Saahil Parekh 08HS2009

Taxes in India

Direct TaxesCentre

Income Tax

Wealth Tax

Indirect Taxes

Centre

Service tax

Excise duty

Custom duty

State

VAT

Entry tax

Luxury tax

Electricity duty

Stamp duty

Tax on lottery

Excise on alcohol

Entertainment tax

Octroi

Service tax: Rendering of services in India is subject to service tax imposed and administered by the

central government. Currently, ~112 services are taxable under the act. The rate of service tax is 10% (reduced temporarily from 12% to support recession-hit

industry).

Customs duty: Import/export of goods is subject to customs duty, which is imposed by the central

government; however, most exports are generally exempt from indirect taxes. The basic rate for levy of customs duty is 5%.

Excise duty (CENVAT): Levied on goods manufactured in India Comes under the jurisdiction of the central government, except alcohol which is under the

jurisdiction of state governments. Current basic rate of duty is 8% (reduced temporarily from 12% to support recession-hit

industry).

VAT: VAT (Value Added Tax) is levied on intra-state sale of goods It is levied and administered by individual state governments and

contributes ~50% to state tax revenues.

CST: Central sales tax (CST) is an origin based tax, levied on inter-state sale of

goods. It is a Union levy, but is administered by states and the revenue is

retained by the state from which the movement of goods originates. The basic CST rate levied on a sale made to registered dealers is 2%.

Entry Tax: Entry tax is levied by many destination states at the time of entry of

goods in their jurisdiction. Few states levy entry tax ~1-3% in lieu of octroi charged by them earlier.

Luxury Tax: Accommodation and other allied services provided in hotels and clubs

are subject to luxury tax, imposed by state governments. The rate of tax varies from state to state. In Maharashtra, luxury tax is

levied ~ 4-10% on hotels on the basis of tariff classification. However, a duty of 12% is charged on services provided by clubs.

Electricity Duty: State government levies electricity duty on the energy consumed by

consumers other than for captive consumption. Rates of duty vary from state to state in the 6-20% range.

Entertainment Tax: Entertainment tax is levied by states on the rendering of entertainment

services to customers Examples are movies, exhibitions, horse races, or other sports. The rate for entertainment tax is generally in the 20-60% range.

Octroi: Most states have done away with octroi, which was charged at the time

of entry of goods into a municipal area. Few states have increased the basic VAT rate in lieu of abolishing state

octroi.

VAT is a multi-point destination based tax, levied on value addition at each stage of transaction in the supply chain.

It works on the “input tax credit (ITC)” mechanism, wherein VAT paid on inputs is allowed to be set off against VAT payable on subsequent sale.

The tax credit is available on both inputs and capital goods for manufacturers as well as traders. The above credit mechanism works well only for intra-state sale of goods.

VAT was introduced w.e.f. April 1, 2005, for wider commodity coverage and to avoid multiple taxation of commodities due to lack of co-ordination between the Centre and states on the rates charged and commodities covered under sales tax.

Since the inception of VAT, taxes on commodities and services have increased (on an average) to 5.2% of GDP in 2005-09 from 4.5% of GDP during 1995-2000.

Two basic rates of VAT at 4%/12.5% A special rate of 1% for precious metals Items of basic necessity (around 75) are exempted The 4% rate has been extended to items of common

consumption (covering around 275 items such as medicines, agricultural and industrial inputs, food, utensils, fabrics and garments, paper, sporting goods, and IT products)

All other items are taxed at 12.5% Certain goods such as liquor, petrol, diesel, and

aviation turbine fuel are kept outside the purview of normal VAT and are taxed as per the earlier sales tax act or under a special section in VAT.

Cascading Impact (Tax on Tax):The current tax system involves multi layered taxes levied by central, state governments, and local authorities at multiple points in the supply chain.

State VAT paid on inputs in one state is not available for set off if the output is sold in another state.

Excise duty on alcohol is levied by state governments; hence, CENVAT credit in respect of excise duty paid on inputs to central government is not available for set-off in case of excise duty payable to state governments.

Excise duty paid on manufacturing is not allowed to be set off against state VAT payable on sale of goods and vice versa.

With the service industry, wherein the major cost other than employees is the infrastructure cost. Companies are charged VAT on purchase of infrastructure goods; however, VAT is not allowed to be set off against service tax liability levied on services rendered. However, service tax payable can be set off against excise duty and vice versa. Examples: Infrastructure, telecom, logistics

Inter-state Trade

Regional Differences in Tax Rates: There is no uniformity in the rate of tax charged

on goods. Breaches the motive behind implementation of

VAT Results in differential prices of goods amongst

states and diversion of trade from costlier states to cheaper ones.

