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Why India's GST system could be jeopardized

State governments may have received a message from India's Supreme Court that they can change GST policy, including tax rates and compliance requirements, with potentially "devastating" consequences for taxpayers.

According to one vice president of tax at an Indian pharmaceutical company, this could mean a shift away from a uniform GST rate.

"Any such measures taken by the states could lead to the introduction of multiple tax rates across states, varying compliance requirements, and diverse interpretations of tax provisions," he says. 

"Any of these eventualities could be devastating for the taxpayers, especially those who have business operations across states. The extraordinary tax reform that is GST could be in jeopardy ," he adds.

On May 19, the Supreme Court ruled in the Mohit Minerals case that the central government and states have the authority to legislate on GST policy, despite the GST Council's recommendations not being binding.

An appeal against the Gujarat High Court regarding the integrated goods and services tax (IGST) on importers resulted in this decision. The question was whether the importer was liable to pay tax on the shipping line's freight services under the reverse charge mechanism.

In this case, the Supreme Court upheld the lower court's decision that no IGST can be levied. The implications for the GST Council and state powers, however, were the focus of attention.

"The concern about this judgment is that GST Council members may seek to pursue their own individual agendas," the vice president explains.

According to him, the federal government could back out of its commitments to the states on GST compensation, while state governments may seek flexibility in their GST policies.

The Indian Constitution gives the union a "higher share of power to avoid chaos," according to the court. Indian federalism, on the other hand, was described as "a dialogue between cooperative and non-cooperative federalism."

States have the authority to enact tax policy, but the court stressed that the GST Council should work "harmoniously" with states to reach practical solutions.

At the time of the ruling, Abhishek Rastogi, a partner at law firm Khaitan and Co, who represented the petitioners in the case, wondered about the impact on tax unity.  In response to the court ruling, Rastogi said, "this opens up the question whether different states could have different rate structures for a similar supply."

"Such a deviated position would fundamentally affect the concept of one nation, one tax," he continued.

The Supreme Court acknowledged that the GST Council's lack of binding recommendations could cause the "entire structure of GST to collapse" if each state imposes a conflicting tax.

Taxpayers are concerned that the outcome will result in a reintroduction of a plethora of different levies and rates.

Since its inception, there have been concerns about the GST regime's future, and the Supreme Court decision has only added to the speculation. Despite the fact that many businesses expect the regime to survive, taxpayers may face significant challenges.

"The GST system will not be dismantled," one Indian biochemical company's CFO says. "However, this court ruling will make the states more aggressive in coming to consensus decisions on deciding rates on various products and will result in inordinate delays and tussles moving forward."

Some tax experts are skeptical that the Supreme Court's decision will result in increased GST complexity for businesses. According to the head of indirect tax at an Indian manufacturing company, the ruling may not cause any additional issues on its own.

"Even though there are issues which need to be addressed as a consequence of this ruling," he says, "it is unlikely to add further complexity to any other unrelated issues."

In 2017, Prime Minister Narendra Modi introduced the Goods and Services Tax (GST) to simplify the tax system and overhaul indirect taxes across the country. About 20 federal and state taxes, such as factory-gate duties, service, and local taxes, were replaced by the GST.

Despite this, there is still friction between the federal government and state governments over the application of taxes and the distribution of tax revenue.

"Many states refuse to reduce fuel taxes, though the centre has reduced excise duties on petrol and diesel since the states are complaining they are not receiving their ‘fair share’ of GST taxes," the biochemical company's CFO says.

The GST reform was a watershed moment for the Modi administration, but its future remains uncertain. COVID-19 has wreaked a fiscal crisis to match its terrible human cost, so tensions over GST revenue are not going away.

At the same time, the Indian Constitution places strict limitations on state governments' powers. Under the constitutional framework, the GST Council has "recommendatory powers," not mandatory powers, according to the head of indirect tax.

"While the Constitution gives concurrent powers of the union and the state government on tax matters," he explains, "the GST Council acts as a governing body with the backing of the Constitution itself, which provides that the decisions have to be taken by a three-fourth majority."

"This means that, practically, it won’t be feasible for any state to levy any new tax which is not approved by majority by the GST Council," he says. "This also gets reflected in the consistency in maintaining the uniform tax provisions across the country since the inception of GST in India."

Businesses can plan for changes in GST policy over time, though it is difficult to predict proposals that have not been written yet. Tax professionals must be ready for unexpected legislative shifts and court decisions that could change how the law is interpreted.

Agility is the key attribute that will determine how businesses navigate any challenges, according to the vice president of tax.

"Keeping abreast of developments in this area, the power and political dynamics at play, and understanding how they could impact policy decisions will be crucial," he says.

Companies, on the other hand, can stay ahead of the political agenda by maintaining strong data systems in addition to closely following developments.

According to the vice president, "internal processes and systems should be malleable enough to accommodate any new changes."

He explains that "having excellent data control on data, automating routine processes, and ensuring appropriate digital interventions for carrying out tax processes would significantly aid in adapting to changes quickly."

However, it is not all about business. The Indian government may take steps to ensure that the GST system does not become unstable in the near future. This would entail making a concession to states that are experiencing a fiscal crisis as a result of COVID-19.

"The centre should make the first move by displaying magnanimity – either by ensuring that the states receive the full compensation promised for the five-year period, or by extending the compensation for a few more years, which can be negotiated," the vice president stated.

"This would quell the trust deficit created over the years and dispel the need for states to diverge from the unanimous decision-making process of the GST Council," he explains.

The federal government may attempt to reach an agreement with state governments. However, the government would need to act quickly to give businesses more certainty. On June 30, the five-year compensation period will come to an end.

"Such an agreement could commit the centre and states to work together in the GST Council to simplify and rationalise rates, and further cement the foundations of cooperative federalism," says the vice president.

In other words, the federal government may take action to avoid the worst-case scenario for businesses.