As the 161st entrant into the GST club, India’s arrival has been an arduous journey. While the reaction of Indian businesses has been overtly positive, there is scepticism with respect to the implementation of an underwhelmingly drafted legislation. Despite these concerns and misgivings, for investors looking at India, GST will provide a simplified and more transparent tax regime at the central and especially state level, lowering investor risk and providing assurance from a business continuity perspective.
The three primary reasons for this are:
- Clarity in tax positions. The federal structure in India permitted the states to take an autocratic approach in what and how they wanted to tax transactions. The high handedness of states resulted in unnecessary litigation, with very little outcome. As a GST would necessitate all states to have almost identical state legislation, the consistency in taxing statutes would be a relief to companies operating across the country and also provide a degree of certainty in tax positions helping to manage risk.
- Easier compliance. Under a GST, theoretically, compliance would increase significantly. By conservative estimates, companies will be required to file almost 61 statutory filings each year. Though this may look daunting, the filings would be iterative and built on disclosure and submissions made by vendors. The significance of this change in compliance cannot be underestimated. Under the present regime, each assessee makes its own filings without any linkages to the other suppliers/customers in the value chain. In cases of disputes, which are common, this results in businesses struggling to establish their bona fides. Under a GST, as statutory filings and disclosures would be built on information supplied from vendors, it would be easier for businesses to address queries and draw upon information within the entire value chain to explain themselves.
- Reduction in hidden tax costs. The Indian transaction tax regime does provide for cross credits between goods and services. However, the regime created an inequality between service providers and manufacturers, with the latter being taxed at a lower rate. With a GST, the disproportionate burden on services will stand corrected, and ultimately this will reduce the tax cost of businesses working in India.
Despite the benefits that a GST would introduce, there are also a few risks that investors will be signing up for.
- Related party transactions. Departing from the existing principle of taxing the sale of goods or the provision of services by one distinct entity to another, a GST seeks to treat two business establishments of the same legal entity within different states. Accordingly, intra-company transactions would have to be revisited and aligned with the new regime to minimize the increased demands on working capital. The related party aspects are bound to create several institutional challenges, and would be a significant opportunity for the tax authorities to augment revenues.
- Increased risk of disputes. The past transition from sales tax to a VAT regime was a tumultuous period for businesses due to lack of jurisprudence, which resulted in interpretational disputes. Though the majority of disputes ended with the judiciary siding with the interpretation adopted by businesses, the litigations added costs. Another important issue with tax litigations in India is that court fees have been increasing, and need to be paid as a fixed percentage of the demand, irrespective of the merits of the issue. Disputes hinged on interpretational matters usually involve a tax demand that is raised on the topline of a company, and the court fees incurred for the resolution of the matter are substantial. Therefore, as we transition from VAT to GST, businesses need to prepare for tax disputes in the next three to five years, until jurisprudence begins to emerge and settle.
- Increased obligations for vendor management. Improvements in the compliance system imply that the majority of the tax administration now stands outsourced to businesses. Notably, a customer would be responsible to ensure veracity of the vendor’s disclosures to the extent they apply to the customer, and would impact the customer’s credit and tax liability. Therefore, customers would have to ensure that they have adequate contractual protection to indemnify themselves in case credits
are denied due to lapses in compliance by vendors.
These points just scratch the surface of the macro issues likely to arise within a GST. Though the teething troubles are likely to continue for the foreseeable future, in the balance of things, a GST will perhaps mark the maturing of the economy and provide a long-term stability as far as transaction taxes in India are concerned.
Kabir Bogra is a partner at Khaitan & Co’s New Delhi office
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