Within the fiscal federalism scheme envisaged in the Constitution, the central government has the power to tax interstate sales transactions.(1) Pursuant to this power, central sales tax (CST) is imposed on interstate sales transactions. Even with the implementation of goods and services tax (GST), the central government will retain this power. The 122nd Constitution Bill 2014, which is expected to be discussed in the budget session starting on February 23 2015, seeks to introduce Articles 246A and 269A (for further details, please see "Constitution and scheme of GST"). These articles allow the central government to impose tax on the supply of goods and services occurring in the course of interstate trade and commerce and empower Parliament to make laws to that effect, including formulating principles to determine the place of supply in interstate transactions (which will determine which jurisdiction has the right to tax each interstate supply transaction) on the basis of GST Council recommendations. This update discusses the taxation system for interstate supplies envisaged under the GST regime with regard to the existing system.
Intrastate GST model
Under the proposed GST regime, the intrastate GST model has been accepted for interstate transactions. Within the intrastate GST scheme,(2) the central government has the right to levy intrastate GST at a rate likely to be equivalent to the applicable state GST rate and central GST rate. In other words, if the central GST rate is 10% and the state GST rate is 12%, the interstate GST rate will likely be 22%. However, because state GST rates may vary from state to state (which is contrary to the classic common market regime, which has a unified rate), the interstate GST rate must be constant, as it will otherwise result in identical goods being subject to different rates of interstate GST when sold in different states. Unlike CST – which is an origin-based tax regime – GST is a destination-based tax regime; thus, the state GST portion of interstate GST will eventually be transferred to the state where the goods and services are supplied.
One major advantage of the interstate GST model over the CST model (where input tax credit is not available to the buyer) is that the input tax credit chain will be uninterrupted for interstate transactions. Under the proposed model, the central government will act as a neutral agency and transfer funds to the state governments based on the destination principle. While all details of the interstate GST model have not yet entered the public domain, certain key transactions will be treated differently under the GST regime compared to the current regime.
Some significant changes are tabulated below.
Click here to view the table.
CST compensation issue
While the issue of CST compensation to states has been a roadblock for the introduction of GST, the bill has sought to resolve this issue in two ways. The first is by imposing an additional tax on the supply of goods in the course of interstate trade and commerce at a rate not exceeding 1% for a period of two years, or any other period recommended by the GST Council. This tax will not be imposed on the supply of services. The additional tax will become a cost within transactions, since it cannot be offset. Unlike destination-based tax regimes, this additional tax will be an origin-based tax, wherein the proceeds will go to the state government where the supply originated. Second, on the GST Council's recommendation, Parliament will be able to compensate states for loss of revenue arising from the implementation of GST for period of up to five years.
With the fungibility of credits under the GST regime on interstate transactions, businesses must re-evaluate the need to set up depots in order to optimise tax credits. Further, with the likely introduction of the additional 1% tax on the supply of goods, the differentiation between goods and services transactions will persist. It will be interesting see how this additional tax will be levied on composite contracts, such as works contracts. Interstate transactions of alcoholic beverages will have their own set of issues, given that they will be outside the purview of GST. The telecoms, banking and insurance sectors are anticipating the affect that the GST regime will have on their interstate transactions, given the difficulty in determining place of supply in most tax jurisdictions.
For further information on this topic please contact Kumar Visalaksh or Harsh Shah at Economic Laws Practice by telephone (+91 22 6636 7000), fax (+91 22 6636 7172) or email (firstname.lastname@example.org or email@example.com).
(1) This power stems from Article 286, which specifically prohibits states from taxing sale and purchase transactions that occur outside the state, and Article 246 (read with Entry 92A of List I), which empowers the central government to tax sale or purchase transactions that take place in the course of interstate trade or commerce.
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