GOODS & SERVICE TAX IN INDIA – Concepts and Constitutional Framework Paper II

BASIC CONCEPTS & FEATURES OF GOODS & SERVICE TAX IN INDIA

1I have discussed the basic and fundamental issues relating to Goods and Service Tax (GST)
implementation in India pointing out to the need of constitutional amendments in our
federal governance in my first article “GOODS & SERVICE TAX IN INDIA – Concepts and
Constitutional Framework Paper I”. You can access the article from here:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1596522

In this paper, I would be discussing basic features of GST in India and its proposed
coverage of indirect taxes.

Indirect taxes, by its nature are ultimately borne by the consumers. It is indirect in the
sense, all participants in the supply chain act as collecting agent and collect the taxes from
their customers/consumers and remit it to the state exchequer. The burden of taxes shifts
from one customer to another and ultimately, it falls on final consumers who consumes the
goods and services and does not further pass it to another level.

Earlier, each participant in supply chain did not bother about the tax rate as he only
considered himself/herself as collecting agent and collected the requisite amount from its
customers and paid to the government. However, in the competitive environment, some
participants in the supply chain managed not to pay tax on certain goods and services,
which led not to collect tax from consumers and in turn, made the supply cheaper and less
expensive than competitors. Thereafter, appropriate indirect tax planning has received an
utmost attention from the industry, producers, service providers and consultants to make
their goods and services extra bit cheaper than that of their competitors. As the indirect

1
Authored by Rajib Dahal; B.A; L.L.B (Hons.), NALSAR University of Law, Hyderabad, (2008 May). The author is
a practicing indirect tax consultant. © Rajib Dahal, 2010. No part of this document may be reproduced, copied,
Photocopied, transmitted or circulated in any form without prior permission in writing from the author, except for
the purpose of study and research within fair dealing. The Author asserts the moral right to be recognized as
Author.
Any comments or feedbacks on the paper will be highly appreciated. You can reach me at rajib.dahal@gmail.com
or at dahalrajib40@hotmail.com

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taxes imposed on any goods and services directly translate into the price hike, making the
goods and services costlier, there has been always attempt to reduce the burden of taxes on
final consumers.

In the supply chain, the producer utilizes certain inputs and raw materials to manufacture
finished goods/products and services. While procuring raw materials, the manufacture has
to pay tax on these inputs and when it supplies finished goods to consumers, it again
collects certain taxes from its consumers. As indirect tax burden will be passed to the
subsequent customers, the customers will be burdened by two kinds of taxes; i.e. one tax
on inputs as that being the cost to the manufacturer will be included in the value of the
goods; and taxes collected by manufacturer from customers while supplying/selling the
finished products. In this way, every participant/customer throughout the supply chain will
be burdened by extra cost relating to taxes paid on inputs. This effect of burdening multiple
taxes on the customers/consumers is called ‘Cascading Effects’.

In modern Indirect tax structure, government has to make an every attempt to reduce and
finally to remove these cascading effects. The tax policy with less cascading effects can be
called as scientific and progressive tax policy. The governments have come with ‘input tax
credits’ mechanisms to reduce the cascading effects on each supply chains. As per these
concepts, manufacturer, producer or supplier, as the case may be, can set off its output tax
liability (tax liability on supply/sale of finished goods) with its input taxes. They can set
off/deduct their output tax liability with already paid input taxes and only the balance, if
any, has to be paid by the manufacturer by cash. Therefore, it also overall helps the
business to prevent its cash outflow. Though the full amount of tax will be collected from
customers, he would be entitled to get input credits of taxes collected from him, it will
remove any cascading effects on the consumers. Therefore, the primary objective of any
indirect tax policy is to remove cascading effects and make ‘input tax credits’/’set-off
mechanism’ more consumers friendly.

On this backdrop of policy thoughts, GST in India is being introduced with the highly
innovated tax structure where cascading effects would be removed in each supply chain of

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goods and services and credit mechanisms will be more transparent, easy to practice and
practically viable.

In GST tax regime, both the States and the Union would be empowered to tax on both sale
of goods and services. Therefore, Both states and the Union would be taxing sales of goods
with the state, intra – state sales of goods, production of materials, import of goods and
services, exports of goods and services, and rendering of services within India.

