Understanding Goods and Service Tax # 2: Concept of Origin and Destination Based Taxation and how Indian Model of GST would be a Destination Based Taxation
The fact that GST is destination based taxation is widely acknowledged. India would be implementing Dual GST which would be CGST and SGST and Inter State Transactions would be governed by IGST which would be equal to CGST and SGST. Therefore, for understanding the basic concept of GST we need to know basics about destination and origin based taxation and what they exactly mean. This article would also focus on the tax structure presently prevailing in India and how the proposed structure of Dual GST would be implemented in India alongwith IGST.
Concept of Origin and Destination Based Taxation:
Concept has been explained in the Report on “Reform of Domestic Trade Taxes in India: Issues and Options”, National Institute of Public Finance and Policy, New Delhi as follows:
“In principle, VAT can be levied either according to the origin, that is, where the goods or services are produced or on the basis of destination, that is, where they are consumed.”
Paper on “Destination Principle Border Tax Adjustments For The Corporate Income And Social Security Taxes” by Office of Tax Analysis U.S. Treasury Department Issued: December, 1976 defined origin based tax as follows:
“A tax treated under the origin principle becomes a production tax, no matter what its legal form, since goods are taxed where produced, not where consumed.”
It further goes on to define Destination based tax as follows:
“A taxtreated under the destination principle becomes a consumption tax since goods are taxed where consumed, not where produced.”
In a study “Economic Effects of Origin and Destination Principle for Value-Added Taxes” by Jesus E. S. Oliveira for School Of Business And Public Management George Washington University April 2001 the concept of Destination and Origin Based Taxation was aptly described as follows:
“Goods shipped from one state to another may or may not be subjected to VAT, both in the state of origin and that of destination. That leads to four possible combinations of inter-state taxation.
The first would be that the good be taxed in both states, giving rise to double taxation. The second would be that the good would not be taxed in either state. Both combinations are obviously undesirable. Double taxation is a strong deterrent to inter-state trade, making imported goods more expensive in the importing state, way beyond transportation costs. No taxation at all is just as bad, for it gives imports an advantage over domestic production that has no justification on the production efficiency of foreign manufacturers.
We are then left with two possibilities: either the good is taxed only in the state of origin or only in the state of destination. These two approaches to VAT taxation in inter-state trade are called, respectively, origin principle and destination principle.
Another way to think of these approaches is to consider that under the destination principle everything that is domestically consumed is taxed, whereas under the origin principle everything that is produced domestically is taxed.”
Both these concepts were explained in the report of the Task Force on Goods and Services Tax popularly called as the 13th Finance Commission as follows:
“2.13 A GST can be implemented under either the origin or the destination principle. Under the former, the GST is imposed on the value added of all taxable products that are produced domestically; under the latter, the GST is imposed on the value added of all taxable products that are consumed domestically.”
Thus we can broadly summarize the destination and origin based taxation as follows:
Destination Based Taxation
Destination Based Taxation as the name suggests is the taxation based on destination or consumption of the goods or services. This principle seeks to tax the goods and services on simple theory that the goods or services should be taxed at the stage where their consumption takes place rather than the point where their origin takes place i.e. production and the entire revenue relating to the goods or services should accrue in the jurisdiction where they are being ultimately consumed.
For Example If A in Gujarat produces the goods and sells the goods to B in Rajasthan, then in such case the tax should be levied and collected and should accrue on the goods in the State of Rajasthan and not in the State of Gujarat. The revenue in the case of destination based taxation belongs to the place, where the goods are finally consumed and not to the State where the goods are produced.
Origin Based Taxation:
Origin Based Taxation as the name suggests is the taxation based on origin or source where the goods and services are produced. This principle seeks to tax the goods and services on the basis of the principle that the goods and services should be taxed at the stage where their production or origination takes place rather than where their consumption takes place. Therefore, in case of origin based taxation, the revenue accrues to the jurisdiction where goods and services are produced.
