The passing of the Goods and Services Tax (GST) Bill has been lauded as one of the biggest pieces of reform that India has seen since it opened up its economy in 1991. First proposed by the Vajpayee government in 2000, it aims to bring a raft of state and central taxes under a simplified tax code and to move from a fragmented state-focused market to a single national market.
Under the current tax system, there are direct taxes such as income tax, and indirect taxes that comprise central and state levies such as value added tax, sales and luxury tax and octroi tax, a local tax levied on various goods entering a town or city. The GST aims to bring indirect taxes under one umbrella. On a company level, it reduces the effective tax paid by producers. Currently, each producer along the value chain pays a tax based on the price of his output.
Under the new system, each producer receives an offset on the taxes paid by his suppliers. In other words, rather than be taxed on the gross value of their output, producers are taxed on the value added by their activities. It’s worth noting that such a value added tax does exist but it is limited to trade within a state—the GST looks to broaden this to include movement of goods across state lines, which would make business easier for companies by reducing compliance costs and red tape. The current system causes bottlenecks; for instance, companies have to a pay a tax when selling goods made in one state into another. However, intercompany transfers are not taxed—to minimize taxes, companies build warehouses in each market, transfer finished goods to those markets before finally selling them. Furthermore, stopping trucks at state borders to inspect goods and papers can waste up to 32 hours at checkpoints. It’s no wonder that logistic costs comprise 13%-14% of value of goods in India versus 7-8% in developed countries. The GST should be of benefit to branded consumer companies, as the average value-added tax they incur of up to 25% should fall to 18% under the new system. Longer term, the GST will remove major obstacles facing regional competitors who will then be able to scale and potentially become national brands.
Adopting the GST also eases the administrative burden for governments and reduces the cost of collecting taxes. The new Bill also broadens the tax net and puts into place checks that should reduce tax evasion. A producer can only use the offset if his supplier has paid taxes correctly, thus making tax evasion harder. Finally, from the consumer point of view, the biggest advantage would be a reduction in the overall tax burden, which is currently estimated to be 25%-30%.
The GST is far from perfect—it will not apply to highly lucrative, tax generating sectors of alcohol, oil products and real estate. Further, it will increase the prices on certain services, such as tax on mobile phone bills, which will rise from the current 15% to the 18% as mandated by the GST. There are also political obstacles leading up to the April 1, 2017 execution date of the GST—the opposition (which ironically, while heading the previous administration, championed GST) wants the constitutional amendment to specify the tax rate. The implication is that any future changes to the rate will require a lengthy amendment process once again. Under the GST, taxes accrue to the states where final consumption occurs. Thus, one can expect opposition from states where the goods are produced who will now lose out on tax revenues. Finally, the country is in the process of deploying a massive IT backbone across governments and companies to allow for real-time collection of tax information and offsets. Despite these caveats, it is a promising sign to see economic reform happening in India that should make it easier for companies to conduct business and let investment flow more easily and efficiently between states.
Source: Matthews Asia