GST – ‘tryst with destiny’ for our generation?

Bar & Bench July 1 2017
Hate Speech

Sudipta Bhattacharjee and Abhishek Garg 

Goods and Service Tax (GST) - touted to be one of the biggest tax reforms in India is finally a reality. Given the mid-night session at the Parliament to usher in GST, the comparisons with another midnight session several years ago, in 1947, is inevitable – with the wide sweep of the impact of GST, it is no less than a tryst with destiny, at least for our generation.

GST was first introduced by France in 1954 and at present around 160 countries in the world have implemented the GST structure of indirect taxes with countries like Malaysia, Australia, Canada, and New Zealand adopting it relatively recently. The collective of Middle East countries known as GCC has also started its journey to a VAT regime, which will be implemented there by 2018. We will touch upon some of the key aspects of GST in this article including its relevance apropos us lawyers.

Background of Indirect Tax Structure in India

The Constitution of India does not grant India a federal structure stricto-sensu but the taxing powers of Centre and States have been clearly demarcated with no overlapping with each other. Both the Centre and States could levy indirect taxes in light of different entries contained in List I and List II of the Schedule VII of the Constitution.

As such, the indirect tax structure in India has always been cumbersome, ridden with complexities and controversies owing to multiple taxing statues divided between States and Center. These multiple taxing statues have witnessed a long era of litigation because of numerous interpretations, inconsistencies and overlapping of provisions of one statute over the other. A transaction as simple as whether having food in a restaurant is a provision of service or sale of goods has been prone to numerous interpretations till date and as result the same getting taxed under Sales Tax laws and Service Tax laws simultaneously.

The other major issue in the present indirect tax structure was cascading effect of taxes and as a result higher prices of goods due to payment of a tax on tax. The Government has so far tried a patchwork of measures to solve this problem, starting in 1986 with the introduction of MODVAT i.e. Modified Value Added Tax scheme, under Excise which allowed taxes/duty to be levied only on value added by manufacturer at each stage. This was done by allowing credit or set off of duties paid on inputs/raw materials while discharging the final duty.

After the introduction of Service Tax in India under Finance Act, 1994, the scheme underwent various changes and was finally given a new birth under the name of CENVAT (Central Value Added Tax) scheme in 2002 and 2004. CENVAT scheme allowed fungibility of credit between the central taxes on goods and services.

However, there was no fungibility between State and Central taxes yet - State VAT being a State levy could not have been set off against Central taxes. Further, Central Sales tax (applicable on inter-state sales) had altogether a different mechanism as this was levied by Centre but collected by States. There was no set off available for Central Sales Tax till date and this used to become a cost at every stage of inter-State sale of product and passed on as cost to final consumers.

Goods and Service Tax (GST)

Given the above, foreign investors have always highlighted the need for a simpler tax regime with no cascading of taxes. The Goods and Service Tax (GST) is an integrated tax on goods and services. It is a destination based consumption tax (unlike the present tax structure in India which in many cases is ‘origin’ based), meaning thereby that the tax levied and collected shall go to the State in which goods or services are ultimately consumed.

Given its federal polity, India has adopted a GST structure where both the Centre and States would levy taxes, thereby becoming the second country after Canada to adopt a dual GST structure.

Thus, while GST is often promoted under the tagline ‘One Nation One Tax’, at a fine-print level, there are three levies:

Centre & State Tax (Expected to be levied and collected in equal ratio by the Centre & States) on all intra-State transactions

  • Central Goods & Service Tax (CGST); and
  • State/Union Territory Goods & Service Tax (SGST); or

Integrated Tax (To be collected by Centre and distributed to States in a particular ratio) on all inter-State transactions

  • Integrated Goods & Service Tax (IGST)

However, even though there are three statutes, the taxable event under all the GST Laws is ‘Supply’. The major issue that created complexities in the present laws was the multiplicity of taxable events. The taxable events under various statutes even overlapped with each other in various scenarios. Following table summarizes this:

S.No. Statute Taxable Event
1 Central Excise Act, 1944 Manufacture of Goods
2 Chapter V of Finance Act, 1994 (Service Tax) Provision of Service
3 Central Sales Tax Act, 1956 or State Value Added tax Acts Sale of Goods
4 Entry tax Entry of goods into a ‘local area’
5 Entertainment tax Admission to entertainments
6 Luxury tax Availment of ‘luxury’ facilities

We saw how, in the case of a restaurant, there was a sale of goods as well as provision of service, therefore both VAT and Service Tax used to be levied; same was the case with ‘works contracts’/construction contracts. Overlap between Entertainment tax and service tax led to massive litigations in the DTH services space. For many transactions, more than one of the above taxable events would get attracted prompting the judiciary to evolve the ‘aspect’ theory to deal with legislative competence related issues.