There are many items on which the rate of tax differs from state to state, of which, some are listed below:

Complex Tax Structure: Current taxation involves multiple tax laws,

rules and administrative procedures. An assessee with pan-India operations has to

deal with multiple tax laws at the state level, along with various other taxes levied by the central government and local authorities.

These issues discourage investments by organised sector and are also a huge disincentive for voluntary compliance, which is to a great extent responsible for high effective tax rates.

Differential Rates in Value Chain: In the current VAT structure, inputs for many

industries are taxed at 4%, while output is taxed at base VAT rate i.e., 12.5%.

Such a big gap between input and output rates provides incentives to the manufacturer to not report his sales, as a substantial part of the tax is paid at this stage.

Double Taxation: Globally, the distinction between goods and services is clear with

all intangibles defined as services; however, in India, intangibles are further classified as goods or services.

The distinction between goods and services is increasingly getting blurred with development in technology and services getting bundled with goods.

The current constitutional framework gives autonomy to states to levy tax on sales of goods.

However, states are precluded to levy tax on services that fall under the jurisdiction of the Centre.

With increasing share of services in tax revenues, state authorities often define the ambiguous transactions under the ambit of goods and charge state VAT, whereas central government levies service tax on the same transaction.

Examples: Sale of advertisement (media industry) and standard software (IT industry) is classified as sale of goods and charged to the state VAT by many state governments, whereas, the same transaction is taxed as service by the central government.

Exemptions: Leads to classification issues as well as higher

effective tax rate on other goods/services to maintain revenues.

Because of non issuance of taxable invoice, the exemption generally breaks the value chain and leads to implicit cascading.

Regional exemptions have been used as a measure of tax planning by market participants. For example, in case of some goods only a small quantum of end processing is done in the facilities situated in the exempted zone to avail tax benefits.

To overcome issues mentioned above and to simplify the existing taxation system and procedures

Ex-Finance Minister Mr. P Chidambaram, in his 2006-07 Budget speech, suggested adopting nationwide VAT, more commonly known as GST.

The current Finance Minister Mr. Pranab Mukherjee, in his 2009-10 Budget speech, had reiterated the rollout of GST w.e.f. April 01, 2010.

Perceived as an attempt to join the worldwide shift from emphasis on direct to indirect taxation.

Seen as a positive form of tax since it taxes consumption and encourages savings and investments.

More evenly spread across the population, minimising economic distortions by providing comprehensive coverage.

GST is one of the widely accepted indirect taxation system prevalent in more than 150 countries across the globe.

GST in the Indian context can be elaborated under following broad parameters:

1) Framework and likely tax structure2) Taxes likely to be subsumed3) Tax base: Goods / services likely to be taxed4) Tax rate

GST will be a destination-based tax levied on consumption, applicable on a comprehensive base of both goods and services.

The GST framework will allow full credit for taxes paid on inputs in the supply chain (i.e., taxes paid on input goods and services can be set off against taxes payable on output goods and services).

Considering the federal structure of the Indian government, the finance minister has suggested a dual GST structure. In this, both Union and state governments will be empowered to levy and administer taxes concurrently on a uniform base of goods and services.

Dual GST will comprise:1. CGST: To be levied by the Centre2. SGST: To be levied by states

Considering regional needs, states will be given some freedom to decide rates (SGST) within a narrow band, subject to a floor rate, so as to allow some autonomy to them. Levy of GST will be extended to imports as well as to impart a level playing field to the domestic industry. Currently, states are not allowed to levy tax on imports. Exports will continue to be zero rated. To maintain the progressive nature of taxation, items of basic necessities will continue in the exempted

list and there will be a non-rebatable discretionary tax over and above the GST rate which will be levied on a selected list of luxury commodities.

The GST framework should not allow for region-specific and discretionary exemptions as it will be important in the new framework to not break the value chain.

Duties imposed by Centre: CENVAT/Excise duty Service tax CVD SAD Central sales tax (CST) levied on inter-state sales will be phased out.Duties imposed by states: VAT (sales tax) Entry tax OctroiFew other duties levied by state/local authorities, the future treatment of which is still hazy: Electricity duty Luxury tax Entertainment tax Stamp duty on transactions other than real estate

Under-mentioned taxes are likely to not be subsumed in GST and will continue in their current form: Basic custom duty Anti dumping duty State excise on liquor Taxes on petroleum products Motor vehicle tax Stamp duty on registration of real estate

The current tax structure levies tax on all goods except those included in the exempted list. However, in case of services, the list explicitly specifies services that are under the ambit of taxation;

thus, services that are not explicitly specified in the list are not taxed. GST will be levied at a standard rate on a comprehensive base of goods and services except for a few

goods and services that may continue to be in the exempted list. The above will result in a large set of services which were earlier not under the ambit of taxation, now being brought under the tax net.

