India's historic tax reform -- opportunity and confusion
Tax dodgers won't like the GST, but implementing it will be a challenge
YUJI KURONUMA, Nikkei staff writer
NEW DELHI -- India's biggest tax overhaul since its independence, set to take effect on July 1, is aimed at ushering in a new era of efficiency, but it also carries the risk of creating corporate confusion and pushing up prices.
At a news conference in New Delhi on April 25, a Finance Ministry official said the goods and services tax, which will unify taxation across the states, will greatly benefit businesses by ending double taxation and boosting the price competitiveness of exporters, among other things.
It wasn't anything the public hadn't already heard. The sole purpose of the gathering was to drill home to the media exactly what the GST was. The scale of the reform is enormous. It will reorganize existing indirect taxes -- of which there are currently more than 15, including the central excise duty and the service tax -- under just one tax group. While the government keeps playing up the benefits of streamlining, the local media has voiced concern that the change could trigger inflation and increase the tax burden on companies.
Well-designed, but ...
The ministry is right to point out that such worries are misplaced, at least in terms of how the new system is designed. There is no question that the GST will be good for businesses. For starters, it will eliminate a tax on goods crossing state borders, enabling companies to optimize distribution and the location of their manufacturing bases.
However, if the government does not implement the system properly, the media's fears will, to a large extent, be justified.
The crucial test will be whether the new tax credit system actually works.
Suppose a company buys goods from a supplier for $100. The supplier then issues a tax invoice to the company proving payment of the GST, in this case $18 at the standard 18% rate. The company then uses the tax invoice to claim an input tax credit -- the amount of GST it has already paid through the supplier, in this case $18. If the company collects, say, $23 in GST from its customer, it needs to pay only $5 in GST ($23 minus $18) to the tax authorities.
Currently, the input tax credit mechanism is applied in limited cases. As a result, goods are taxed several times over the course of the distribution process, often pushing up retail prices at the end of the chain.
Arun Bakshi, who runs an accounting and law firm in New Delhi, is excited about the new arrangement, saying it will prompt big companies to encourage their suppliers to pay taxes. The GST will be a welcome addition in a country where tax dodging is rampant, he said.
However, it will be effective only if tax invoices are properly issued to those making purchases to allow for GST credits. In the above example, if the company fails to obtain a tax invoice from the supplier, it will end up having to pay $23 in GST instead of $5.
"Some businesses could start losing money if they cannot get tax invoices," said Hiroshi Matsuki, a tax accountant at an office in Gurgaon, outskirt of Delhi, of the U.S.-based Deloitte Haskins & Sells. "There will be confusion, such as companies being forced to change suppliers or suffering sharp falls in their sales," he warned.
Aware of these dangers, some businesses are taking action in advance. That includes asking auditors to hold seminars to teach suppliers how to report and pay their GST. But that is about the extent of the protective measures they can take. Only about two months remain before the new system takes effect, but companies are unable to fully update their accounting software because the government has yet to decide on the specific tax rates for different categories of goods and services.
The GST Council comprising members from finance ministries of central and state governments put forward an overall framework for the new tax in November last year, setting out four different rates: 5%, 12%, 18% and 28%. The Council is set to work out details by the end of May, such as the scope of the standard 18% rate.
But it is doubtful whether major companies doing taxes on, say, enterprise resource planning systems developed by such companies as Germany's SAP and Oracle of the U.S. will be able to finish reconfiguring their software by July 1, Deloitte's Matsuki said.
In this down-to-the-wire situation, Indian accounting software developer Tally Solutions sees an opportunity. An employee at the company's call center said Tally is the only company that has been cooperating with the government in introducing the GST, and that other accounting software developers will end up copying it.
Thanks to its unique position as a close partner with the government on the project, Tally saw its number of clients double to 1 million from 2015.
But even at Tally, executives are skeptical about whether the new GST system will take root among small and midsize companies and whether the tax credit system will actually work.
According to local reports, 70% of small and midsize companies have not begun preparing for the GST at all. And it is not just companies that are looking to escape taxes; some suppliers may unintentionally undermine the system by failing to pay their taxes on time or correctly, placing unnecessary tax burdens on their clients.
To hedge against such risks, buyers may raise their prices, exacerbating the negative spiral. It would be wise, at least in the beginning, to expect some confusion in industry as the GST takes effect.