As per the plans outlined by First Discussion Paper on Goods and Services Tax in India
released by The Empowered Committee of State Finance Ministers released on
November 10, 2009 at New Delhi (herein after referred as ‘First Report’), the following
existing states2 and the Union taxes would be subsumed in GST:

A. Central Excise Duty;

B. Additional Excise Duties;
C. The Excise Duty levied under the Medicinal and Toiletries Preparation Act;
D. Service Tax;
E. Additional Customs Duty, commonly known as Countervailing Duty (CVD);
F. Special Additional Duty of Customs – 4% (SAD);
G. Surcharges;
H. Cesses
I. VAT/ Sales Tax;
J. Entertainment Tax (unless it is levied by the local bodies like Municipality or Village
Panchayat);
K. Luxury Tax;
L. Taxes on lottery, betting and gambling;
M. State Cesses and Surcharges in so far as they relate to supply of goods and services;
N. Entry Tax not in lieu of Octroi;

2
Taxes mentioned in the list from A to H are taxes imposed by Union, and those mentioned in I to N are currently
State Taxes.

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After GST comes into operation, both Union and States would be levying taxes GST in lieu of
above mentioned taxes. Therefore, First Report has envisaged and recommended that there
should be dual taxes on the goods, i.e. dual model of GST.

The First Report in Para 3.2 states that a dual GST structure with defined functions and
responsibilities of the Centre and the States is recommended and an appropriate
mechanism that will be binding on both the Centre and the States would be worked out
whereby the harmonious rate structure along with the need for further modification could
be upheld, if necessary with a collectively agreed Constitutional Amendment.

The dual GST Model recommended by the First Report bifurcates GST between GST
imposed by Center (Central GST/’CGST’) and GST imposed by States (State GST/’SGST’).

The First Report states as below the silent features of the dual GST:

Salient features of the proposed model are as follows: (The features of the Dual GST have
been reproduced here as they appear in First Report. I have presented my comments on
each feature at the end.)

1. The GST shall have two components: one levied by the Centre (hereinafter referred to
as Central GST), and the other levied by the States (hereinafter referred to as State
GST). Rates for Central GST and State GST would be prescribed appropriately,
reflecting revenue considerations and acceptability. This dual GST model would be
implemented through multiple statutes (one for CGST and SGST statute for every
State). However, the basic features of law such as chargeability, definition of taxable
event and taxable person, measure of levy including valuation provisions, basis of
classification etc. would be uniform across these statutes as far as practicable.
2. The Central GST and the State GST would be applicable to all transactions of goods
and services made for a consideration except the exempted goods and services, goods
which are outside the purview of GST and the transactions which are below the
prescribed threshold limits.
3. The Central GST and State GST are to be paid to the accounts of the Centre and the
States separately. It would have to be ensured that account-heads for all services and

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 goods would have indication whether it relates to Central GST or State GST (with
identification of the State to whom the tax is to be credited).
4. Since the Central GST and State GST are to be treated separately, taxes paid against
the Central GST shall be allowed to be taken as input tax credit (ITC) for the Central
GST and could be utilized only against the payment of Central GST. The same principle
will be applicable for the State GST. A taxpayer or exporter would have to maintain
separate details in books of account for utilization or refund of credit. Further, the
rules for taking and utilization of credit for the Central GST and the State GST would
be aligned.
5. Cross utilization of ITC between the Central - GST and the State GST would not be
allowed except in the case of inter-State supply of goods and services under the IGST
model which is explained later.
6. Ideally, the problem related to credit accumulation on account of refund of GST should
be avoided by both the Centre and the States except in the cases such as exports
purchase of capital goods, input tax at higher rate than output tax etc. where, again
refund/adjustment should be completed in a time bound manner.
7. To the extent feasible, uniform procedure for collection of both Central GST and State
GST would be prescribed in the respective legislation for Central GST and State GST.
8. The administration of the Central GST to the Centre and for State GST to the States
would be given. This would imply that the Centre and the States would have
concurrent jurisdiction for the entire value chain and for all taxpayers on the basis of
thresholds for goods and services prescribed for the States and the Centre.
9. The present threshold prescribed in different State VAT Acts below which VAT is not
applicable varies from State to State. A uniform State GST threshold across States is
desirable and, therefore, it is considered that a threshold of gross annual turnover of
Rs.10 lakh both for goods and services for all the States and Union Territories may be
adopted with adequate compensation for the States (particularly, the States in North-
Eastern Region and Special Category States) where lower threshold had prevailed in
the VAT regime. Keeping in view the interest of small traders and small scale industries
and to avoid dual control, the States also considered that the threshold for Central GST
for goods may be kept at Rs.1.5 crore and the threshold for Central GST for services
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 may also be appropriately high. It may be mentioned that even now there is a separate
threshold of services (Rs. 10 lakh) and goods (Rs. 1.5 crore) in the Service Tax and
CENVAT.
10. The States are also of the view that Composition/Compounding Scheme for the
purpose of GST should have an upper ceiling on gross annual turnover and a floor tax
rate with respect to gross annual turnover. In particular, there would be a
compounding cut-off at Rs. 50 lakh of gross annual turnover and a floor rate of 0.5%
across the States. The scheme would also allow option for GST registration for dealers
with turnover below the compounding cut-off.
11. The taxpayer would need to submit periodical returns, in common format as far as
possible, to both the Central GST authority and to the concerned State GST authorities.
12. Each taxpayer would be allotted a PAN-linked taxpayer identification number with a
total of 13/15 digits. This would bring the GST PAN-linked system in line with the
prevailing PAN-based system for Income tax, facilitating data exchange and taxpayer
compliance.
13. Keeping in mind the need of tax payer’s convenience, functions such as assessment,
enforcement, scrutiny and audit would be undertaken by the authority which is
collecting the tax, with information sharing between the Centre and the States.

