How to make GST more efficient

In its two-day meeting held at Chandigarh on June 28-29, the GST Council increased tax rates on several products. This should not disturb the macro picture as the current weighted average GST rate at 11.6 per cent (RBI calculation, September 2019) is still below the revenue-neutral rate of about 15 per cent. With this comfort, on GST’s fifth anniversary, the GST Council should now focus on introducing bold reforms to usher in the next high-growth phase of GST and the economy.

Proposed below are five such transformational reforms. The proposals are based on insights drawn from data and interactions with users.

First, set the small firms free by raising the exemption limit. GST data show that of the total 1.4 crore registrations, firms with less than ₹1.5 crore annual turnover account for 84 per cent but contribute less than 7 per cent of the tax collected.

Currently, registration for GST is optional for firms with an annual turnover of less than ₹40 lakh for goods and ₹20 lakh for services. The exemption limit must be raised to ₹1.5 crore for goods and services. This amounts to ₹12-13 lakh monthly turnover, which at 10 per cent of profit margin, translates into just ₹1.2 lakh. Only a fraction of this money will remain with the business owner after payment of working capital and fixed expenses.

The new limit would reduce the load on the GST system, which will deal with less than 23 lakh taxpayers in contrast to 1.4 crore now. The reduced load will allow the GSTN to introduce an invoice matching concept, which will result in 100 per cent compliance, solving the problem of fake invoices and tax theft.

The increased tax collection will adequately compensate for the 7 per cent tax loss.

The proposal will take out 99 per cent of small firms from the tax net, increasing their profit and making them more competitive. The step will revolutionise the small sector. Free from GST hassles, small firms can invest in technology and create more jobs. Everyone gains.

Second, do away with State-wise registrations. Today, if a firm does business in 10 States, it must obtain 10 GSTINs and maintain a separate account for each. The GST rules set a restriction on the use of available credit.

For example, if a firm has a surplus SGST credit in Maharashtra, it cannot use this credit to pay SGST dues in Karnataka or CGST dues to the Central Government. This restriction results in capital blockage. Essentially, GST has converted one firm into 10 independent entities. This defeats the ‘One Nation, One Tax’ concept. A mindset change is needed.

GSTN has precise location information of all transactions. It can calculate States’ dues from this data. The GSTN software may be tweaked to allow credit transfer between two States or between the Centre and States. This flexibility of credit transfer will not impact a State’s revenues. The GSTN will credit the due amounts to the State’s account, keeping the principle of destination-based tax intact.

Too many rates

Third, fewer rates and machine-compatible classification. Many countries implementing GST have just one rate for all items. From zero to 28 per cent, India has seven rates. This number increases if we also consider compensation cess rates. The tax slabs should be reduced to three.

Mining the past five years’ GST data will identify less important categories from a revenue angle and help reduce tax slabs without compromising revenue. The government must open this data for research purposes after suppressing commercially sensitive information.

There is also the need to simplify the GST rate list and make it compatible with machine processing. The GST uses Harmonised Structure (HS) codes for classifying most items. HS codes are an accepted product classification system in over 180 countries. Also, HS codes are expressed in 2,4,6, or 8 digits. The larger the digits more precise the product description. For example, HS 62 denotes apparel, 6204 is girl’s suits, 620419 is girl’s suits made of silk, and 62041911 is embroidered girl’s suits made of silk.

But here lies the problem: GST rules have exempted small firms from mentioning any HS code. The product description is sufficient. Others must mention the HS 4-6 digit code; exporters must mention the HS 8 digit code. Non-uniform criteria for mention of HS code ensures that the computer cannot match the invoices.

There is another issue with the current rate list. While most products are listed at HS 4 level, no specific HS codes are mentioned against many products creating hurdles in data processing operations like linking transactions.

The government may mandate for everyone the use of the HS 6 digit code. This gives a sufficient product description. A call centre may help firms in finding the correct code.

All GST rates should confirm to HS 6-digit standard description. The ideal way would be to take a standard HS 6 digit table and insert the GST rate against each code. Such clean classification will remove confusion caused by the current complex classification and help match invoice level details.

Fourth, operationalise invoice matching and unify State portals with GSTN. The GST rules provide system-driven invoice matching to enable quick tax credits and avoid the prevailing fake invoice problem. The GSTN must gear up to implement this.

Fifth, reduce working capital blockage for exporters. The government collects GST from exporters only to refund it later. This is because GST is a tax on domestic consumption while exports go out of the country. The GST refund process blocks exporters’ money for a long time.

The GST Council in 2018 recommended a new e-wallet facility for exporters. The exporters’ e-wallets will have notional credits. The exporters will use these instead of cash to pay GST. The transactions have to be reconciled periodically to prevent misuse. The scheme must be notified at the earliest. Using blockchain to maintain the integrity of the e-wallets may be explored.

The GST, launched on July 1, 2017, is regarded as the most significant tax reform in India since Independence.

The reforms proposed here will prevent tax leakage and make GST more efficient and inclusive.

The writer, a former Indian Trade Services Officer, is author of the book ‘The GST Nation’