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Goods And Services Tax In India: Rationale And Reform Directions – IMPRI Impact And Policy Research Institute

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Goods and Services Tax in India: Rationale and Reform Directions

The session on ‘Goods and Services Tax in India: Rationale and Reform Directions’ was conducted by Prof Sachchidananda Mukherjee. He began the session by mentioning the indirect tax reform that the introduction of Goods and Services Tax has brought about.

Issues in Taxation Before Goods and Services Tax

Prior to the implementation of the Goods and Services Tax (GST), there were several significant challenges in the realm of taxation that needed to be addressed. One such challenge was the issue of input tax credit, particularly in the context of interstate movement of goods. This problem arose because when goods moved from one state to another, it disrupted the seamless flow of tax credits. Hence, it became imperative to devise a comprehensive tax system that could effectively tackle such issues. The introduction of the Integrated Goods and Services Tax (IGST) played a pivotal role in successfully integrating both the Central Goods and Services Tax (CGST) and the State Goods and Services Tax (SGST), mitigating this particular challenge remarkably.

Another noteworthy problem pertained to the various taxation acts outlined in the constitution. A significant disconnect existed between taxation at the manufacturing level, which fell under the jurisdiction of the central government, and taxation beyond that point, which was under the purview of the state government. This disconnect resulted in numerous complications and inefficiencies within the taxation system. Additionally, there was a notable discrepancy in the definitions of goods and services, further complicating matters.

Therefore, the need for a well-designed and unified tax system in a diverse country like ours was abundantly clear. Overcoming these challenges required careful consideration and effective solutions. The introduction of GST, particularly the integration facilitated by IGST, marked a significant step towards harmonizing these tax-related issues, thereby enhancing the efficiency and effectiveness of the taxation framework in India.

History of Indirect Tax System

The history of the indirect tax system in India has evolved significantly over the years. One pivotal moment came in 1957 with the introduction of the Central Sales Tax system. This marked a shift in the Indian tax system towards being ‘origin-based.’ In essence, this meant that as goods traversed through the supply chain, they carried their tax liability with them until they reached their final destination state.

Another noteworthy development occurred in 1986 with the implementation of the Modified Value Added Tax (MODVAT). This system underwent further modifications based on the recommendations of the Tax Reform Committee during 1991-93. Subsequently, in 1994-95, a selective tax for services was introduced, accompanied by reforms to the MODVAT system. This transformation culminated in the establishment of a more streamlined tax system known as the Central Value Added Tax (CENVAT) system in 2000-01. However, it’s important to note that at this stage, there was no provision for Input Tax Credit within this system.

The introduction of Input Tax Credit provisions came into play in 2002-03, marking a significant leap forward in the evolution of the tax framework. These provisions were initially introduced for CENVAT and service tax, laying the foundation for a more comprehensive and efficient taxation system. The Input Tax Credit system was further refined and expanded in 2004-05, bringing greater clarity and functionality to the indirect tax landscape in India. These developments culminated in the establishment of the Input Tax Credit system, a critical component in India’s ongoing efforts to modernize and streamline its taxation structure.

State Value Added Tax System

Prior to the implementation of the State Value Added Tax (VAT) System, the State Sales Tax system in India presented a landscape fraught with complexity. It was characterised by a lack of uniformity in sales tax rates, regulations, and administrative procedures among different states. This lack of harmonisation created a situation where the tax system was prone to cascading, a scenario where taxes were levied on top of taxes, leading to increased financial burden and inefficiency.

The absence of a standardised approach to sales tax across states resulted in a challenging environment for both businesses and tax authorities. Companies operating across multiple states faced the daunting task of navigating a patchwork of differing tax structures and compliance requirements, adding to their administrative burden and often resulting in disputes and confusion.

Recognizing the need for reform, the introduction of the State Value Added Tax (VAT) System brought about a fundamental shift in how sales tax was approached. This new system aimed to harmonise  tax rates and procedures across states, thereby mitigating the complexities and challenges associated with the earlier State Sales Tax system. In essence, it sought to create a more cohesive and efficient tax framework that reduced the risk of cascading taxes and streamlined tax administration.

Value Added Tax System

The implementation of the Value Added Tax (VAT) system marked a significant step toward standardising the design and structure of the State VAT system in India. It aimed to bring coherence not only in the tax rates but also in the rules, regulations, and certain aspects of the administrative process. However, it’s essential to note that while it achieved substantial harmonisation, some challenges persisted.