The 13 points features as presented by the First Report have been viewed from different
aspects in my subsequent part of this Article.

A. Duality of GST

The First Report has recommended having dual GST in India. The first one will be Central
(‘CGST’) and the second GST will be at state level (‘SGST’). For dual GST, there should be
one central legislation in the center and for SGST; there would be one legislation in each
state in India. This gives us a fear that the GST implementation in India will not be better
than the current existing and prevailing indirect tax regime in India. However, the First
Report tries to allay our fear mentioning, “……………….the basic features of law such as
chargeability, definition of taxable event and taxable person, measure of levy including

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valuation provisions, basis of classification etc. would be uniform across these statutes as far
as practicable.”

However, such statement has been qualified with the term, ‘ as far as practicable’ which
tries to instill the fear in the mind of the industry that this liberal approach may create the
same anarchy which present Value Added Tax (‘VAT’) Acts in state level are creating. It is
worth remembering that VAT Act in state level was introduced as a new phase of tax
reforms and economic reforms in India. A White Paper on State – Level Value Added Tax
released by the Empowered Committee of State Finance Ministers in January 17, 2005 had
also outlined to provide full set-off for input tax as well as tax on previous purchases3.
However, in GST only time will tell if SGST would be different from VAT laws in India which
were also introduced infusing much enthusiasm in tax payers. If GST has to be better than
current VAT laws, the following issues must be addressed by some nodal central agency
without leaving much room for individual states to tinker with the law:

i. The list of exempted, zero rated and taxable goods and services must be
uniformly determined under each SGST;
ii. The basic threshold value of tax base must be uniform across all the states;
iii. The rate of tax of same commodity across all the states must be same so that
there will not be competition among states on the basis of tax rate. It also
reduces the risk of unfriendly taxes like entry tax which states generally resort
to prevent the tax leakage from such rate competitions;
iv. There is a need of central constitutional body which will handle all the issues
relating to changes on the issues of taxability, rate, definition, taxable events,
taxable entity or persona, valuation and classification so that the role of
individual states will be reduced giving greater uniformity among SGST4. This

3
The White Paper can be accessed from http://finmin.nic.in/the_ministry/dept_revenue/rtiman/salestax/sales-
tax%20Folder/White%20Paper%20on%20VAT.pdf ; (Last Accessed on April 29, 2010).
4
The second Report on GST has been issued as REPORT OF THE TASK FORCE ON GOODS AND SERVICES
TAX, THIRTEENTH FINANCE COMMISSION, 15TH DECEMBER, 2009 by Finance Commission. It also
recommends the need of Constitutional body to oversee the matter relating to the rate, valuation, classification,
coverage and exemption in the GST after GST comes into operation so as to make it more predictable and workable