For Example If A in Gujarat produces the goods and sells the goods to B in Rajasthan, then in such case the tax should be levied and collected in the State of Gujarat and not in the State of Rajasthan. The revenue in the case of origin based taxation should accrue to the place, where the goods or services are produced and not to the State where they are consumed.
The basic difference between the two lies in the fact that origin based taxation seeks to levy and collect tax on the basis of location of production and destination based taxation seeks to levy and collect tax on the basis of location of consumption.
Taxation of Import of goods and services from outside the country and Exports of goods and services to outside the country in case of Origin and Destination Based Taxation.
The concept has been explained in “Reform of Domestic Trade Taxes in India: Issues and Options”, National Institute of Public Finance and Policy, New Delhi as follows:
“Under the origin principle, to which a reference has been made earlier, the tax is levied on all value added domestically, that is, the total value of domestic production, including exports while the imports are excluded. Under the destination principle, all value added in goods sold within the country whether produced domestically or imported are taxed. Exports do not bear taxation while imports are taxed in the same manner as domestically produced goods.”
In the International VAT/GST Guidelines on neutrality issued by OECD (Organisation For Economic Co-Operation And Development) on 28 June 2011, applicability of Destination Based Taxation has been explained as follows
“The application of the destination principle in VAT achieves neutrality in international trade. According to this principle, which is the international norm, exports are exempt with refund of input taxes (that is, free of VAT) and imports are taxed on the same basis and with the same rates as local supplies. This implies that the total tax paid in relation to a supply is determined by the rules applicable in the jurisdiction of its consumption and therefore all revenue accrues to the jurisdiction where the supply to the final consumer occurs.”
It further goes on to provide that
“The destination principle contrasts with the origin principle, according to which each jurisdiction would levy the VAT on the value created within its own borders.”
It further clarifies that
“Tax paid on a supply would then reflect the pattern of its origins and the aggregate revenue would be distributed in that pattern.”
Therefore, origin based taxation seems to tax value creation in its own borders and revenue accrues to each of the jurisdiction where goods and services are produced or any value is added in such goods and services. On the other hand destination based taxation seems to tax consumption and revenue accrues to jurisdiction where ultimate consumption of goods and services takes place.
The above proposition can be summarized s follows:
Taxation of Exports: The principle which can be applied while understanding the concept of taxation of exports in case of origin and destination based taxation is as follows:
Origin Based Taxation:Exports would always be taxed in the origin based taxation as tax under this principle is levied on goods or services produced in the territory irrespective of the fact that whether the same is meant for export or domestic consumption.
Destination Based Taxation: Exports would not be taxed and would be zero rated in the territory as tax under this principle is levied in the territory where the goods or services are finally consumed.
Taxation of Imports: Further applying the same principle while understanding the concept of taxation of Imports in case of origin and destination based taxation
Origin Based Taxation: Imports would not be taxed in the territory where they have been imported for consumption as origin based taxation only provides for levy of tax on the goods and services on the basis of territory where they are produced.
Destination Based Taxation: Imports would be taxed in the territory where they have been imported as they would be consumed in that territory.
As can be observed from the above that in destination based taxes, the goods and services exported from the country are zero rated and imports are taxed at the rate of tax at which the goods and services produced locally are subject to tax. Destination based taxes create a level playing field for the goods and services produced domestically and goods and services imported from outside the country i.e. Neutrality principle of Taxation. If the domestic rate of Tax on say Television is 5%, the goods imported from outside the country would also be subjected to 5% of tax. Thereby, firstly creating a level playing field for goods and services produced domestically and imported from outside the country and secondly allowing the consumer to choose goods or services on the basis of consideration other than unequal tax rates.
In India, we are primarily following destination based taxation for export of goods and services outside the Country and Import of goods and Services into the Country. In India, destination based taxation is applied in cased of import of goods in the form of levy of different types of Import Duty and in case of import of services from outside the country in the form of Reverse Charge Mechanism. Further, exports of goods and services to other countries from India are Zero Rated i.e. taxed at zero rate.
