Kelkar on Indirect Taxes

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					                                         TAX REFORMS

                                                   Kelkar on
        Tax hound

                                                he preface to the Vijay Kelkar report hints at
                                                an ambitious bargain between the Central
                                                government and States towards rationalizing
        The Task Force                  all the State taxes on goods and services. A majority
                                        of proposals will most likely be resisted by the
        headed by Shri                  States. Further, when the emphasis has been on a
                                                                                               K. Vaitheeswaran
   Vijay Kelkar on imple-               state-level VAT, the Task Force headed by Shri
                                        Kelkar recommends a state-level goods and service tax (GST) as well
   mentation of the                     as a Central GST.
   Fiscal Responsibility
                                                         Goods and Services Tax
   and Budget Mana-
   gement Act, 2003, has                The report states that independent taxation of goods and services under
                                        different laws create the same kind of problems as selective taxation of
   submitted its report,                services and that the line between goods and services is getting blurred
   which will have far                  with disputes landing up in the Supreme Court. Since there is a strong
                                        inter-dependence of goods and services in the production and distribution
   reaching conseque-                   activities, the report recommends that tax on services should be fully inte-
   nces. The report con-                grated with the existing central VAT (Cenvat) on goods by a modern VAT
                                        type levy on all goods and services to be imposed by the Central
   tains proposals for                  Government hereinafter called the Central GST.
   integration of goods
   and services taxation                                 Features of Central GST

   as well as the sharing               (i)   Value addition in the post manufacture stage being in the nature
   of service tax rev-                        of services can be taxed by the Centre.

   enues        with                    (ii) The practice of allowing abatement on MRP in respect of goods
                                             covered under Standards of Weights and Measurement Act
   States.                                   should be discontinued.

The author is an advocate. He can be reached at

THE CHARTERED ACCOUNTANT                           439                                            OCTOBER 2004
                                                TAX REFORMS

(iii) concept of removal as it exists in Central Excise
      should be discarded and the tax should go to the              The Task Force has recom-
      extent of the retail price thereby avoiding the neces-        mended that exports must
      sity of distinguishing goods and services.
                                                                    be zero-rated and the
(iv) The tax base must be comprehensively extended to               exclusion from tax should
     cover all goods and services going up to the final
     consumer reflecting the tax base of a typical con-             be only on the ground of
     sumption VAT.                                                  significant externalities,
(v) The Central GST liability computation should be                 merit goods and adminis-
    based on an invoice credit method, whereby credit               trative feasibility. Further
    for the tax paid on all intermediate goods or ser-
                                                                    the new law must have a
    vices would be granted, based on the invoice
    issued by the supplier.                                         well-defined negative list
(vi) The tax should be structured on destination principle          of goods and services.
     and the base will shift from production to consump-
     tion whereby imports would be liable to tax and            (c) Medical services which will be defined in consul-
     export will be relieved of the burden of goods and             tation with Health Ministry.
     services tax.
                                                                           (d) All school and college education.
   Tax rates in Central                                                       (e) Service transaction between an
           GST                                                                     employer and employee as a ser-
                                                                                   vice provider or recipient.
The report recommends a lower rate                                             (f)          Unprocessed food articles
of 6% on necessities like matches                                              (g)          Life saving drugs and equip-
and processed food, 12% for most                                                     ment
commodities and services and
higher rate of 20% on items like                                               (h)        Equipment used in national
automobiles, air-conditioners, aer-                                                  security functions.
ated water, polyester filament yarn,
etc. The Task Force has recom-                                                  Petroleum: The grand plan of integra-
mended that exports must be zero-                                           tion of Central Excise and Service Tax Law
rated and the exclusion from tax                                          and the concept of a Central GST as proposed
should be only on the ground of sig-                                    falters when it comes to petroleum products.
nificant externalities, merit goods and administrative          The Task Force has recommended that commodities
feasibility. Further the new law must have a well-              like petroleum crude and products, natural gas and
defined negative list of goods and services.                    tobacco should be subjected to a Central GST at higher
                                                                rate and that input tax credit should not be granted to the
          Proposed negative list:                               purchasers of these commodities on administrative
(a) Commodities with negative externalities whose               consideration. The Task Force has recommended the
    consumption has to be checked.                              imposition of specific rates. In other words, an ‘island
(b) Public services of Government, Municipality,                of isolation’ is once again created and petroleum prod-
    Panchayat, Defence, Civil Administration, Para-             ucts will attract higher duty without credit for the pur-
    military, Police, Intelligence but excluding                chaser, thereby creating a break in the chain.
    Railways, Post and Telegraph, other commercial
    departments, public sector enterprises, banks and           Tax Payer Base: The report recommends that since
    insurance.                                                  only a small number of firms account for large propor-
                                                                tion of revenues, the resources for collection must con-