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 provision can be, though, relaxed in the case of grave economic emergency
where states may be given power to amend in SGST without any consultation or
intervention of Central Constitutional body. However, this mechanism should be
of temporary measures and such amendments in SGST, if any, should expire
within next six months in case such Constitutional body does not approve or
ratify such interim measures which can be extended by another six months in
case such amendments are ratified by constitutional body.
v. It needs to be highlighted here that the above mechanism explained in (iv.) may
face challenges from states as it to a great extent, diminishes the roles of states in
financial matters which have been utilized by states and political parties there as
a sign of their greater independence and authority. In our federal mechanism,
states exercise a greater political and economic autonomy which gets translated
into their absolute freedom in framing economic policies and taxation in local
levels. Therefore, any curtail of such powers may be viewed by states as
disturbance to federal structures envisaged by Constitution of India. However, in
case the recommendations proposed above are accepted and passed, industry
and assessee can hope to see a reformed and articulated piece of legislation in
India which lessens the burden on the industry reducing the wastages and costs
to a great extent.

B. Nature of GST

One of the features of GST is that it will apply to across all the goods and services. Both
SGST and CGST will have impact on goods and services except those that are exempted
goods or services, or such services and products which fall below the threshold limits, or

with its intended benefits to the public. In Para 28 of Report under Executive summary recommends, “28. The GST
envisages a mechanism whereby both the Centre and the States will cease to have any independent power to make
changes in the design and structure once agreed upon. The existing mechanism for arriving at a collective
decision on the structure of the GST should be permanently institutionalized so that changes in the initial design
of the GST are collectively agreed and implemented by both the Centre and the States. The Empowered
Committee of State Finance Ministers may, upon the introduction of the GST, be transformed into a permanent
constitutional body known as the Council of Finance Ministers. This Council shall comprise of the Union
Finance Minister and all State Finance Ministers. The Union Finance Minister would be the Chairman of this
Council”. In my article this proposed/recommended body has been referred as ‘Constitutional Body’.

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such goods and services that may be kept out of GST net. While applying GST, utmost care
should be taken that there are minimum number of goods and services which are exempt
so that input tax of the producer/service provider can be utilized while discharging its
output tax liability; otherwise, same will be the cost and will be burden on the consumer.

Regarding the threshold limits, there should be uniform threshold across all the states so
that business decisions of persons will not be decided by the tax base of the states.
However, this uniform tax base may face a problem as India, not being equally developed;
North East States like Assam, Tripura, Meghalaya, Mizoram etc. would have to make tax
base to a very low level so that states can earn some revenue. Similarly, in bigger and
developed states like Andhra Pradesh, Tamilnadu, Karnataka, it may not be feasible to keep
the tax base too low as that creates difficulty for small scale entrepreneurs as well as
administrative costs of managing such a huge tax base for the government may outweigh
the benefits/revenue derived from such tax base. Therefore, while deciding on the tax base,
these two factors – the loss of revenue to small and economically not so advanced states on
the one hand and discouragement to small business people and administrative costs in the
big and developed states, on the other must be meticulously balanced.

The author feels that the tax base should be kept slightly higher. The present
recommendation in relation to tax base made by the First Report for the implementation of
SGST is Rs. 10,00,000, which I feel is correct, or that should be even slightly higher as in
many cities, the impact of making low tax base will lead to either excessive administrative
costs or excessive leakage of tax and corruption by the officials. In case there is loss of
revenue to small states, Center can compensate such loss calculated on a scientific basis
and as decided and recommended by experts of Constitutional Council. This mechanism
will help small states to implement GST very effectively without being worried about loss
of revenue and the administrative and compliance costs of both the department and
assessee also remains low.

C. Mechanism for credit of tax

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In GST, there are two components: one SGST and another CGST5. These taxes would be
collected by states and the Union respectively. Therefore, taxes would have to be credited
to separate accounts of the state government and Union government. The First Report
recommends having separate codes for tax remittance to states’ and Union’s Accounts and
taxpayers must be made aware of it.

D. Input Credit/Set – off Mechanism

One of the parameters where GST would be closely watched and monitored would be the
area of ‘inputs credit mechanism’. If GST has to score above all the taxes prevalent now, it
should be in the areas of input credit mechanism and in removal of cascading effects. From
this perspective, though GST concept paper in the First Report makes elaborate
recommendations on how credits should be utilized, it is not as much as industry was
expecting in relation to cross utilization of GST.