However, under GST, given the uniform taxable event of ‘supply’, such debates are hopefully a thing of the past.

What is ‘Supply’?

The GST Laws provide for an ‘inclusive’ definition of Supply and thus is wide enough to cover every kind of transaction of supply of goods or services under its ambit. Some of the illustrative events mentioned in the definition itself are sale, exchange, barter, transfer, license, rental, lease etc. But not every supply is a taxable supply under GST. Only those supplies of goods or services or both which are made for a consideration (except in some specified cases) and in course or furtherance of business are taxable under GST.

Supply includes barter

One of the important aspect of definition of supplies is that it includes ‘barter’ transactions as well. This is something in contrast to the present laws where barter is not taxed under VAT laws (except in Gujarat). This planned inclusion has implications for certain specific industries like the automobile, real estate, consumer durables and mobile handset industries, where barters and exchange of old models for new ones is a common practice.

Supplies without consideration also taxable in some cases

The GST Laws has a unique provision whereby activities specified under Schedule I of CGST Act are leviable to GST even if the same are done without consideration. Out of all, the major impact under this provision seems to be on transactions between related parties and ‘distinct persons’ (same legal entity having separate registrations in one state or different states) since every transaction in goods or services between such related parties or registered branches of the same legal entity will be treated as a ‘supply’ and made liable to GST. Though the Input Tax credit would be available, but there may be a significant cash flow impact in such cases. Specifically, one of the biggest adjustments under GST would be to get used to transactions between registered branches of the same legal entity being taxable – processes would need to be recalibrated to capture (and cross-charge) all such ‘internal services’/ ‘supply of goods’.

Further, things like gifts by employer to employees exceeding Rs. 50,000/- in a financial year would be liable to GST which is not there in the present regime.

Reverse Charge mechanism for Purchase of Goods & Services

The concept of payment of tax on reverse charge basis is quite common under the Service Tax laws but the same has been extended in case of goods as well, especially for purchases from unregistered vendors. A similar provision exists under some State VAT Laws and commonly known as ‘purchase tax’ if goods are purchased from unregistered dealers.

Under GST Laws, the government’s intent while enacting such provisions is quite clear – to discourage unregistered vendors and to discourage people from buying from unregistered vendors.

Other key concepts: Place of Supply’

One of the key aspect of GST laws is to properly determine the ‘place of supply’. As explained in the foregoing paragraphs, there are three statutes under GST – their respective applicability would depend upon the place of supply. If the supply of goods or services or both is an Intra-State supply, the tax to be levied is CGST + SGST in equal ratio. However, if the supply is an Inter State supply, the tax to be levied would be IGST.

Though the provisions explaining place of supply envisage a lot of specific situations, the thumb rule to determine this is that the place of supply of goods or service would be the State where the consumption happens, since GST is a destination based consumption tax. Following diagram illustrates this:

Transaction Treatment today Treatment under GST
a. VAT+ Excise duty(?)+ Entry tax(?) CGST+SGST (+GST Cess)
b. CST+Excise duty(?)+ Entry tax(?) IGST (+GST Cess)
c. Basic Customs Duty(BCD)+Additional customs duty (pegged with domestic tax on manufacture) +Additional Customs Duty (pegged with other domestic taxes) BCD+customs cess+IGST (+GST Cess)


Exclusions under GST

In order to arrive at a political consensus on GST, a few items were excluded from GST like specified petroleum products, alcohol for human consumption, sale of land and completed buildings etc.

Though on a technical analysis of the constitutional amendments, GST can indeed be extended to ‘Power’ sector as well, but inclusion of Power is not envisaged under GST Laws. As per the FAQ’s issued by CBEC on GST, it has been specifically mentioned that Power too is outside the purview of GST.

This will lead to a scenario where there will be significant GST impact on the input side for constructing a power plant but none of that input GST will be available as a credit/set-off, since there will be no GST on the output side. The government, in past few years, in order to promote renewable sources of energy like solar, wind etc. have given wide range of exemptions under Customs and Excise Laws for these sectors. However, these sectors are likely to bear significant adverse impact on account of GST due to exclusion of power from GST and consequent blockage of Input Tax Credit as mentioned above.

It may affect their profitability and sustainability to a major extent – for example, the GST rate of Solar Panels has been fixed at 5% which is presently exempt under customs/Excise, the cost of setting up a solar power plant is likely to go up by Rs 45-55 lakhs per MW post GST. The adverse impact of GST appears contrary to the avowed objectives of the Government to encourage renewable energy.

Similarly, there are around five petroleum products which have been kept outside the purview of GST, and they will suffer the same fate as power (ie., credit blockage - as discussed above).