Issues arising out of application of Destination Based Taxation in case of Multipoint Tax levied in National and State Government structure of Governance
Taxes administered, levied and collected by one single Government i.e. either National or State Government: In case of a Multipoint Taxation Structure wherein tax is administered, levied and collected by a single government i.e. National or State, entire revenue accrues to that government only.
In such case administration of tax is simple as every tax paid at the time of purchase as input may be allowed as credit and adjusted against the subsequent liability of the dealer. Further, as the goods or services are produced and consumed or transaction originates and is completed in the jurisdiction of the same government, therefore, revenue would also accrue to that government only which is common to the territory where the goods or services were produced and where the goods and services are ultimately consumed.
Taxes administered, levied and collected by Different State Governments: In case of Inter-State movement of goods or supply of services from one state to another and tax is administered, levied and collected by different State Governments, issue arises for levy of tax and subsequent credit of the tax paid with regard to the inter-state movement of goods or supply of services.
In the given scenario, tax structure in case of administration, levy and collection of tax on inter-state trade between two different states would work on the same principles as it works in the case of trade between two different countries. It makes no difference even if the two states or locations fall within the same country. Each State would be treated as a different territory although falling in the same country.
In simplistic terms, In such a structure, supply of goods or services from one state to another would be treated on the same principles as export of goods or services from one country to another and import of goods or services by one state from another state would also be treated on the same principle as import of goods or services from one country to another.
The report on “Reform of Domestic Trade Taxes in India: Issues and Options”, National Institute of Public Finance and Policy, New Delhi provided that
“This is because the destination principle cannot operate unless sales between VAT registered dealers across inter-jurisdictional borders within the country (or block) are treated as essentially intermediate sale and relieved of all taxes suffered at the earlier stages of production or trade. Operation of this rule is not simple and calls for a high degree of coordination and harmonization when sub-national governments in a federation or member countries of a large group or trade block exercise their autonomous or sovereign powers of taxation and appropriate the revenues realised for themselves.”
The Destination based concept provides that when the goods or services are exported to territory of another state from one state, goods and services should be zero rated and no tax should be levied on the goods and services. Further, where the goods and services are being imported into a state from another state, that state would levy tax on the import of goods and services in its territory which would be allowed as a credit and adjusted in subsequent liabilities and all tax revenue would accrue to the importing state.
In a study “Economic Effects of Origin and Destination Principle for Value-Added Taxes” by Jesus E. S. Oliveira for School Of Business And Public Management George Washington University April 2001 the same was explained as follows:
“the non-cumulative character of the VAT is brought to practice by mechanisms that ensure that the tax paid in previous stages is recovered, either through the subtraction method or, as is often the case, the credit method. In a destination-based environment, though, items shipped from one state to another are not subjected to VAT, so no recovery is needed.”
“Under the destination principle, imports are taxed but exports are not. This requiresborder tax adjustments, for the VAT must be removed from products leaving the stateand then added upon entry in the importing state, at the importing state internal rate.”
The paper further provides that if any tax is levied by the exporting state even though the revenue might be transferred to the importing state subsequently, then also it would be origin based transaction and not destination based transaction as destination based taxation does not purports levy of taxes on exports and it’s the origin based taxation which provides taxation of exports:
“That means these recovery mechanisms only apply to inter-state trade if the states are subjected to the origin principle. This leads to some confusion, as the origin principle is often referred to as “credit method” in political discussions.”
Therefore for implementation of GST on Destination Based Taxation, movement of goods or rendering of services from one state to another should be on zero tax and no tax should be levied on the same and if taxes are levied at the time of export of goods or services from one state to another then in such case it would be origin based taxation which would tend to move towards destination based taxation provided the revenue is transferred by the exporting state to the importing state.
Present Scenario of Indirect Taxation in India:
Under the present scenario, first we have to understand the fiscal autonomy structure of the country. Under the present scenario, broadly fiscal autonomy has been balanced under the Constitution in respect of taxation of Goods as follows:
a. States Levy Tax on the Sale of goods during the course of Intra State Trade as Value Added Tax
b. Centre Levies Tax on the Sale of goods during the course of Inter State Trade as Central Sales Tax and the same is collected by the States.
