Demystifying Tax

There is no alternative to tax for a civilised society. Taxes existed since ancient times in India, but the present-day taxation has evolved from the British systems of taxation. The new avatar of tax in India, the GST, is envisioned as a one-point taxation system across the country, but like all new systems, comes with its own set of challenges....

Benjamin Franklin had said, “There are only two things certain in life, death and taxes.” There are many such quotes about taxes. Einstein goes to add that the hardest thing in the world to understand is income tax. But, the fact remains that taxation is the price which civilised communities pay for the opportunity of remaining civilised, as stated by Albert Hart.

Through the years...

The history of taxation in India is very old. Kautilya in his Arthashastra has elaborately discussed the taxation system. He has advised that the collection of taxes should be like the bee gathering honey from flowers, without causing any pain.

Taxation can be broadly classified into two parts: Direct and Indirect tax. The modern-day direct tax or income tax was first enunciated in India in 1860. The main objective of the Britishers in bringing this tax was to compensate for the loss incurred during the 1857 ‘war of independence’, which was called the ‘sepoy mutiny’ by them. However, it was by the 1922 Act of Income Tax that it was formally elucidated. Then, after independence, the ‘Income Tax Act 1961’ came into force and the same is still continuing with several amendments, brought about almost every year, since then.

The modern-day indirect tax came with the levy of customs duty and excise duty. There is a record of indirect tax being collected by kings in the past, as the share of the state against the agricultural yield or even tagged to the land holding.

After the industrial revolution in Europe, the Britishers started dumping textiles in India and to make their products cheaper in the Indian market, tax started being levied on the domestic textile production and this was called excise duty. Gradually, taxes on imports also came into being and that was called a customs duty. After independence, indirect taxes started being levied by both the states and centre and to some extent, even by the local authorities.

State and central taxes

The Constitution clearly spells out the subjects on which the centre and state can levy taxes. The levy of direct tax, namely income tax, corporate tax and the allied taxes, remained strictly a central subject. With effect from 1 July 2017, the Goods and Service Tax (GST) has come into existence, subsuming 27 central and state taxes including octroi levied by local bodies. GST is an indirect tax and the objective behind it is to have one indirect tax throughout the country. However, some exceptions are petroleum and alcoholic products.

Direct tax is considered a progressive tax since it is paid based on the income of a person. No tax needs to be paid if the income is less than the threshold limit. The quantum of payable tax rises with the rising income slab. A rich man pays tax, while a poor man does not pay any tax. Indirect tax is considered retrograde taxation as such tax is paid in equal measure by both the rich and the poor. Indirect tax is levied on goods and services and it is payable by whoever consumes the goods or uses the services. For example, a tycoon and a beggar pay the same tax when buying a matchbox.

A developed country collects more direct tax while a poor country collects more from an indirect tax as the tax base for direct tax is big in rich countries but smaller in poor countries. To begin with, just after independence, our collection from indirect tax used to be much higher, compared to direct tax collection. However, the situation today is the reverse.

Coming to the definition, income tax is a tax on the income of a person during the previous year. The ‘person’ has been defined to include: individual, HUF, AOP, BOI, company, partnership firm and artificial juridical person.

GST is a value-added tax levied on most goods and services, sold for domestic consumption. It is a comprehensive, multistage destination based tax. It is comprehensive because it has subsumed almost all indirect taxes, except a few state taxes and customs duty levied by the centre.

‘GST is a value-added tax levied on most goods and services, sold for domestic consumption. It is a comprehensive, multistage destination-based tax. It is comprehensive because it has subsumed almost all indirect taxes, except a few state taxes and customs duty levied by the centre’

How GST works...

With regard to GST, this new indirect tax got evolved after the 101st Amendment of 2016 of the Constitution. Article 246 of the Constitution distributes legislative powers, including taxation between parliament and state legislatures. Schedule VII enumerates the subject matters on which parliament and states have the power to make laws and they are provided in three lists: List I (Union List), List II (State List), and List III (Concurrent List). Some indirect tax subjects used to be in the Union List and some in the state list.

To have one comprehensive tax, an amendment to the Constitution was needed. With the amendment, a new provision 246 A has been inserted which mandates the power to impose GST. The new article 246A (I) bestows the power on both the parliament and state legislatures to make laws on GST, with exceptions noted in the article 246 A (2).

The amended provisions in the Constitution include another new article 279 A, which provides for constituting a council named the ‘GST Council’. The members of this council, which will act as an apex body for GST, will include: Union Finance Minister (Chairperson), Union Minister of State of Finance (Revenue), Ministers in charge of Finance or taxation of states and Union Territories. The GST Council will be empowered to decide about the taxes that may be subsumed. The council will also list out the goods and services that may be subjected to GST or exempted, along with the GST rates and the threshold limit for taxation. The votes by the members of the council are weighted as one third for the centre and two thirds for total States/UTs. All the decisions by the GST council have to be passed by a majority of not less than 3/4th votes of the members present.

