly from the taxpayers without having the obligation to split their revenue with the Central government. However, the new regime made it imperative for the states to share their revenues with the Centre in the ratio of 1:1.

This naturally fuelled the anxieties of states. To allay this fear, back in 2017, the states were guaranteed compensation for revenue losses resulting from the implementation of the GST, assuming a 14% year-on-year growth, for five years i.e., until June 30, 2022. To establish a compensation fund, a cess was imposed on sin goods (like alcohol, tobacco, etc).

But due to the pandemic, consumer spending on these items did not increase at the desired rate. Consequently, to make up for some of the shortfalls in cess collection, the Centre had to borrow Rs. 1.1 lakh crore in 2020-21 and Rs. 1.59 lakh crore in 2021-22, thus worsening its fiscal position.

Currently, a dozen hard-hit states want this guaranteed compensation to continue for a few more years. While the collection of this cess shall be continued till 2026, it remains to be seen whether these would be routed to the states as before, or are used by the Centre to service its liabilities arising out of the compensation scheme.

What are the options for the states?

Interestingly, GST Council recommendations are persuasive in nature and not binding on states. This observation was recently made by the Supreme Court in the Mohit Minerals Case. The SC also recognised that both Parliament and State legislatures have an equal right to legislate on fiscal matters.

However, dismissing the GST Council as ineffective won’t be wise either. It has an unparalleled normative influence over the agenda and policies adopted by member states. Designed to serve as a forum for cooperative federalism, recommendations of the GST Council, necessarily born out of nationwide consensus, cannot be completely ignored by states.

In conclusion, while over 90% of CXOs (Chief Experience Officers) in India, according to a Delloite survey, feel that GST has improved the ease of doing business, it is yet to live up to the expectations of an aspiring nation. Reform and converging perspectives between central and state governments are needed to ensure the overall success of GST, which will undeniably play a crucial role in shaping India’s journey to 5 trillion dollars and beyond.

Curated By: Priyanshi Dwivedy

(Priyanshi Dwivedy is a 1st year student pursuing B.Com(H) at St. Xavier’s College (Autonomous), Kolkata and a Research Analyst of the Xavier’s Finance Community.)

GST 2.0

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