What is GST ? I - The Conceptual Design

I am yet to come across an informative article in the mainstream media on what GST is and why is it an important milestone in the Indian economic history.

The media, wedded as it is to sensationalism, hardly ever discusses it except in terms of skulduggery by Congress and BJP. Even when  it does , feebly or incompletely, as a result of the din it raises on other such banal issues around the affairs of a 'celebrity' murderess or about foolish acts like meat bans, people who want to maintain sanity tend to ignore them as a necessary mechanism of coping with life in present day India.

What is more surprising is the quality of reportage in the pink press which should know better and try to create public opinion strongly in favour of GST. There is one from an economist in a premier national economic research bureau arguing that GST is being hyped up and it is not some magic wand that would boost our GDP numbers. There is another, more recent one in the editorial pages, arguing that the Government must first reform the the current separately levied central taxes like Cenvat and Service Taxes to coalesce into one single tax, as it requires no agreement among states or parliamentary approval. You will see how flawed such arguments are in the paragraphs that follow. Any system must be first understood and agreed between the stakeholders at the conceptual design, then the approach must be to take the logical design where the options will have to be agreed upon and only then the physical design of how to implement it must be attempted or discussed. So let us first focus on the conceptual issues behind GST in this first post in the series.

GST is not another set of taxes or calling existing taxes with another name. Before you exclaim why this fellow is writing something as banal as this, let me remind you that in the 90's , the UP State Government , in a major attempt at 'tax reform', abolished Sales Tax; it started calling it UP Trade Tax!. I do not remember greater buffoonery in the annals of tax administration in our country. All business establishments had to change the legend '”UP Sales Tax No:” on their invoices and challans to “UP Trade Tax No:”. This was the only difference. The point here is in a country where such fiscal foolishness, crudity and tax terrorism prevails, the conceptual clarity on GST, when absent can lead to great disaster. Besides, indirect taxes like GST impact all the 1.25 billion Indians and the logistics of goods movement across the country unlike in direct taxes like Income tax, corporate tax or MAT where goof ups at current levels are much less disruptive.

GST or Goods and Service Tax is a tax regime that levies taxes on 'goods and services taken together' upon their 'sales'. Here 'taken together' is important so also the term 'sales'. As any economy becomes more and more sophisticated, services share in the GDP increases dramatically and there is no gainsaying the fact that services need to be taxed. The problem in either leaving out services or taxing it separately is in determining what proportion the value of service is in the goods that is being bought and sold. When you order food in a restaurant do you pay only for the food or for the food and the service you get there and if so how much of the final is what expecting that the restaurant charges you for both and cannot give you a break-up between the two accurately. In the times that have gone by, buying a fridge was going to the shop , identifying the piece , pay the money and have it delivered at home. The service of delivering at home was insignificant in terms of value. Now, even if you do not order on a e-commerce site, chances are that the shop like Croma, passes your order for delivery to a third party last mile delivery company, who in turn take delivery from a 3^rd party warehouse operator as Croma would have outsourced its warehousing to a specialized agency, and after the delivery is made, the original manufacter's engineer will come to your home to unpack, install and certify its working. So much of 'services' is now embedded in a goods transaction these days that it is difficult to have a split between the service component and the goods components so that they can be taxed separately. The way the split is achieved now is thru government notifications on abatement which are often arbitrary. For example, the service component on a restaurant is fixed at 40% value. This leads to plethora of notifications, revisions, interpretations, and appeals to tax tribunals that it goes against all canons of a good tax law and administration.

The definition of 'service' is nebulous, Is software services is 'goods' or 'services'. We find the state authority calling it 'goods' and apply VAT and the Central Statue calls it 'service' liable for service tax. More over Software can be sold shrink wrapped in CDs or downloaded from a site. It becomes a manufactured product when shrink wrapped and sold and attracts both Cenvat and VAT while basically it is a service.

What if the software is downloaded and the license bought separately ? What if it sold on the SaaS model ?

