29 March 2017
Doing Business with India: Opportunities Arising from GST Reform
Ease of doing business and economic efficiency to greatly benefit from GST
India’s Goods and Services Tax (GST) is one of the most significant economic initiatives since the Big Bang reforms introduced in the early 1990s. Passed in August 2016 and expected to be implemented in the second half of this year, it marks a key achievement of Prime Minister Narendra Modi, along with many critical reform initiatives (such as the Make in India Initiative and Ease of Doing Business Reforms) adopted since Modi took office in 2014 to enhance the business environment, attract foreign direct investment (FDI), raise jobs and spur the economy.
GST – More Than a Decade in the Making
India, the world’s largest democracy, is a Union of States with divisions of power between the federal government (Centre) and state governments. Attempts to conceptualise and design a GST model were first commenced by the Centre in the early 2000s, but proposals for a comprehensive national GST model were not put forward until the mid-2000s due to recognition of the many shortcomings and intricacies of the prevailing tax systems adopted by both the Centre and the states.
Additional difficulties in pushing through the GST reforms arose from the typical Centre-state conflicts over taxing authority and revenue appropriation, leading to many rounds of GST model debates. Furthermore, the GST reform process was affected by the ebb and flow of the election cycles of different levels of governments in the country.
In pursuing a comprehensive GST model agreeable to all parties, the initial deadline of April 2010 was missed, followed by many failed attempts of the then Congress Party-led government to enact the GST bill. It took well over a decade together with a change of government at the Centre to finally turn the GST concept into law. After the GST bill – formally called The Constitution Amendment Bill for Goods and Services Tax – was passed, the GST Council, chaired by Union Finance Minister Arun Jaitley, was formed to make recommendations to the Centre and state governments on important GST issues.
With broad consensus and popular support that a unified GST will benefit India, the new GST system is expected to make big strides into unifying India into a single market, breaking down state boundaries as far as movement of goods and services is concerned. In particular, it replaces many layers of inefficient indirect taxes levied by the states, while substantially improving tax transparency of the country as a whole. Meanwhile, the GST Council is hurriedly working on the final details on tax-collection arrangements before rolling out the GST in the second half of 2017. The national GST – perhaps the most important tax reform ever achieved in India – will have far-reaching and long-term economic implications for the country.
Issues of the Existing Indirect Taxes on Goods and Services
India’s tax system is notoriously complex, reflected by the poor “paying taxes” scores in the World Bank’s Ease of Doing Business rankings. A wide range of taxes is levied at both the Centre and state levels. The following taxes are paid by consumers for goods and services:
As shown above, numerous taxes and levies are administered by both the Centre and state governments, resulting in a mundane process for businesses paying their taxes to different government agencies. Furthermore, the administrative cost of collecting these indirect taxes by the Centre and state governments is also high.
To further complicate the matter, Indian states have their own levies on goods and services at different tax rates. Certain levies are paid in some states but not across the country. When inter-state transactions occur, taxes have to be paid to two states separately. For example, when a container of goods is imported into West Bengal, the state levies of West Bengal will apply. If the importer wants to sell part of this container of goods in Mumbai, he has to pay an Inter-State Centre Sales Tax (CST) for the inter-state transaction, on top of the state levies he has already paid to West Bengal.
Under such an arrangement, India has created a fragmented consumer market where different states are operating their own goods and services regimes, and extra costs are incurred during the inter-state flow of goods and services. In addition, tax on goods or services tax is levied along the whole value chain. Tax on-tax is common, and this ultimately raises the final price paid by consumers.
In sum, India’s existing levies on goods and services are complex and costly for governments to administer, and for businesses and consumers to comply with. On the other hand, the high administrative costs inevitably translate into high prices for goods and services. With many parties in the Centre and state governments involved in administrating this complex and cumbersome tax system, this has given rise to bureaucratic inefficiencies, red tape and tax evasion.
How the New GST Works
The national GST model is intended to substantially simplify or rationalise the existing system in the tax treatment of goods and services along the supply chain from producers to consumers. The GST unifies all indirect tax rates and structures across the country. All previous Centre levies will be subsumed under the Centre GST (CGST) and all state levies will be unified into one states GST (SGST). A four-tier GST system combining Centre and state taxes will be adopted for goods and services, which can be broadly summarised as follows:
The following figures illustrate how the GST is levied along the value chain:
At the first stage of production, the calculation is simple. As illustrated above, the tea farmer simply has to pay GST to the Centre and state governments at the designated rate of 5%.
