Pondering the GST (with a tailpiece about FBT)

Business Standard has an edit on the GST, and has an article on it by Sukumar Mukhopadhyay, where he emphasises the differences between alternative formulations of the GST. My sense is that the positions of Kelkar and Bagchi are actually 99% the same. And, I think Mukhopadhyay gives inadequate weightage to the remarkable implications of the 88th amendment of the Constitution.

There was an interesting edit in Financial Express, which I will discuss in reverse order. First, the part that I agree with, on the GST:

Exemptions made for one or the other industry only make space for lobbying and pressures that result in even more distortions in the future. If Indian business has to become globally competitive, then the finance ministry needs to institute a tax system that reduces friction and costs. That the country has begun to absorb the principle of value-added taxation (VAT) is encouraging. But beyond that, taxation policy must focus on converging the current system of multiple varied taxes towards an efficient, VAT-based, nationwide goods and services tax (GST) that removes all barriers within the country, gives the tax code cohesion, reduces the innumerable contact points between tax administration and industry and lowers cost of compliance. The finance minister must turn his attention towards a clear roadmap for this, and adhere to it. An increase in service tax to 14% and a reduction in central excise from 16 to 14% is only a first step in this direction. This should be done in the forthcoming Budget.

Compare the performance of Indian manufacturing with that of China, and one crucial fact that is often forgotten is that Chinese manufacturing was given a GST in the early 1990s. A better taxation system gave the Chinese no less an edge over Indian industry than did China’s superior infrastructure. Prime Minister Manmohan Singh and finance minister P Chidambaram have both made promises that India will see a GST. But the difficulty is that while other tax reforms—such as rationalisation of customs, removal of exemptions, changes in tax rates/items—can be done at the stroke of a pen, implementing any VAT-based system is difficult in many ways. It is administratively complicated, involves the consensus of states and requires changes in mindset all through the value chain, which is never easy in a country such as India. To be sure, there has been progress. The Union Budget for 2004-05 brought services into the VAT framework and integrated the credit on Cenvat and services taxes. Another step was the implementation of state VAT from April 2005. Now, for India to move towards a countrywide GST involving both the centre and states, the central government must provide clear leadership in setting up a well-functioning central GST system with the requisite administrative capacity. In doing this, its own revenues will go up and its dependence on direct taxes will go down.

As for other taxes, central excise deserves a closer look for possible problems of non-compliance. With some extra effort, however, such problems can be a thing of the past. Greater computerisation, for example, could help to quite a degree. The finance minister could make full use of the latest information technology enablers to merge databases and re-order data on transactions to make the entire taxation framework amenable to desktop overview on a consolidated basis. In fact, a vast central tax database should serve as the centrepiece of how VAT credits and refunds take place, and the treatment of VAT on imports and exports should be linked to it as well. Such a system, integrated electronically with the current tax information network (TIN) system that was up and running in eight months, can be easily initiated in the next fiscal year. The number of establishments involved would be smaller than the number that have already been plugged into TIN. This will help eliminate fraud in central excise and service taxes. And, when the centre demonstrates, by example, to the states that there are gains to be made by joining this system, the path towards an all-India GST will open up.

For those interested in the GST, there is more on GST in this blog. And then, the early part of the edit that I don't agree with:

Collections from the Fringe Benefit Tax (FBT) in the period April 1, 2006 to January 31, 2007 stood at Rs 3,984 crore, a tiny part of the Rs 1,56,429 crore collected as direct taxes during this period. The distortionary impact of the tax is, no doubt, much larger—so large that even larger collections would not justify them. The FBT is a presumptive tax that poses enormous headaches for employers who have genuine business expenses that are burdened by it. ‘Fringe benefits’ are deemed to have been provided when the employer incurs any expenses on account of maintenance of guest house, conferences, sales promotion including publicity, conveyance, tour and travel, hotel stay, boarding and lodging. These are routine business expenses for most enterprises, but a specified percentage of these are taxed. Which means that these expenses are effectively treated as profits. This goes against the basic principles of taxation.

Perks, or fringe benefits provided by an employer to his employees, in addition to the cash salary or wages paid, are often a way of paying a part of the salary in a manner such that the employee has to pay no tax on it. In other countries such fringe benefits are subject to varying tax treatment. These benefits are either taxed in the hands of the employees themselves or subject to a 'fringe benefit tax' in the hands of the employer. The rationale for levying a fringe benefit tax lies in the inherent difficulty in isolating the 'personal element' where there is collective enjoyment of such benefits and attributing the same to the employee. Many times the expense may be incurred for the purpose of business but,like in the case of entertainment, have benefits of a personal nature. The problem lies in being able to correctly identify the true business expense from a cash component of salary.

The real contribution of the FBT lies in the way that it has encouraged employers to move towards more transparent pay packages where the full cost-to-company is seen as total taxable income. The success or failure of the FBT should not be judged by the tiny direct collection of the FBT.

The FBT attempts to bring on par employees of private companies that offer a part of the salary as a tax free component with that of those with fully taxable salaries. Yet, there are difficulties in the tax for the employers who have genunine business expenses which get hit by the FBT. For example, fringe benefits are deemed to have been provided when the employer has incurred any expenses on account of maintenance of guest house, conference, sales promotion including publicity, conveyance, tour and travel, hotel, boarding and lodging. These are genuine expenses for most business enterprises but a specified percentage of these expenses are taxed. This distorts the behaviour of firms.