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Financial services: Taxing finances in the GST era

GST will maintain status quo on financial services tax base but will increase tax compliance

Published: September 19, 2016 6:22 AM
GST is likely to maintain status-quo on the tax base of financial services. However, the shift is anticipated to result into increased tax compliances and regulatory control for the participants. GST is likely to maintain status-quo on the tax base of financial services. However, the shift is anticipated to result into increased tax compliances and regulatory control for the participants.

GST, touted to create a unified tax market will not only merge state borders but also diminish the importance of terms such as manufacture, services and sales. It is therefore important to envisage how the new tax regime impacts the services sector, especially the financial services.

Broadly speaking, the financial services sector consists of banking, capital market related services (asset management, stock broking etc.) and the non-banking financial service providers such as asset finance, lending, leasing etc. The sector has largely been subject to the central levy of service tax only. The basic theme has been to levy tax on fee-based activities such as processing fee, brokerage, administration fee, investment banking services etc, while excluding interest on loans and advances from the scope of the levy.  Likewise, barring asset lease or intermittent sales transactions for asset finance companies or scrap sales, the sector does not deal with the VAT legislation.

GST is likely to maintain status-quo on the tax base of financial services. However, the shift is anticipated to result into increased tax compliances and regulatory control for the participants. With a consumption based taxation approach, states would become stakeholders for tax revenues generated from financial services consumed within the respective state. A presence across multiple states would mean that the service providers would now be assessed by respective state regulators.

The state of consumption, entitled to tax revenues, need to be determined based on the place of supply principles outlined under the GST Law. The Model GST Law proposes to tax Account Linked Financial Services (ALS) in the state of the service recipient. However, non-ALS are proposed to be taxed in the state of the service provider. For ALS, the question to be debated would be which address of the customer needs to be referred to— as there could be permanent address, current address, address for communication and KYC address. Given that the last one in the list may be the most complete in terms of backup available, it is possible that companies may opt for referring to the KYC address for determining place of supply.  A specific clarification in this regard will clearly help avoiding debates in the future. The big question for ALS would be from where the services are provided. The sector has a complex service delivery setup where multiple offices of the legal entity (possibly in different states) would get involved in serving a customer.

For non ALS, taxing in the state of service provider may yield competitive distortion in favour of state based service provider. This may create state based barriers for non-ALS and defeat the GST principle. For example, inter-state supply of non-ALS by a Maharashtra based service provider would be liable to Maharashtra GST (MGST). The said, MGST, may become a cost for the service recipient located in another state in absence of an output MGST liability. This could tilt the selection criteria in favour of an intra-state non-ALS provider. It is thus relevant to relook at the place of supply rules for non-ALS activities in order to enhance trade efficiency and competence.

With self-supplies being made taxable, service flows inter-se the same legal entity (but in different states) is also likely to create several challenges. These will include mapping such transactions to begin with, measuring them as per the valuation code, and reporting them so that the other office can take credit. Question is that in a complex industry like FS, how would these map and measure rules apply and what is the potential risk of authorities debating the basis in the future.

Needless to mention, an increased industry representation at this stage may iron out certain deficiencies and help table a well-researched draft law in the winter session of the Parliament. However, with the increased compliance requirement the need to undertake an IT system overhaul is an imminent action point for the industry participants. The quantum of transactions and the various sources of service dissemination (online, on-site, m-commerce, ATMs, POS devices etc) further coupled with the dispersed geographical presence may create tax computation and reporting complications in many cases. It is, thus, essential to review (and possibly revamp) IT Systems to deal with multiple variables for tax computations and undertake automatic reporting and reconciling.

Thus, it is for the sector to evaluate and maximise the available time-frame for business process reengineering and IT optimisation with a target to mitigate any business disruption on and from the go-live date.

(With contribution from Piyush Bihani, senior tax professional, EY)

The author is Divyesh Lapsiwala, tax partner (financial services), EY. Views are personal.

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