GST: Reimagining input tax credit norms

With Goods and Services Tax (GST) reaching its seventh-year mark, one should acknowledge and appreciate the endless efforts of the Indian Government for implementing it in a country which has had a history of complex and multi-tier indirect tax laws. The Ministry of Finance, along with the GST Council, has undertaken a major responsibility of bringing in many clarifications by issuing over 300 circulars in the last seven years, focusing on trade facilitation, reducing the burden of compliance, and providing relief to taxpayers. This has demonstrated to the global market that India is capable of rapid growth and evolution, with emphasis on enhancing the ease of doing business in the economy.

 

This approach has also benefited the Government, which is evident from the significant increase in GST revenue collections over the last few years.

One of the key aspects under GST is that tax should only be on the ‘value addition’. Also, the legacy issue of ‘tax on tax’ will be eliminated. This means that each supplier in the value chain is required to pay tax on the value addition at this stage, and there is no tax on tax, which results in a seamless flow of credits. The supplier is not burdened by the tax component on the purchases he makes. This was achieved by allowing credits on procurements when the supplier has to pay tax on his output supplies as envisaged under the GST law.

Over the years, a key focus area for the Government and the GST Council has been simplifying the rules for taxpayers towards input tax credit (ITC). The rules regarding ITC eligibility and availment are essential and have gained significant importance for both taxpayers and Government officials. During the introduction of the Constitution Amendment Bill on GST in Lok Sabha in December 2014, the then Finance Minister assured that ‘Due to the seamless transfer of input tax credit from one state to another in the chain of value addition, there is an in-built mechanism in the design of GST that would incentivise tax compliance by traders.’

ITC in GST is permissible for all expenses incurred in the course of business, except for a specified list of expenses on which it is disallowed. This calls for a rigorous reconciliation and review exercise to be conducted by both the taxpayers and the revenue department in order to determine what is eligible and what is not. The expenses on which ITC is disallowed are the ones related to motor vehicles, food and beverages, renting or leasing of motor vehicles, works contract services, construction services, corporate social responsibility expenses, etc. All these expenses are incurred for the purposes of business itself but are not creditable. It is thus important to bear in mind that exceptions should be bare minimum and not become the norm. This also creates difficulties for the taxpayer since one has to follow a different mechanism in income tax vis-a-vis GST. Under income tax, personal expenses are excluded for the purposes of deductions while all other business outlays are allowed for the taxpayer to consider as an eligible deduction. The Government may consider aligning the practice in both GST and income tax regimes and simplify the credit mechanism by allowing ITC on all business expenditure.

ITC has also been a source of concern for industries engaged in exempted supplies such as education, healthcare, and power sectors. Although an exemption has been granted to these sectors on output supplies, most input supplies procured by them are subject to GST, which contributes to the cost of procurement. Moreover, this added cost of input tax diminishes the benefit of tax exemption which is granted on the output supplies. Therefore, one way to overcome this challenge would be to make all input supplies zero-rated so that there is no procurement tax cost for such sectors.

In addition to the above, there are other process-related issues related to ITC availment. Taxpayers are able to obtain ITC based on its reflection in GSTR 2B, a form which contains the details of inward supplies of goods/services received from registered suppliers. This form is important for businesses as it helps them to reconcile their purchase ledger with vendors. This requires an extensive follow-up and reconciliation exercise before availing of the ITC. Moreover, there exist reversal rules of ITC that are applicable to industries engaged in both exempted and taxable supplies, which requires tagging of each expense under different buckets (taxable/exempt/common) before making the reversal calculations. These reversal calculations are required to be performed on a monthly basis, followed by a true up/true down annually, which could lead to interest and penalty implications for the taxpayers.

A simplified method for calculating eligible ITC amount can be introduced as an additional option for such assesses. It could either be in the form of notifying a fixed percentage of the total ITC as the eligible amount applicable for the banking sector, or notifying a fixed percentage of the exempted turnover to be reversed as illegible credit, which would be similar to the option available in the erstwhile regime.

In the past few years, India’s ranking in the Ease of Doing Business Index has seen a sharp upward rise from being at the 100th place in 2018 to 77th in 2019 and 63rd in 2020 – i.e., a leap of 37 positions in three years. Therefore, we believe that such measures and simplifying ITC-related rules and processes would further help achieve the Government’s aim to simplify business processes, and overall tax administration and compliances in India.

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The author is Principal - Price Waterhouse & Co LLP

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