Introduction

The various laws on the principal taxes (eg, central excise duty, service tax, central sales tax and state value-added tax (VAT)) which will be replaced by the goods and services tax (GST) regime provide exemptions and concessions from GST under certain circumstances. Apart from de minimis exemptions, these can broadly be categorised as: 

  • area-based exemptions;
  • end-user exemptions; and
  • product/service-specific or sector-specific exemptions.

Under the GST regime, exemptions are distortionary and affect the free flow of tax credits; thus, the ideal GST regime would limit the number of available exemptions.(1) However, the existing exemptions have been necessitated by various considerations (eg, promoting a particular sector, regional development, infrastructure development or public health). In addition, many of the exemptions have limitation periods in the form of sunset clauses. Thus, some exemptions are expected to continue under the GST regime, at least until their sunset clauses expire.

Whether and to what extent exemptions will continue under the GST regime is of significant concern for industry, as is the new mechanism for allowing ongoing exemptions and concessions. This update provides insight into the impact of the new regime in relation to different types of exemption. 

Product/service-specific and sector-specific exemptions 

It is unlikely that product/service-specific or sector-specific exemptions providing for concessional rates of duty or no duty will continue under the GST regime. An example of a sector-specific exemption is the healthcare sector's exemption from service tax. Under the GST regime, the effect of sector-specific exemptions extends beyond their impact on the effective tax rate, leading to a distortion in the availment of tax credits. For example, if the rate of central GST was 10% and a 4% concession rate were applied to the manufacture of specific goods, the credit flow would be distorted and the manufacturer would accumulate credits, as inputs would be procured at a 10% tax rate while the final product would be taxed at a significantly lower rate. 

The exemptions that will continue to apply will likely be converted into a cash refund scheme (subsequent to tax collection), which will not affect credit flow. 

End-user exemptions 

End-user exemptions may continue, as the value chain remains largely unaffected by this type of exemption. Examples of end-user exemptions include exemptions: 

  • for supplies provided to mega-power projects;
  • for supplies provided to export-oriented units and special economic zones; and
  • from central excise duty on goods used for the manufacture of fertiliser. 

End-user exemptions may be converted into a scheme whereby refunds are granted to end users in order to prevent credit flow distortion. 

Exemptions for abatements 

The exemptions that allow for abatements may continue, or abatements may be listed under the valuation provisions contained in the GST regime. Unless works contracts are treated as single supplies, exemptions and abatements which mitigate double taxation may continue in some form, perhaps by way of abatement. 

Area-based exemptions 

Area-based exemptions are provided by the central government (eg, for industries in the northeast region and Himachal Pradesh) and the states (eg, under the package incentives scheme), and contain sunset clauses. Area-based exemptions are applied in the form of:

  • outright tax exemptions;
  • tax liability deferments; or
  • refunds for paid taxes. 

Given the government's commitment to promoting regional development, area-based exemptions may continue until they expire. However, it is likely that the mechanism for area-based concessions will either change to a deferral scheme or operate under a cash refund scheme, neither of which affects the credit chain. However, the amount of duty and tax refunds that will be offered (ie, total refunds or partial refunds) is still being considered, as is whether refunds should have time limits. Where a substantial change in a party's benefits occurs before an area-based exemption expires, the affected party must determine whether the doctrine of promissory estoppel can be invoked.

Exemption scenarios under concurrent taxation

There is no uniformity between the exemptions granted under federal laws and those granted under state VAT laws. Further, the number of goods exempted under the central excise law is greater than that exempted under state VAT laws. In addition, the goods exempted under each state's VAT laws differ. According to the Constitution, the central government and the states have the power to legislate and levy central GST and state GST separately;(2) thus, unless alignment or consensus is achieved with regard to exemptions, some products may be subject to:

  • central GST and not state GST; or
  • state GST in one state and no state GST in another state. 

Comment 

The availability of exemptions has been an important consideration for many businesses. Due to the change in the available exemptions and the mechanism for applying exemptions, businesses must re-evaluate their business models, cash flow, price points and profitability. 

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

Endnotes

(1) The Empowered Committee of State Finance Ministers extended similar views in the First Discussion Paper on GST.

(2) As per the 122nd Constitution Bill 2014 (introduced in Lok Sabha on December 14 2014), the central government and the states separately have powers to legislate and levy central GST and state GST, respectively (for further details please see "Constitution and scheme of GST").

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