The Turbulent Case Of Fiscal India: Transformation From VAT To GST
Dec 21st, 2016
How many of us really know our taxes? Do you know there is a luxury tax that is levied every time you book a room in a five-star hotel?
We hope you'll feel better to know that the new tax system GST(goods and service tax) is going to subsume this luxury tax. No longer you'll be taxed extra for enjoying luxury!
Yes, we write GST! No, not VAT. Yes, there is a VAT system prevailing in India right now. And GST in near future.
Too confusing? Let's simplify in these following dramatic acts.
Note– The characters below are inspired from real life Indian Prime Minister, Narendra Modi & Financial Minister, Arun Jaitley having a conversation in a fictional setting in the past. Since GST bill has been strongly supported by Arun Jaitley and our Prime Minister, they are the central characters behind GST. The artistic freedom of the discussion below is inspired by best-imagined memes of former US President, Barack Obama and current Vice-President of US, Joe Biden.
ACT 1- Present tax system isn't enough to tackle inflation, cascading effect & tax evasion
Modi: Arun, everybody thinks that the government eats up all the revenues and there is so much corruption in the system.
(Aside) It's true somewhere.
However, how to tell the 'janta' that the government itself is going through heavy loss known as a budget deficit, where government expenditure is more than the revenues? How to tell billions of Indians that the taxes they pay on commodities are not really coming to us?
I know as a Prime Minister, I will have to be the mouthpiece. No, I still want to win the next term elections! Find a solution right now Arun. I already have over-promised.
Arun: [Shuffles nervously through the files] What about the long-pending GST(Goods and service) bill?
Modi: Are you sure? The Congress party is going to flip and walk out of the Parliament!
Arun: [fixes his glasses in concentration] Yes. The prevalent tax system is not working out. Tax evasions in supply chains are happening all the time in today's market.
Modi: Why do you think tax evasion happens, Arun? Wasn't the sales tax substituted by VAT in 2005 only to curb tax evasion and all the other problems? Explain me the present situation.
Arun: Mr Modi, you are right. Let me explain.
Indian government levy a lot of indirect taxes such as VAT, CST, excise duty(12.36%) and service tax(14%), etc. VAT is charged when the trade is done within a state, whereas CST( Central sales tax) is charged when the buyer and seller are in two different states.
Our problems are many. One, we have too many indirect taxes that are inflating the rates of commodities. Second, VAT is only state specific. The whole idea of collecting taxes at every step of the supply chain doesn't work when the trade happens from one state to another. Third, we allow availment of input-tax credit only till manufacturing and within one state.This incompleteness hasn't completely removed the 'tax on tax burden', known as the cascading effect.
Modi: Cascading effect? Go back to basics. Give me an example of a regular transaction in a supply chain.
Arun: Let's consider a simple example of VAT(say 10%) within a state, provided the transactions are ideally done under proper invoicing.
A manufacturer buys raw material for Rs. 100 which includes tax of Rs 10.
He adds Rs. 30 as margin and sells the good for Rs. 130.
The input tax (the tax he paid on purchase) was Rs. 10 and the output tax (charge on the good sold) is Rs. 13 (10% of selling price). So under VAT since, the manufacturer will get his Input tax credit back that is Rs 10, he will pay Rs. 13 to the government.
The wholesaler buys the material for Rs. 130. He adds a margin of Rs.20. Now, for wholesaler, the input tax is R.s 13 that was included in the purchase cost and the output tax is Rs.15. So, he pays VAT of Rs.15-13=Rs.2(an offset amount) to the government since he doesn't get his input tax credit back.
The similar procedure is followed in the next chain. For more example, let's look at this video.
The VAT did stop cascading effect to an extent, but couldn't stop tax evasion and other tax frauds.
Modi: Sorry to interrupt, but how are tax evasion and frauds still happening?
Arun: The above example I gave was an ideal situation. The government provides input tax credits and setoffs under VAT only when the dealers/traders can show that the Input tax has already been paid on papers and are registered under VAT.
Now, what if the transaction done between a manufacturer and dealer is via cash. There is no proper invoice and no proof of input tax paid.
