What is GST ? II - Logical Design

While Jaitley bravely declares GST will be resolved before 2016, and the bill will be presented in the winter session of the parliament, the fact is here tthere is still no consensus on some aspects of the conceptual design.A news report in 'The Economic Times' on the 25^th of Sept, 2015 talks of some states asking for powers to tax the Business-to-Business(B2B) transactions. This means the concept of GST being a destination tax should be applied in B2C scenarios and not in B2B scenarios of inter-state commerce. Nothing is more damaging to the cause of GST if such a course is adopted. It will be better not to tinker with the Indirect taxation regime as it is than to tinker with GST and allow all kinds of exceptions and deviations that are antithetic to the idea of common market creep into it. Such arguments reflect a very narrow thinking and are mooted by ill-informed bureaucrats in the states to curry favor with obdurate and intemperate state politicians like Jayalalitha, for example, who would want to poke holes in a federal initiative. Such talk must be nipped in the bud.

The logical design is where the options are discussed and the various scenarios are debated and provided for. The modalities of valuations, actors or entities, use cases, triggering events, definition for the GST jargon need to be put in place. Besides, a high level data flow diagram to explain the sharing of information between the entities needs to be figured out.

Under logical design the following aspects need to be considered:

CGST, SGST & IGST

Goods and Services will be taken together and taxed by both the centre and the states accordingly. Therefore there will be a Central GST or CGST, State GST or SGST and an Inter-state GST or IGST. The following table shows how GST will replace the existing gamut of indirect taxation on goods and service at all levels in the country. In this scheme of taxes, IGST is the most interesting and critical and we shall discuss it separately in the coming paragraphs.

Sl	GST Component	Subsumes	Goes to
1	CGST	Countervailing duty on imports Cenvat Service Tax Additional Excise duty Special Excise Duty	Centre
2	SGST	VAT Works Contracts Act Luxury Tax Tax Collected at Source Entertainment Tax Entry Tax	State
3	IGST	CGST + SGST	For inter-state commerce. State Center, routed thru Center.

Place of Supply

Another aspect logical design is the Place of Supply ( POS) rule. The place of supply is the place where a supply is made and where GST may be charged and paid. While it is straight forward for goods, and for services that are delivered as part of supply of goods, it is complicated for services not accompanied by goods.

Let us consider some scenarios:

• An order placed with  a e-commerce aggregator  in Banglore who supplies it from a manufacturer in Hyderabad for a customer in Gujarat and the installation and commissioning services are provided in Mumbai , but Mumbai has just a Sales agent fort the Hyderabad firm  without any capacity for delivery, what is the Place of Supply for purpose of deciding the tax jurisdiction ?
• What is the Place of Supply when you book your car insurance when you doi it through internet ?
• What is the Place of supply when the vendor's  development center is in Bangalore and a Noida based mobile manufacturer downloads device drivers from the vendors's Bangalore centre and ports to the mobiles that are manufactured ?
• What is the place of supply when an audit firm like PwC does a due dilligence service for their Mumbai customer , but the audit is conducted in Tamil Nadu , where neither PwC nor its mumbai customer has Place of Business ?
• What is a place of business for a non-resident coming to Delhi for a few months to provide consulting to Delhi Golf Club for designing a new Golf course ?

These questions are not taken up and addressed yet. ( At least I have not come across so far ).

The general rule for deriving the tax jurisdiction is as follows:

The service is delivered to a:	The place of service delivery and hence the Tax Jurisdiction is:
GST Registered Customer ( B2B )	Where the customer belong
GST Non-Registered Customer ( B2C)	Where the supplier belongs

However this is just a general rule with possible exceptions like, -

• Transportation of goods and passengers
• Vehicle hire
• Services like DTH, Organizing events & sports activities, e-services thru websites, advertising .
• Services like property construction , where the Jurisdiction is always the state where the property is located

I am just pointing to the unfinished task with the GST panel of the Government in the area of logical design. My observations above are based on what I have seen in countries like Australia , UK and some countries of Europe where I have delivered ERP Projects. It is not to say that the rules that these countries follow will be good for India.