These questions have no clear answers even to this day! Does downloading firmware from the parent company websites and loading them on the chips of the mobile and paying royalty to the parent company constitute payment for services and hence subject to deduction of service tax that needed to be remitted to Government? As it was 'Firmware', Nokia did not think so, probably following the advise of the 'tax experts' here. Finally, the company was brought to its knees by the tax terrorism unleashed by the department with a claim of over 20000 crores! The matter went to court and an ethical Finnish company left India for good after somehow settling it for a sum arbitrarily fixed by the Court!. If the law was clear in the first place, why would Nokia not pay it and why should the tax claim needs bargaining in a court! There are more than 250000 crores now stuck in appeals in various tax tribunals and courts like this basically arising from the lack of transparency in laws relating to indirect taxes fattening only the experts and consultants and the corrupt officials of the department. Let me give you a test, Is Direct-to-Home tv telecast is a Service subject to Service Tax or Entertainment that is subject to State taxes on Entertainment ?

Believe me, it is a jungle out there. 'Make in India' slogan has to first address it so that businessmen know what needs to be factored in as input taxes as it determines their cost of production and as output tax as it determines the cost of the product or service to the end customer. When service tax was new in India, the law named some 100 services as those subject to tax. Slowly they were expanded by adding new services; now the statue specifies a negative list of services exempted from tax and all other services are uniformly taxed at 14%. As a result, there is lot of overlap between VATable goods as defined by individual states and Services as defined by the Central government. Like the onion thief in the sufi fable, who got to eat the onions and lashes as double punishment; we suffer double taxation as a result of the sheer clumsiness of the statues.

An indirect taxation regime must be self documenting and non-cascading, ie., there must not be tax on tax and set off must be allowed for taxes paid in the previous stage in the supply chain ( called as Input Tax Credit - ITC ). In other words, taxes on goods and services must be taxed only for the value added. How is the system of value added tax implemented ? If taxes on purchases ( inputs ) whether goods or service, are fully adjusted against payment against tax liabilities on sales (output ), it is called a system of value added tax. Central Excise duty or Cenvat in India and countervailing duty that we pay on imports are value-added tax. VAT as implemented by states is a value added tax, but both Cenvat and the state VAT are very imperfect in their current form. 

When VAT was first mooted, it was to replace the myriad state level taxes like Sales Tax, Local Tax, Turnover tax, luxury tax, octroi, Works Contract tax, Tax Collected at Source ( Freight) etc etc. Besides, the each state had different approaches to levying Sales Tax by product or product groups. Some states levied it on the last stage and some levied on the first stage. When levied on the last stage, the retailer collected the tax and other players in the supply chain like manufacturers and distributors collected Sales Tax forms in proof of selling goods to a registered dealer of their goods. When the tax was on the first stage, the first player in the state , be it manufacturer or wholesaler or distributor collected and paid the tax and the retailer showed the sale as resale within the state and was exempted from collecting any tax from the retailer. 

Now,all states have more or less adopted VAT, but the other taxes like luxury tax, entertainment tax , Local Body tax etc etc remain in some form or the other! I hear Punjab has reverted to taxing at first stage for several goods. The states never understood or wanted to understand the essence of a well designed value-added tax system which is equity, transparency and its self-documenting comprehensiveness. They have implemented it in some moth-eaten form, belying the spirit behind it when it was mooted.

Besides, each state started varying from the schedule of rates that was agreed to at the start. Kerala perversely levies additional VAT on goods purchased from organized retail, the ideological compulsions sullying the consensus to create a common market for goods at least within a state and to prevent competitive beggar-thy-neighbor tax polices across the states.

