GST exemptions can disrupt the value chain

We are closing on three months since the Centre imposed a nationwide lockdown to fight the Coronavirus pandemic and during this time, the Government has worked on a number of tax measures in a bid to bring relief to struggling taxpayers. While these relief measures include accelerated refunds, extensions in deadlines, waivers of late fees and reduction in interest on delayed filing, they do not meet the one expectation of business verticals across the country - exemptions and rate cuts.

It is common knowledge that industries have demanded a reduction in GST rates since the implementation of the Goods and Services Tax back in July 2017. Whether they are pandemic led economic difficulties or just another recession, rate cuts and GST exemptions are always in demand but are never a good idea. Here’s why.

Value chain distortion

The GST framework has been designed around the fact that the indirect tax captures value addition at each stage of production. So the credit of the tax paid on earlier stages in the chain offsets the tax on the subsequent stage. But when an exemption is made on an end product, the tax paid at various earlier stages of the manufacturing chain will inevitably stay with the product and any possibility of carrying forward or offsetting the tax will be removed because of the exemption, resulting in adding to the cost of the final product.

Reduction in pricing not guaranteed

A number of anti-profiteering cases have come to light in the last few months where businesses have continued to charge consumers with regular rates even though the GST rates on a specific category of products were reduced. So even if the GST council announces a reduction in GST rate, there is no guarantee that the benefit of the reduced rate will be passed on to the consumer. Moreover, acts of anti-profiteering are only detected and investigated after consumer complaints and if the business is proven to be guilty, the excess money earned is deposited with the Centre - the consumer still ends up paying a higher price.

Additional compliance burden

Taxpayers will be required to maintain separate accounts for inputs used in the manufacture of exempted goods. As prescribed by GST law, ITC cannot be claimed on the manufacture of exempted goods as the supply already enjoys exemption. Any ITC claims on exempt goods will be reversed as they will lead to negative taxation.

What happens when basic custom duty is nil?

When basic custom duty is exempted, the protection that a domestic manufacturer receives under integrated GST will now be levied on imports at a rate corresponding to the GST rate. This will make imports a lot more cheaper which will negatively impact domestic manufacturers and also dampen the country’s ‘Make in India’ cause.

In the 40th GST council meeting last week, Union Finance Minister, Nirmala Sitharaman announced a number of relief measures greatly benefiting MSMEs and small taxpayers but she did not hint on a reduction in GST rates in the near future.

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