In the previous post we saw, how GST will facilitates sales of goods in transit. However, the rules regards to the point of sale when goods are in transit between two states is yet to be deliberated upon. For example, if the title to goods are transferred at the point of receipt, it is fine. However, if the title to goods are transferred at the point of dispatch, how can the receiving state pass on the Input Tax Credit which it has not received in the first place. Similarly, when the goods are sold when they are in-transit, the point of sales require clear definition as otherwise the old problems of check-posts, forms and origin-based taxation will continue to bedevil the GST tax regime as hitherto.

GST Base

Currenty, Pertroleum Products are kept out of GST. ( They are included in GST , but with Zero percent rate)

Similarly, Electricity duties, Real Estate are also outside the ambit of GST as it is today. Later they can come under GST, but getting a Constitutional Amendment for such inclusions at a latter at day will be a onerous task that may take another decade.

There is no reason for these items to remain outside GST.

Rules with respect to Input Tax Credit ( ITC)

There is no clarity on whether input tax credit ( ITC ) will be available for goods and services that are 'attached to the ground'.

There are exclusions  galore in VAT. Aviation fuel, Electricity duties, taxes on Diesel, Alchohol are kept  This should not happen with GST.

For example, whether  the GST paid by my software services company to buy paint for our building is  available for input tax credit when my company will pay its GST dues to State / Central Governments ?.

 Currently, Input Tax Credit is not available under Cenvat Rules and State VAT laws for items purchased by business but are not used in the manufacture or traded by the entity. For example, if an Air Conditioner is purchased for a factory manager's cabin, the Excise duty paid on it is not available as input tax credit when paying the excise duty of the goods produced at the factory. It is necessary the Empowered Committee of State Finance Ministers for GST quickly come out with rules in respect of admissibility of Input Tax Credit under various scenarios.

Revenue Neutral Rate for GST

GST imposition is supposed to be revenue neutral for the centre and the states. What shall be this RNR rate is anybody's guess. It can be done with some guess work and at least for the initial years, a leap of faith. A composite rate ( SGST + CGST ) of 27% was mooted and it created a furore. Now that states are going to collect tax on services, there is no way GST will reduce the income for the states. Now unnecessary noise is only serving to sow dissension amongst the stake holders.

Compensating the 'Producing States'

In addition to the above three taxes the Constitution Amendment Bill before the parliament provides for levying a 1% tax on inter-state sale to compensate for the producing states. As this tax will be at the origin, it will not be available for Input Tax Credit in the receiving state. This is to placate the Manufacturing states viz. Maharashtra, Tamil Nadu and Gujarat. This is a retrograde step and was mooted by the Finance Minister of Gujarat in Dec 2014. There was no talk of this tax till that time. As Centre has promised to compensate the states for any fall in revenue for next 5 years as a result of GST, there is no need for this tax. By allowing a demand for such an additional tax, BJP has created an unnecessary talking point which creates noise and provides handle for recalcitrant states to raise one issue or the other.

Tax Events

Tax events is another aspect of logical design. For example, let us take the case of telecom / DTH company selling Prepaid Vouchers to distributors. Service Tax is collected in the first stage of sale to distributor and paid to Government by the telecom / DTH company the next month. However, the service is not yet provided. The Prepaid vouchers need to be sold to dealers/retailers. Thereafter, after an end-customer buys and tops up the account and use the services, no case of Service Tax should arise. However, in practice, for the fear of terrorized by our expert tax terrorists, companies pay Service Tax when they collect it from distributors. The argument is having collected money on behalf of Government, they are not supposed to hold it or make adjustments to it and make deferred payments.

Besides, if the Voucher is sold to distributor in Maharashtra and the same voucher is purchased from a dealer and used in Karnataka, how will it work. Owing to such complexities, companies should be allowed to gross up Service Tax on the prepaid vouchers, but charge and recover taxation only upon usage. The current vexatious rule of determining service tax liability ahead of actual delivery of service should be done away with under GST.

