We are now at the horizon of the Constitutional Amendment and passage of the GST bill, which are now in its final stages. By far, the GST amendment will be the biggest step the country has taken in ensuring economic integration. While the draft law comes with a promise of economic growth, it poses several critical pitfalls that can adversely affect businesses in the country.
GST: Great or Gruesome
The trust deficit between the Citizens of India and the Government of India has plummeted to new depths when one reads the Draft GST Law. In one fell swoop, a swathe of businesses is staring at their death knell – as instead of being the promising vehicle for growth, GST has the potential to destabilize all that is good. On the bright side, this is still a draft law – and corrections can be applied, so that GST indeed becomes the Greatest Simplified Tax regime, and the biggest economic event of Independent India. It has all the ingredients to become so. Why then, am I sounding the danger bells?
The most critical cause of failure of GST will be in the transference of responsibility and liability of tax remittance to the customers of a supplier (Section 16(11)( c)). Basically, the law postulates that if a particular supplier has failed to comply with the law correctly – by furnishing the correct returns (Section 27(3)) and/or making the correct payment (Section 27(2)) – then its’ customers cannot avail the input credit, and if given, it will be reversed.
The origin of this provision lies in the history of tax avoidance through false representations by a small section of businesses[i] and the fact that it was not feasible for the Government to systematically contain this problem. With the framing of this law, the Government hopes that the market will self-weed out the bad eggs – which is not wrong in theory. What is wrong is not understanding the cascading consequences of doing this in practice – and the mayhem it will create. While the effort for driving compliance will reduce, the consequential effect of businesses shutting down, and therefore collections going down, have not been treated seriously enough.
What exactly is the problem?
Let us understand this by visualizing a scenario.
Assume Business A operates on a retained margin in the range of 8-9% [ii]
Because it is (say) an SME, it buys without access to good credit terms. So, it has purchased goods worth 50,000, and with GST of 20%, it has paid Rs. 60,000 for the invoice. It now sells this at Rs. 55,000, with an applicable GST of 11,000 – so raises an invoice of Rs. 66,000 on Business B.
Business B is a distributor, operating on a margin of (say) 2% [iii]
Now, Business B is concerned that the input credit of Rs. 11,000 may or may not available to it, in case Business A is negligent in its compliance. Therefore, it refuses to pay the GST amount UNTIL it can be certain to get the input credit (which is an entire ‘return’ cycle away). So, it pays only Rs. 55,000 on an invoice valued Rs. 66,000.
Business A, in order to ‘get’ the balance due of Rs. 11,000, has to first finish all compliance requirements, including payment of Tax, when it has not yet ‘collected’ the Tax amount! In contrast, if Business B ‘trusts’ Business A and DOES pay the Rs. 11,000 – and if, for whatsoever reason (negligence, cash difficulties, mal-intent), Business A fails to complete the compliance, Business B will lose not just Rs. 11,000, but in effect, the ‘margin’ it makes on 10 other such invoices (since it operates on a thin margin of 2%)!
Critically, this is not just an ‘invoice to invoice’ problem. Business A probably supplies to twenty-thirty people, and each of its customers will not have access to input credit due to any negligence of Business A!
Apart from this, there are going to be enough collateral problems. For example, when the input credit is denied, will this be formally treated as a ‘business expense’ and not be taxed by Income Tax? Obviously yes! But at what point do I treat this as ‘contingent expense’? Will my Advance Tax payments made on the assumption of ‘possible write back’ be accepted? If not, will I be reimbursed for the cash-flow cost I incurred? How do I report my end-of-quarter and end-of-year? Will banks fund me? Will insurance cover this risk? How much more working capital will I require? Will I be eligible for it?
When the input credit is uncertain and outside one’s span of control, the correspondent questions which will arise – and correspondent litigations can only be imagined. The last two-three questions will kill a large number of businesses (SMEs, Distributors, Stockists, Industrial Retail, Commodity traders – who either work on wafer-thin margins, and/or with inadequate cash).
The reasoning of the Government is: people are today colluding (albeit in small percentages) to fraudulently take input credit when it is not due. Therefore, it is only fair to put this risk back on the citizen. It also reasons that because this is a small percentage, which will keep declining due to self-correction by citizens, it is not a ‘great burden’ – that is, the ‘business risk’ is small enough to be manageable.
The problem is not the ‘management of a manifest risk’ – the problem is the side-effects of cash flow, improper accounting, and reduced ability for people to trade with new suppliers and new customers – since there is uncertainty about the business outcome.
Is there a solution?
Of course. One of the greatest benefits of GST is that it is built ground up as a technology-enabled-tax-system.
In the past, it was not feasible for the Government to systematically mitigate the risk of fraud, since there was no practical human ability to keep track and trace the culprits – who could/would repeatedly create phantom organizations, and/or phantom invoices. Against this history, it is no wonder that the Government wants to control this menace!
However, GST gives extraordinary traceability. For one, it fully eliminates the ability to have phantom invoices. That alone, will massively reduce the problem. Secondly, with the near ubiquity of Aadhaar and the passage of the Aadhaar Bill, the Government MUST mandate that all GST registrations are traceable to individuals based on their Aadhaar identity. Now, the ability to repeatedly create phantom organizations which allow credit to be taken without correspondent payment will rapidly evaporate. And, of course, the sheer traceability of the individuals, and strong public actions showcased for deterrence, will NOW become effective.
While Tally has been working to ensure that the right software is available to all of you to simplify and manage your business when GST comes, it will obviously not help to solve this basic problem created by the law itself.
GST has all the ingredients to be Great. Making it practical and convenient, by removing this one MAJOR lacuna, will go a long way in its ‘welcome embracement’ rather than ‘resisted embracement’. Being technology led, it also has all the ingredients to spiral upwards the trust deficit, rather than spiral downwards. If all of us, as responsible citizens of India, rally together to help make it Great, we will all live together in a Greater and Grander India.
The author is the Founder & Managing Director of Tally Solutions Pvt ltd.