The First Report outlines that the dealers have to maintain separate books of accounts for
recording and maintaining inputs credits with respect to SGST and CGST. There would be
mechanism to set – off taxes paid on SGST with SGST payment and those paid on CGST
would be allowed to be set – off only against CGST. The First Report in its recommendation
makes it clear that there will not be any cross-utilization of taxes paid on inputs. That
effectively means, the tax paid on SGST cannot be set-off against CGST and vice-versa is also
not possible. On this count, if GST is implemented as per this recommendation, it would
definitely fall short of expectation and customers can not completely get rid of cascading
effects. However, with the concept of IGST6, where cross-utilization of credit is possible,
GST is expected to serve better in reducing cascading effects.

E. Reduction of Incentive schemes under GST

5
There is another component/concept in GST which is called IGST (Integrated Goods & Services Tax/Inter-state
Goods and Services Tax) which has been explained in Point H in Page 12 of this Article.
6
IGST is the sum of CGST and SGST which will be imposed on inter-state sale/transfer of goods or in inter-state
provision of services under GST regime. IGST would be imposed by Union and its liability and input taxes both can
be cross-utilized which means both CGST and SGST can be utilized to pay IGST and also IGST can be utilized to
pay both CGST and SGST. Further modalities of IGST have been explained in details in page 12 of this paper.

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Under existing excise laws, there are various area based exemptions like North East States
and Hilly regions like in Himachal Pradesh. Under CST also, there is a mechanism of tax
refund if supplies are made to EOU and SEZ7. In erstwhile tax regime of General Sales Tax
also provided various incentives like sales tax deferment schemes, or some kind of Target
schemes like Target – 2000 in State of Andhra Pradesh in order to advance the
industrialization in those states. Under the GST regime, it is expected that all such
incentives and exemptions will be phased out to make the market more competitive and to
lessen the cascading effects on the consumers of each supply chain.

The evil aspects of these straightway exemptions were that any input taxes on the products
would become costs to the manufacturer and it had to be grossed up in the sale of such
goods which led to rise in price of final finished products. Therefore, unless all the inputs
are also exempted from taxes, any exemption to output products did not lend any support
to manufacturers though at the first sight, it may seem to be encouraging. Similarly,
straightway exemptions on the outputs lead to competition among the states to give
various incentives. However, these incentives have been proven to be distortive measures
on the one hand and on the other, make taxes paid on inputs as sunk cost which only leads
to the expensive output products.

The First Report in Para 3.9 deals with the issue. The Report highlights that there is a need
of doing away with all those incentives, exemptions, and remissions schemes and there be
any such need, then, cash refund mechanism should be adopted. The Report says,

Quote

After the introduction of GST, the tax exemptions, remissions etc. related to industrial
incentives should be converted, if at all needed, into cash refund schemes after collection of
tax, so that the GST scheme on the basis of a continuous chain of set-offs is not disturbed.

Unquote

7
The refund mechanism is handled by Director General of Foreign Trade (‘DGFT’).

11
The primary aim of doing away with these exemptions is not to affect the credit
mechanisms in the supply chain, which ultimately reduces the high cost burdens on the
consumers.

The First Report also proposes to reduce any GST refund except in certain situations like
exports purchase of capital goods, input tax at higher rate than output tax etc. Therefore,
there could be mechanisms of refund of GST when goods are manufactured and exported
and where input taxes cannot be utilized by the manufacturers. This recommendation
implies that any other refunds; such as CST refund to EOU or SEZ Unit, which is currently
sanctioned by DGFT, should be done away with.

F. Threshold for imposing GST

As discussed above in our Point B, the First Report stresses on having a uniform threshold
of Rs. 10, 00,000/- across all the states and compensation to those states which may lose
revenue owing to much lower threshold currently under VAT regime. The First Report also
proposes to have threshold of CGST for goods to be at 15,000,000/- and threshold for
services also to be high.

G. Other Procedural Mechanisms

The GST First Report devotes its substantial space on procedural and micro-level
management of taxes. It recommends to have a PAN/TAN linked identification Number to
dealers which would bring GST at par with Income Tax identification Number and
governments across all the departments can share data, information and intelligence. Also,
the First Report emphasize on the filing of compliances, returns, scrutiny, and audits by
Center and States differently.

