The introduction of the Goods and Services Tax or GST was supposed to create a unified market of 1.4 billion people and encourage entrepreneurship and job creation. The other aim was to bring more and more firms into the formal sector of India’s economy, which will help expand the tax base needed to raise the country’s tax-to-GDP ratio that has been hovering around 10-11 per cent for a long time.
However, multiple rates and never-ending filing and reporting requirements have turned the GST regime against smaller businesses and first-time entrepreneurs. No wonder, out of 6.3 crore enterprises (the latest available data from NSSO 2015-16), only 1.34 crore have joined the GST network. There is no official data on how many firms have cancelled their GST registrations. But anecdotal evidence suggests that an increasing number of small businesses are either de-registering, and/or trying to remain small by not letting their sales turnover increase the threshold of Rs 20 lakh for services firms and Rs 40 lakh for manufacturing entities, above which GST registration is mandatory.
The current discourse on GST is mostly about how unscrupulous elements are using fake invoices to claim more input tax credits (ITC) than they should. That’s true. However, the major reason for that is too many rates and wide gaps between rates (0-28 per cent) for different inputs that facilitate over-claim of ITC. For instance, cement attracts 28 per cent GST while steel bars 18 per cent. Obviously, real estate firms will use more cement (on paper) than steel to claim more ITC than they should. The solution is to cut multiple rates into fewer ones and reduce the rate differentials. However, the regulators responded by dis-allowing input tax credit for real estate players, which defeats the purpose — to check cascading effects of tax on tax.
One thing that is not getting any serious attention but it should, is how suffocating compliance burden and unchecked inspector raj is discouraging smaller business entities and first-time entrepreneurs from turning formal by joining the GST network.
How small companies suffer
I am listing some common irritants.
In addition to helping expand the tax base for the government, formalisation also helps smaller businesses entities in getting access to cheaper finance from banks. So, to promote formalisation, RoC (Registrar of Companies) has rightly simplified the registration process and has been allowing registration of businesses with (registered) addresses in residential buildings and apartments that help save on office rentals. That, in turn, encourages skilled professionals engaged in consultancy, online coaching, yoga and fitness training, research and advisory, and other knowledge-intensive services to have their own formal setup. Separate office space is not really needed for such ventures. Rather the only thing needed is laptops with internet connection, and most employees can work from their homes till the business operations become big enough to require separate offices and more employees.
But GST inspectors (many of them have seen the good old days of sales tax and VAT, and obviously don’t want to let go of their power to extract bribes) harass such firms on flimsy grounds like ‘why don’t you have a company’s nameplate clearly displayed’ that can create nuisance in residential areas. That is quite stupid at a time when the difference between home and office has blurred. Moreover, this runs counter to the contributory role played by RoC and discourages entrepreneurship and creation of knowledge-intensive well-paying jobs that India badly needs, the more the better.
Of late, small business entities are getting automated GST notices based on their bank statements and being asked to furnish documents that are easily available with the government, for instance, tax returns or audited balance sheets.
The registered office of a company I deal with is Noida, but its bank branch is in Dehradun where the directors of the company live. All tax returns are filed properly. As the company has 100 per cent export sales, there’s no GST payment obligation, and yet it has got a notice from the GST Dehradun office simply because the company’s bank branch is in Dehradun. Unlike large corporations, small business entities can’t really afford to have full-time “government affairs” teams to navigate the opaque tax bureaucracy and struggle to deal with it.
GST tightens the noose
The system of invoicing and GST payment is a big pain. Suppose company A raises a GST invoice against its client company B, say in November 2021, for supply of goods or service that attracts 18 per cent GST, A (the seller) is liable to pay up the GST amount equal to 18 per cent of the invoice value (on behalf of B) to the government, latest by 20 December 2021, irrespective of whether A has received the payment from B or not. Company A can’t cancel the invoice merely because it expects delays or default on payment because it has already supplied goods or services with respect to the GST invoice raised. Thus, seller A must pay GST on behalf of their buyer/client B by December 20, 2021.
In case A doesn’t deposit the GST amount in the government’s account by the said date due to whatever reason—A doesn’t have sufficient cash balances and the buyer delays (or defaults)—the GST authorities cancel A’s GST registration, usually after a month or two. It’s difficult to understand why the seller’s GST registration is being cancelled when the problem lies with the buyer.
Suppose, the buyer B now has money and wants to pay up their supplier A. The client/buyer checks the GST registration status (as GST registration cancellations by officials have become quite common these days) of the seller/supplier A, but doesn’t find it because of cancellation, B then would obviously want to pay only the principal amount to A and not the applicable 18 per cent GST as they can’t claim input tax credit. That is not all.
Now suppose seller A gets a new client ‘C’ who is interested in buying goods or services from A but asks for A’s GST registration as they want to avail ITC. Now A has the following option: Pay up the GST dues of its former client B with interests and penalty if any, and bribe or plead the concerned GST inspector for restoration of its GST registration or forget sales to client C. Or, A may ask C for reverse GST charges i.e. the buying client (C) to pay GST on A’s behalf and pay only principal amount to A. In this case, C will be able to claim ITC but seller A won’t be able to do so as the latter’s GST registration has been cancelled.
Usually, large companies (the kind of client a small vendor must not lose) delay paying smaller vendors forcing them to pay GST from their own pocket. This consumes a lot of working capital (even if temporarily) of the supplying vendors, and reduces the amount of working capital needed by the buying companies. But that would cost the small vendor interest on additional working capital. This is one of the ways in which large companies are squeezing smaller vendors.
Seller A can think about raising the invoice in December 2021, the actual month in which they expect to get the payment. This is possible in the case of supply of services but not in the case of goods as it involves the generation of E-way bills for transportation at the time of sale. In either case, the seller will have to bear the cost of delayed payments from the buyer. The only relief the seller (of services only) can get is that they could pay up GST later and yet his registration will not be revoked. But tax inspectors can always threaten to cancel the GST registration, especially of a small firm for delaying payment (forced by delayed payment from the buyer) to extract bribes. That is another side effect of this strange GST rule.
The way forward
It’s next to impossible to do away with inspector raj completely. However, the following tweaks can help. At the moment, manufacturing firms with annual sales turnover of Rs 40 lakh are exempted from compulsory GST registration. This limit is Rs 20 lakh for services firms. It would help to raise this limit to Rs 50 lakh for both manufacturing and services. This will free up thousands of smaller firms from clutches of inspect raj and let them focus on business development. That’s the way to faster GDP growth and job creation. The switch to GST shouldn’t be forced upon a small business entity that doesn’t see any benefit from joining the network.
Second, the suppliers of goods and services should be asked to pay GST only after they receive the payment from buyers. This can end all harassment related to invoicing and payment.
Third, making GST payment and filing GST returns quarterly just like income and corporation taxes irrespective of size and sales turnover, will help all kinds of businesses by cutting down compliance cost. Tax avoidance can be checked by better coordination between direct and indirect tax departments without hurting entrepreneurship. I rest my case.
The writer is a business economist and currently the CEO, Indonomics Consulting, a policy research and advisory startup. Views are personal.
Source: The Print