Key macro-level challenges

Expected difficulties in ‘Dual Control’ over taxpayers

As per the agreed framework of assessment, the states and the Centre will assess in ratio of 90:10 for assesses having a turnover of less than 1.5 crore and ratio of 50:50 for turnover above 1.5 crore. This may create some disruption while carrying on such assessments, given that the assessees may be susceptible to different authorities for different assessment years.

Though all State tax officers are being trained for GST, concerns remain as to how effectively State level bureaucrats will be able to handle taxation of services under GST given that so far they have zero experience in assessing services.

Challenges envisaged in IT network

It is no secret that backbone for successful implementation of GST is the robust IT network – unfortunately, the GST Network is not ready even today in its entirety; even the parts that are ready, have not been adequately tested (by the own admission of the GSTN CEO). Though the government has taken steps such as introduction of GST Subidha Provider (GSP) etc. for helping assesses in their GST compliances, however, its success remains to be tested.

The transition of small and medium businesses is going to be challenge when they are not even acquainted with using IT for present tax laws.

Anti-Profiteering Provisions

The Indian government seems to have introduced anti-profiteering clause as a last minute thought by borrowing the concept from Malaysia and Australia – the same is not carefully drafted. It does not provide any policy guidance on how will a taxpayer determine as to how much reduction in price will meet the test of “commensurate reduction” under section 171 of the CGST Act. Neither does it provide any guidance on what happens if someone profiteers. Despite such lack of guidance, anti-profiteering Rules prescribe severe penalties for ‘profiteering’ including cancellation of registration. Given the foregoing, the constitutional validity of anti-profiteering provisions is highly suspect. In any case, in their current form, anti-profiteering provisions are likely to create more confusion rather than serving their intended purpose.

How lawyers come into play

Contracts

GST shall have significant implications on the entire spectrum of contracts for businesses.

For example, under GST, taxable event is ‘supply’. However, transfer of title/ ownership clauses today are predicated upon taxable events under Excise, VAT/CST Laws. Now that these tax arbitrages are over, contracts may have to be reviewed to agree upon a ‘transfer of title’ clause that makes greater sense from a business/commercial perspective.

Further specific clauses would need to be added for capturing indemnities and obligations apropos tax compliances to ensure that there is no leakage of tax credits. Given the concept of credit mismatch under GST, companies ought to introduce specific indemnity clauses obligating the supplier of goods/service to comply with all procedural requirements so as to enable the recipient to avail input tax credit in a timely manner.

Furthermore, given the several rate slabs and classifications under GST and ambiguities about ‘composite’ and ‘mixed’ supplies the eternal debate of ‘single-versus-multiple’ contracts will transition to GST also. The contract structuring best-practices from the current regime would need to be remembered and suitably applied even under GST.

Last but not the least, several contractual disputes are foreseen owing to GST on account of ‘change in law’ clauses. In tax inclusive contracts, extent of ‘change in law’ will be disputed. For example, if a service provider claims that his tax rate has gone up from 15% service tax to 18% GST and the client should pay him 3% extra, the client is likely to ask him: “15% was on Rs 100. But now owing to GST, your 100 may have gone down to 95. Before I pay the extra 3%, you need to pass on the benefit of this reduction from Rs 100”.

Even if the contract price is on a ‘taxes-extra’ basis, the benefit of commensurate reduction in price may be demanded on the basis of the anti-profiteering provisions of GST.

Litigation

GST was originally envisaged as a ‘simpler’ tax – unfortunately, along the way to its current shape, enough and more complexities have accreted on the GST framework. Resultant, the GST in its current form is likely to be highly lucrative for litigators – starting from classification disputes for goods and services, to claiming of credits, to availment of concessional tax rates/’zero’ rates – this GST is a minefield of litigation-generators.

In the initial months too, we are likely to witness a flurry of advance ruling applications on various aspects of GST.

GST – a small step towards a tax regime whose impact on businesses is neutral

Today, many companies have warehouses/depots in several States, just to avoid the CST cost on inter-state sales. With stock transfers becoming taxable under GST, the tax arbitrage is gone and companies may now choose to opt for large centralized warehouses – tax will no longer play such a key role in logistics.

Similarly, the concept of ‘In transit sales’, presently considered as a tool for saving VAT/CST, shall be leviable to GST in future and such transaction models may no longer remain relevant, if used only from a tax saving perspective.

Thus GST offers a good opportunity for businesses to revamp their business processes.

GST could have done more, but as of now, let us celebrate the small steps in the right direction.

Concluding thoughts

While implementation of GST would be disruptive given the overall lack of preparedness, no landmark change can be ushered in without disruptions in the status quo.

It is hoped that in a six-month to one year span, the benefits of GST would become visible and gradually we can start moving towards an ideal GST.

Sudipta Bhattacharjee (l) is a Partner at Advaita Legal and Abhishek Garg (r) is an Associate.