Why it is critical to start with ‘good’ GST, then transition to an ‘ideal/best’ one

The goods & services tax (GST) is currently levied/imposed in about 160 countries, with the average GST rate of around 16%. There are variations from this average charge. To illustrate, GST rates range from 1.5% in Aruba, 6% in Malaysia, 7% in Singapore to 25% in Sweden and 27% in Hungary.

It is estimated that the average rate of indirect tax on any product in India is bound to be around 27% (excise plus VAT plus in-build input taxes).

To begin with, India, like Australia and New Zealand, also wanted to adopt a single unified GST rate. However, due to our federal structure, where the Centre currently levies multiple excise and service tax rates (with or without abatements) and states levy a plethora of taxes like VAT, entry tax, entertainment tax, purchase tax, etc, at different rates, achieving the target of a unified tax rate on all goods and services is extremely challenging.

The compulsion of multiplicity of rates under GST was also explained by the finance minister in his response to the GST debate in the Lok Sabha by stating that India cannot afford to have the same rate on ‘hawai chappal’, ‘baby food’ and ‘BMW cars’. He further added that while computing GST rates, one needs to keep in mind not only the use of a particular product, but also the people and their financial background using the said product.

Also, where a single GST rate (say, in the range of 16-18%) is applied to all goods and services, the same could result in steep inflation on products and services which currently attract a lower rate of tax, say, within the range of 5-7%.

While the aforesaid arguments are true, having multiple rates under GST comes with its own set of demerits and complications.

First, having seven different rates for goods—i.e. nil, 2-4% for gold, standard rates of 5%, 12%, 18%, 28% and 40% (demerit rate), and 3-4 different rates for services, i.e. 5%, 12%, 18% and 28% may continue or perhaps aggravate tax classification issues in the country.

This would mean that the age-old classification issues of spectacles versus goggles, raw meat versus cooked meat, toffee versus biscuits, sandal versus chappal are likely to remain under GST as well. While most of the principles laid down under the current regime for classification of products or services may still hold true, given the thorough reach of GST, one cannot rule out an increase in the number of classification-related disputes.

Second, multiple rates for goods and services may also pose a challenge for computing the tax liability on composite and mixed supplies of goods and services. To illustrate, while the GST Bill provides what should qualify as composite supply versus mixed supply, depending upon the GST rate applicable on the products or services under consideration, tax authorities may like to classify a ‘composite supply’ as a ‘mixed supply’ in order to garner more revenue.

Similarly, as the revised definition of ‘works contract’ under the GST Bill covers only contracts involving immovable property, with multiple rates applicable on goods and services, assigning a value to the goods and services portion under a works contract involving movable property would be a challenge. Tax authorities are likely to assign a higher portion of the value on goods or services which attract a higher GST rate, while dealers are likely to do the opposite.

Third, implementation of a structure with multiple GST rates increases the chances of having an inverted duty structure. This is a scenario where the output rate of tax is lower than the rate of tax on inputs that go into it, creating a situation of surplus tax credits for the assessee.

Therefore, the goods entitled to a lower GST rate should be carefully chosen to tackle this problem to the best extent possible. Thankfully, the GST Bill provides for refund of input tax credit in the case of an inverted duty structure, nonetheless the same increases the compliance burden of not only dealers, but also of the government.

Fourth, multiplicity of rates could lead to configuration of additional rate masters in the ERP system, thus increasing the complexity as well as the cost of compliance of dealers. The tax rate determination logics may increase and would need to be appropriately configured to ensure that an effective rate is being applied to each product/service under GST.

To conclude, although having multiple rates under GST is not a desirous situation, but as the forecasters of GST are saying, we cannot let ‘best’ be the enemy of ‘good’, so let us start with a ‘good’ GST which subsumes multiple taxes, nullifies cascading taxes, etc, and slowly tries and moves towards an ‘ideal/best’ GST with one rate across goods and services.