H. The Aspects of IGST/Inter – state GST/Integrated GST

In the prevailing taxation regime, inter-state sale of goods are governed by Central Sales
Tax Act, 1956. The jurisdiction to frame laws, to levy and collect tax (Central Sales
Tax/CST) on inter-state sales has been given by Constitution of India to Union. However,
for an efficient tax administration in collection and appropriation, the powers to collect tax

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has been vested to States and they can appropriate such taxes for state’s own purposes
though the rate of tax is still determined by the Union.

In GST regime, the CST will be replaced by IGST. One of the lacuna with CST regime was the
lack of credit mechanisms for the dealer where the taxes paid on inputs on inter-state sale
could not have been set-off with local sales or intra-state sales. The introduction of IGST
would take care of such credits aspects and would be a major improvement over CST.

One of the recommendations made in First Report on IGST states,

“The scope of IGST Model is that Centre would levy IGST which would be CGST plus SGST on all
inter-State transactions of taxable goods and services with appropriate provision for
consignment or stock transfer of goods and services. The inter-State seller will pay IGST on
value addition after adjusting available credit of IGST, CGST, and SGST on his purchases. The
exporting State will transfer to the Centre the credit of SGST used in payment of IGST. The
Importing dealer will claim credit of IGST while discharging his output tax liability in his own
State. The Centre will transfer to the importing State the credit of IGST used in payment of
SGST. The relevant information will also be submitted to the Central Agency which will act as
a clearing house mechanism, verify the claims and inform the respective governments to
transfer the funds.”

Therefore, as per the recommendations of First Report on IGST, we understand that IGST
will have following characteristics:

A. The IGST would be levied by Center/Union. Union will have the power to make and
amend the rules relating to IGST. However, its rate would be CGST plus SGST.
B. The IGST would be imposed on inter-state transactions/transfer/sale of goods and
services.
C. In IGST model, there would be appropriate provision for consignment sale and stock
transfer of goods and services. This recommendation is yet to be clearly understood.
The recommendation does not clearly lay down any rule either to have some taxing
mechanism or exemptions to stock transfer or consignment of goods and services.
Currently, under the central sales tax regime, the stock transfer of goods and

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 consignment sales has been exempted. However, any such move to tax under GST
may be counterproductive.
D. The liability to pay IGST is on seller of goods, which deals in inter-state sale of goods.
Such liability can be discharged after adjusting CGST, SGST and IGST incurred on
inputs, and only the balance amount would have to be discharged as IGST.
E. The most interesting aspect of IGST is that though the credit pertaining to SGST can
be utilized by the trader to discharge its IGST liability; the exporting states should
transfer the amount of SGST utilized to pay IGST to Center.
F. IGST can also be utilized to pay liability under SGST. Therefore, any IGST amount
paid on inputs can be set-off against local sales tax obligations i.e. SGST. This is by
far the biggest improvement of IGST over current CST tax regime as presently; no
credits of CST can be taken by dealers.
G. One more interesting aspects with the whole mechanism of GST are that center
would transfer the credit amount to the importing states where the importing
dealers have utilized IGST to discharge its CGST liability.
H. As relevant procedural aspects, states have to submit the relevant data to central
agency which will act as a clearing agent.

The First Report outlines following as advantages of IGST over present CST
mechanisms:

a) Maintenance of uninterrupted ITC chain on inter-State transactions.

b) No upfront payment of tax or substantial blockage of funds for the inter-State seller
or buyer.
c) No refund claim in exporting State, as ITC is used up while paying the tax.
d) Self monitoring model.
e) Level of computerization is limited to inter-State dealers and Central and State
Governments should be able to computerize their processes expeditiously.
f) As all inter-State dealers will be e-registered and correspondence with them will be
by e-mail, the compliance level will improve substantially.
g) Model can take ‘Business to Business’ as well as ‘Business to Consumer’ transactions
into account.

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THE RATE OF TAX UNDER GST REGIME:

Though there is more or less conceptual clarity in the GST, one of the important aspects i.e.
the rate of GST has not been decided by the parties yet. In the supply chain, keeping in mind
the effects on price, the rate would have significant impact. The rate of GST would have a
major impact on the sustainability and effective implementation of GST.

Before deciding any rate, the major attributes of GST rates and its impact should be fully
understood. The GST rate should not be so high, neither so low as higher rate of tax leads to
possibility of avoidance of tax; low tax rate, on the other, will not yield enough revenue for
the states to sustain its revenue requirements. In fact, economists argue that low tax rate
will give unnecessary benefits to rich and makes them even richer widening the gap
between ‘haves’ and ‘have-nots’.

