The government should place high priority on the suppression of fake invoices and liberalising GST procedures to facilitate trade and let the GSTN operate at full throttle.
By Sujit Kumar Sinha
In the Indian federal tax system since 1935, the Constitution armed the Union and the states with a large number of taxes that they could levy. Capsizing a variety of taxes into a single GST has been a revolutionary step in simplifying the tax regime. The other central task in GST was to create a system wherein credit of tax paid on inputs is laid out as an unbroken chain, starting with the initial stage of production from raw materials to the final stage of supply to a consumer. This system, known by its acronym ITC (input tax credit), came with severe restrictions and punitive measures that traders have resented and so far not let these come into force. Moreover, the extent of revenue loss on account of the ITC system is astounding. The leap forward with respect of ITC has clearly missed its threshold and more needs to be done.
The ITC system envisions that a claimant would seek an ITC against the tax invoice issued by the supplier of that input, provided the supply has been received by the recipient. The claimant would be entitled to use the credit to pay the tax on his supplies and then file a report (titled GSTR 3 in GST laws) of all supplies made by him and the various input credit availed by him. This is the basic procedure followed in any ITC system. The GST law has placed a clutch of other regulatory controls to check tax evasion under which input suppliers must file details of supplies made by them in a report (GSTR 1) and the input recipient must file details of inputs received by him in a report (GSTR 2). To assist the recipient in preparing GSTR 2, the Goods and Services Tax Network (GSTN) system creates an auto-populated report GSTR 2A of all inputs supplied to the input user. The GSTR 1, GSTR 2 and GSTR 2A are appurtenances to conduct invoice matching of details furnished by the input suppliers with details filed by the recipient. The invoice matching system, as it is called, is meant to prevent ITC misuse.
The trade has resisted the adoption of the reporting system that supports invoice matching. Traders followed the basic minimum procedure of using ITC and filing a comprehensive report similar to GSTR 3 titled GSTR 3B. Recently, the GST Council has put a restriction on traders that they can claim only 10% of the ITC claim till the input supplier files details of the supply of the input (GSTR 1 return). The measure has shored up revenue collection in the short run and is, on the face of it, designed to herd the trade into the thorny field of GST tax compliance with its invoice matching system and harsh penal clauses.
Many traders have been dealt unjustly due to GST provisions. The law presumes that if a recipient is in possession of an invoice whose maker cannot be traced, then the supply was fake and no tax was paid. In many cases it may be so, but the law should not presumptively burden a person with tax recovery and interest. Moreover, the law gives powers to pre-emptively block credit of the recipient if there is suspicion of mala fide on part of invoice-maker and supplier. The system procedure of invoice matching asks GST registrants to acquire and generate data of high quality so that data from two different sources will match. This requirement will be very hard to meet as it has been proven in most countries where it has been introduced.
The draconian laws on ITC were passed against the background of heavy infusion of fake invoices. The GST system was built over several tax systems of the Union and the states. In the old systems, there were a large number of registrations where poor people acting at the behest of fraud operators lent their names for registrations of shell companies. The real operators remained invisible. Such companies issued invoices to show supplies that were never made, and indicate payment of taxes that were never deposited with the government. These registrants later migrated to the GSTN portal to play their game in the new regime at the national level; new ones may well have been added in the GST regime. They hid their operations in a labyrinth of phoney transactions made within their own fraudsters group, till they sold an invoice to a willing GST supplier who bought the invoice without the supply. The registrant who purchased the invoice took credit of the amount of tax indicated on this invoice, which had not been deposited in the government coffers. This has knocked the base out of the input credit system.
The extent of the subterranean explosion caused by fake invoices can be gauged by government statistics. The government answered on 2-7-2019 to a parliamentary question saying that GST officers have booked 535 cases of fake invoices involving a total fraudulent claim of Rs 2,565 crore of ITC and arrested 40 persons so far in the current financial year. In 2018-19, 1,620 cases of fake invoices were registered involving fraudulent ITC claim of Rs 11,251 crore under GST and 154 persons were arrested. In September 2019, central tax officers carried out searches and detected evasion of Rs 470 crore, in which the modus operandi of fake GST invoices was used to claim export refunds. People aware of the percentage of evasion that agencies are able to unearth estimate the loss of revenue due to fake invoices at more than 5% of total GST revenue collected.
The damage to the fabric of public finance is not limited to GST revenues. Purchase of fake invoice by a fraudulent recipient is accompanied by bank transfer of full value of the invoice to the fraud operator, who returns 96% of the proceeds in cash. This leads to income-tax escapement. Further, it enables the fake invoice buyer to show higher inventory on paper than he holds, which inflates his entitlement for bank loans.
The government’s response has mainly been in creating capacity for gathering actionable intelligence through data analytics and reinforcing it with harsh deterrent laws. The GSTN provides the environment for intelligence collection. So far, however, there is no agreement in the GST Council on evolving a standard operating procedure for intelligence sharing and coordinated action against fraud between the Centre and the states. The Directorate General of GST Intelligence (DGGI) under the Central Board of Indirect Taxes and Customs (CBIC) is the only central agency for enforcement of GST laws, yet it is not recognised as a nodal agency by the State GST departments to play a role similar to that of the CBI and the NIA in countering serious GST fraud.
A pure enforcement strategy for checking revenue loss doesn’t appreciate that the cost of operating a fraudulent firm and the chances of detention of actual fraudsters are both very low. Besides the taxpayers who will be most severely affected, at least monetarily, are those who may not have had an active role in the fraud. The impact of enforcement agencies on the full magnitude of the fraud is often disproportionately small to the manpower employed. This was evident in the case of gold smuggling, which could be tamed only with a change in gold import policy.
The policy measure that may provide an answer to both the needs of better enforcement and trade facilitation is a re-look at the data use policy. The data in tax payment modules has not been harnessed into reporting and verification systems though bank data is being used by many apps. This module can help generate a tax payment index number for each invoice that would distinguish a genuine invoice from a fake one, on a real-time basis; we could call this the ‘Tax Document Index Number’ (TDIN). The input receiver would then receive the inputs with an invoice indicating TDIN and the system would immediately validate the invoice and inform whether tax has actually been paid on it. The system may require some refinements such as creating an e-wallet, because today traders do not pay taxes at the time of issuing invoices.
The verification of data in central excise records with bank scrolls was a practice of the civil accounts department in the past, but a manual operation became impossible with an explosion in the number of transactions. This system would get reintroduced in the electronic environment with the generation of TDIN and strengthen revenue accounting as well as control over faked invoices. Such a strict control over input credit use would severely reduce the administrative needs for such legal provisions, as the recovery of ITC with interest in case no mens rea has been discovered on account of the taxpayer, or the need to pre-emptively block credits. The best outcome of this system would be the scrapping of the invoice matching system that has failed in most countries and, currently, the vast majority of our traders are not ready for the rigours that the system demands of them.
The government should place highest priority on the suppression of fake invoices and liberalising GST procedures to facilitate trade and let the GSTN operate at full throttle. For this, they must immediately strengthen DGGI and seek the cooperation of the states for enforcement action. In the long run, what would give the highest dividend to revenue and traders is the introduction of the TDIN validation system and removal of many vexatious penal provisions in the GST law.
The author is former chief commissioner of Customs and Excise, and advocate, Delhi High Court