Is there a vaccine for inverted duty structure in GST?

The recently concluded GST Council Meeting had a prolonged debate on giving exemption for Covid related materials and ultimately decided to set up a panel to examine the issue and arrive at a conclusion. The Panel is anticipated to submit its report on or before the 8th of June 2021. This issue has led to veritable political slugfest with emotions running high. At the core of this issue lies the problem of inverted duty structure. Covid items cover a whole spectrum of items with different GST rates. Vaccines and mask are taxed at 5%; testing kits, medical oxygen, oxygen concentrators and ventilators attract 12% tax rate and hand sanitisers, hand wash and disinfectants fall within the 18% tax bracket.

What is an inverted duty structure?

Every taxpayer procures inputs of goods and services and supplies goods and/or services. Where the rate of GST on inputs is higher than the GST rate applicable on the supplies, the taxpayer gets into a quagmire called inverted duty structure. Here the additional gst that is paid on the inputs but which is not collected from the customer adds to the cost of carrying on business. Taxpayer expects the government to make good the additional burden by way of refund. The administrative machinery is extremely hesitant when it comes to refund and thus leads to further complications by way of delays, disputes and litigations. Is there a way out of this quagmire?

The pandemic of Covid-19 has been tectonic or earth shattering event in the annals of Indian economy. Let us assume that a building is constructed in an area which abruptly starts experiencing tremors. The logical step would be to examine the ability of the building to withstand tremors and provide reinforcements so that the structure serves its purpose. Let us apply this to GST.  Does the architecture of Goods and Services tax has the tenacity to withstand the tremors caused by the pandemic?

This article is a gentle effort to examine this issue.

Tremors caused by the pandemic can be broadly grouped as follows:-

1. Taxpayers have had long periods of lull in activity resulting in operational losses in business. In other words, taxpayers are confronted with negative value addition with value of inputs procured being more than the value of sales. Additionally, enterprises in certain sectors have had to contend with burden of increased cost of inputs with demand for output nosediving, proverbial double whammy.

2. Taxpayers have incurred capital investment just before the onset of pandemic and are left to count the days to reap the returns. Here the goods and services tax paid on capital goods is an additional burden as the taxpayer is unable to utilise it fully forthwith. 

3. Taxpayers who are caught in quagmire of inverted duty structure as explained above.

To summarise, the first two are issues of negative or no value add and the last one is one of inverted duty structure.

Architecture of Goods and Services Tax(GST):- 

The GST is a system of value added tax. The conceptual basis for any taxation is provided by Economics while the administration is done through a web of tax laws. Value added tax systems are designed and implemented in three forms and they are:-

1. Subtraction method:- Every entity deducts the value of purchases from the value of sales and applies the GST rate on the net value addition and remits the tax. This is more entity specific and accounts based. There are not many countries that have adopted this method barring exceptions like Japan. Purchases from dealers who are outside the VAT net would also be deducted and being entity specific, there is scope for abuse when purchases are made from related entities. 

2. Addition method:- This method is more theoretical in nature and very less practical utility. Tax is levied on the elements of wages and profits being the value addition that an entity generates.

3. Invoice credit method:- GST in India follows this system. Here purchases from registered dealers as evidenced through invoices is multiplied by the tax rate and the same is deducted from the value arrived at by multiplying the gst rate on the sales effected through invoices. The system is more fool proof as only value addition arising from transactions between registered dealers are considered for the purpose of levy of GST. This is more transaction based and not entity specific. However, the system attains optimal efficiency when the number of GST rates is limited to one or very few. 

There are multiple rates of GST in India along with exemptions. Inverted duty structures are a fallout of having multiple tax rates. This has undermined the efficiency in tax administration. To offset the burden of inverted duty structure, there is need to include items of domestic supply under zero rating. Zero rating involves negating the burden of input tax through a process of refund. Here the taxpayer is eligible to refund of the taxes on inputs and the outward supply is exempt from GST. 

To alleviate the problem of inverted duty structure, (a) the Government has to look at seriously reducing the number of GST rates and (b) implement an efficient scheme of zero rating for goods and services. This change in the GST framework is required as it will improve efficiency even in the post pandemic phase.

Negative value add during the pandemic:-

The legacy systems of value added taxation are ill equipped to meet the challenges associated with substantial volume of negative value add in the economy. Negative value add in common language refers to operating losses in business. Value added tax by definition looks at taxing the positive value add. GST is avowedly a tax on consumption. However in a scenario where many enterprises have negative value addition in the economy, the tax becomes a tax on production instead of being a tax on consumption. This gravely impairs already enfeebled productive capacity in the economy. Hence the architecture of GST requires some radical tinkering in phases of pandemic as well as some innovative solutions.

The GST administration is driven through information technology. Hence the revenue collection efficiency has improved over time as the Revenue has been able to plug leakages. Technology driven system provides sufficient leeway to implement innovative solutions during pandemic.

The Government can alleviate the suffering of the enterprises that either face periods of lull in activity or have invested in capital goods but have to wait to reap the benefits by allowing the units to monetise the GST paid on inputs and lying surplus in their returns. The surplus input tax credit should be allowed to be transferred to another taxpayer for consideration. This can be mediated through Information Technology by the Government as the input tax credits are already available in electronic mode with the government. The ecosystem of GSTN, GSPs and ASPs can play an effective role in developing a system for monetising the input tax credits. 

Enterprises procuring the credits can be allowed additional credits for every unit of input tax credit procured on the lines of weighted income tax deduction given for research and development expenditure. Enterprises transferring the input tax credit can enhance their liquidity during the pandemic and this will also enable the lenders to view the GST credit as liquid asset during times of suspended animation. Though the Government may lose revenue in the short turn, it will surely benefit in the long run if the stakeholders are provided an opportunity to survive, or to use oft-quoted but rather unpalatable medical phrase, “stabilise” a sick business.