How GST is marred by the ‘residence principle’; a vital role for Centre in new regime is essential

New Delhi | April 07, 2017 3:58 AM

The Cabinet has approved four GST draft Bills for presentation in Parliament. The final draft legislations and GST Council recommendations considerably alter the original idea of GST.

The final draft legislations and GST Council recommendations considerably alter the original idea of GST.

The Cabinet has approved four GST draft Bills for presentation in Parliament. The final draft legislations and GST Council recommendations considerably alter the original idea of GST. The concept of residence in determining the territorial jurisdiction of the states has been used in the taxation of services in GST, and knowing that residence principle of assigning tax jurisdiction generates intense competition between claimant tax regimes (i.e., the base erosion issue in income tax), the Government proposed to ride over the problem by keeping the responsibility of collection of GST on services with the Centre. The GST Council, under pressure from the states, has assigned the collection of GST on most goods and services to state tax departments; so much so that it seems to them that the Centre need not have any role whatsoever. Disturbing as it is to legal experts, the GST Council has gone ahead and made a retro-fitting in the original proposed GST laws, and inserted the concept of residence in the taxation of goods. The principle that residence of a business entity decides which taxing authority will collect tax from it has become a feature common to GST taxation of services and goods. It is a serious question of how much is the new GST plan conducive to cooperative federalism and the degree of revenue security inhering in it.

In today’s indirect tax laws, jurisdiction of a tax administration is not dependent on any action that parties in a transaction may undertake. Territorial jurisdiction can be determined by verifiable evidence. In levy of customs duty, the taxing event is the entry of goods into India, verifiable from the Import General Manifest of conveyances. In central excise, the place of physical removal of goods from factory gate decides jurisdiction. Similarly, in VAT, the place of delivery of goods determines which state gets to tax VAT on the transaction. There is no room in these tax laws by which disputes on jurisdiction of a tax department can be raised by making innovative interpretation of the law. This comfort is absent in the levy of service tax, but the problem is limited to transactions between an Indian entity and a foreign entity. The residence principle notoriously lends itself to interpretation, and by artful devices, territorial jurisdiction over taxable transactions can be shifted away from one tax department to another as has happened in income tax with birth of tax havens.

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Tax departments work under intense pressure from their governments to meet revenue targets and officers universally adopt interpretations of law that suits the revenue interest of their government. The GST plan visualises that a supplying state will cooperate with another state to augment the revenue of the latter in interstate transactions. How cooperative would supplying states be if certain actions of residents in that state can change the jurisdiction of the tax collection from the receiving state to the supplying state? The force with which a few developed states have got the concept of residence inserted in taxation of supply of goods shows that the anxiety is not misplaced. If the consumption principle is fundamental to our indirect tax laws, it can be applied effortlessly in the taxation of goods where there is no difficulty in finding out where goods are being consumed. Why is law being altered to make it possible for someone to create a company which takes orders from a customer, communicates the order to him and, in the process, change the jurisdiction of taxing department? Secondly, this insertion may have been done for certain sectors like iron and steel or cement, but the benefit will have to be given to all goods. The deliberations in the GST Council is a strong indicator of the mindset of states and what they may do when they face competition for revenue from fellow states. There appears no doubt that cooperative federalism will be sacrificed and states will assert their persuasive powers on resident companies to turn an inter-state transaction into an intrastate one, so that revenue paid by a person resident in a state stays in the treasury of that state, to the disadvantage of the consuming states.

Cooperative federalism will further get tested in respect of investigation and searches in tax evasion cases conducted in one state but pertaining to a different state. Assessment, collection or investigation in to evasion of tax on goods or service that has taken place outside the state will have little interest to the officers of that state because such work hampers their functioning. The tax officers and the tax administration of the supplying state itself, may see greater commonality of interest with the resident supplier of the goods rather than the revenue of a different state, as the supplier contributes to the economy of that territory and has political influence. Taxation of inter-state supply of goods and services will always have a shaky foundation and, for that reason, certain trade may see undue advantage in sourcing supplies from outside their own state.

The proposed GST law for services adopts residence as the basic principle for determining the place of provision of service, which again determines which state department will get to collect GST on such a supply. The law makes exceptions for specific services such as that in relation to real estate. There is some administrative convenience in using the residence principle for deciding tax jurisdiction of services as these are intangible goods and they do not have visible movement. The concept itself has an ugly past and a controversial present. Bret Wells and Cym H Lowell, two legal scholars in USA, found that the principle of residence is taken from the lexicon of British imperialism and the purpose was to get taxes paid after World War I by British companies operating in India credited to the British treasury in London. Today, the principle plagues international taxation as profits get exported from countries where they arose to shell companies in tax havens. The GST law will incubate this concept and put one state in unhealthy competition with another state, where each will try to use subterfuges to deprive the other of GST revenues.

The GST Council decision to reject the Centre’s suggestion to allow it a minor role in assessment and collection of GST, especially on services, has adverse implications for revenue as well as federalism. In the past, when states came in to conflict over the issue of inter-state sale of goods, it was Centre which intervened and after amending the Constitution enacted the Central Sales Tax Act. Since the, the Centre has been playing a coordinating role in VAT taxation of interstate sale of goods. The problems in applying the residence principle are many and, to some extent, endemic to taxation of services, but they do not pose such a significant challenge if the Centre collects GST.

The proposed Section 7(3) of IGST that introduces the residence principle in taxation of goods, will open the floodgates to residence manipulation in supply of goods and generate bad blood; it must be deleted if states are to collect this tax. All assessment of services, where the law does not lay down a verifiable evidence to decide the territorial jurisdiction of states, must be assessed and collected by the department of revenue of the central government only. The state of affairs calls for reassigning a vital role to the Centre in the GST regime.

– Sujit kumar Sinha, Retired chief commissioner of Customs and Excise and advocate, Delhi High Court

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