THE CHARTERED ACCOUNTANT                                  440                                            OCTOBER 2004
                                              TAX REFORMS

                                                             number of excise officials. Under the current law, each
                                                             factory requires registration, filing of monthly returns,
       The Kelkar report does not                            periodic visits and audit and there is a significant activity
       mull the reason why there                             in the Taxation Range. In Income Tax, it is only a central
       are only a few firms account-                         assessment based on the filing of a return. Once this pro-
                                                             posal is accepted and the unit of taxation becomes the
       ing for revenues. The prob-                           person then the necessity for having range officers near
       lem is that several firms                             the factory would disappear and all of them would have
       blissfully evade taxes.                               to be relocated at the central office in the city or region,
       Enforcement mechanism                                 etc.
                                                                       The administration is expected to ride on the
       has not been able to                                  newly developed OLTAS of the Income Tax
       increase the number of new                                      Department to collect information regarding
       assessees.                                                          payment of taxes from banks. All regis-
                                                                            tered tax payers are required to file a
                                                                            monthly information return along the
centrate on the largest taxpayers as a part of risk man-
                                                                            lines of the TDS annual information
agement. Small dealers, including service providers
                                                                           return detailing all transactions relating to
and manufacturers, should be exempted from the
                                                                          sales and purchases of goods and services.
purview of the tax by up to a threshold limit of
up to Rs.25 lakhs in annual turnover. However,
                                                                       Date of implementation: The fully inte-
those below the limit can be voluntarily regis-
                                                                       grated goods and services tax outlined above
tered to enable them to sell to registered manu-
                                                                       should be implemented as the Indian Goods
                                                                       and Services Act, w.e.f. 1.4.2005 in order to
    A compounded levy of 2% can be levied on
                                                                       replace the Central Excise Act, 1944 and ser-
small dealers with annual turnover of up to Rs.40
                                                                        vice tax levied under Finance Act, 1994.
lakhs without any input tax credit. The limit of 40
                                                                           Further, this legal framework should be
lakhs has been fixed taking into account the tax audit
                                                                             consistent with the best international
provisions under the Income Tax Act.
    The report does not address the reason why
there are only a few number of firms accounting for rev-
                                                             Small Scale Industries: The Task Force has recom-
enues. The problem is that there are a number of firms
                                                             mended that the small-scale exemption should be
which carry out activities attracting taxes but are bliss-
                                                             reduced from Rs.1 crore to Rs.40 lakhs. Further, for
fully evading taxes. The enforcement mechanism has
                                                                               clearances between Rs.40 lakhs to Rs.1
not been able to increase the number of
                                                                               crore, the assessee should have an
new assessees. Instead, the entire
                                                                               option to pay duty at the rate of 4%
energy and resources is directed
                                                                               without any credit for the integrated
towards creating new demands on
                                                                               GST paid on inputs or at a standard
existing assessees who are complying
                                                                               GST rate, and claim credit. This limit
with the law. This methodology is
                                                                               is based on value of total clearances
blessed and the report is absolutely
                                                                               including exempted items but exclud-
silent on the ‘parallel economy.’
                                                                               ing export clearances.
                                                                                         This will create more confu-
Assessee/Administration: The
                                                                               sion since there is an exemption up to
unit of taxation under the Central GST
                                                                               Rs.40 lakhs and after Rs.40 lakhs there
as per the report should be the person
                                                             is an option of 4% without credit or normal rate with
defined under the Income Tax Act, 1961 and not the pro-
                                                             credit. This would create a number of issues such as date
duction unit/branches. This is a sweeping tax reform
                                                             of purchase, availability of credit, transition, exercise of
which, if implemented, would result in loss of work for a

THE CHARTERED ACCOUNTANT                                 441                                            OCTOBER 2004
                                              TAX REFORMS