Therefore, if the goods are sold within the State then in such case tax is leviable and collected by the State and in case goods are sold in the course of Inter State Trade or Commerce, then CST is levied by Centre but collected by States.
Further Centre has the power to levy and collect tax in respect of
i. Goods at Manufacturing stage in the form of Central Excise
ii. Rendering of Services as Service Tax
iii. Additional Custom Duty on the goods imported from Outside India: This duty is leviable at a rate equivalent to the excise duty leviable on similar goods manufactured or produced domestically in India
iv. Special Additional Duty of Customs on goods imported from Outside India: This duty is leviable to equate various local Taxes like VAT or CST applicable on sale of goods domestically in India during the course of Inter-State or Intra State Trade or Commerce.
The above classification covers the major avenue of revenue for the States and Centre. However there are certain other taxes which either Centre or State has the exclusive power to levy tax such as Purchase Tax, Entertainment Tax, Entry Tax, Luxury Tax, Additional Excise Duty, Excise Duty levied under the Medicinal and Toilet Preparations (Excise Duties) Act, 1955 etc which have not been covered for the sake of simplicity.Further, Basic Import duty has not been considered in this analysis as credit of Basic Import Duty paid is generally not allowed against the other taxes to be paid subsequently.
Tax where the Territory from where the goods or services exported and to which goods or services imported falls under the jurisdiction of one single government which is collecting and levying tax:
Taxes Administered by State Government:
Out of the above taxes which have been specified, in the case of State VAT or Intra State Sales, transaction is originated and completed or goods are produced and consumed in the same territory therefore revenue accrues to the same state government where goods are produced and consumed.
Taxes Administered by Central Government:
Service Tax, Additional Customs Duty, Special Additional Duty of Customs also follows destination based taxation. In case of Additional Customs Duty and Special Additional Duty of customs, both are levied on the concept that goods imported from outside should be taxed on the similar lines as goods produced and sold domestically. Therefore, Additional Customs Duty and Special Additional Duty are levied on goods imported from outside the Country to counter balance Excise Duty and Sales Tax levied on goods produced or sold domestically.
Prior to implementation of MODVAT, Excise Duty was an origin based single point levy however with the implementation of MODVAT previously and now CENVAT with Service Tax, it’s not a single point levy but it is still restricted till the manufacturing stage and does not extends itself to retail or consumption stage.
Analyzing above statutes on one to one basis we can observe that irrespective of the fact that the above taxes are origin based or destination based, they are being levied and collected by one single government, be it the State Government or the Central Government. Both exporting and importing territory of the goods fall under the jurisdiction of the same government which is administering, levying and collecting tax. Therefore, revenue accrues to one single government only. Hence, Credit of the Tax paid at an earlier stage is allowed against subsequent liability in the same statute and in some cases across the statues as well provided governed by the same government.
Tax where territory from where the goods exported and to which goods imported fall under the jurisdiction of different state government and tax is levied and collected by the government of exporting state:
Central Sales Tax Act follows the Origin Based Concept.However in case of Central Sales Tax, the goods are consumed in the State other than the origin state and therefore two separate state governments are involved in the transaction. One is the government of the State where the transaction is originated i.e. exporting state and the second government is of the State where the goods are consumed i.e. importing state. Now as Central Sales Tax is an origin based taxation following issues arises:
a. Tax is collected by state government of the exporting state as origin based taxation provides for levy of tax on exports,
b. Tax is not collected by the Importing State as Import of goods in case of origin based taxation is not liable to be taxes.
c. Therefore as the Importing State does not collect any taxes on import or is not entitled to get reimbursement of the tax credit if it starts allowing the credit of the tax paid in the exporting state, therefore credit of the tax is not allowed by the state government of importing state of the taxes paid in the exporting state and it leads to cascading effect and various other distortions.
