VAT or GST is the most preferred taxation system as it is a tax on final consumption of goods and services in the jurisdiction where it occurs according to the destination principle. Generally collected as a multi-stage tax, GST system facilitates the ‘flow-through’ of the tax burden to the final consumer while maintaining neutrality within the GST system. Laying down principles for the identification of the consumer who has to ultimately bear the tax burden of GST is a prerequisite. These principles are necessary to ensure that the chances of double taxation and unintended non-taxation are minimised.
In a federal economy, taxing goods does not pose much problem. The movement of goods in the chain of business sale or transfer can be used to locate the place where the goods are used by businesses or ultimately consumed.
Implementing the destination principle with respect to inter-state supplies of goods is facilitated by the existence of border controls. However, implementing the destination principle with respect to trade in services—which by their very nature cannot be subject to border controls—has difficulties. It is not always easy to locate the place of consumption of services, on which also depends the tax jurisdiction.
As of now, in India, services are taxed only by the Centre and revenue accrues only to the Centre. The place of consumption of service, whether in one state or the other, is of no material consequence. In this situation, barring some exceptions, service tax has been conveniently collected from the service provider. However, the situation would drastically change when states also acquire the right to charge tax on services as consumed in the respective state. In the dual structure GST, which is the basic feature of GST to be introduced in India, tax on services would comprise the central component and the state component and the tax collected in a manner that the sanctity of the destination principle—which is the soul of VAT or GST—is not violated. For collecting the central component of tax on services, in most situations it is good enough if tax is collected from the service provider. Only in certain cases, for reasons of administrative convenience, like road transport service, tax collection needs to shifted to the service receiver. The place where service is consumed has no bearing on the revenue attributable to the central government. However, the state component derives its legitimacy from the place of consumption of service. Revenue from tax on a service should accrue only to that state in which service is consumed. Here lies the importance of deciding upon principles to be applied for determining the place of consumption (supply) of services.
In the first place, where a service can be said to be supplied or consumed can defy perception and cause practical difficulties in administering tax. For example, company X contacts a firm in Bangalore to prepare a software. It downloads the newly developed software to a laptop in Gurgaon and uses it at a business conference in Delhi. Where has the service been used? In Gurgaon or in Delhi? Clearly, irrespective of the place where the service is considered to be used, it would be impossible to administer tax in such situations. In most cases, it would be difficult for software supplier to track use of services in this way and difficult for a tax administration also to know where the services were used. In order to overcome such difficulties, VAT or GST employ proxies to determine where use or consumption of service occurs and thus which jurisdiction has the right to tax. Adoption of proxy or deemed place of consumption is necessary because while the tax on service is planned to be collected as soon as the service is provided, the time or place of actual use of service is not always certain.
The need of proxy for use of different kinds of services has led countries using VAT or GST to notify rules to determine the place of supply where a given service is deemed to be consumed. Such rules are necessary to deal with cross-border (even inter-state) supply of services.
In the Indian context, no such rules were framed till 2012, when the Centre notified the Place of Provision of Service Rules, 2012. It identifies the place of supply of services, employing criteria like the nature of service, location of the recipient of service, place of performance of service, location of service provider, etc. In most cases, though, the location of the recipient of service is considered as the place where the service is deemed to be supplied or consumed.
But it is important to realise that when the tax on services is collected only by one authority, the central government, the Place of Provision of Service Rules have had little practical significance. On the other hand, they have created confusion like in the case of service provided by intermediaries.
Nevertheless, when GST would empower states to levy and collect their component of GST on services, the Place of Supply Rules would play the most crucial role in protecting states’ revenues from services. In the above example, whether the state component of GST would accrue to Karnataka or Delhi or Haryana would depend on how the Place of Supply of Service Rules determine the place where the service would deemed to be consumed. States would be the main stakeholders in the Place of Supply of Service Rules.
The introduction of GST is long overdue in India. The basic design of GST itself remains hidden beneath a shroud of political confusion. Who knows, consensus on the nitty-gritty of GST, like the Place of Supply Rules, might turn out to be no less unpredictable. Poor taxpayers!
The author is a retired chief commissioner and former joint secretary in the finance ministry