India: GST Impact And The States

Last Updated: 10 October 2016
Article by Rakesh Nangia and Rajat Mohan

Introduction

GST, which is considered as biggest tax reform since 1947 which seeks to replace a slew of taxes and levies in 29 states and aims to simplify and harmonise the indirect tax regime in the country. Implementation of GST will bid farewell to the different indirect taxes that are currently applicable in different states, thereby bringing about uniform taxation across states. GST is seen as an economic unifier that brings all the states and the centre together. This is going to be a regime that transcends all borders within the country.

How will a transaction be taxed simultaneously under Dual GST within a state?

The Central and State GST would be levied simultaneously on every transaction of supply of goods and services except on exempted goods and services which are out of the purview of GST and are below the prescribed threshold limits. Further both would be levied on the same price unlike State VAT which is levied on the value of goods that is inclusive of central excise. Seamless credit of input tax paid in earlier stages will facilitate removal of cascading effect and lead to reduction in overall burden on consumer.

Transaction New System Old System Comments
Sale within the state SGST
CGST
VAT & Excise/ST Under the new system, a transaction of sale within the state shall have two taxes, SGST- which goes to the state and CGST which goes to the Centre.
Sale outside the state IGST CST& Excise/ST Under the new system, a transaction of sale from one state to another shall have only one type of tax, the IGST-which goes to the Centre. However the state portion will be remitted to destination state from it later.

What is proposed for India is not a single national tax but a set of 38 taxes — 29 states taxes (SGSTs), seven Union territories taxes, one central GST (CGST) and the integrated GST (IGST) on interstate supplies — all harmonized to look like a single tax. Major raging concerns of states remains over the apparent loss of revenue and loss of fiscal autonomy from the transition into GST regime.

Major concern of states Post GST

GST is a destination based taxation system, by which the IGST revenue on interstate sales (SGST portion) will accrue to the state which consumes the goods - destination based tax ('DBT'). Whereas in the existing scenario where CST is charged @2% (when form C is produced) or local vat rate (if C form not produced) is charged, it will accrue to the state which supplies the goods. Hence CST is origin based taxation as it accrues to the state which supplies it. Now, when this Origin Based Taxation is replaced by a DBT, then the manufacturing states is going to lose its portion of revenue from interstate sales and the consuming states are going to earn higher. Thus, state Govts. fear loss of revenue and expects compensation from the centre. Manufacturing states (Tamil Nadu, Gujarat etc.) loses and consuming states will gain due to this change. States with high and strong manufacturing base will be the biggest contenders for compensation Tamil Nadu government will lose Rs 3,500 Crores annually due to abolition of CST and wants compensation from the Centre. Maharashtra government is set to lose Rs 14,000 Crores that it collects as Octroi.

The select committee of the Rajya Sabha addressing to the concern states. In its report submitted to the House, the committee has endorsed all the provisions of the Bill while recommending a liberal compensation package for possible revenue losses to the states for five years In the Bill, the Centre has proposed 100 per cent compensation for first three years, 75 per cent and 50 per cent for the next two years. However, the committee has recommended 100 per cent compensation for probable loss of revenue for five years. Central Government has agreed in GST Constitutional amendment Bill that 100% of the revenue loss would be provided by Central Government for a period of 5 years.

Loss of federal autonomy

According to the Constitution (122 amendment) Bill, 2014 — passed in the Lok Sabha last month, India will have not a single federal GST but a dual GST, levied and managed by different administrations. The Centre will administer the central GST and the States, the SGST. The monitoring of compliance will also be done independently at the two levels. Moving to a GST regime in federal setup will mark some curtailment of state's freedom. "All goods and services will be divided into certain categories. The rates will be fixed by category, and a state, cannot shift a commodity from a lower to a higher rate, or put it in the exempt category.

GST will mark erosion in the states' freedom to decide on taxes and tax rates.