Central Excise or Cenvat is a tax on manufacturing. Service Tax is a deferred tax biased on sale of services and becomes adjustable against Cenvat or Service Tax collected by a business establishment on the output side only after it is paid by it ( hence the name deferred). Constitutionally, it is beyond the powers of the Central Government to levy tax on sale of goods. Hence the idea put forth by the editorial of the esteemed pink paper is impractical. Central Government needs to get a constitutional amendment ( with two thirds support in parliament ) to be able to blend Cenvat and Service Tax and levy it on sales. Though Cenvat is a manufacturing value added tax, it is calculated on the sale price of the goods to the end customer ( Net Realizable value), as a fixed amount per quantity or on the value after an abatement on the MRP printed on the packaging. The Cenvat rules provide for different methods for arriving at this NRV and is a fertile ground for tax consultants, experts and other bandits that live off the fat of the land. Besides services post manufacturing operations are not available for adjustment and this is a serious flaw in the Cenvat regime. For example, Service Tax on inputs ( for example on repair of machinery ) paid by a car manufacturer in Chennai are adjustable against Cenvat payable when they dispatch cars from their factory. However, the Service tax that they pay on rent to a showroom in Delhi where they display the cars is not available for adjustment and adds to the costs of their operations!!

Besides the confusion, distaste and need to pay thru the nose to these 'tax experts' who mediate with the departments, the effect such a conceptually wrong tax regime has on the logistics of goods movement across the country is a horror story by itself. As the VAT levied by the states is a tax on the origin, if goods are sold outside the state, Central Sales Tax is levied in place of VAT. This is levied at 10% or the local VAT whichever is lower unless sold to a dealer of goods who can provide 'C' form, in which case it is limited to 4%.

This Central Sales Tax goes to the state from where goods are sold and hence by design not vatable in the state where the goods are received for purpose of resale. To avoid this 4%, all businesses in India, open branches in all the states where they have customers so that they can do a 'stock transfer' to their own place of business in the receiving state. As there is no sale when sending stock to one's own branch in another state, there is no tax. However some states were levying a 'consignment tax' so stock transfers; I do not know if it is still in vogue. Apart from unnecessarily setting up an establishment in the receiving states, costs of hiring a 'local tax expert' on a monthly retainer, filing monthly returns etc, this arrangement increases the costs of logistics that I will explain in the following paragraphs.

Many of us while driving on inter-state highways come across lines of trucks waiting at 'check-posts'. Stopping goods movement for collecting taxes like octroi or verification of documents for purpose of effective administration adds, as per one study, close to 13% of the cost of moving the goods from Point A to Point B. Imagine a truck leaving Punjab and reaching Tamil Nadu. Count the number of check-post it has to wait at. If there is one way to identify how advanced a country is, just see their systems of goods movements and how the persons involved in the transportation are dealt with by the Government agencies. In my reckoning being a inter-state truck driver is among the most taxing professions in India. However, let us not digress to another topic here. It must be natural for exporters in Coimbatore to export goods through Cochin port. The check-post at the entry points of Kerala like Walayar can break any exporter's back with Trucks waiting for 4 to 5 days on end. They avoid Cochin container port and go to Tuticorin as it is within the same state as Coimbatore and trucks do not spend 70% of the time waiting at check posts! However, Tuticorin is not a container port and the textile and engineering goods exporters of Coimbatore do not get t/cellular vessels there. They have to put the containers and ship them to Colombo which they will be transshipped to container ships!! The capacity at Cochin port is mostly unused as Kerala has no manufacturing to boast of that would require Containerization.

