Introduction

Under the current taxation scheme, businesses earn tax credits under the central value-added tax (CENVAT) scheme for specified central levies and value-added tax (VAT) credits under various state VAT laws. Other than large taxpayer units, manufacturers avail their credits at the factory level and service providers avail their credits depending on their registration status. The CENVAT provisions also include the input service distributor concept, which allows for some mobility of credits between different units of the same entity. On the other hand, credits under state VAT provisions are accounted for at the state level.

Businesses face two issues with regard to credits – the inability to avail of credits for all taxes paid on sourcing and the accumulation of credits. These situations occur for a variety of reasons and ultimately increase the cost of doing business. The credit mechanism under goods and service tax (GST) is therefore a key issue for businesses. In theory, the switch to the GST regime should facilitate the pass through of all credits, thereby allowing tax to be passed on to the consumer without any cascading.

Central GST credits and state GST credits

Given the dual GST structure, central GST credits and state GST credits will be accounted for separately.

It is still uncertain how the central GST legislation will account for and use central GST credits across jurisdictions and how the large taxpayer unit mechanism will operate within the regime. It is expected that state GST credits will continue to be accounted for and managed at the state level.

The credit provisions are likely to follow the principle of value addition (ie, that all taxes charged to businesses in connection with their business activities (goods or services) should to be creditable). As a corollary, taxes linked to exempt activities will not accrue tax credits.

Fungibility between central GST credits and state GST credits may be unavailable. Given that goods will be taxed by both the central government and the states (at the same rate), tax credit accumulation is likely to arise mainly where there is an inverted duty structure on goods or because of the difference between the expected concessional tax rate on goods and the tax rate on services. Further, the states are not likely to allow fungibility of state GST credits availed of in other states.

Internationally, tax credit provisions enable businesses to obtain refunds for unused tax credits, which minimises the negative effect of accumulated credits on cash flows. While the current CENVAT mechanism does not include such provisions (except in respect of exporters), the VAT legislation provides for refunds of unused credits after a specified period. It remains to be seen whether and how the refund mechanism will be incorporated in the central GST and state GST credit provisions.

There are several differences between the CENVAT scheme and the state VAT schemes, including the following:

  • The CENVAT scheme is inclusive and covers nearly all inputs, whereas some states have VAT input tax credit schemes which cherry pick eligible inputs. In addition, several states have long lists of goods that are ineligible for VAT input tax credits.
  • Credits for service tax are available only on payment, unlike the VAT input tax credit mechanism, which is purely invoice based.
  • The VAT input tax credit provisions in states such as Maharashtra link the availment of credit to a threshold of sales activity.

The provisions for central GST credits and state GST credits must be harmonised on such fundamental criteria. 

Integrated GST credits 

Under the GST regime, integrated GST (ie, central GST and state GST combined) will be levied by the central government on all interstate transactions of taxable goods and services. 

As per the proposed model, fungibility of central GST and state GST towards integrated GST and vice versa may be allowed. Central GST credits must be used first towards central GST and then towards integrated GST liabilities; the same will apply to state GST. Integrated GST must be used first towards integrated GST and then towards central GST and state GST. 

Additional 1% tax on interstate transactions 

The central government will collect the origin-based 1% tax on interstate supplies of goods for two years and assign it to various states. This proposed additional tax may not be creditable, which will create a cascading component in the GST credit chain. 

Migration of accumulated credits 

No clarity has been provided on the transitional provisions for accumulated CENVAT credits and state VAT credits or how these will be dealt with once GST has been introduced. Ideally, the transitional provisions will allow for claw back of tax (ie, provide refunds for accumulated credits or allow a tax credits under GST). 

For further information on this topic please contact Rohan Shah or Bharath Madakari Economic Laws Practice by telephone (+91 22 6636 7000) or email (rohanshah@elp-in.com or bharathm@elp-in.com).

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