Before deciding any tax rate under GST, it is worthwhile to understand the tax rate
structure under present excise and VAT/Sales tax laws. Under excise duty the rate of tax
varies from ‘NIL’ rate to 16% depending on goods and under service tax rate, it is pegged at
10% rate. However, the rate in change in central legislation, if any under GST should not
cause any problem for its implementation as Central Government is receptive to speedy
and effective implementation of GST. The difficult task to implement GST would be mainly
because of the conundrum created by various tax rates prevailing under local sales tax
legislation/VAT laws. Under present VAT, there are mainly six types of tax rates applicable
depending on the nature of goods.

The first category of goods which are in the nature of basic necessity, and are related to
agricultural products are taxed at the rate of 0%, or exempted goods in some states, not
brought within the purview of local sales tax in the States. Some goods, mainly the gold,
silver, and the goods having nature of having precious metals are currently taxed at 1%
rate. Normal goods of common necessity are generally taxed at 4% tax rate. Any goods
which are normally called ‘sin goods’ like liquor, tobacco, and petroleum products are taxed
in the very high tax rate ranging from 20-70% depending on each state. And, any goods
which are not covered by any schedules are generally taxed as residual goods falling under
residual entry and are taxed at 10-14% depending, again, on each state. Though this is a

15
normal pattern by which tax is levied on sale of goods across the states, there are a lot of
deviations from each state to another and the good which is taxed at lower rate in one state
could possibly be taxed at higher rate in another state.

In this varying situation, it is a difficult task to determine, and introduce a tax rate similar
to all goods across all the states. States fear that a uniform tax rate across all the states on
all the goods, and emasculation of power to change the tax rate on their sweet will, on one
hand, disturbs the concept of ‘fiscal sovereignty’ and on the other, takes away state’s major
chunk of revenue and state cannot discharge its welfare activities due to lack of fund.

Most possibly, echoing this sentiment and reservation of states, the First Report has
proposed that there would be two tax rates, one for necessary items and for goods of basic
importance, and another standard rate for goods in general. Though, the Report
recommends two tax rate structures, after reading little down the recommendations, it can
be felt that there is no consensus among the states on rate of tax. This is clear from the First
Report as it mentions in Para 3.6 in Page 30,

“The Empowered Committee has decided to adopt a two-rate structure –a lower rate for
necessary items and goods of basic importance and a standard rate for goods in general.
There will also be a special rate for precious metals and a list of exempted items. For
upholding of special needs of each State as well as a balanced approach to federal flexibility,
and also for facilitating the introduction of GST, it is being discussed whether the exempted
list under VAT regime including Goods of Local Importance may be retained in the exempted
list under State GST in the initial years. It is also being discussed whether the Government of
India may adopt, to begin with, a similar approach towards exempted list under the CGST.

The States are of the view that for CGST relating to goods, the Government of India may also
have a two-rate structure, with conformity in the levels of rate under the SGST. For taxation of
services, there may be a single rate for both CGST and SGST.”

The above paragraph from the First Report clearly endorses the special tax rate for
precious metals like gold and silver and necessity of having exempted goods’ lists. Under
current VAT laws also, precious metals like gold and silver have been placed in a special

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schedule under 1% tax rate. Similar is the case with exempted goods/zero-rated goods
which are provided under all the states’ VAT laws. Therefore, though it is claimed that GST
will be a major improvement over local state level VAT laws, if tax rates are determined in
line with VAT laws, most of the virtues of GST would be redundant. The point, I would like
to highlight once again here, is that if states are vested the power to change the SGST/ or
tax rates of different goods, again, the rate war among the states based on their perceived
threat will make whole GST mechanism a illusionary effort.

Therefore, there is a need of broader consensus to arrive a revenue neutral tax rate which
should be as low as possible and also should not deprive states’ its major chunk of revenue.

