How can a Value Added Tax (VAT) tax system, which has brought within its fold all taxes with the express aim of ensuring no cascading of taxes, not ensure free flow of credit? Why is credit being curtailed, why is there an inverted duty structure, why are there no refunds - have been the constant complaints.

Let us take a step back to understand why this was so and why it took more than eight to nine years to address these concerns. In an ideal VAT system of taxation, there is a single rate with a seamless flow of credit taxes paid in the earlier input stages of value addition, be it goods or services being set off against the tax on the final product. Thus, there is no tax on tax.

This is the ideal tax architecture which looks at the design rather than at rates or revenue which becomes the consequence of a good tax design. But we do not live in an ideal world - and revenue was and is of great concern to the states, especially since they were in effect surrendering their right of taxation to a pooled body, the GST Council.

Ideal Design, Not Ideal World  

In this background, the GST design was flawed at birth - and it was a conscious call. The mantra being that we should not let the best be the enemy of the good; chase an unattainable ideal which would have paralysed progress in finalizing the law. So, there were a multiplicity of rates and slabs; there were exemptions and exemptions, carve-outs like the petroleum sector, which effectively meant the free flow of credit was thwarted.

The consequence of multiplicity of rates was inverted duty structure, which meant accumulation of credit. Revenue and concerns of possible evasion meant that credit was not permitted in several situations - capital goods was a classic instance of this design. And to top it all, there was also a compensation cess to address the concerns of states of possible loss of revenue.

The 56th GST Council meeting took several long pending measures. It rationalised the duty structure, reduced the number of slabs but did not bite the bullet and take the next big step of a single rate. So, while this was a major reform, the compression of slabs and rates, paradoxically also increased the inverted duty structure issue. Since there was no change in the processes, this meant accumulation of credit.

Next Big Step

The 57th Council meeting has taken the next big step in the journey towards an ideal tax architecture. The decisions taken were momentous - and nothing bigger than freeing the flow of credit. The first set of reforms related to the returns itself smoothened the process of making amendments which in turn would lead to reduction in litigation. A series of amendments have been recommended in the CGST Rules to facilitate taxpayers in reporting - from supplies liable to the reverse charge, to permitting rectifications of liability, to facilitating better reconciliation of details furnished in the various forms, to declaring the details of the underlying invoice for which payment has been made to an invoice management system. Some regular irritants to the taxpayer filing returns have been resolved.

The next set of decisions aimed at the seamless flow of credit. Intrinsically tied up with this dictum is the principle of refunding accumulated credit. This as mentioned earlier was particularly so in the case of capital goods and on account of input services. While refund in the case of services will be available prospectively from November, in the case of capital goods it would be staggered over 60 months. A classic case of the tax officer parting with the money with some reluctance! Further this provision kicks in only for capital goods after April 2027.Credit would be available on telecom towers, pipelines-these were contentious issues with the tax officer holding that these were not ‘goods’ but more in the nature of immovable property. This is a welcome clarification and will cut down litigation.

But the irony is that all states are now concerned about the impact on revenue, which is bound to get impacted.

There were a host of other far-reaching recommendations - from easing registration, refunds, zero-rating of supplies, matching invoices, cutting down on frivolous notices and litigation, rationalising provisions of E-way bill to ensure there is no in-transit checking of vehicles - all small but as a package, substantial and should contribute immensely to ease of business. The other big-ticket call was to completely omit the provisions of arrest. Without getting into the merits of this suffice it to say that the taxpayer now must demonstrate that the trust being reposed is paid back.

C-Efficiency

The C-Efficiency (or collection efficiency is a measure of VAT revenue efficiency – or the gap between what ought to be collected and what is actually collected) as per a NIPFP 2023 paper of Indian GST was estimated to be 0.54 or 54%. This means that there is a policy gap and compliance gap which in effect led to lesser collection than what should be.

The policy gap has largely been addressed. Improved compliance should now fill up the remaining gap till such time the last major policy call, of a single rate, reduction in exemptions and bringing petroleum products within the GST fold, happens. In the meantime, the taxpayer should ensure that all taxes due are paid, the benefit of input tax credit is passed on to the consumer and prices are reduced.

(The writer is the Chairman (Retired) of Central Board of Indirect Taxes and Customs)