Column: Alcohol under GST-States objection defies logic

Written by Satya Poddar | Updated: Sep 5 2014, 06:41am hrs
Even as the Union finance minister engages with the states to build consensus on the Constitution (115th Amendment) Bill for GST implementation, the states continue to resist GST which is irrational and unfortunate. This has become a serious hurdle in the governments plan to revive the economy and provide a boost to manufacturing and employment growth.

One of the points of contention is the states opposition to the inclusion of petroleum and alcohol in the GST base. They argue that they raise a lot of revenue from these products, which would be undermined by their inclusion in the GST base.

This argument is baffling and defies logic. The strongest virtue of GST is that it leads to more revenues, not less. Virtually all countries that have adopted this tax have done so to strengthen the tax system to gain revenues. It has proven to be a cash cow for them. How can then GST on petroleum and alcohol cause revenue loss to the states

Let us take the case of the alcohol sector. Inclusion of alcohol in the GST base can lead to revenue gains in three ways. First, assuming a state GST (SGST) of 10%, the application of GST to alcohol will provide about R10,000 crore additional revenue to the state governments, according to the sales reported by the industry to the tax authorities. This revenue will be over and above the revenue from excise duty and other taxes such as licence fee and bottling fee which the states currently levy on alcohol. The states will continue to have the powers to levy the existing taxes as the Constitutional framework for GST does not contemplate dilution of these powers in any way.

The second aspect is that GST will create an audit trail which will allow a more effective control and monitoring of the taxes paid on alcohol products. It is no secret that unreported sales in this industry are rampant and that cartels are a pervasive feature of the industry. These cartels thrive on opaqueness of the system, corruption and collusion. They peddle spurious products to the innocent, causing serious health hazards. The GST audit trail will provide greater exposure of the unreported activities.

The most significant source of leakage for the states is the inter-state movement of goods. Alcohol is no exception. The states have been trying to monitor such movement of goods through check-posts at entry points, but these have proven to be completely ineffective. Rather than contributing additional revenue to the government, the check-posts have become a source of comfortable retirement income for those manning them. Under the proposed GST regime, movement of goods across state borders will be subject to a Central levy (IGST) which will create an audit trail and facilitate a more effective monitoring of the sales reported for Centre and state GST.

Another important source of leakage is imports smuggled into the country. Under a GST regime, imports would be subject to tax, which would be collected and enforced by the Customs authorities. Application of GST will create incentives for customs officials to devise more effective ways of controlling smuggling.

If alcohol were to be excluded from the GST, the states would not only lose out on the R10,000 crore income from sales already declared, but also forego the opportunity for improvement in compliance, reduction in inter-state leakages and leakages from imported products. On the other hand, if alcohol is included in the GST, the only losers will be the cartels and the people they collude with.

The GST will also bring in greater efficiency in production of alcohol and simplification of tax compliance. The current system suffers from the problem of tax cascading which increases the cost of production and introduces inefficiencies in the production decisions. Removal of cascading and the efficiencies in the production system will provide a 2% boost to the GDP. Any sector excluded from the GST will be deprived of this benefit.

This is the reason why the industry has been pleading the government to include alcohol in the GST base. Even though it will mean an additional R10,000 crore tax burden on them, they are hoping that inclusion in GST will bring greater transparency and fair competition in this industry.

Exclusion of any sector from GST creates economic distortions in the supply chain and adds to the overall complexity. An ideal GST is one that is levied at a modest rate to a comprehensive range of goods and services. Any exclusion or exemption creates classification disputes and a compliance nightmare, particularly for the small and medium taxpayers.

Take, for example, restaurants and hotels that serve alcohol. Currently, they generally attract three different taxes: state sales tax or VAT on alcoholic beverages, state sales tax or VAT on food and non-alcoholic beverages (F&B), and the Central service tax on 40% of the invoice amount which is deemed to be a charge for the services provided to the customer. If alcohol was excluded from the GST, the complexity of these taxes would be compounded even further. The restaurant bills could be subjected to potentially five different taxes: State sales tax or VAT on alcoholic beverages, Central GST (CGST) on 40% of the invoice amount for alcohol (which is deemed to be a charge for the services provided to the customer), SGST on the same 40% of the invoice amount and CGST and SGST on the charges for other F&B. Managing such complexity is beyond the ability of small and medium enterprises even with significant incremental effort.

It is strange that all the above arguments repeatedly put forth by the industry before the states have had little impact on them and they remain entrenched in their demand for exclusion of certain sectors from the GST base. If there was any merit to their demands, why werent they raised at the time of introduction of VAT in 2005 In concept, GST is nothing but VAT applied to both goods and services. Virtually all states experienced a significant growth in revenues as a result of the switch to VAT in 2005.

The states must re-examine their demands for exclusion of alcohol (and petroleum) from GST and certainly not exclude it under the Constitution Bill itself. Even if it is excluded at the inception of GST, the Constitution should allow the flexibility of bringing it within the ambit of GST at a later date. It is a view shared by the Parliamentary Standing Committee on Finance and the erstwhile Chairman of the Empowered Committee, Sushil Modi. One hopes that wisdom dawns on the states and they will come together as Ek Bharat to build a Shreshtha Bharat.

The author is partner, EY