The Cascading Effect Of Taxation; What We Understand by it?

By Ashish Kumar:

One of the primary goals of a taxation regime is always avoidance of “taxation over taxes” or “cascading-effect” of the incident taxes as it adds to the deadweight loss i.e. slump in total surplus of supply chain consisting of supplier, manufacturer, retailer and consumer. These cascading caused due to levy of variety of charges by state and union governments has raised the tax-burden on Indian products and made them less competitive in the International market. The gargantuan-sizes of corporate-taxes owe much to this taxation structure and have led to adoption of tax-evasive practices. The common man finds himself strangled in a Gordian knot of multiple tax-rates, laws and elaborate processes and often fails to comply with these complex legislations. The extra tax paid due to taxation of the already taxed amount is finally bore by the end consumer which is common man and strikes them badly in addition-to inflation.

Cascading effect of taxes is one of the major distortions of the Indian taxation regime. Federal structure of our democracy, allows both states and center to levy taxes separately and this has caused this cascading. While Income tax, Excise duty, Service tax and Central Sales tax (CST), Securities Transaction tax is levied by the center; VAT/sales tax, Entry tax, State excise, Property tax, Agriculture tax and octroi is charged by the State governments. There are many possible transactions which come under the ambit of two or more of these taxes and the value of the second tax is calculated on the value arrived at by adding the value of first tax to the value of transaction. For example, inter-state purchase of goods would attract both Central Service tax and Sales tax and manufacturing and sell would be liable to Cenvat over and above CST.

The prevalent complex, multi-staged and cascading tax-structure steals the advantage of availability of cheap labour and other factors-of-production from India and brings the market-price (post-taxes) at par or above par the price of the international price. The manufacturing industry of India thus is not able to compete with that in China and Brazil. Presently, for industries, the decision of how many inventories to maintain or where to maintain them is guided heavily by the concerns of tax avoidance. Most of the industries maintain warehouses in each state and union-territories to avoid the CST charged on crossing the border. This gives rise to 25-30 warehouses as compared to 8-10 in developed countries and leads to various inefficiencies in terms of space, cost-structure and operations. Extra money is wasted in procuring space for these inventories as well as operating them. This trade-off between cost and quality manifests in inefficient quality to the final consumer. Need to ensure real-time visibility of inventory across the diversified warehouse-network amounts to higher IT cost, Further, multiple handling across the various layers of distribution and multi-layered compliance requirements result in higher material handling and cost-compliance cost. Generally, the numbers of these warehouses being high, their sizes have remained very small and have caused duplication of overheads and have inhibited racking and automation. In short, the prevalent taxation policy has left our industries with no choice but to make do with obsolete and inefficient warehouses and inventory.

Introduction: Good and Services Tax:

In a bid to see-off these complex and obsolete taxation policies and usher-in an era of transparent, fair and legitimate taxation and remove the inefficiencies of supply chain due to such lax policies, India has decided to join the bandwagon of 140 countries already practicing Goods and Services Tax (GST). GST is an indirect tax on goods and services which would be charged on every point of sale in the supply chain and every entrant in the supply-chain would be eligible for input credit of tax which she had paid to the previous entrant for the procurement of goods and services. The sellers or service providers collect the tax from their customer, who may or may not be the ultimate customer, and before depositing the same to the exchequer, they deduct the tax they have already paid.So, the manufacturer will get the input credit of all the taxes paid by them on the raw materials and also on the services.

How does it work?

Let us suppose that the uniform rate of GST is r% and the supply chain. Suppose the manufacturer procures good and service worth of Rs. A and B respectively. Then the supplier is liable to pay r*(A+B). Suppose manufacturer adds some value to the good and its price becomes more than (A+B), say, c*(A+B) (c>1). The tax liability of manufacturer towards the government would be [r*(A+B)*(c-1)]. Looking at the details, one can make out that his total tax liability is r*c*(A+B). But, he has already paid r*(A+B) to the supplier who, in turn, would pay it to the government. The amount r*(A+B) is called input credit or tax and the amount r*c*(A+B) is called the output credit or tax. The difference is the total tax liability.

Let us now consider the case of retailer selling it to the final consumer. He would try to incorporate his profit into the price and hence the price would increase to p*c*(A+B) (p>1). He would charge a total of r*p*c*(A+B) as tax from the final consumer. But, he has already paid tax amounting to r*c*(A+B). So, the retailer needs to pay a total of [r*c*(A+B)*(p-1)] to the government. r*c*(A+B) is the input credit while r*p*c*(A+B) is the output credit.

The total tax earned by the government is r*p*c*(A+B) which equals the total tax-burden on the final consumer. The flow of goods and services is from Supplier to Manufacturer to Retailer to the Final Consumer while the tax-burden flows in just the opposite direction. Never in this mechanism, is tax calculated on any amount which is already taxed. GST is termed last-point retail tax because it is the final consumer who bears the ultimate burden of it.