The Bagchi Report i.e. the Report on “Reform of Domestic Trade Taxes in India: Issues and Options”, National Institute of Public Finance and Policy, New Delhi questioned the very contention of the exporting states to continue the levy of CST at the time of Implementation of VAT
“An argument put forward on behalf of producing states in support of origin bases taxation is that they need to collect at least some tax from inter-state sales in order to recover the cost of infrastructure and public services provided by the State Governments to the Industries producing the goods which are consumed in other states. This line of reasoning is based on the assumption that in the absence of a tax on inter-state sales, the location of export industries within their jurisdiction would not contribute to the tax revenues of the exporting state. This is clearly fallacious. Any value addition(through production or distribution) in a jurisdiction necessarily means extra income in the hands of the residents of that jurisdiction. Spending of this income on consumer goods expands the sales tax base of the producing states and theirby contributes to their revenues. In fact, to the extent that consumer expenditures are dependent on the level of income of the residents of a state, it is the producing States that stand to gain the most in additional sales tax revenues(even under the destination basis of consumption taxes) from increased export output.
The final comment in the series of observation nailed the conclusion and questioned the very basis of the reasoning of levy of CST in Inter State Trade as follows
“It is for this reason that countries are prepared to let exports leave their boundaries free of any domestic taxes. If zero tax makes sense for exports to other nations, it should make equal sense for exports to other states.”
If Tax on Inter State Trade or Commerce would have been a destination based tax, then in such case the exporting state would not have charged any tax on the goods exported from one state to another and the importing state would have levied and collected the tax in similar manner as goods produced or sold in that state would have suffered. Goods from one state to another would have been sold on zero tax rate and devoid of any tax. In the alternative, the dealers of the importing state would have got the credit of the tax paid in the exporting state against their subsequent liability.
The fact that stands as on today is that CST is an origin based tax and a major impediment in Free flow of trade and market.
Indian Model of IGST: Whether Destination Based Tax or Origin Based Tax
Talking about the proposed model of GST to be made implemented in India whereby there would be levy of IGST on Inter State movement of goods or supply of services. The question arise that whether IGST is Origin Based Taxation or Destination Based Taxation.
The IGST Model has been referred to in “First Discussion issued paper on Goods and Services Tax in India” as follows:
“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 dealerwill 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, what was suggested was a levy of tax in the state where transaction originates and subsequent transfer of the amount by the selling state to the Importing State through a Central Agency acting as a clearing house mechanism.
The Indian Model of GST discussed as given in the First Discussion paper above was discussed in the “Consumption Tax Trends 2012VAT/GST and Excise Rates, Trends and Administration Issues” published by OECD while dwelling upon the proposed structure in India for GST as follows:
“Inter-state Supplies of goods or services would be subject as well to a unified GST aggregating to CGST and SGST that is called integrated GST(IGST). However the IGST would be an origin-based tax. Therefore, IGST would apply in the state of the supplier although credit will be given to the consumer in the other state. Thus the Central Government will operate like a clearinghouse and compensate the consuming state according to the destination principle.”
It finally concludes that
“Therefore, although the supply is taxed at the origin, the clearing house mechanism ensures that IGST in effect destination based.”
The report of the Task Force on Goods and Services Tax popularly called as the 13th Finance Commission suggested that either the movement of the goods or rendering of services from one State to another should be based upon purely destination based taxation wherein no tax is levied on the goods supplied or services rendered from one State to another. The transaction would be zero rated transaction and in the alternative they also suggested the Modified Bank Model wherein the seller was to levy tax on the buyer state and required to deposit the tax with the nodal bank. The nodal bank would in turn credit the tax to the consuming state.
The 115th Constitutional Amendment Bill 2011 provided that only Centre would levy and Collect IGST on Inter -state trade or commerce and tax collected would be divided between the Centre and the States in a manner prescribed by the parliament law.