Why is there a need for these abominable check-posts and what do they check ? The current taxation regime is based on origin. That means goods coming into Kerala needs to be documented for follow up so that verification is possible that they indeed get taxed and it accrues to the coffers of Kerala. In Tamil Nadu, they have to check if items purchased by Kerala are not charged the concessional  4% unless they are accompanied by Form 'C'. Receiving goods under 'C' form means that the buyer in Kerala intends to resell it and it would generate revenue for Kerala and therefore foregoing 4% to Tamil Nadu is a small price to pay. Kerala will seek to control this controlling the issue of 'C' forms to its sales tax registered dealer and seeking full details of its consumption every time before replenishment. This is a high cost and cumbersome process that requires dedicated manpower for follow up with the Department. Stocks Received as 'Stock Transfers' to the consignors own registered entity in Kerala will also require to be documented thru a form called 'F' form. These 'F' forms need to be submitted to Tamil Nadu Sales Tax to prove that goods have indeed not been 'sold' but 'stock transferred' to Kerala and hence there has been no payment of tax to Tamil Nadu. These 'F' forms will be issued by the entity in Kerala in favour of its sister entity in Tamil Nadu. Kerala tracks issue of 'F' forms as it can check if the receiving entity has indeed paid taxes commensurate with the 'imports' ( as they call it in sales tax jargon) from Tamil Nadu. You need 'well connected' tax experts to keep the wheels of business moving. A truck moving from Gurgaon in Haryana to Mumbai will have to wait at probably some 30+ check-posts. It takes close to 10 days for this travel, while in Europe, trucks moves across 10 countries in the same period. When foreigners complain of lack of ease of business in India, they mean such things. India is signing bilateral treaties and multilateral treaties with every trade block the world to ease foreign trade, but domestic trade is shackled by fiscal tribalism. Foreigners come to set shop in India seeing the big potential and then get disgusted when they see the country tie itself into knots out of sheer shortsightedness and the venality of the officialdom.

No where in the world, except of course Brazil, I have seen a more stupid and complex arrangement within one single country for tax administration.

Let us see how Railways are used negligibly in inter-state commerce and its potential to be a very significant logistics player in the service of the country is stymied by tax laws. Almost 90% of the manufactured goods go by road. Only 25% of all goods traffic is handled by Railways, even though for distances more than 300 km, it is better to move goods by Rail. Indian Railways with its vast network and plenty of land bank is ideally placed to be the best logistics provider in such a vast country. However, the indirect tax regime militates against using Railway yards as logistics hubs. Let us take the example of supplying a rake load ( 1400 mt to 2500 mt) of Fertilizer from a plant in Uttar Pradesh to Punjab. Uttar Pradesh has 10% tax on Fertilizer while it is tax free in Punjab. Handling it as a stock transfer from Uttar Pradesh plant to the state of Punjab and selling it to distributors in Punjab ex-godown is fraught with extra costs. For example, when the train reaches Punjab, they have to be unloaded and stacked on the platform, counted and then de-stacked and loaded to trucks and taken to local godown, unloaded again, stacked in godown and again de-stacked loaded to trucks for onward dispatch to distributors. When the agricultural season is at the peak there is no reason to take any fertilizer to godowns as the distributors and dealers will be ready to lift them in their own trucks from the railway yard in Punjab itself and it will reduce costly handling and multiple transfers of the material as delicate as Fertilizer bags which easily tear. However this arrangement can lead to a situation where the state of Uttar Pradesh may deem this transfer as a device to avoid UP tax and claim Central Sales Tax on the entire quantities that have been delivered to distributors/dealers!  The same may hold good for Cement manufacturers as well.

Even the provision in Central Sales Tax Act to treat the sale as one of 'Sale of goods in-transit' with the support of E1 & E2 forms is fraught with danger as in one case the Supreme Court had decided that where the Sale agreements exist before the goods are dispatched from the sending state, CST cannot be avoided. In any case, procuring E1 and E2 forms case by case and handling inter-state commerce is an impractical solution. So our industry and business resort to many a 'jugaad' to overcome the depravity of tax regime of individual states.

GST must enable India to become a common market, reduce cost of logistics, remove competitive fiscal policies that thwart inter-s tate movement goods, remove the artificial separation between goods and service, move all taxes to destination point thru a system of allowing for input tax credit ( ITC ), base the value on sale consideration rather than on multiple basis of calculation like NRV,
Ad valorem, Ad quantity, MRP minus abatement etc. There must be no separate treatment between capital and revenue goods. GST paid on Cement and the freight paid on its transportation must be available as Input Tax Credit when paying GST for a property builder.

The system should not depend on exchange and submission of 'forms' but be self-documenting. This will automatically happen when no intermediary gains by not paying tax to the previous stage. It should lead to new solutions and economies in logistics. What is calls for is an understanding of the issues involved and sublimating the provincialism with respect to state fiscal policies in the interest of common good.