Explain the rationale behind the Goods and Services Tax (Compensation to States) Act of 2017. How has COVID-19 impacted the GST compensation fund and created new federal tensions (UPSC GS-3 mains 2020)

Goods and Services Tax (GST) is intended to be implemented ad a new, consolidated indirect tax regime from July 1, 2017. Lok Sabha passed four Bills, relating to the implementation of the GST

  • The Constitution (122nd Amendment) Bill, which was passed by the Lok Sabha in May 2015, was   again passed by the Lower House on 8 August 2016 after approving the changes made in it by the Rajya Sabha.
  • Rajya Sabha passed the Bill with amendments at its sitting held on the August 3, 2016 and returned it to Lok Sabha.

What Is GST ?

  • GST would be a comprehensive indirect tax on manufacture, sale and
  • consumption of goods and services throughout India, replacing taxes levied by the
  • central and state governments. It is one indirect tax for the whole nation, which will
  • make India one unified common market.
  • GST is a value added tax where a producer in the value chain will pay tax only on
  • the amount of his value addition. It will have input tax credit mechanism which
  • allows GST-registered businesses to claim tax credit to the value of GST they had
  • paid on previous purchase of goods or services. This will make tax avoidance difficult
  • and result in voluntary compliance.
  • Taxable goods and services are not distinguished from one another and are taxed at
  • a single rate in a supply chain till the goods or services reach the consumer.
  • GST is a multi-point destination based tax, where taxes need to be paid at each
  • point in value chain.
  • For the GST to be purely consumption based, all related indirect taxes and cesses
  • will be subsumed into it.

GST vs VAT: What Is the Difference?

  • From above illustration, it is evident that the credits of input taxes paid at each stage is available in the subsequent stage of value addition, which makes GST essentially a tax only on value addition at each stage. The final consumer will thus bear only the GST charged by the last dealer in the supply chain, with set-off benefits at all the previous stages.
  • Thus, GST is another name of VAT. VAT also taxes value addition on products, eliminating cascading effect. Then, what is the difference between the two. The difference is explained below.
  • The concept of Value Added Tax (VAT) was introduced for central excise duty in 1986 (first as MODVAT and then as CENVAT).
  • Prior to this, excise duty was levied on both inputs used and the output produced. This meant that an amount paid as tax on the input was subject to taxation again at the output level (with limited set offs). This was applicable to each intermediate good in the manufacturing process.
  • This “tax on tax‟ led to cascading of taxes. This problem was sought to be addressed by the VAT regime under which tax paid on the inputs is deducted from the tax payable on the output produced.
  • Similarly, sales tax also had a cascading effect through the distribution chain. All states have now adopted the concept of VAT for state sales tax.

GST Across The World

  • France was the first country to introduce this system in 1954. Currently, there are
  • 160 countries in the world that have implemented VAT/GST.
  • Most of the countries have a unified GST. Brazil and Canada have a dual GST
  • model, so is the case with India.
  • GST in China is applicable to only goods and the provisions of repair, replacement
  • and processing services.
  • US does not have a national level VAT.

Synopsis  of GST Bill

  • The GST bill basically seeks to amends the Constitution to empower both the
  • Centre and the states to levy GST. This they cannot do now, because the Centre
  • cannot impose any tax on goods beyond manufacturing (Excise) or primary import
  • (Customs) stage, while States do not have the power to tax services.
  • GST bill, considered to be the biggest indirect tax reform in independent India, aims
  • to transform the country into a uniform market by replacing a slew of federal and
  • state levies. The proposed GST would subsume various central (Excise Duty,
  • Custom Duty, Service tax, Countervailing or Additional Customs Duty, Cess,
  • Surcharges etc.), as well as state-level indirect taxes (VAT/sales tax, purchase tax,
  • entertainment tax, luxury tax, octroi, entry tax, etc).

What are the advantages of Goods and Services Tax?

  • It makes the taxation simple.
  • It promotes exports. Zero rated exports i.e full tax credit will be given for exports.
  • No/Less cascading effects.
  • It will increase job creation and promote MSMEs. Currently, Big Companies make their spare parts themselves to avoid indirect taxes in between manufacturing. Now these businesses will be delegated to smaller MSMEs.

