Traditionally, indirect tax policymakers have accorded the small and medium industry favourable tax treatment. This favourable treatment was provided on the premise that small-scale units use less amounts of capital per unit of output and also provide more employment per unit of output.
There is, however, not much evidence to establish that small-scale excise exemptions in the past have really helped in the growth of the small-scale sector.
Notwithstanding all this, the new Goods and Services Tax law does protect the small-scale duty benefits. The GST Council, which is the joint policy formulating group consisting of both the Centre and the States, has accepted an annual threshold limit of ₹20 lakh turnover up to which GST will not be payable.
Beyond ₹20 lakh , for another additional ₹30 lakh annual turnover, the GST rates would be a flat 1-2 per cent based on self-certification of the turnover, or on the basis of the turnover declared in the financial accounts of the company.
Hardly an incentive
While the very small units are provided duty benefits or duty concessions, the GST does bring the small and medium units under a tight regulatory regime which would be IT-driven. Every unit paying GST must have a GSTN number after registration. Smaller units that are under the compounding scheme with a turnover between ₹20 lakh and ₹50 lakh would require to be registered with a GSTN number. There is now growing evidence that the small-scale exemptions in the past did not really incentivise the small-scale units to grow. On the other hand, they encouraged fragmentation in order to remain below the threshold level of exemption.
The big difference in GST is that the entire value chain, from raw material to retail, has become integrated for the purpose of taxation. The Constitutional Amendment Bill empowers the Centre to tax trading, and the States to tax services. The Constitutional Amendment really ushers in the dual VAT.
In the GST scenario, the decision to remain small would become counter-productive as units under-reporting transactions would suffer from blocked credits. Today, with the integration of the value chain for taxation, units would be eligible for credit for input goods, input services and imported capital goods. Many of them carry Central duties, which the State VAT-paying traders hitherto could not utilise.
We can, therefore, see in the GST scenario, more and more units in the informal sector pretending to be small, forced to enter the formal duty-paying segment. This would have significant revenue consequences, as it would also result in smaller units having to report higher incomes to the Direct Tax department in view of the synergy between Direct Tax and the Indirect Tax department established by the common PAN registration number.
It is also important to make a distinction between the small and medium industries in the goods sector and their counterparts in the services sector. The exemption threshold in the service sector was only ₹10 lakh compared to a turnover threshold of ₹1.5 crore on the goods side. Therefore, there has been less incentive to fragment and remain small in the services sector compared with the goods sector.
Compliance and after
The GST scheme announced by the Government spells out a clear design of the dual control regime. This really covers the whole area of compliance verification.
Compliance verification has broadly three prongs, namely return scrutiny, audit and anti-evasion. It is now agreed that small units manufacturing goods beyond ₹1.50 crore annual turnover will have to deal locally with the State government. Small service providers, on the other hand, will have to deal with the Centre, whom hitherto they have been dealing with. The small and medium units have, therefore, been protected from the vagaries of dealing with both the Central and the State Indirect Tax departments. This is undoubtedly a big relief.
Finally, where does all this leave the small and medium industry in the GST era?
The self-policing mechanism provided by the design of GST and the tracking of every transaction by the GSTN system will ensure a more level playing field for all units, whether big or small. The GST philosophy represents a shift in tax thinking, which is that tax incentives must be relied upon less and less to encourage particular segments of the industry. The tax rates must be low with fewer exemptions covering a larger tax base.
Recent studies by the International Monetary Fund and the World Bank have shown that tax incentives do not confer any real benefit but merely distort the resource allocation. Small and medium units would be better off if there is greater ease of doing business which would require easing of the regulatory mechanisms, loosening of the labour laws, and greater access to bank credits. Expenditure switching from tax incentives to infrastructure spending could benefit small and medium units more than tax incentives. Perhaps this new thinking in the GST may end up helping the small and medium units even more.
The writer is advisor to the Tax Policy Group, EY and former member of the CBEC. The views personal
Free Education Guide on Goods & Service Tax (GST)
Model GST Law
Transition to GST
Input Tax Credit
Assessment and Audit
Inspection, Search, Seizure and Arrest
Offences, Penalty, Prosecution & Compounding
Demands and Recovery
Appeals and Review