Here comes the idea of 'kacha bill system'. Many times, a trader issues a 'kacha bill' or no bill at all to avoid paying taxes. As taxes are calculated after the transactions, many traders do not reflect proper sales on their books.
Such situations also give rise to carousel fraud in India where an inter-state sale can be made zero-rated or acquisition fraud where dealer charges VAT but goes missing without paying VAT due.
Let's take the above example.
The manufacturer sells the material for Rs. 130 to the wholesaler. Transaction done until now is properly maintained under a registered manufacturer. Now, the wholesaler sells the material in cash to the distributor for Rs. 150. He doesn't give any tax to the government, nor provide a proper invoice to the distributor.
Now, the distributor cannot submit a set-off to the government. So, he carries on doing the transaction in cash and includes the tax in the price of the material. He also doesn't pay any VAT to the government.
So, a material that is bought for 150 has an input tax of Rs. 15. This tax is not given to the government by the wholesaler and is not in the records. The distributor adds Rs 30 margin and Rs. 15 extra. He sells the material for Rs. 195.
The tax keeps on cascading till it reaches consumers at an overpriced value.
Modi: Okay. Now, tell me how GST can help this situation.
Act 2- GST makes India, 'One-tax Nation'
Arun: Mr Modi, GST will replace or subsume most of the indirect taxes, especially VAT and CST.
This will result in two things. The interstate trades, where traders and buyers in different states will have to follow same tax system. The price of commodities will be same everywhere.
Another thing, it will stop the cascading effect in interstate where CST is levied. The cascading effect on services will also be reduced as VAT system was not applied to services before.
Also, there will be an availment of input tax credit in all stages of the chain to the purchasing dealer with respect to the tax paid by supplying dealer.There will be a seamless flow of credit.
This will act as a self-policing system. The input tax credit will be an incentive for the dealers and traders to maintain their invoices in records. A bona fide purchasing dealer will not be provided with credit even if he has paid GST to the supplying dealer if the tax has not been deposited to the government by the latter.
This time (in both interstate and intrastate trades), if a trader has to pay his set-off amount, he will have to show proper records on paper. Also, the traders will have no reason to levy any more different kind of taxes as the government will provide a fixed slabs rate structure of 0%,5%,12%,18%,28% for all commodities and services.
Modi: Wonderful! However, Arun shouldn't we set up a tax authority to track each transaction?
Arun: Yes, we will set up a tax authority under GSTN(good and service network). We will track under-voicing of trades especially, imports that are used to evade payment of custom duty. Since, at every level of the transaction, the trades will have to submit invoices to claim input tax credits, GSTN will be able to track sales price of imported items.
We will also provide customers with information on price benchmarking on each commodity. It will come with an integrated online system with the database of bills of entry and the invoices to keep everything transparent.
With one tax system in the country, it will also be easy for state and centre to not only track black money but distribute taxes efficiently between each other. This will also remove competition among states.
Modi: Will 'aam aadmi' be happy about it?
Arun: Probably not at first. Though, it shouldn't affect consumers that much. Having a fixed slab of tax rates would mean some things will become cheaper and some will become expensive. However, a fixed cap of 28% and an anti-profiteering clause will prevent over-pricing. In case of multiple supply of goods or services, the GST will be capped at the single highest rate of tax to avoid multiple taxing.
Modi: Not a bad start Arun. Let's take this to Parliament. One thing is still bugging me.
By GST, we can manage the supply chain from the very initiation point. But, how do we track the transaction between retailers and consumers?
It may happen that many consumers do not ask for or receive receipts.
Arun: It is a valid point. There is a need to control transactions happening between consumer and retailer as well. Probably, a concept of fiscalisation can come into play.
Modi: Let's discuss this in another meeting next week. First, I have to take some actions.
The above play is a creation of fiction and a medium to convey facts about GST. Each government fiscal policy affects retailers and traders and GST will impact the traditional way of doing business in India. Retail in India is transforming. So, be a part of this digital transformation with Infinia retail. Infinia retail is helping business in India adopt to new GST regime.
By- Gaurav Soni | Dec 21st, 2016 | Retail
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