A notable achievement of introducing the State Value Added Tax system was the establishment of the Empowered Committee of State Finance Ministers. This committee played a pivotal role not only in the successful implementation of VAT but also in laying the groundwork for the eventual introduction of the Goods and Services Tax (GST), underscoring its importance in India’s tax reform journey.

Despite its merits, the VAT system faced certain challenges. One significant challenge was its lack of integration with other central tax systems, such as the Central Value Added Tax (CENVAT). This fragmentation resulted in inefficiencies in the broader tax landscape.

Furthermore, specific goods and services continued to remain outside the purview of the VAT system, which created disparities in the tax treatment of different commodities. Additionally, the issue of the cascading effect of the service tax system remained unaddressed. This meant that a continuous chain of tax set-offs from the original producer to the service provider and up to the retailer level was not established, leading to a burdensome cascading effect on taxes at various stages of the supply chain.

While the introduction of the State Value Added Tax system marked a significant stride toward tax reform in India, it also underscored the need for further integration and refinement within the tax ecosystem to achieve more comprehensive harmonisation and alleviate issues like cascading taxes. These challenges would later inform the development of the Goods and Services Tax, which sought to address many of these issues on a national scale.

Features of Goods and Services Tax

The introduction of the Goods and Services Tax (GST) in India was driven by several compelling factors. The pre-existing taxation system had its shortcomings, failing to provide adequate incentives for unregistered businesses to formalise their operations. Additionally, it inadvertently encouraged tax evasion and illicit trade, particularly concerning high-value, low-volume goods. GST represented a significant departure from the previous origin-based Value Added Tax (VAT) system, transitioning to a destination-based VAT approach.

One of the key transformations brought about by GST was the elimination of definitional distinctions between production and distribution, as well as between goods and services. This harmonisation contributed to simplifying the tax structure. Moreover, GST played a crucial role in nurturing the concept of a common market by phasing out the Central Sales Tax (CST) and entry tax, fostering a more seamless flow of goods across state borders. The tax base was broadened by integrating services into the VAT system, broadening the scope of taxable transactions.

A notable feature of GST was the introduction of the Input Tax Credit mechanism for intrastate transactions, made possible through the Integrated GST Framework. This mechanism allowed businesses to offset the taxes they paid on inputs against their overall tax liability, reducing the overall tax burden. GST is best described as a comprehensive, multi-stage VAT system that encompasses both goods and services. It empowers both the Central and State governments with concurrent taxation authority, enabling them to levy taxes on goods and services at every stage of their value addition during production and distribution.

Furthermore, Indian GST incorporates multiple tax rate structures to accommodate various goods and services. This flexibility in tax rates caters to the diverse nature of commodities and services within the Indian economy. Another noteworthy aspect of GST is its endeavor to enhance the competitiveness of domestic industries in the international market. By eliminating hidden embedded taxes, GST aims to make Indian products more competitive globally, thus supporting the growth of domestic industries and boosting their presence in international trade.

Conclusion

In conclusion, the implementation of the Goods and Services Tax (GST) in India marked a significant shift in the country’s taxation landscape. It addressed critical challenges from the pre-GST era, such as input tax credit disruptions, definitional discrepancies, and cascading taxes. The historical progression of indirect tax systems, from the Central Sales Tax (CST) to the Value Added Tax (VAT), paved the way for GST’s introduction. GST streamlined tax rates, simplified administrative procedures, and broadened the tax base.

GST, as a comprehensive VAT system covering both goods and services, revolutionised taxation in India. It eliminated definitional differences, introduced multiple tax rates, and incorporated mechanisms like Input Tax Credit. Moreover, it fostered a common market by phasing out CST and entry tax, facilitating smoother inter-state trade. The overarching aim of GST was to simplify taxation and enhance the competitiveness of Indian businesses globally by removing embedded taxes. As India continues to grow economically, GST remains a cornerstone of tax reform, reflecting the country’s commitment to modernising its tax structure for a rapidly developing economy.

Acknowledgement: Aasthaba Jadeja is a research intern at IMPRI.

Disclaimer: All views expressed in the article belong solely to the author and not necessarily to the organisation.

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