Introduction:
The Government of India introduced the Goods and Services Tax (GST) in 2017, as a multi-layered taxation framework aimed at promoting uniformity through a single, cohesive tax system. This system replaced several indirect taxes, including Value Added Tax (VAT) and Service Tax, streamlining the previously complex taxation structure. The GST framework encompasses four central laws: CGST, IGST, UTGST, and SGST Acts. Since coordinated efforts between the Centre and States are required for proper implementation, modifications to the GST framework are made through the GST Council, which comprises finance ministers of all State governments and the Central government.
The GST Council:
The GST Council, established under Article 279-A of the Constitution, makes recommendations on GST-related matters to Union Territories and states. It is responsible for determining tax rates, tax laws, exemptions, deadlines, and ensuring uniformity in the GST structure. Its majority consensus approach conflicts with cooperative federalism principles, where parties typically retain autonomy in negotiations. While the Supreme Court has ruled that its recommendations are not binding, the Council's frequent changes in tax rates and compliance requirements create significant business uncertainty.
The Council has faced criticism on multiple fronts, particularly regarding mid-year rate revisions that disrupt financial planning and add to compliance burden. The multiple tax slabs (0% to 28%) undermine GST's original intent of establishing a uniform tax regime, leading to classification disputes and litigation. These disputes particularly affect cases where goods and services fall ambiguously between two slabs. Additionally, the Council's ad-hoc decision-making has resulted in delays in refunds and procedural ambiguities, primarily affecting Small and Medium Enterprises (SMEs). The Council's decisions to raise rates in essential sectors like healthcare, construction, and food, often implemented without adequate consultation, have increased financial pressure on lower and middle-income groups.
Analysis of Council's key recent recommendations:
Input Tax Credit on construction of immovable property:
Following the Supreme Court's judgment in Chief Commissioner of Central Goods and Service Tax & Ors. v. M/s Safari Retreats Private Ltd. & Ors.1, which allowed commercial real estate companies to claim Input Tax Credit (ITC) on construction expenses, the Council proposed restricting these credits retrospectively from July 2017. The change involves replacing 'plant or machinery' with 'plant and machinery,' interpreted according to Section 17 of the Act. This modification explicitly excludes building structures from credit claims, even when used for making outward supply of goods or services.
Hotel accommodation and restaurant services:
From April 2025, GST rates on hotel accommodation will be based on actual supply value rather than declared tariff. Two rates will apply: 18% with ITC for units exceeding Rs. 7,500, and 5% without ITC for units at Rs. 7,500 or less. Hotels can opt for 18% GST with ITC on restaurant services by submitting a declaration before the financial year or at the time of registration.
GST under RCM on renting of immovable property:
From October 2024, registered tenants must pay GST under the Reverse Charge Mechanism (RCM) when renting from unregistered landlords. Composition scheme taxpayers are exempted from this requirement to preserve the scheme's simplicity, and past practices will be regularized on an "as is where is" basis.
Ready to eat Popcorn:
The Council faced criticism for attempting to categorize caramel popcorn as a luxury good at 18% GST, citing its additional processing and ingredients. Following public backlash, loose caramel popcorn in theaters was assigned a lower 5% rate.
The GST rates have seen periodic increases since implementation. The initial structure included rates of 0%, 5%, 12%, 18%, and 28%, but subsequent revisions have expanded the highest slab's coverage. The 28% slab now includes more products, including cement (increased from 18%). Essential food items have seen increases from 5% to 12%, while real estate taxes on under-construction properties rose from 12% to 18%.
The rationale behind this increase often revolves around meeting growing expenditure demands, particularly during economic downturns. State governments' increasing reliance on GST for financial support has made rate increases an appealing option to shore up funds. The government has also increased taxes on luxury goods, tobacco, and alcohol to discourage consumption while raising revenue. However, these frequent revisions create market uncertainty, reduce purchasing power, and complicate compliance processes for businesses.
Implications of GST on medium-sized enterprises:
The compliance procedure of GST is highly complicated and has proven particularly challenging for small and medium-sized enterprises (SMEs), and the unorganized sector. The burden of filing numerous returns monthly, maintaining detailed invoices, and complex documentation requirements has increased operational costs and created financial stress. Many small traders, hawkers, and informal businesses have either exited the formal economy or faced penalties due to non-compliance.
