March 21, 2017 2:41 am JST

Modi cabinet clears GST legislation hurdle

India's most ambitious tax reform expected to finally roll out in July

KIRAN SHARMA, Nikkei staff writer

A hawker sells bags near a long distance bus terminus in Kolkata, India, on March 20. © AP

NEW DELHI -- India's long overdue goods and services tax, which is intended to unify the country within a common market, is due to finally roll out on July 1.

The cabinet of Prime Minister Narendra Modi on Monday approved four pieces of legislation related to GST, the biggest indirect tax reform in Indian history.

GST will replace a plethora of confusing levies imposed by the central and state governments with a uniform national sales tax, promising a seamless transfer of goods and services across the national economy.

About a dozen existing taxes will be subsumed into GST, including the central government's excise duty and service tax, and the entertainment and value added taxes levied by state governments. Revenue is to be shared between central and state government on an almost equal basis.

Among the legislation approved at the meeting Modi chaired is a provision to compensate states for any loss of revenue over the next five years while GST gets bedded in. This will go to parliament during the budget session that runs to April 12, a finance ministry official told the Nikkei Asian Review. State-level GST legislation will be sent for ratification in 29 state assemblies.  

The Modi government originally hoped to roll out GST in April 2016, but the need for a constitutional amendment saw the tax reform stall in the bicameral parliament's upper house, where Modi's Bharatiya Janata Party has not hitherto enjoyed a majority. Resistance there from the opposition Indian National Congress helped set GST's onset back a year.

In order to achieve a political deal, the government made some concessions to opposition demands, including dropping an additional 1% tax on interstate sales of goods, which was cleared by the upper house in August. The remaining GST legislation due to be tabled in parliament this week only needs to pass through the lower house, where the BJP is unassailable.    

Tax structure

After the passage of the constitutional amendment bill in parliament last year, a GST council comprising representatives from both central and state governments was established to fix rates. It settled on four slabs of GST at 5%, 12%, 18%, and 28%. There is also to be a zero tax rate for about half the items found in the consumer price index basket. Rice and wheat will be untaxed, reducing inflationary pressures on ordinary people.

"A single rate would be highly inflationary," said Finance Minister Arun Jaitley after calls from the opposition INC for GST to be fixed at 18%.

Specific goods and services have yet to be classified in the other brackets. Some items are being used more by the lower middle classes, such as soaps and shaving kits. These are currently taxed highly at over 30%, which includes 12.5% excise duty and 14.5% value added tax, and in future are likely to be taxed at 18%.

Broadly, items for mass consumption such as tea, cooking oils and spices are likely to fall in the 5% bracket; processed foods will be 12%; smartphones, soaps, and footwear 18%; and top consumer goods, including cars and LED televisions, 28%.

A 1kg Tata Tea Premium pack, with a maximum retail price of 420 rupees ($6.40), is currently taxed a 5.66%. GST will drop this 0.9%, according to local media. A 40-inch Samsung LED TV costing 53,000 rupees with a present effective tax rate of 19.63%, will cost 2.3% more.

The GST council has also agreed to cap at 15% the excess on the highest GST rate of 28% levied on goods such as luxury cars and aerated drinks, making the maximum tax incidence on these items 43% compared to 40% at present.

"In the near term, we expect the GST to be fiscally neutral, the resulting inflation impact to be minimal at less than 20 [basis points] and the impact on growth to be marginally negative in the run up to its implementation," Japanese brokerage Nomura said in a note on March 17.  

"However, over time, we expect the elimination of cascading taxes and its simplified tax structure to boost productivity, lower costs, aid in the formalization of the economy and result in large revenue benefits for the government," Nomura said.

On Monday, the government reiterated its commitment to the early introduction of GST. It had hoped to roll the tax out in April, but appears confident of making the July 1 deadline.

State poll victory

The GST rollout is expected to give a major boost to Modi's reform agenda and to attracting foreign investment. The BJP's recent victory in state elections, particularly northern Uttar Pradesh, which is home to one-sixth of India's population of over 1.25 billion, has helped. Modi's reform initiatives, including his Nov. 8 demonetization of 500- and 1,000-rupee banknotes, have received widespread public endorsement, brightening re-election prospects for the 2019 general election.

The controversial demonetization initially sucked 15.4 trillion rupees out of circulation -- about 86% of the total. Modi was targeting "black money" and untaxed wealth, counterfeit bills and corruption. While effective, the move was highly disruptive, since the Indian economy remains overwhelmingly geared to cash.

With new bills fully in circulation, Modi's boldness appears to have paid off.  His success in Uttar Pradesh will also pay him dividends in the upper house, which is elected by state assemblies. With GST under his belt, Modi will be able to turn his attention to labor issues and other overdue reforms.

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