The 122ndConstitutional Amendment Bill 2014 also provided the levy of IGST and sharing of the revenue on the same lines as of 115th Constitutional Amendment Bill 2011 that Centre would levy and Collect IGST on Inter -state trade or commerce and tax collected would be divided between the Centre and the States in a manner prescribed by the parliament law.
The final model of revenue sharing between Centre and State and thereby resulting in transferring of revenue to the destination or consuming state is yet to take shape until the Constitutional Amendment Bill is passed by both the houses and the parliament prescribes the law for sharing of revenue between the States and Centre.However one thing is for sure that consuming state would give the credit of the tax paid in the exporting state, and consuming states would be reimbursed whatever the mechanism may be adopted.
Therefore IGST is not in principle, destination based taxation as goods and services are not zero rated at the time of export of goods and services from one state to another. IGST would be an origin based tax which through the working of the revenue sharing mechanism by the Central Government would be modeled and converted into a destination based taxation.
IGST in India has been developed broadly on the concept as follows:
i. Under the destination based concept the imports are generally liable to tax in the consuming territory equivalent to the taxes being levied on the goods and services produced in that territory. Therefore under proposed model of GST in India, all goods and services which would be imported from outside India would be liable to tax equivalent to CGST and SGST.
ii. One of the salient features of destination based taxation is that the revenue of the goods or services consumed should accrue to the Importing State so that the importing state may allow the credit to the dealer of the taxes paid earlier. If the revenue of the taxes paid earlier is not transferred to the importing state, then in such case it would not be possible for the importing state to give credit of the taxes paid earlier. Another salient feature of the destination based taxation is that the goods or services exported from one state to another should be taxed on zero rate of tax and power to charge tax should only lies with the importing state where they are ultimately consumed. Therefore, under Ideal Destination Based Taxation, this component of CGST and SGST under Inter State trade or commerce should have been levied and collected by the importing State to bring the taxation on goods and services imported equivalent to the taxation of goods and services produced in that state.
iii. However, under the proposed Indian Model of GST particularly with respect to the Inter State Trade of goods and services, power to levy and collect tax has been given to the Centre under the nomenclature of IGST. IGST would be collected in the exporting state.
iv. The Government intends that GST should be destination based and the revenue collected and levied by Central Government under IGST should be transferred to the Importing State, to the extent importing state gives credit to its dealer of the tax paid in the exporting State as IGST.
v. Therefore, there were two options one either the exporting state to transfer the credit directly to the importing state to the extent credit allowed by the Importing State to the dealer of the importing state of the taxes paid in the exporting state as IGST or second was someone to act as an agency for transferring the amount to the importing state so that the credit may be allowed by the importing state to the dealer of the importing state of the taxes paid in the exporting state as IGST.
vi. The government has preferred the second option and then came out with IGST which is nothing but the tax which would have been levied and collected by the Importing State in ideal destination based taxation but would now be levied and collected by the Central Government. The mechanism of sharing of revenue between the states and the centre would be laid down by Parliament in a manner so that no state suffers loss of revenue. Through this mechanism the government has tried to ensure that the revenue accrues to the importing state and destination based taxation can be implemented in a modified manner.
With this I would conclude this article with the remark that in the course of Inter State and Commerce, IGST would be the sum total of CGST and SGST. It would be levied and collected by Centre and then transferred to the Importing State in all probability at least to the extent of credit allowed by the importing state to the dealer of the importing state of the taxes paid in the exporting state as IGST. The mechanism of sharing of revenue between the Centre and State however would be laid down by Parliament probably in a manner so that no state suffers loss of revenue. This entire exercise would then result in IGST becoming a destination based taxation.
In the next article I would dwell upon Principle of Neutrality in Taxation and how in Indian Context, it would be taking shape. The article would also dwell upon why Neutrality in Taxation is a one of the key aspect of the area of implementation of tax structure.
By CA Dr Arpit Haldia
Note from the Author: This series of articles on Goods and Services Tax would be an effort to put forward a detailed view of the subject. The series would make an effort to analyze the intricacies and details about Goods and Services Tax. It would be an effort to narrate the issue to have an understanding on the subject.