Multiple GST rates on Services - will it be inflationary?

The much awaited GST rates barring few items (like gold, biscuits etc.) are out.  With this, July 1 roll-out looks now imminent, despite noises from certain quarters of the industry that they need some more time.  

Rate of tax on goods was largely on expected lines, with necessities such as milk, food grains, education and healthcare being exempt and items such as edible oil, tea, coffee etc. attracting a concessional rate of 5%.  While the general rate was expected to be 18%, it comes as a bit of unpleasant surprise to see that about 19% of the items have been classified under 28% slab, much more than what industry was expecting.  However, in few cases, even where the current effective rate is high, the products have been kept under 18% category since these are items of ‘mass consumption’ such as soap, toothpaste, hair oil and few other products.  

The rate structure decided for services, however, came as a big surprise.  The industry was expecting a 2 rate structure – at best three – as currently there is a uniform rate of 15% on most services, with a lower incidence of tax on few services (like real estate, transportation etc.) due to abatement provided. 

However, the Council decided that services are also to be taxed at 5, 12, 18 and 28% respectively, just like goods.  The overall philosophy seems to be to keep the rates closer to the effective rate and ensure that consumers do not get materially impacted.  To the extent, these are used by businesses, the GST rate is of little consequence as it would be allowed as an off-set.  

Services falling under 5% include goods transport, rail tickets (sleeper class is excluded), cab rentals, economy class airfare and print media advertisements.  Here, the tax incidence is more or less in line with existing service tax, except advertisement in print media, which does not attract service tax at present.  

Few services such as business class air travel, hotels upto Rs 2,500 per day (less than Rs 1,000 per day is exempt), non AC restaurants and those not serving liquor and real estate services would attract 12% GST.  Business class travel becomes a bit more expensive, as the current incidence of service tax is around 9%. On real estate, tax of 12% (stamp duty continues to apply) is a tad higher than current effective rate of 10-11%.  However, since input credit is allowed to the sector, it would help in reducing the cash component in the business.  It is not clear as to whether the additional charges towards PLC, car parking and club would be subjected to 12% GST or residuary rate of 18%.  

However, a higher rate of 28% was rather unexpected, which would covers five star hotels, cinema halls, amusement parks and few other services.  While arguably, here also the effective incidence of tax (currently most of these services attract luxury tax in addition to service tax) has not increased significantly, but it does complicate the tax structure.  Also, once GST is implemented, expansion of this list cannot be ruled out.

So, the GST rates on services is really a mixed bag.  While most essential services such as road transport, rail travel, and budget hotels should not see any price rise, there might be an impact on few consumer services such as telecom, banking and insurance, where the rate is moving up from 15% to 18%.   

The stated objective of the Government is to maintain revenue neutrality i.e. to ensure that they continue to collect the same amount of tax that they do currently.  From a consumer standpoint, it should mean that prices should not increase on an overall basis.  However, this would depend on the economic status and consumption pattern of the consumer.  People consuming more services, typically the middle and higher income group, would have to shell out a bit more.  Lower income group should largely be insulated from GST.  While one was expecting that prices of most manufactured goods would come down but that may happen only for few products given that GST rates are largely similar to what we have today.  

So, rates seem to be a zero sum game for the consumers.  

Does it mean the prices won’t increase and there would not be any inflation?  International experience suggests that typically introduction of GST kind of tax system leads to price rise, at least in the short term.  The reason is that businesses take time to understand the benefit of input credit. For instance, in real estate, the developers currently charge say 5.5% tax (4.5% service tax and 1% VAT).  However, they do not get the benefit of input credits on tax paid on inputs like cement, steel etc.  Under GST, they would charge 12% from the customers and would be expected to pass on the benefit of input credit to customers by way of reduction in base price of the apartment sold. 

Also, now we have an anti-profiteering clause in the GST laws, which mandates the passing on the benefit of reduced GST rate or incremental input credit to customers.  The message to the industry is clear – either pass on the benefit to consumers or be ready to face the consequences!!

Also, the consumers are more educated as well now and have been waiting for GST for a long time.  Rates aside, there is an expectation that cost of doing business would be lower due to supply chain efficiencies that GST has to offer, which would in turn mean lower prices to the customers. 

Any price increase under GST, therefore, would need to stand the test of scrutiny.
Pratik Jain, Partner and Leader Indirect Tax, PwC

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