Purchase Tax

In any logical design, there will be exceptions that may buck the conceptual design . It can be in the form of a project constraint, budget or technology constraint, a special scenario or an outlier that requires a break from the design principle. One such case is the Purchase tax. States like Punjab and Haryana that contribute overwhelmingly to Grain production and contribution to Central pool levy Purchase tax on agencies like Food Corporation of India when they do the annual procurement. Punjab is an outlier with agriculture as the mainstay. Without any tax on sales of agricultural produce, it is only natural that Punjab demands revenue for the contribution it makes to food security in the country. It is not clear, however, how this would be handled. Though Centre has promised compensation for loss of revenue as a result of introduction of GST, it is only for 5 years and not for perpetuity. When a category of items like Food grains is completely exempt from all taxes, the state that is totally agriculture oriented needs to be compensated for some how.

IGST Model

When sales happens between states, the center will collect IGST which is merely SGST and CGST on the goods taken together. The IGST model is interesting. For example, let us assume there is an automobile engine manufacturing plant in Pune which has suppliers of ancillaries in both Maharashtra and Tamil Nadu. It would have paid CGST, SGST on Maharashtra purchases and IGST on Tamil Nadu purchases. When it sells the engine to Haryana for a car manufacturer, it will collect IGST from the car manufacturer , but will deduct the CGST, SGST and IGST it has paid to Maharashtra and Tamil Nadu suppliers while paying IGST to the Central Government. Now Maharashtra will transfer the amount that represents the credit taken for SGST while the engine manufacturer paid IGST to the Central Government. This amount will be transferred to Haryana while the Car Manufacturer in Haryana will take input tax credit for IGST paid by it to the engine manufacturer while paying output tax collected from inter-state sale in Delhi where the cars are sold to the end customers. The funds flow thru the RBI Clearing Account is shown in the figure below:

GST Funds Flow

T-Accounts will show that the flow of Input Tax Credit thru RBI Clearing and IGST Clearing Accounts to the final destination , the state of Delhi.

Alignment of Tax rates

It would be evident from the T-Accounts above that taxes on inputs should be lower than those on finished goods. Besides, the tax rates for SGST between states should vary minimally, if at all. This requires the states to collaborate and not complete for tax revenues. We have to see the precept of co-operative federalism in practice. It may be politically necessary to give freedom for states to decide their own SGST rates. However, this should not result in fiscal wars between states. For example, Kerala is dependent on Tamil Nadu for most supplies. For example, Chicken meat. By keeping SGST on chicken meat very low, Tamil Nadu can encourage imports from Tamil Nadu into Kerala that may not be liked by the Kerala Government.

Just as I am about to finish this post, I read in the papers that the Centre has circulated model GST Act to states. I have not read it. It is possible they are at a variance from what I have understood hitherto which I have laid out before your in this post.

PS: Answer to question posed in the previous post on the subject:

Is Direct-to-Home tv telecast is a Service subject to Service Tax or Entertainment that is subject to State taxes on Entertainment ?

Actually in the subscription of about Rs.450/- you pay, 12% goes to Central Government as its revenue share, 14% is the Service Tax, any where between 25% to 35% goes to state as Entertainment Tax! No wonder, the mafia is active in cable business as they do not pay any of these taxes and very little to content providers like Nat Geo, Discovery etc. etc.While Jaitley bravely declares GST will be resolved before 2016, and the bill will be presented in the winter session of the parliament, the fact is here tthere is still no consensus on some aspects of the conceptual design.A news report in 'The Economic Times' on the 25^th of Sept, 2015 talks of some states asking for powers to tax the Business-to-Business(B2B) transactions. This means the concept of GST being a destination tax should be applied in B2C scenarios and not in B2B scenarios of inter-state commerce. Nothing is more damaging to the cause of GST if such a course is adopted. It will be better not to tinker with the Indirect taxation regime as it is than to tinker with GST and allow all kinds of exceptions and deviations that are antithetic to the idea of common market creep into it. Such arguments reflect a very narrow thinking and are mooted by ill-informed bureaucrats in the states to curry favor with obdurate and intemperate state politicians like Jayalalitha, for example, who would want to poke holes in a federal initiative. Such talk must be nipped in the bud.