The items, which, in our view, will continue to be in the exempted list include:1. Unprocessed food and agricultural products; however, processed food items will be taxed at the

standard rate.2. Non-profit public sector services3. Education and health care services

It is highly desirable to keep the exempted list small and large comprehensive tax base, so as to have a lower GST rate that will encourage better compliance and fewer classification issues.

Goods and services likely to outside the purview of GST:1. Banking and financial services2. Real estate transactions3. Petroleum products4. Liquor5. Tobacco products

Likely GST rate will be based on revenue neutral rate (RNR), which will be a function of:

1. Tax base: Extent of goods and services that will be brought under the ambit of GST. Higher the tax base, lower will be the GST rate and vice-versa.

2. Concessional rate of duties levied on certain goods and services.3. Higher non-rebatable discretionary taxes levied on certain luxury

goods and on petroleum and liquor products. On a revenue neutrality principle, higher exemptions and subsidies will

result in a high GST rate, which will result in very high resistance, especially from sectors that are currently not taxed.

High rate will also result in non compliance and demand for exemptions. Lower rate and a broad tax base will lead to higher voluntary compliance and buoyant tax revenues.

Ex-Finance Minister P. Chidambaram, has indicated likely GST rate in the 14-16% range.

Harmonised tax structure, unified tax base, and common rules and administrative procedures across the nation

Widening of tax base to a comprehensive list of goods and services

Simplifying tax procedures will bring in transparency and encourage investments in the organised sector; hence, it will result in higher FII inflows, helping the economy gain growth momentum

Mr. Vijay Kelkar, Chairperson, Thirteenth Finance Commission: “…the potential impact of GST implementation will be to the tune of USD 15 bnannually.”

Only specified services are currently under the ambit of taxation.

Will bring goods and services under the same umbrella of taxes, thereby reducing the disparity.

Increase in tax base will help to reduce the overall tax rate across various organised sectors

Will also aid the government in consolidating its fiscal position.

With increasing share of services in GDP, taxing services not taxed currently will help reduce overall tax rate.

Significant increase in voluntary compliance. When GST was introduced in New Zealand, it

generated 45% higher revenues, primarily on account of improved compliance.

Stock transfer between factory and C&F agent/depot of the same entity is not liable for levy of CST.

All major pharmaceutical, cement, and FMCG companies currently operate depots/C&F agents in all major states to avoid the levy of CST. Companies incur an average of 1-2% of revenues towards maintenance of these facilities.

Companies need not bear these additional infrastructure costs primarily used for tax planning.

Facilitate a smooth flow of input credit across the value chain for inter-state trades as well as in respect of taxes levied by multiple authorities (for which either no input credit is available or there are procedural hassles to claim input credit).

Moreover, taxes will not be levied on taxes as is the case currently

Result in significant avoidance of disputes on classification issues.

Industry will be relieved from the problem of double taxation of the same transaction.

Agreement of Centre and states for levy and administration of duties

Rate of taxes; goods to be exempted/subsidised

Constitutional amendment: Hurdle in GST implementation

Infrastructure issues Revamping tax administration

The impact will be negative for sectors where the current tax rate is lower and positive for those where current effective tax rates are higher than the likely GST rate.

The negative impact will be muted because of minimum cascading impact and higher input tax credit available

The positive impact could be subdued on account of higher discretionary taxes levied on select luxury goods.

We have worked out the effective tax rates applicable across sectors and directional impact of GST, assuming GST rate at 14% for all goods and services with some basic necessities put under the exempt category.

In an economy there are usually three participants—consumers, industry, and government.

In an indirect tax regime, the industry acts as a pseudo collecting agent of the government, collecting taxes from consumers and remitting the same to the government.

The government, in turn, incurs public expenditure for the benefit of consumers. The discussion above leads us to conclude that both industry and consumers will

gain on account of reduced effective tax rates. A classical question which arises is how will it be funded? Will it be out of government’s pocket? Based on experience of VAT, we are of the opinion that government revenues

are also likely to increase, which will be funded out of the parallel economy, expanding the tax net over goods and services and the increased consumption.

GST, being a destination-based tax on consumption of goods, will ensure better compliance, as goods/services once entering the value chain across the nation will be tracked till the end consumer. Hence, chances of tax avoidance will be minimal.

Also, since taxing will be effectively only on value addition, there will be lower incentives for participants to avoid taxes as they will receive credits on inputs.