option, subsequent periods, etc.
Immovable property: The Task Force has recom-                     The computation mechanism
mended the following:                                             called as a subtraction method
(i) Existing stamp duty system                                    is in reality a tax on the profit
    should be abolished.
                                                                  made on the transaction. The
(ii) Central GST should apply
     to all the newly con-                                         report while dealing with
     structed, residential or com-                                 direct taxes does not refer to
     mercial property. Where it is
     self-used, the tax should be on the cost of con-             any abolition of income tax on
     struction.                                                   banks and other financial ser-
(iii) Where it is sold or transferred, the Central GST            vices providers.
     should be on the consideration received at first
     transfer or sale. Credit would be available for the
     Central GST embedded in the raw material used in          a purchaser of a residential unit will not be able to take
     the construction.                                         a credit in the absence of any Central GST. Even
                                                               though there are discussions on this issue, the recom-
(iv)Rental charges in respect of lease of immovable            mendations do not reflect any benefit for the person
    property for commercial purposes would be liable           who gets a residential property constructed.
    to central GST. However, rental for residential
    properties would be exempted.                              Financial Services:
(v) All secondary market transactions in immovable             (i) All regulated finance companies registered with
    property would attract GST on the difference                   RBI, IRDA, PFRDA, FMC and Stock exchanges
    between the sale proceeds and purchase price and               registered with SEBI, banks, brokerage firms,
    the payment would be borne by the purchaser of                 insurance companies, primary dealers, pension
    immovable property and the proceeds from the                   fund managers, etc. will have to separately regis-
    levy of Central GST should form part of the divis-             tered with Central Excise Department.
    ible pool.                                                 (ii) Value will be calculated by subtracting allowable
(vi)States can continue to levy registra-                                                  purchases (purchases of
    tion fee at a specific rate not exceed-                                                  revenue or capital nature
    ing Rs.200 per transaction in                                                            on which integrated GST
    immovable property, which is merely                                                       has been paid or deemed
    a user charge for the IT systems used                                                     to be paid and eligible
    in property registration.                                                                for credit) from the net
                                                                                              revenues. (All receipts in
     This proposal is unlikely to find                                                         the nature of income
acceptance, since the premise behind the                                                       including receipts from
proposal is the prevalence of black money                                                     sale of assets as reduced
in the real estate sector in a big way. The paral-                                          by the amount of service
lel economy exists in every sector and a proposal like                               tax deemed to be included
this would only affect the organized sector, which is               therein.)
already complying with existing tax laws at Central,
State and Municipal levels. It is not as if that this pro-     (iii) Net revenue shall not include farm loans, home
posal would immediately bring to an end the parallel                 loans, loans to non-profit organisations, student
economy in real estate. The whole purpose is defeated                loans, and commercial loans to all registered GST
since the Central GST is on the purchaser. The tax is                tax payers.
proposed on both residential and commercial, whereas

THE CHARTERED ACCOUNTANT                                 442                                           OCTOBER 2004
                                               TAX REFORMS

                                                              products respectively. The report is silent on credit
       Neither the States had been                            against services under Central GST.

       a party to the crucial “Task                               (iv) The revenues collected from Central GST
                                                              should form part of a divisible pool that would be
       Force” headed by Shri Vijay                            shared between Centre and State at the appropriate
       Kelkar nor has their point of                          rate. The revenue collected from State VAT on imports
                                                              would be assigned to the State of import destination.
       view been considered in the                                 States are not likely to be very enthusiastic about
       matter even though the tax                             this proposal, since very few States have ports and air-
                                                              ports and only some States have significant traffic in the
       reforms involve a major par-                           form of imports.
       ticipation by the States.                                   It is not clear that as to what is meant by assignment
                                                              of the revenue to the State of import destination.
                                                                   Import happens at the port, which is within the con-
                                                              trol of the Customs Department. If the plan of the
(iv) The purchaser of the financial services can claim        Central Government is to collect the State GST on
    credit in respect of services received from a regis-      import and assign it to the State, the same would not be
    tered financial service provider.                         acceptable to the States.
                                                                       Further, the States, which don’t have any port or
   The computation mecha-                                         airport, are unlikely to agree. Sharing of revenues has
nism called ‘subtraction                                            always been a sore point between the Centre and
method’ is in reality a tax on the                                   States.
profit made on the transaction.
The report while dealing with                                                 Agreement between Centre &
direct taxes does not refer to                                                States
any abolition of income tax on                                                 The Task Force seeks that Centre and States
banks and other financial ser-                                                 reach an agreement for a comprehensive
vice providers. The report,                                                    tax on goods and services comprising the
thus, on proper translation,                                                   following:
indicates an Income Tax on the                                                       Centre and States should exercise
profits, a Central GST on the                                                       concurrent but
profits as well as a State GST                                                   independent jurisdiction over common
on profits.                                                                         tax bases.
                                                                  Centre and States have to replace existing octroi,
Imports: (i) The counter vailing duty is to be                    CST, State level sales tax, entry tax, stamp duty,
replaced by two-part levy, the first being a reflection of        telecom license fee based on revenue sharing,
the proposed Central GST and the second being a State             turnover taxes, tax on consumption and sale of elec-
level GST. This indicates that services, which are                tricity, tax on transportation of goods and services
imported, are also likely to taxed.                               and passengers, excise taxes and all other cascading
 (ii) The collections under both parts should be separately       type levies and replace with two separate laws viz.
accounted and all imports should be taxed at the same rate        Indian Goods Services Tax Act and State Goods
under Central GST and State GST as applicable to con-             and Services Tax Act.
sumption of domestic goods.                                       Both tax jurisdictions will exclude the tax paid to the
                                                                  other jurisdiction from the assessment of value bases.
 (iii) Where the imported goods and services are used as
                                                                  Centre and State should have independent power to
intermediate inputs in production or distribution, credit
                                                                  fix tax rates. However, there must be co-ordination
for the proposed Central GST and State GST shall be
                                                                  between the levels of the Government.
allowed against Central GST and State GST on final
                                                                  The Central GST should be at 6%, 12% and 20%

