The goods and services tax
(GST) was a truly transformational reform. One of the key expectations from GST was that the revenue gains would be significant because of its design, which ensures self-policing and compliance by bringing the entire value chain from raw material to retail under a single tax system. In the pre-GST era, the value chain was fractured for the purpose of taxation, with the Centre taxing the value chain up to the manufacturing stage and the states taxing the later trade chain.
The first study on the buoyancy of GST was made by Arvind Subramanian and Kapil Patidar for 11 months in June 2018, and then extrapolated for the full year. Their study showed a revenue growth of 11.9 per cent with an implied buoyancy of 1.20, which was far higher than any indirect tax in the pre-GST period (buoyancy rate was well below 1 for both Central excise and service tax). The study was possible in the first year when tax rates were broadly maintained at the pre-GST levels.
In the second year, it became difficult to measure buoyancy with a substantial reduction in the tax rate and difficulties in estimating the undistributed Integrated GST credits. In the third year, GST collections have been made under the shadow of the Covid-19 crisis. How then do we look at tell-tale signs of buoyancy? The answer probably lies in studying the revenue trends on the direct tax side (corporate tax and personal income tax) for the last three years since the implementation of GST.
One of the significant beneficiaries of the GST regime was the services sector, which got access to capital goods tax credit. This is reflected in the marginal effective tax rate significantly going down for trade, transportation and financial services from pre-GST period to post-GST period. The reason for this is that in the pre-GST regime, the manufacturing sector got the benefit of input tax credits of Central excise paid on plants and machinery installed in the factory of production. This benefit was unavailable for the services sector in the pre-GST era. One can, therefore, expect that the services sector would in the GST regime truly reflect its turnover at least to the extent of utilising the extra tax credits available on capital goods. Therefore, it would be worthwhile to look at the taxable turnover reported by services companies, both from unincorporated and proprietary firms in the personal tax collection and incorporated service companies in the corporate tax collection data. The study would show the effectiveness of the design of the GST on buoyancy. This would also help us to fashion an effective compliance strategy.
It is quite clear that to get the compliance benefit of the GST design, all economic entities must be brought within the tax net so that the invoice trail is established. This would require phasing away of exemptions and introducing a GST paid on reverse charge basis on small firms, including units opting for compounding. As sales of these units are largely to larger companies, the reverse charge mechanism would facilitate large companies to avail tax credits and therefore incentivise purchases from smaller units. This would help the tax department to improve compliance in these smaller units. The larger units could also be incentivised by SEBI to trade with the micro, small and medium enterprises (MSMEs) units on the Trade Receivables Discounting System (TReDS) platform so as to facilitate the issue of invoices and also expedite early payment of dues to the MSMEs.
The recent linkages between the indirect tax and direct tax information system offers the opportunity of streamlining the registration system by linking it to past direct tax payment records. Similarly, the e-invoicing initiative will help to curb evasion by reconciling supplier and buyer invoices. The e-invoicing system applicable to companies with an annual turnover exceeding Rs 500 crore is to be extended to companies with an annual turnover exceeding Rs 100 crore from January 1, 2021, and to all B2B companies from April 1, 2021. The elimination of the fictitious units would address the problem of bogus input invoices which erodes the tax base.
The importance of doing this is evident from looking at certain ballpark numbers. Today, roughly Rs 5 trillion is the monthly GST amount payable, of which Rs 4 trillion is paid through utilising the tax credits and the remaining Rs 1 trillion is paid in cash, which accrues as revenue to the government. This roughly represents a cash-to-credit ratio of 20:80. If we were able to improve this ratio even marginally to, say 23:77, we could garner an additional monthly GST revenue of Rs 15,000 crore, which would improve the monthly GST collection from Rs 1 trillion to Rs 1.15 trillion.
The other aspect of the compliance strategy is to build up capacities among tax officers. The state government is especially required to improve capacities in the area of services, which is not surprising as services taxation was handled by Central government officers in the pre-GST period. It is also important to streamline the Compliance Directorate in the State Commercial Tax Department to make a distinction between the three prongs of the compliance verification system — namely, return scrutiny (to ensure correctness of assessment), audit (to reconcile the tax return with the financial records) and intelligence-based investigations. Each of these segments requires special skills and capacity-building. This training programme will help the states to improve GST collections from services that have not been up to the expectation.
To sum up, in Covid-19 times, with growth stalling, GST revenue augmentation has to naturally look at better compliance. The measures to improve this through streamlining the registration system, universalisation of e-invoicing and building up skill levels, among the commercial tax officers, could nudge GST collection to a higher normal. Let us, therefore, use adversity to fashion an effective compliance strategy.
The writer is a retired member, Central Board of Indirect Taxes & Customs. Views expressed are personal