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GST Regime: How Can States Maintain Autonomy Over Inter-State Supplies?

GST Regime: How would the Integrated GST mechanism of revenue transfer work?



Workers load trucks with bags of refined sugar. (Photographer: Kuni Takahashi/Bloomberg)
Workers load trucks with bags of refined sugar. (Photographer: Kuni Takahashi/Bloomberg)

The run up to the implementation of the Goods and Services Tax (GST) has evidently gathered speed. The GST Council was formally constituted on September 15, 2016, and its prime agenda consists of bringing consensus across the states and the Centre on issues of threshold, tax rates, revenue neutral rate (RNR), tax base, exemptions and certain other procedural yet very delicate state taxing autonomy related issues like centralised registrations.

Securing something similar to the present taxing autonomy would be the cardinal desire of all stakeholders while steering decisions of the GST Council. This line of thought poses a very intriguing challenge as to how the Integrated GST (IGST) mechanism of revenue transfer would work.

IGST Mechanism

The IGST mechanism of taxing inter-state transactions was adopted as the most suitable for our country, disposing off mechanisms like the Modified Banking Model, Bank Model, Tax Deducted at Source (TDS) Model and Tax Information Exchange System (TINXSYS) Model. It is the enabling mechanism for a destination-based consumption tax.

To explain the IGST mechanism lucidly, let us look at an example:

Singh in Punjab supplies goods to Mohanty in Odisha and charges IGST. Assume Singh has Input Tax Credit (ITC) of local tax paid to Punjab. He uses it to discharge his IGST liability to the Centre. In effect, he asks Punjab to pay the Centre on his behalf to the extent he uses Punjab ITC against his IGST liability. Now, Mohanty in Odisha can avail ITC on IGST paid. When he makes a local supply in Odisha, he discharges Odisha GST (OGST) using IGST credit. In effect, he asks the Centre to pay Odisha on his behalf to the extent he uses IGST credit against his OGST liability.

Hence, as long as the IGST transaction is business-to-business (B2B) and the recipient avails ITC, the Centre would act as a mere settlement agent between the originating and consumption state. No balance would be left in the Centre’s IGST account. The Centre as well as the states would remain revenue neutral in B2B transactions. Therefore, collection of revenue would ideally happen when the credit chain is snapped. The question of distributing the IGST collected would also consequentially arise in case of business-to-consumer (B2C) interstate supplies and situations where ITC is not availed by the recipient. As per section 10 of the Model IGST law, the Centre would retain the CGST portion of the amount lying in IGST account and the remaining would be distributed amongst the consuming states as state GST (SGST) portion.

The intriguing question is: How will the consuming state maintain taxing autonomy over inter-state supplies?

IGST Rate

At the drawing board stage, it can be conveniently assumed that IGST would be a summation of CGST and SGST. However, the reality is a far cry. Recently, business daily The Economic Times reported Revenue Secretary Hasmukh Adhia hinting that there may be multiple GST rates. The GST Council would recommend the GST rates and also a band of rates, for the states to tweak according to their prerogatives. Therefore, a situation where tax rates for sugar and cotton in Maharashtra being different from that in Madhya Pradesh is a distinct possibility.

Let us assume a transaction where cotton is sold inter-state from Maharashtra to Odisha and IGST is to be paid. The tax rates (GST) are as follows:

  • Maharashtra: 5 percent
  • Odisha GST: 10 percent
  • Central GST: 10 percent
  • Integrated GST: 20 percent (only for Variant A)

There may be three variants for collecting IGST as summarised below:

  • IGST charged at a flat rate across India
  • CGST + SGST of origin state
  • CGST + SGST of consumption state (place of supply state)

In case of Variant A, tax rates adopted by the states would become irrelevant in inter-state supplies. The consuming state would not be able to determine the revenue it wants to collect on the consumption of goods and services in its jurisdiction. In certain circumstances, inter-state supplies may become more attractive than local procurement which may lead to tax driven business decisions.

On the flip side, it may also become an enticing proposal if states with a consumer base offer lower tax rates to incentivise establishment of business units within the state to make local supplies. The branch stock transfer route would become encouraging again as businesses would pay higher IGST on stock transfers and bill lower local taxes to consumers for free movement of goods.

If Variant B is adopted, the consuming state would effectively be at the mercy of the origin state to determine its revenue collection. No state would want to lose its taxing autonomy to another state. Further, this concept does not gel with the ultimate objective of co-operative tax federalism as states would end up deciding the tax rates for consumption happening outside their jurisdiction. In the example above, cotton supplied from Maharashtra to Odisha would carry a tax of 15 percent.

According to Section 10 of Model IGST law, 10 percent would be retained as CGST component by the Centre and remaining 5 percent would be paid out as OGST to Odisha, notwithstanding that Odisha chose to tax cotton at 10 percent.

Variant C perfectly ties in with the ideals of GST. The consuming state has control over the taxes it wants to levy on consumption happening within its jurisdiction. Business decisions would not be tax driven as the tax component of a commodity would remain unaltered for both inter-state and intra-state supplies. It is a stable mechanism of tax collection.

The Intriguing Question

Coming back to the question: How will the consuming state maintain taxing autonomy over inter-state supplies?

To my mind, Variant C is the best answer, if not the ideal answer. If we must live with multiple tax rates, Variant C checks off many boxes on the ideal GST list. However, that again leaves the tax manager with a matrix of 31 tax rates (29 states and 2 Union Territories) to be applied while effecting an inter-state supply. Determining the Place of Supply would be crucial to discharge correct tax liability. Nevertheless, businesses would probably prefer to have Variant A as it would reduce compliance hassles.

With the government and GST Council firing on all four cylinders, clarity in this regard is expected soon. Until then, Variant A, B or C is anybody’s guess right now.

L Badri Narayanan is a lawyer and partner with well known law firm Lakshmikumaran & Sridharan. He specialises in advising technology companies on corporate, commercial, intellectual property and tax laws.

Shashank Kumar, Lakshmikumaran & Sridharan also contributed to this article.

The views expressed here are those of the author’s and do not necessarily represent the views of BloombergQuint or its editorial team.