Continuing special incentives under GST — clear mandate required

We had discussed the preparedness of the government in introducing the goods and services tax (GST), the roles expected to be played by the stakeholders for ensuring a smooth transition and a legislation which should adequately address the industry issues.

This article picks up one of the crucial issues currently being debated by the corporates having set-ups in various indirect tax havens such as Uttaranchal, Himachal Pradesh and the Northeast states and enjoying special incentives in the form of exemption/ refund of excise duty/ value added tax (VAT) in addition to exemption from electricity duty, waiver of stamp duty, refund of entry tax, etc.

The objective of extending tax benefits was essentially to build industrial infrastructure and generate employment in these industrially backward areas.

The current regime of benefits extends either in the form of exemption from payment of excise duty, or by way of refund of the duty paid after utilising the Cenvat credit.
As a result, the units do not pay the excise duty payable on removal of goods from their factory or else utilise the Cenvat credit, pay excise duty, and then seek a refund.
The results of these efforts have paid off with substantial growth witnessed in these zones.

For instance, the Uttaranchal government reported an industrial growth of 18% in 2005-06 from a mere 1.9% in 2001-02, achieved by extending these tax benefits.
Whether the exemption benefits prevalent under the existing central excise and state VAT regimes would continue and operate in a similar way under the new GST regime is a very important question which should be addressed by the government.

With crores of rupees worth of investments committed in these jurisdictions, the government needs to ensure that the momentum generated is kept intact without affecting the intended objective of ensuring a seamless movement of goods and services, thus maintaining the tax credit chain.

The joint working group set-up by the empowered committee of state finance ministers in its report on the draft GST model did mention continuing with location-based excise and VAT benefits by way of a refund mechanism.

The government has recently indicated that it is looking at the possible options to replace the excise duty exemption under the GST regime.

If one were to ascertain the government’s approach in continuing with tax benefits, it would be worthwhile to peek into the past to see how such incentives were treated at the time of transition from the sales tax regime to the VAT regime.

It is evident that region-based incentives were allowed to be continued in different forms such as refund schemes, deferment schemes or remission schemes.

For instance, in Gujarat, the units already availing such exemptions were provided an option to either avail the remission benefit or opt for the deferment scheme.

Similarly, the states of Uttar Pradesh, Haryana, Andhra Pradesh and Tamil Nadu extended benefits by converting the then existing exemption schemes into deferment schemes.

To continue with outright exemption under the GST may not be the correct approach, as it would break the tax chain, resulting in a cascading effect of the tax levied at each stage. For instance, it may result in the input tax remaining a cost that companies are unable to pass on to consumers.

Similarly, the buyer of goods would not be able to take benefit of tax embedded in the cost of goods, resulting in breaking of the tax credit chain.

The government may, therefore, either consider granting direct subsidy based on capital investment or grant refund of all duties/ taxes. However, the success of the refund mechanism would lie in timely disbursement of refund claimed by the units.

Whilst introducing the refund mechanism, one of the important aspects that need consideration is the method to refund the tax paid by the incentive units on inter-state sales made by them.

Presently, the central sales tax (CST) applicable on inter-state sales is collected by the originating state i.e. the state where incentive units are established and therefore, there were no issues for such state government to grant refund of CST.

However, under the GST regime, the GST applicable on inter-state supplies would be collected by the consuming state. In such a scenario, it is imperative the consuming state compensates the originating state for the refund to be provided by the latter to the incentive units.

The government needs to iron out such issues for a seamless introduction of the GST.
Though the government is bound by its actions under the principle of promissory estoppel, the principle of public policy may override it. Accordingly, where withdrawing benefits is found to be in the public interest, the same may be resorted to by the government, notwithstanding its prior commitments.

Nonetheless, the government in the past has been seen as keeping its commitments and extending the benefits it had granted and on that basis, one could reasonably assume continuance of such commitment.

The draft white paper, expected shortly, should address such issues and put to rest the fears in the minds of corporates.

Goel and Chhajed are managers with PricewaterhouseCoopers. Views are personal