One of the principal problems that has caused the indirect tax regime in India to be complex and cascading is the delineation of taxing powers between the centre and the states. The centre collected excise duty and service tax; the states collected value-added tax (VAT), i.e. sales tax, and entry tax.
However, transactions did not always fall clearly as being goods or services, or manufacturing or processing, etc. This led to litigation and artificial overreach by the centre and the states to tax transactions that were not always within their powers. In many cases, to avoid litigation, taxpayers would charge both service tax and VAT on a transaction. The delineation also caused input taxes to be lost in the process.
Goods and services tax (GST) solves these problems to a great degree by ensuring concurrent powers of the centre and the states to levy tax on transactions. In order to put an end to long running litigation, the draft model law includes Schedule II, which deems certain transactions as either goods or services.
Transactions such as works contract, transfer of goods without transfer of title and supply of food have been deemed as services. Similarly, supply of goods has been kept to supply of goods where the title in the goods gets transferred. These changes will go a long way in putting to rest a lot of litigation and bringing clarity to taxation.
There is, however, a risk that some litigation may emerge if the classification of transactions as goods and services remains. Typically, if the rate of tax for goods and services is the same, then classification becomes irrelevant and compliance becomes easy. If the tax rates differ, there will be tendency on the part of the assessee and the department to dispute classification, bringing uncertainty to the regime. While rate difference remains at the heart of any dispute on classification, there are other provisions that may require the classification of goods and services to remain relevant.
PLACE OF SUPPLY
Place of supply (POS) rules determine whether a transaction is intra-state (local) or inter-state supply. POS rules for goods and services are different under the draft model law. An error in determining the nature of supply may result in payment of the wrong tax to the wrong authority.
To make things worse, the draft model law has provisions requiring the taxpayer to repay the tax in the correct state and claim a refund. This can be tricky and will have a severe impact on the finances of the taxpayer.
TIME OF SUPPLY
Time of supply (TOS) determines the point of time at which tax needs to be paid. The TOS rules are also different for goods and services. If TOS is incorrectly determined, it may lead to delay in payment of taxes, in which case interest will be charged.
INPUT TAX CREDIT
The provisions for obtaining input tax credit (ITC) are different for goods and services. Where goods are received in instalments, ITC can be claimed only when the last lot of goods is received. Further, the input service distributor (ISD) mechanism of transferring credit is available only for input services and not goods.
Shared assets such as heavy equipment or servers may be supplied as services to enable easy distribution of ITC via the ISD route. If such assets are supplied as goods, ITC may get accumulated if there is no outward supply. Hence, the classification into goods or service again assumes great significance.
The above issues exist in most GST regimes and are not insurmountable. Nevertheless, it is important for businesses to be aware of these risks and take adequate steps. Having a uniform GST regime with concurrent taxing powers is extremely beneficial for most businesses. It will definitely put to rest a lot of litigation. It would be best if the tax rates for goods and services are adequately addressed. The draft model law will undergo changes over the next months and it is hoped that further issues also will get ironed out.
L Badri Narayanan is a partner at Lakshmikumaran & Sridharan.