According to the Constitution, the States have complete autonomy over levy of sales taxes, which, on average, accounted for 80 per cent of their revenue. But with the GST, which mandates a uniform rate, even this limited autonomy would be gone.

The task of designing GST is assigned to the GST Council, a collective forum of state and central government. Any change to tax rates will have to be within a narrow band prescribed by the GST Council. Any changes to the tax rate will need to be agreed to with three-fourth majority at the GST Council. While states together have weightage of two-third in any decision and Centre will retain the balance one-third. This is akin to giving the Centre veto power, which is biggest apprehension of the states. The council will be deciding on all important aspects of the tax, including the base, rates, allocation of tax base among the states, administrative architecture and compliance procedures This effectively means that states together will not be able to act on their own or take any decision, consent of the Centre will be necessary.

Uncertainty clouds over major incentives offered by State government

Tax incentives granted by state governments to companies making investments in the respective states. Some tax benefits are generally granted by states as subsidies based on the quantum of taxes paid (i.e. VAT and CST) by companies to the State Government on their manufacturing activities and that too, over a specified time period. Of course, such incentives are subject to a maximum ceiling limit based on total capital investments made by these companies. Since the amount of incentives are based on the amount of indirect taxes paid to the State Government, it is important to analyse how these incentives would get impacted under the GST scenario.

Let us take a hypothetical example which would resemble many large investment units in Maharashtra. This hypothetical unit is promised that 100 % gross VAT/ CST paid by it will be refunded by the State Government as a subsidy for a period of 15 years (of course subject to the cap of total investments made). On its sale of, say, INR1000 crore per year it gets an incentive of INR 41 crore which is the tax paid by the unit on its 20% local sales and 80 % inter-state sales. Since CST is also paid to the Government of Maharashtra (being the originating State) that too is calculated towards the incentive.

In GST, however, there would a two-fold impact on the quantum of incentives – one, inter-state sales would not contribute to the incentives under GST and two, the effective tax rate could also be lower. With respect to the tax on inter-state sales, since the tax would accrue to the destination state, the Government of Maharashtra is not likely to give any benefit. The benefits are thus limited to the 20% local sales which will bear say 9% SGST (assuming a GST rate of 18% divided equally between the Centre and the State). Today local sales attract a VAT of 12.5%. As a combined impact the hypothetical unit would get an incentive to the extent of INR18 crore per year – which is less than half of the INR 41 crore it received in pre-GST period.

Shift in the power

Currently the centre alone can tax 'services'. In GST it is proposed to delete entry 92C ("tax on services") from List I so that the states as well as the centre can tax services. Also, both centre and states are to be explicitly empowered to levy goods and services tax, which is defined as a tax on the supply of goods or services or both. Thus the Constitution, upon amendment, will support levy of tax on services as well as goods by the states as well as the centre.

States to retain power to levy tax on certain goods

States have insistently demanded certain goods to be kept outside the ambit of Goods and services tax. Taxes on alcohol make up major chunks of state revenues — for instance, in Kerala it contributes 22 percent of revenue, while in Tamil Nadu it yields about Rs.21, 000 Crores per year. Transport fuels like petrol and diesel are taxed at 20 per cent, while states earn 35 percent of their sales tax revenues from them. Initially, most of the states were not in favour of keeping many commodities under GST. The main reason was that states enjoy autonomy in collecting state taxes and they were afraid of losing their rights. State governments wanted the Alcohol and Fuel to be kept out of GST system as these two commodities are the biggest contributor to their revenues. State government's 50% revenues come from petroleum products alone.

Conclusion

Implementation of GST by States would be most challenging job, especially keeping in view of losses that would be suffered by most of the states. Even in such a scenario more than 15 states passed the constitutional amendment bill in their state assemblies in a short span of 23 days against a target of 30 days. This is a commendable job which shows the spirit of cooperative federalism. I am of firm belief that in such testing times, India will come victorious and be better state.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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