THE CHARTERED ACCOUNTANT                                  443                                           OCTOBER 2004
                                                TAX REFORMS

    and the State GST should be 4%, 8% and 14%.
    The grand plan therefore clearly depends upon the            The ultimate raison d'être of com-
    agreement to be arrived at between the Centre and            petition is the interest of the con-
    all the States. In a federal structure with fierce inde-
    pendence being exercised by States, it is difficult to
                                                                 sumer. Consumer's right to free
    imagine that such an agreement is likely to surface          and fair competition can’t be
    immediately.                                                 denied by any other consideration.
                                                                 There is also a need for supportive
           Mandate for the States
                                                                 institutions to strengthen a com-
The Task Force report suggests that:                             petitive society.
   States should allow the Centre to levy tax on
    land and building, electricity, trans-                                Central Law. This is likely to be opposed by the
    port, luxuries, waterways, bet-                                              States.
    ting, gambling, etc. in                                                                        States are not going
    exchange for the right to                                                     to be enthusiastic about the tax on
    levy tax for all services.                                               imports specifically when the revenue is
    States should abolish all entry tax into                                to be assigned. Further, the report recom-
    local area for consumption, sale or use                                 mends rates at 5% to 10%, which would
    therein.                                                                mean significant lower collections.
                                                                                States have been demanding that they
    States should abolish stamp duty on                                   should be allowed to tax services as a com-
    lands and buildings but they can levy                                pensation for bringing VAT, whereas the
    VAT on immovable property and the munici-                      report expands the scope of tax for the Centre by
    palities will continue to levy property tax.                   removing the existing areas of domain of the
    Right to tax tobacco will remain with Centre                 States.
    and right to tax alcohol with the States. These              The abolition of CST is likely to be resisted by States
    ‘sin taxes’ will be in the nature of excise.                 such as Maharashtra, Gujarat, Haryana, Andhra
                                                                 Pradesh, Tamil Nadu, Karnataka, Madhya Pradesh,
                     Conclusion                                  Kerala, Uttar Pradesh and West Bengal for revenue
It is no doubt true that sincere efforts have been put in by     reasons as the CST collections for the year ending
the Task Force in creating a report and giving new ideas         31.03.2004 is Rs.2130 cr., Rs.1200 cr., Rs.1147 cr.,
for tax reforms as well as for eliminating the budget            Rs.1106 cr., Rs.976 cr., Rs.884 cr., Rs.749 cr.,
deficit. However, the following problems are inevitable:         Rs.546 cr., Rs.485 cr. and Rs.384 cr. respectively.
                                                                 The Central Government collection of service taxes
    When States have geared themselves for VAT on
                                                                 for the year 2003-2004 is Rs.8,300 crore and the bud-
    commodities, the proposals which talk about an
                                                                 get estimate for the year 2004-2005 is Rs.14,150
    integration of goods and services at the Centre and
                                                                 crore. The proposal envisages a continuation of the
    State level is likely to derail VAT.
                                                                 tax on service by the Centre through the Central GST
    A number of meetings amongst States have still not           as well as allowing the States to tax the services
    resulted in the finalisation of the list of exempted         through the local GST. Even assuming the same rev-
    commodities. This report recommends that the                 enues are possible, the revenue would be for all the
    Centre and the States must agree upon a common               States put together. To get this, the States are required
    list of exempted commodities both under the                  to abolish all existing revenue streams such as elec-
    Central GST and State GST.                                   tricity, registration, stamp duty, gambling, betting,
    The report recommends that the penalty and related           CST, sales tax, entry tax, etc. and provide a credit
    provisions in the State Law should be the same as in         mechanism for both services and commodities.

THE CHARTERED ACCOUNTANT                                   444                                         OCTOBER 2004

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