Indirect tax reform in India, spanning two decades, is a spectacular achievement of Indian fiscal policy. In terms of its sweep, it is a testimony to the political will of the government, the tax bureaucracy, and the intellectual and legal skills of professionals who have conceptualized and drafted the legislative framework.
The introduction of lower rates of duties; the transition to the central value-added tax credit scheme to counter cascading; the expansion of service tax to cover major services; the integration of the excise duty and services tax in the credit scheme; and the introduction of the state value-added tax across states, is noteworthy.
The proposal to introduce goods and services tax (GST) at both the national and state levels in a vast country like India with different parties running state administrations, is a daunting challenge. However, the series of reform steps taken earlier has enabled the government to move encouragingly to the next level of reform.
The GST announced by the finance minister in his budget speech in 2006 – though ambitious, given the sticky questions involved – reflects the government’s realization that the Indian economy’s increasing global exposure calls for the removal of tax disadvantages from the fiscal system. The need to provide an appropriate environment is beyond debate.
What would this new proposal entail? Are states ready to reconcile their revenue needs, willing to integrate their tax systems into a unified scheme? Would they share their sovereign powers to tax with the federal government, and enter into a joint legal and administrative framework? Or would they insist to levy taxes at separate rates on a common tax base? What constitutional amendments would be required to accommodate state demands for powers to tax services, and which services would they accept as taxable and cede to the federal government? These questions are not easy to answer and achieving consensus among such a large number of states by 2010 seems, as of now, a tall order.
Single versus dual tax
The principal discussion and debate relating to the introduction of GST surrounded the issue of whether a single unified GST was the appropriate model, or whether the dual GST was more practical.
The dual GST model currently appears to be the preferred option. Taxes will have to be collected under two parallel systems: the central goods and services tax (CGST), and the state goods and services tax (SGST). Further, CGST and SGST will consist of multiple rates where they relate to goods, and comprise a single rate in relation to services.
GST is a national value-added tax and a comprehensive indirect tax on the manufacture, sale and consumption of goods as well as services. Its objective is to combine all indirect taxes into a single tax, replacing multiple levies on commodities and services, and removing cascading as an embedded cost, which inflates the cost of products and services in the Indian economy compared to other global and regional markets.
Indian policy makers have a wide spectrum of international variants to draw upon including proposals put forth by their own fiscal experts.
The model proposed by the Kelkar Committee is a unified GST, based on combining central excise, service tax and state value-added taxes into a common base.
Recommendations by the committee for a 20% combined rate fall within the band of international rates. The highest rates, in Sweden and Denmark, are at 25%. Countries at the higher end of the tax scale are Iceland at 24.5% and Finland at 22%. At the lower end, Switzerland, Japan, Thailand and Singapore have rates at 5%, or marginally above.
Most countries have rates that are less than 20%. For example, in the UK the value-added tax rate is 17.5%, in Spain it is 16%, in Russia 18%, in France 19.6%, and in Germany 19%. Canada is a federal country where both federal and provincial rates are charged. The combined incidence of federal and provincial rates varies between 6% and 14%.
The Indian system must resolve the issue of a dual federal and state system versus a unified federal tax, however, it is felt that to begin with, the dual system will be unavoidable given the hard facts of political economy in India. Crystal ball gazing is a hazardous occupation for professionals, but the signs point that way.
Ravi Singhania is the managing partner at Singhania & Partners. The firm is headquartered in Noida and has offices in New Delhi, Mumbai, Bangalore and Hyderabad.
H-186, Sector 63
Noida, 201 301 (NCR of Delhi)
Tel: +91 (120) 463 1000
Fax: +91 (120) 463 1001
Email: [email protected]