Why GST exemptions would prove to be a bane rather than a boon

It is far more prudent to levy GST at a lower rate so that the input tax credit is available through the value-chain and the cascading effect is completely neutralised.

Now that more than a year has passed since the GST implementation, and the revenues are more or less steady, and considering the fact that the general elections are scheduled for next year, expectations that the government should exempt more and more goods and services from GST levy are high. In the last GST Council meeting, many decisions were taken concerning GST exemptions. On the face of it, exempting any supply of goods/services from the levy of GST appears to be consumer-friendly as no GST is payable on such supply. However, in reality, the consumers may end up carrying the burden of at least a certain amount of GST due to the cascading effect of the GST exemption.

GST follows the value-added tax (VAT) mechanism, where tax is payable on every value-add in the supply-chain (either supply of goods and / or services). Further, India’s policymakers have chosen the tax-invoice method (which is the most popular method, globally) for the VAT mechanism to be followed by businesses. The crux of any VAT system is the ability of the buyer (in a B2B scenario) to claim credit of the tax paid on the purchases while discharging the tax payable on the sales effected. Any break in this chain results in increase in the cost of goods/services supplied. Hence, ultimately, the final consumer bears the burden of the tax applied on every stage of value-add as she can’t claim any input tax credit as the goods/services are consumed by him/her and are not used for any furtherance of business.

Hence, before asking for/granting exemption from GST, a detailed analysis of the tax paid on procurement of inputs, input services and capital goods for the supply of goods/service needs to be done to ascertain the quantum of input tax credit foregone so that, ultimately, the benefit is maximised in the hands of the final consumer. Also, the anti-profiteering provisions embedded in the GST law need to be complied with to ensure that the right quantum of the benefit is passed on to the consumers.

The existence of almost five GST rates (3%, 5%, 12%, 18% and 28%) that are applied to various constituents of the inputs, input services and capital goods procured by businesses makes it even more difficult to ascertain the exact quantum of the input tax credit. Adding to the complexity is the fact that, in most of the cases, inputs, input services and capital goods are commonly used for manufacturing taxable as well as exempt supplies. In such cases, proportionate input tax credit is available, and one has to apply the prescribed formula for arriving at the eligible and ineligible input tax credit. Having done all of this for every tax period, the businesses are then required to determine the benefit to be passed on to the consumers for complying with the anti-profiteering provisions in the GST law.

Coming back to the GST exemptions, take the case of a product having a maximum retail price (MRP) of Rs 200, which is taxed @ 12% GST. The GST component @12 % in the MRP is Rs 21.43. Assume that Rs 100 is the value of input, input services and capital goods which is subjected to a levy of 12% GST (it could be 5%, 18% or even 28%) used in the manufacture of the product. The manufacturer (and other value-chain partners such as wholesalers and retailers), in this scenario, can claim input tax credit (`12) through the value-chain till the product is sold to the final consumer for Rs 200 and the GST paid on inputs, input services and capital goods is a pass-through tax with no impact on the earnings as the GST chain is intact.

Now, the GST Council decides to exempt the above product from GST, though, inputs, input services and capital goods will continue to be taxable. In such a scenario, the expectation of the consumer is that the new MRP, other things being constant, would be Rs 178.57 (200 – 21.43). The manufacturer may not want to bear the incidence of the GST paid on inputs which has now become a cost incurred for the goods sold and, hence, she would revise the MRP to Rs 190.57 (178.57 + 12). In this example, when compared to the original MRP of Rs 200, the consumer would be benefited only to an extent of `9.43 (200 – 190.57) as against an expectation of Rs 21.43. Imagine, if instead of an exemption, the GST Council would have chosen to reduce the rate to 5% on the above product. All other things being constant, this would have resulted in a revised MRP of Rs 187.50 [Rs 178.57 + 8.93 (GST @5%)] arrived at after completely avoiding the tax cascading effect as the manufacturer would have continued to claim full input tax credit as in the case when the GST rate was 12%. Thus, the consumer would have benefited by an additional Rs 3.07 (190.57-187.50) had the GST rate been reduced to 5% instead of granting of an exemption.

From the above example, it can be seen that rather than exempting the supply of goods/services, especially those where GST is applicable on inputs, input services and capital goods used in supply of such goods/services, it would be more prudent to levy GST at a lower rate so that the input tax credit is available through the value-chain and the cascading effect is completely neutralised, ultimately paving the way for reduced prices to the end consumer. If this is not done, GST exemptions would prove to be a bane rather than a boon!


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