The system's complexity has disrupted the smooth flow of tax credits, making SMEs less competitive compared to larger businesses that can better absorb costs. This has led to supply chain disruptions and reduced demand in several sectors. The inability to effectively claim ITC, combined with higher operational costs, has forced many businesses to either pass costs to the consumers or exit the formal economy entirely. This trend has undermined one of GST's primary objectives: fostering economic formalization.
GST and Legal Services:
Legal services, though exempt for individual advocates and law firms, are subject to GST when provided to business entities exceeding the prescribed revenue thresholds. The impact of GST on legal services includes compliance requirements, cost implications RCM. Law firms and individual practitioners can claim ITC on the GST paid on inputs used in providing taxable services. The payment on Legal Services will be subject to RCM2. RCM is applicable to legal services provided by individual advocates or a firm of advocates to corporate bodies. Under RCM, the liability to pay and deposit GST shifts from the supplier to the recipient of such goods and services. Therefore, the input tax credit can only be claimed by the recipient and not the supplier. The RCM is, however, not applicable where services are provided to foreign clients as "export of service" is not covered under GST.
Law firms, like any other business, incur various operational expenses such as office rent, consultancy fees, and IT services, all of which attract GST. Typically, businesses can claim ITC on such GST payments, reducing their overall tax burden. However, legal services provided by lawyers and law firms to business clients fall under the RCM, meaning the responsibility of paying GST shifts to the client instead of the lawyer. Because of this, law firms do not collect or deposit GST on their services, unlike other service providers who charge GST and can claim ITC.
GST on Electricity:
GST, on the supply of electricity, is one of the prominent issues. Taxpayers are under a dilemma of whether electricity supply is sale of goods or services, or whether it is taxable or exempt under GST. Supply of electricity is exempted under GST as per a Notification3.
Further, services provided by an electricity transmission or distribution utility (e.g. state electricity board), by way of transmission or distribution of electricity, is exempted under GST4. Accordingly, if any person other than electricity transmission or distribution utility supplies electricity, it will attract GST at the rate of 18%. Before GST, electricity supply was exempted under the respective state's VAT Acts. Also, services provided by electricity transmission or distribution utility, by transmission or distribution of electricity, were exempted under the Service Tax Act.
Per se, electricity supply is exempt from GST and is not taxed. However, related services like installation and maintenance may attract GST. Electricity charges for residential properties are not subject to GST as residential rental services are exempt from GST, however, businesses can claim ITC on GST charged for services related to electricity, thereby reducing their overall production costs. GST is applicable when electricity utilized for commercial property is bundled with rental or maintenance services for commercial properties, and it is considered a composite supply. The GST rate of 18% applies in such cases5
It is essential to clarify that while generating companies have to pay GST on all their inputs like machinery etc, however, they cannot claim input credit since sale of electricity by generating companies does not attract GST.
Our Analysis:
While GST marked a significant step towards unifying India's tax structure, its implementation has faced considerable challenges. The multi-tier tax system has created complications rather than simplifications, failing to eliminate the cascading effect of taxes as intended. The system's complexity has particularly affected SMEs and labor-intensive sectors like construction and hospitality, resulting in job losses and economic hardship.
Law firms, having no output GST liability, cannot offset the GST they pay on their expenses. This puts law firms at a disadvantage, effectively increasing their cost of operations. Similarly, as GST is not applicable on electricity supply, industries are unable to claim ITC benefits resulting in increased prices of electricity for the consumers. Charging GST on the supply of electricity will bring many benefits for businesses. GST levied will serve as an ITC for businesses, reducing their cost of production. Manufacturing companies can also improve price competitiveness in domestic and foreign markets.
The impact of these issues extends beyond immediate financial concerns, as many businesses either pass costs to the consumers or leave the formal economy, exacerbating income inequality. The contraction of the informal sector, coupled with reduced job opportunities, has undermined the broader goals of economic inclusivity and equitable growth. Despite its ambitious aim of simplifying India's tax structure, GST is yet to fully achieve its goals of creating a seamless and efficient tax system that promotes economic equality and sustainable development.
Footnotes
1. Civil Appeal No. 2948 of 2023
2. vide Notification No. 13/2017 issued by the Department of Revenue
3. Notification 02/2017 (Central Tax) dated 28 June 2017 under the heading "Electrical Energy" (HSN Code: 27160000).
4. Notification 12/2017 under heading 9969
5. GOI notification 34/8/2018-GSTdated 01/03/2018.
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