Consider the present scenario. A dealer from Maharashtra purchases tools worth Rs.L from Andhra Pradesh on payment of CST s% Rs.s*L. When the dealer sells the same tools within the
State, his cost would be L*(s+1) on which adding his margin, sales tax would be charged. If credit of CST was allowed, then the cost would have been reduced by Rs. L*s plus sales tax charged on it. This is an example of cascading effect of taxes. Sales tax is being charged on already taxed (CST) amount.

In order to get credit for the GST paid already dealers must be registered for it and must possess a legitimate tax-invoice. Each dealer would be authorised to issue invoices for the tax paid to her and by showing these invoices input credit can be claimed. If the output-credit is more than the input-credit, the dealer should pay the balance to the government; else if the input-credit is more for that particular taxation-period, the dealer would get a refund. Essentially, each unit of the supply chain become the tax-collection points for the government. Certain goods and services may be declared as exempted goods and services and in that case the input credit cannot be claimed on the GST paid for purchasing the raw material in this respect or GST paid on services used for providing such goods and services. Export of many goods and services is zero-rated and hence the GST paid by them is refunded.

GST is not yet another tax over-and-above whatever already present. GST aims at subsuming prevalent taxes like central excise duty (Cenvat), service tax, and additional duties of customs at the Central level and value-added tax, central sales tax, entertainment tax, luxury tax, octroi, lottery taxes, electricity duty, state surcharges related to supply of goods and services and purchase tax at the state level. Eradicating all these taxes and instead charging an uniform rate of tax across all point of sales in the supply chain is the vision of GST. The uniform rate is the subject of discussion yet but experts suggest that it may lie in the range of 14-16%.

Benefits:

Imports would be subject to GST but the exports are zero-rated, so, exporters needn’t pay any GST. This incentive is bound to bring a boom in exports. Also, the alleviation of cascading of taxes would reduce the price of goods and services in the international market and would hence aid the exports.

Implementation of GST promises many benefits as reduction in the number of taxes at the Central and state levels, cut in effective tax rate for many goods, removal of the current cascading effect of taxes, reduction of transaction costs for taxpayers through simplified tax compliance, and increased tax collections due to wider tax base and better compliance. GST will allow manufacturers to see Indian market as one geographical expanse with no state boundaries which would allow single warehouse for a cluster of 5-6 states. This would cut on logistics as well as inventory costs. It will reduce distortions by completely switching to the destination principle (the tax reaches to the territory where it is sold). It can provide a fiscal base for local bodies to enable them to fulfil their obligations. It will facilitate investment decisions being made on purely economic concerns, independent of tax considerations. GST also promise to offer cash-flow benefits to dealers. The dealer would get the tax payments from their customers as soon as they make sales but need to remit it to the government only when the ta-period i.e. either month or quarter is over. The inventory cost of FMCG companies would be reduced as Cenvat which is included in inventory cost would be abolished and GST paid on the inventory would be credited back as input-credit. Under GST, all goods and services would be subject to tax, unless specifically exempted. Further, it is also anticipated that the number of exemptions would be significantly reduced. Accordingly, the total revenue collections are expected to go up, as already proven by post-GST scenarios in several other countries.

Challenges in implementation:

In general, there are two versions of GST popular- unitary and dual. In the first, only union government collects GST while in second both state and union governments collect GST. India has chosen to adopt dual GST. They will be called Central GST (CGST) and State GST (SGST). Being a consumption-based tax, it is perceived that the less-developed and backward states would get less tax-revenue due to meagre consumption and has thus been opposed by several less-developed states. Some states also allege that by abolishing all the state-levied taxes, the centre is making the states financially crippled and hence is a breach of federal structure of Indian democracy.

The introduction of the GST system is set to be a paradigm-shift in the taxation firmament of India. Consensus and coordination among states is required for it to succeed. Before it can be introduced, the Centre and states have to sort out issues like agreement on uniform GST rates, constitutional amendments empowering states to tax services (services where not taxable in India before 1994 in-spite of the fact that service-sector is the largest contributor to our GDP) , taxation on inter-state transactions of goods and services, drafting of CGST and SGST laws, consultation with all stakeholders including trade and industry associations, administrative and infrastructural preparedness to implement the new tax regime and resolution of all other issues under discussion. Business would also need to change their strategies. They would have to gear-up to prepare new supply-chain infrastructure and attract professionals and experts to harvest the benefits of GST. Some businesses may have to re-work their pricing strategies with the changed tax regime – higher credits coupled with possible change in rate of tax on output.

Currently, an Empowered Committee of State Finance Ministers has been set up to support the implementation of GST. The Centre and states have on agreed to a dual structure for the GST, with multiple rates for goods and a single rate for services.

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