What were the objections made to the bill?

  • The disempowerment of Parliament in setting tax rates as GST council will be formed for this purpose.
  • There is still need for several tax rates when the principle is to be of ‘one nation, one tax’. The ceiling rates are expected to be 0%, 5%, 12%, 18% and 28%.
  • The reduction in the fiscal autonomy of the States.
  • The uncertainty over the addition of petroleum products, land etc. under GST.
  • Concerns raised by banks and insurance companies over the need for multiple registrations under GST.
  • The levy of additional cess.
  • The law allows the States leeway to depart from a recommended SGST rate. Therefore, the challenges ahead lie in GST Council’s leadership skills to carry everyone along.
  • The monthly filing of Goods and Services Tax returns is ‘auto-populated’ — which means that a registered supplier must upload all details of his transactions, with the tax element.
  • Such humongous data gathering has not been attempted elsewhere, and the software should be tested.
  • The capacity of State tax authorities, so far used to taxing goods and not services, to deal with the latter is an unknown quantity.
  • The success of GST depends on political consensus, technology and the capacity of tax officials to adapt to the new requirements.

What is the justification of the government?

  • Parliamentary power – The recommendation of the rates will come from the Council but the GST Council has been given the power to only make a recommendation regarding the model law.
  • The Constitutional amendment gave that power in Article 279A. The plenary power to frame legislation can only be with Parliament or the state legislative assemblies.
  • State Autonomy – The Council has two-thirds voting by the States and one-third by the Centre.
  • But the states and the Centre must be guided by the federal nature of the agreement between the Centre and the states.
  • If every state decided not to act on the GST Council’s recommendations and set a different rate, then the implementation of GST become practically very difficult.
  • Multiple Rates – If there was only a single rate, then the GST regime would be a highly regressive one as luxury goods would then be taxed at the same rate as necessities.
  • Real Estate – The Council had taken a decision that the aspect of bringing the real estate sector under GST would be reviewed in the first year of rollout.
  • Petroleum Products – The Constitution provides that these items would attract GST, though the rate has been kept at zero.
  • Going forward, it would require only an executive decision on setting a rate on petroleum products.
  • Multiple Registrations – A clause has been provided that can provide an exemption in exceptional circumstances and the GST Council will take a call on it.

GST Compensation

After the introduction of GST States have very limited taxation rights as most of the taxes, barring those on petroleum, alcohol, and stamp duty, were subsumed under Goods and Services Tax.

GST accounts for almost 42% of states’ own tax revenues, and tax revenues account for around 60% of states’ total revenues.

Under the GST (Compensation to States) Act, 2017, states are guaranteed compensation for loss of revenue on account of implementation of GST for a transition period of five years between 2017 and 22.

The compensation is calculated based on the difference between the states’ current GST revenue and the protected revenue after estimating an annualised 14% growth rate from the base year of 2015-16.

Logic Behind Goods and Services Tax Compensation

In theory the GST should generate as much revenue as the previous tax regime.

However, the new tax regime is taxed on consumption and not manufacturing.

This means that tax won’t be levied at the place of production which also means manufacturing states would lose out and hence several states strongly opposed the idea of GST.

It was to assuage these states that the idea of compensation was mooted.

To make this promise watertight, the idea of compensation was both written into the Constitution and its finer details passed by way of central legislation.

Impact of covid-19 on Goods and Services Tax compensation and creation of federal tension

  • Decrease in GST revenues have impacted the government’s ability to compensate the state as they simply don’t have the money to fulfil their obligation. The shortfall is about 1.75 lakh crore.
  • Compensating for state’s loss has to be done through raising of alternate sources, which is difficult in times of the pandemic.
  • The state needed the money to fight the pandemic but the centre was reluctant to perform its obligation. It invoked force majeure to escape from the binding clause.
  • The state cited the constitutional safeguard and demanded their legal share, causing a conflict between federal ideas under the constitution.
  • The matter has reached the supreme court, where opposing states have questioned the centre’s move to break its federal agreement.

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