At stage 2 of the value chain, to avoid tax-on-tax, a total of Rs10 tax credit is given as it is the GST already paid in Stage 1. Hence the tea processor has to pay a total GST of only Rs10.
The same principle also applies in stage 3. An input tax credit equivalent to the GST paid in stage 1 and stage 2 is given. Hence the tea retailer also pays a total of Rs10 GST.
Revamping the taxes levied on inter-state transactions is one of the most important parts of the GST reform. An Integrated Goods and Services Tax (IGST) levied by the Centre government will replace the taxes levied by two different states. For example, when a tea processor in West Bengal sells his produce to Karnataka, he no longer needs to pay taxes to both governments of West Bengal and Karnataka.
Under the new GST regime, that tea processor only has to pay an IGST to the Centre government, equal to the sum of CGST and SGST (5%+5%=10%) with adjustments on tax credits in the previous stages of the value chain (total of Rs10). The new GST will be a destination-base tax, and all SGST on the final product will be charged by the consuming state. Therefore in the above illustrative example, the SGST will be charged in Karnataka. No additional tax will be paid for inter-state transactions.
Improving India’s Ease of Doing Business in the Long Run
If the GST is properly rolled out and executed, businesses and consumers will surely benefit from it. The GST opens up more opportunities for doing business in India, as the business-operation environment will be enhanced in the following aspects:
Reducing the Tax Burden
One salient feature of the GST is a clear system of input tax credits throughout the value chain. The previous taxes levied on goods and services had no clear mechanism for rebating the tax paid in the previous stages of the value chain, and so created a cascading effect (tax-on-tax). With the cascading effect eliminated, the total tax burden will be reduced for both sellers and buyers (including the final consumers).
Easing the Flow of Goods and Services
Many foreign businesses are often intimidated and confused by the jumble of taxes in different Indian states, which is a major deterrent to doing business in India. Furthermore, they have to pay two sets of taxes if they move the goods across state borders. Such practices restrain free flows of goods and services, therefore lowering profit margins and the flexibility in doing business. The new GST allows greater flexibility in manufacturing and retail as the tax barrier on inter-state transactions has been removed.
Facilitating Manufacturers and Exporters
With essentially all kinds of goods subject to the intertwining Centre and state sales and services tax, it is not difficult to envisage the confusing number of taxes that Indian manufacturers had to pay during the procurement process before the GST reforms, let alone the mundane administrative work involved in filing and paying them all. These compliance costs inevitably make production in India more expensive. A comprehensive GST regime subsuming the present Centre and state levies will reduce the costs of producing goods in India and improve its competitiveness as a production base. This ties in well with India’s aspirations to become a world-class manufacturing hub as per the Make In India Initiative championed by the Modi government. Furthermore, the GST will not be levied on exports of goods and services.
Another important objective of the tax reform is to reduce the excessive bureaucratic procedures and non-compliance prevalent in India. The GST has been developed as a set of much clearer tax rules on goods and services with uniformity and tax rates and structures across the whole of India. In addition, a newly developed IT system will serve as a one-stop-shop for all taxpayers’ services including registration, returns and payments. All procedures can be carried out online by taxpayers, making compliance easy and involving minimal bureaucratic intervention.
These reforms will reduce the transaction costs of selling goods and services in India, improving the ease of doing business in the country.
The Road Ahead
In March 2017, the GST Council agreed on the streamlining of cess arrangements, the last major hurdle of GST reform, which is now entering the final stage of the Centre and state legislative processes. Given that India is a large federal nation with 29 states and seven union territories, states will have to enact their own SGST legislation, although successfully implementing the GST at the Centre and state levels will remain an ambitious and challenging undertaking, and it will take time to monitor its effectiveness.
Modi’s Bharatiya Janata Party (BJP) is not just the ruling party at the Centre, but also in more than half of Indian states and union territories. With the BJP expected to fare strongly in the current cycle of state elections, this will certainly help smooth out the enactment of the GST and subsequent implementation. With GST reform, India is on the right track towards unifying its internal market, further improving the ease of doing business, brightening the prospects of the country becoming a manufacturing base, while creating new business opportunities for Indian, as well as overseas, companies.
 India is ranked 172 out of 190 economies in paying taxes in the Ease of Doing Business 2017 ranking.