‘After the industrial revolution in Europe, the britishers started dumping textiles in India and to make their products cheaper in the Indian market, tax started being levied on the domestic textile production and this was called excise duty’

Shared GST

GST was launched at midnight on 1st July 2017, by a special session of both the Houses of Parliament. The process to enact GST had started almost 15 years ago by the earlier NDA government. The succeeding UPA government also tried its best to launch this, but could not succeed as the manufacturing states were not agreeable, on the ground of anticipated revenue loss. Finally, the present government could implement it as it promised the states that for five years, the centre will compensate the states if their revenue falls short of growth of 14%. The government has set in place a scheme for creating a cesspool for financing the compensation.

The GST of India is dual-system taxation as both centre and states legislate and collect taxes. GST has three components:

• CGST- Collected by the central government on an intra-state scale (say, transactions happening within Maharashtra)
• SGST–Collected by the state government on an intra-state scale (say, transaction within Maharashtra)
• IGST – Collected by the central government for inter-state scale (say, Maharashtra to Tamil Nadu).

The CGST and SGST will be of an equal rate. There are 5 slabs for GST: 0%, 5%, 12%, 18% and 28%.

Tax on value addition

GST is a multi-stage taxation. We know that there are multiple change of hands from raw materials to finished goods and finally to consumers, like:

• Purchase of raw materials
• Production or manufacture
• Warehousing of finished goods
• Sale to wholesaler
• Sale to retailer
• Sale to consumer

GST is levied at each of the above steps and hence it is multi-stage taxation. The value addition at each stage attracts GST. The GST has a system of an input tax credit at each stage and this unique factor is the most important aspect. In the process, GST eliminates the cascading effect and thus goods become cheaper for the consumers. The GST scheme has the following advantages:

• Removes cascading tax effect
• Higher threshold for registration
• Composite scheme for small businesses
• Online simpler procedure
• Lesser compliances
• Increased efficiency in logistics
• Regulating the unorganised sector
• Wider tax-net for direct tax

‘Direct tax is considered a progressive tax since it is paid based on the income of a person. No tax needs to be paid if the income is less than the threshold limit. The quantum of payable tax rises with the rising income slab. a rich man pays tax, while a poor man does not pay any tax’

No tax on tax

In the pre-GST regime, every purchaser, including the final consumer paid tax on tax, giving rise to a cascading effect of taxes. GST has removed this, as tax is calculated on the value addition at each stage of the chain. To understand this, let us take the case of biscuit manufacture in both pre-GST regime and ununder the GST regime.

Pre-GST Regime

We see from above that tax liability was passed on at every stage of the transaction and the final liability is paid by the consumer.

GST Regime

The system of input tax credit helps save the situation at each stage of value addition and the final consumer pays less than what he had to pay in the pre-GST regime.

Criticisms aplenty

There are many criticisms about GST also. First, it is about the multiple slabs of tax rates when other countries have just one slab. The government has clarified that India is a big country with a huge population, which has a small portion of the rich, but a very big portion of the poor and the middle class. In addition, about 30% of the population is still below the poverty line. The highest rate of 28% is for ‘sin’ goods or for goods used by the rich. 0% tax is for commonly used goods, goods used by the poor. 5%, 12% and 18% tax rates have also been decided based on the sections of population using the goods. A Hawai chappal and luxury car cannot be taxed at the same rate. It is still felt that the slabs should be reduced from five to three without sacrificing the revenue.

Seen as ‘complex’

Secondly, the GST system requiring filing many returns have also been criticised. The government has clarified that the system has been periodically simplified. It is true that the system which stands today is much better than what was initially launched. It takes time before a new system settles down.

Third, the many notifications issued by the government confuse both the tax collectors and taxpayers. The intention of the government is honest as the notifications are supposed to be clarifications.

Gradually people will get used to the new taxation and they may appreciate it. GST code is simple legislation, where the involved issues from registration to adjudication are clearly spelt out. One very important thing is that the entire process is online and there is no need of visiting tax offices. Incidents of corruption will decline as there will be no human interaction.

Bogus GST invoicing

The sad thing which is being seen is that the tax collection from GST is falling short of the target. It is really ironical that the tax base of the registered GST assessees have increased much compared to the pre-GST regime and even then the collection is falling short. Tax authorities have detected large scale planned tax evasion by raising bogus invoices to claim a refund against illegal input tax credit. Instead of paying tax, many are engaged in illegally earning from GST. The government is trying to plug the loopholes but still much is desired. The only solution is that our people should be enlightened enough to realise that it is their duty to pay tax. I will conclude with what Henry Ford said, ‘A business that makes nothing but money is a poor kind of business.’