This concern has also been shared by the Second Report on GST that has been issued as
REPORT OF THE TASK FORCE ON GOODS AND SERVICES TAX, THIRTEENTH FINANCE
COMMISSION, 15TH DECEMBER, 2009 by Finance Commission (herein after ‘Second
Report’) where it has suggested that there is a need of single rate of tax to make GST
effective and functional to achieve its objectives. The Second Report in search of support
for a single rate of GST refers to Task Force on Implementation of the Fiscal
responsibilities and Budget Management Act, 2003 wherein it was expressed that high
tax rates are the cause for economic distortion. The task force at that time opined that
fewer tax rates and lower tax rates are ideal for effective implementation of any fiscal
legislation. The Report then highlighted that fewer classifications in Customs would in
effect encourage the tax compliance and reduce unwarranted and protracted litigations.
The Second Report also cites a Research by Bogetic and Hassan8 which concluded that a
single VAT rate would mobilize high amount of revenue than the VAT regime having
multiple tax rates provided the base of tax is wide and administration and enforcement is
strong.

8
Page 55 of Second Report. Refer Foot Note No. 26 in Second Report. The citation of the Research of Bogetic and
Hassan is “Bogetic, Zeljko and Fareed Hassan (1993). Determinants of Value – Added Tax Revenue: A Cross –
Section Analysis, The World Bank Working Paper No. 1203.”

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After citing the Research of Mello9, Michael Keen10, the Second Report recommends to have
a single rate of tax under GST as it has been more efficient yielding more revenue and
incentivizing for compliance. After noting these insightful backgrounds, the Second Report
recommends for a one positive rate each for CGST and SGST, and a zero rated tax for
exports of goods and service taken out of India.

While deliberating on the rate of tax, the Second Report focuses on the Revenue Neutral
Rate of tax (‘RNR’) which is a required rate of tax under GST to collect the same amount of
Revenue as that is being collected under various indirect taxes presently. After taking into
account the economics and finance of the current revenue collection, the Second Report has
recommended that the CGST and SGST rate for Non-SIN Goods11 should be a single rate of
5% and 7% respectively. Therefore, in one of the most controversial topics, though the
First Report does mention only that appropriate tax rate would be disclosed once the
legislations are formed, the second report emphatically recommends a very low single tax
rate. We are yet to see how these recommendations are incorporated in the main
legislations when they are enacted.

CONCLUSION:

In the process of reform of tax administration in India, GST will be playing a major role
provided its enactment and implementation is done with absolute sincerity. Though the
governments of States and Center acknowledge the need of modern tax regime which is
effective, transparent and assessee friendly, there is still no consensus among the states on
its modalities and implementation. First of all, the urge of states to retain their
‘constitutional state sovereignty’ over taxation matters may derail the process and only few
states taxes may be subsumed in GST leaving many taxes outside its purview. It is needless
to say that more state taxes are to be subsumed in GST to bring the intended objectives into
a reality.

9
Mello, Luiz De (2008). Avoiding the Value Added Tax: Theory and Cross-Country Evidence, OECD, Economics
Department Working Paper No. 604.
10
Michael Keen (2009): “What makes a successful VAT?”, Presentation at the Workshop on September 30, 2009
at the National Institute of Public Finance and Policy (NIPFP), New Delhi.
11
The term SIN GOODS refer to goods of the nature of tobacco, liquor etc. which are not basic commodity and
society in general do not accept the free and unregulated sale of such goods.

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Secondly, the rate of tax would be another major bone of contention among states and
centers. States may stress upon imposing different tax rates to different kinds of goods;
essentially trying to retain the tax rate prevalent under local sales tax/VAT that has been
presently imposed. This is one area where if states succeed, will certainly dilute the
positive effects and impacts that GST would bring in future.

The issue of compensation of taxes may also delay the implementation of GST. Mostly, the
states which have road tax, octroi in State of Maharashtra, purchase tax on agricultural
produce in State of Punjab and states having low threshold limits for VAT wish to have
assurance from the Union that there will be compensation for any loss of tax by subsuming
the various states taxes. However, mostly the states which have octroi and purchase tax are
not willing to subsume these taxes in GST. Therefore, there is a need to have a broader
consensus and reasons why such states should retain these taxes when majority of state
taxes are being subsumed as proposed by First Report.

Therefore, in conclusion, we can say that a vibrant economy can be created only if major
indirect tax reformations in India through GST is implemented at the earliest with no or
minimum such flaws so that it can have a life of longer duration and can also contribute to
the Indian economy reducing cascading effects across all the supply chain. To achieve this
utopian objective, the major roadblocks and hiccups that have been on the way must be
brushed aside as soon as possible by the Union and the States through consensus.

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