A redesigning of the Goods and Services Tax (GST) was long overdue. So, the Centre’s bid to embark on this crucial tax reform is widely welcomed. However, the question that lingers is whether the attempted changes will help address the infirmities of the tax that was born eight years and a month ago, and to what extent.
Given that all details of the Centre’s plan are not known, there’s also a fear among expert circles that the reformed GST could even end up no better than the current one, and may only redistribute the tax pangs among the taxpayers, without mitigating them at the aggregate level.
While the finance ministry‘s proposals to be considered by the GST Council have reportedly ironed out the key issue of “inverted duty” structure and the resultant accumulation of unusable tax credits with businesses to a large extent, several industries and experts are keeping their fingers crossed.
Inverted duty and industry concerns
It may sound ironic that a host of industries including textiles & garments and pharmaceuticals are demanding that their outputs be taxed at a higher than what is presumed to be on the cards, and others like insurance insist that no exemption should be granted to them. But that is the defining feature of GST, the objective of which is to minimise tax cascades.
Rajiv Memani, president of Confederation of Indian Industry, says: “Within the proposed realignment, the government strives to correct the inverted duty structure by readjusting the rates of the inputs that go into production. This will help in neutralising the impact to a certain extent but the concerns around possible accumulation of credits remain.”
Exemptions are of two kinds – product or service-wise and the turnover thresholds for businesses to join the GST chain. Experts would like both to be minimised. To be sure, the GST exemption thresholds are more liberal than in the value added tax (VAT) regime it replaced, whereas GST was supposed to broaden the tax base. Rahul Renavikar, managing director at Acuris Advisors, notes: “On the face of it, exempting any supply of goods/services from the levy of GST appears to be consumer-friendly. However, in reality, the consumers may end up carrying the burden of a certain amount of GST, thanks to the cascading effect of the exemption.”
According to experts, the crux of any GST system is the ability of the buyer in a business-to-business supply scenario to claim the credit of the tax paid on the purchases while discharging the tax payable on the supplies. Any break in this chain will result in an increase in the cost of goods/services supplied. So, ultimately, the final consumer will be forced to bear the burden of the tax applied at every stage of value-add, as he/she can’t claim any input tax credit (ITC).
Revenue implications and exemptions debate
With the available information on the rates rejig, the revenue losses from the proposed GST reforms are estimated by independent analysts at anywhere between Rs 70,000 crore to Rs 1.8 lakh crore on an annualised basis. Government circles say the figure could be even less at Rs 60,000 crore, and even this loss may not materialise as the reduced tax incidence will boost compliance and widen the tax base, rather immediately. As such, the 12% slab that is to be scrapped (and largely merged with 5% rate) yielded just 6% of the gross GST revenues of Rs 22 lakh crore in FY25. The 28% rate, which also is to be dispensed with, will remain for all sin goods, and high-end vehicles; only a few items – certain white goods like air conditioners, vehicles other than the premium ones, and cement for instance– are to be moved from 28% to 18% slab.
In many cases, a lowering of output tax from 18% or 12% to 5% may raise duty inversions, as inputs may remain taxed at higher rate, analysts feel.
Take the case of the textile industry. At present, most dyes, chemicals, and finishing agents used in dyeing, printing, and processing of textiles fall under the 18% GST slab while finished fabrics and garments are often taxed at 5%. “This mismatch has created instances of duty inversion,” says Suketu Shah, CEO at Ahmedabad-based Vishal Fabrics. According to him, the proposed move to a simplified 5%–18% structure can ease compliance and reduce complexity, but it may also intensify the inversion problem if inputs remain at 18% and outputs at 5%. “The effectiveness of the GST reform will depend on careful classification of goods and a robust mechanism to ensure smooth input credit flows,” he adds.
Ronak Chiripal, promoter at Chiripal Group concurs, and adds that man-made fibre (MMF) segment is the worst hit by the inverted duty structure since upstream feedstock like PTA/MEG are taxed at 18% while fabrics and garments attract just 5% tax. “There is a need to have fibre-neutral fixes or lowering of tax on PTA/MEG.”
Renavikar stresses that rather than exemption, GST at a lower rate must be levied on goods and services, paving the way for reduced prices to the end-consumer. “Another method would be to zero-rate such supplies (as for exports) where there is no tax payable on the output side and full input tax credits are available,” he adds.
In a similar vein, Pallavi Malani, MD & partner at BCG India says that while GST exemption for insurance looks consumer- friendly, it risks creating “deeper distortions and dissonance for the customer.” According to Malani, a large share of insurers’ GST credits today comes from technology platforms, operations and distribution services that are taxed at 18) and once policies are exempt, these costs will become embedded, raising operating expenses
even as premiums appear cheaper. “In an industry, where the customer trust and awareness are low, this further accentuates the problem since customers will now expect an 18% reduction in premiums but will not see that delivered,” she warns. Zero-rating could have been a better tool, preserving affordability while avoiding hidden costs being passed back to the customer. Currently, insurance can claim ITC on costs for reinsurance, commission, third-party administrator services and other operational expenses for delivering the insurance services. If premiums are exempted, ITC will no longer be available, forcing insurers to pass on the burden to policyholders. Insurers are estimated to set off 8-10% of their premium costs through ITC.
Jignesh Ghelani, partner at Dhruva Advisors, also says GST exemption may not necessarily reduce premium by 18% for all the types of health and life insurance policies. While 18% tax is applicable on the value of taxable supply, it excludes a portion of the premium allocated for investment or savings. Around 40% of the premium in traditional life insurance policies goes towards investment in early years while for ULIPS, more than 80-95% of the premium is invested. “Where GST exemption is allowed, the companies will not be able to avail ITC of GST paid on its purchase of goods and services thereby increasing the cost of providing insurance services,” Ghelani adds.
Viranchi Shah, spokesperson of Indian Drug Manufacturers Association (IDMA) feels the expected drop in the GST for drug formulations from 12% to 5% coupled with the 18% GST on API is going to worsen the inverted duty problem. GSK Velu, chairman and managing director at Trivitron Healthcare, says: “It will be a welcome step to bring all medical devices and supplies under 5% GST, but inverted duty affecting some of the products should be addressed. Reducing the rates, and ensuring no loss due to inverted duties will benefit MSMEs and will improve compliance.”
The current thresholds for GST registrations, exemptions, etc have been fixed in 2017. These need to be reviewed and revised upwards to extend the relief to the businesses and citizens,” says Renavikar.
Tomorrow: Addressing compliance issues and how the industry is preparing for the reforms.