It’s been over a month since demonetisation was announced by the Prime Minister. One of the major objectives of this drive was return of 86% of the cash in the economy into the banking system, so that detection of undisclosed or ill-gotten income is expedited.
While this move definitely hits black money, which was part of this 86%, we must understand what demonetisation actually does. It targets black money, but not the methods by which this black money is generated.
With demonetisation, all the black money earned over decades and stored as cash was brought back into the banking system, but besides the temporary withdrawal limits, demonetisation by itself doesn’t curb future generation of such black money.
The only future-oriented effect of demonetisation is that once a person deposits a huge sum of cash in the bank, the tax authorities are instantly alerted that this person has so much wealth, hence he can remain on the radar in the future. But nothing stops this person from generating further black money.
In effect, demonetisation is a humongous reset button on the parallel economy, where every crook is forced to start afresh. It is like pulling some runners back to the starting line, because they got ahead in the race using unfair means. But nothing stops these runners from using the same means again and darting ahead.
The only thing that can stop these runners, or make them slower, are hurdles. And GST will be one such major hurdle.
Till now GST’s marketing has only been that of “One Nation One Tax”. Something which will render defunct, a complex system of taxes which was created over many years, and unite it into one single, business friendly, consumer friendly tax regime. While this is true, GST deserves more credit than this. At least the GST which is proposed to be brought in, does.
A look at the draft GST laws reveals that this could do more to hurt black money generation, than any other tool till date.
To understand this let’s take a very simple example. Picture your neighbourhood grocery store. Mr. A, your shopkeeper sells all sorts of FMCG products from toothpaste to milk to maybe even cigarettes. In big cities, Mr. A type shops might be doing a business of around Rs 1-2 crores a year, and at a modest profit margin of 5-10%, earning net profit of anything between Rs 5 lakhs to Rs 20 lakhs.
Now ask yourself: Have you ever paid such Mr A’s by cheque, debit card or credit card or any such banking channel (especially before demonetisation)? Has your Mr. A ever issued you a bill? Do you think Mr. A shows all his sales and income in his income tax returns? Heck, does even file income tax or sales tax returns? Does this explain why just 1% of Indians pay income tax?
What is the way to avoid this tax evasion? His shop is there for all to see, even your local Income Tax department or Sales Tax department. But they just don’t have the data nor the resources to crackdown on thousands of such Mr. As all over your city. Further, the exercise would not even be profitable to the tax departments since the cost to recover the taxes would be substantial.
This is where GST comes in. The entire GST model will be run with the IT backbone called GST Network (GSTN) which will ensure a high level of compliance.
GST will form a virtually unbreakable chain of transactions right from the initial raw material, till the goods are sold to the consumer. Remember how Mr. A sells mostly FMCG products? And how most of these FMCG products are branded, packed goods sold by big corporate houses? Under GST, every seller will have to upload all his sales details, with invoice-wise details, to the GSTN. Most states already follow this model, then what will GST bring in?
In GST, the GSTN will automatically parse through the sales details of corporates, and reflect them in the accounts of the individual purchasers.
For example, as soon as say Coca-Cola sells 1 lakh bottles in a month, it will file with GSTN a detailed breakup of bottles that are sold to each distributor. GSTN will ensure that when each distributor logs in to the GSTN portal, he will get to see exactly how many purchases he has made from Coca-Cola. Next, each distributor will file with GSTN a detailed breakup of bottles sold to each retailer. And in the list of retailers will be your Mr. A. Thus Mr. A’s GSTN account will also show exactly how many bottles he has been supplied by his retailers. And obviously, all this data will be available to the tax department.
In the current system, Coca-Cola does upload such details, but the mechanism to transfer these to the respective purchasers’ accounts doesn’t exist (except in some states like Maharashtra). Further, since as of now each state has different state taxes and tax authorities, this sort of matching never happens for inter-state supplies. Thus if Coca-Cola Maharashtra had sold something to a distributor in Goa, Maharashtra was not able to match this with Goa to ensure that the the sales and purchase records reconcile.
GST will solve this problem. GSTN will know Mr. A has purchased Coca-Cola bottles worth Rs 10 lakhs, but Mr A is not showing any sales, or is showing sales only of Rs 6 lakhs. It becomes a piece of cake for the GSTN and the GST authorities to nail tax evader Mr. A now, all thanks to the seamless flow of credit via GSTN.
Further, in GST, (like in VAT now), there is a concept of “input credit” which is basically credit for the GST you pay on purchases, which can be used to pay your GST dues. Under GST, this credit would be available ONLY if your supplier uploads the sales details to GSTN AND if these details reflect in your GSTN account. Thus, this chain becomes unbreakable as soon as a big corporate enters the chain, since as a purchaser, the corporate would want input credit, and would force the supplier to be GST compliant and file proper data. As a seller, it would be very hard for well-regulated corporates to sell in “black” hence the people down the line would also get caught in the GST web.
The only way to then avoid GST is to formulate a chain in which nobody at any level is maintaining proper record and therefore not filing any data with GSTN. While this is not impossible, it would be very hard to cobble up such a chain in most sectors because very often some or the other component has to come from a highly regulated sector.
Further, all GST registrations will be linked to PAN, thus data will be shared between the Income Tax Department and the Indirect Taxes Departments. The beauty of GSTN would be that the IT systems would do most of this matching of sales and purchases, with minimal human interface and effort. The draft laws and rules provide for heavy computerisation and automation.
And this is where demonetisation comes in. For such a GST system to work, the system needed to be cleaned up, it needed a reset button. And that has just happened to a large extent. Many businesses have begun using banking channels to do regular trade, thus coming into the taxation net. GST will be natural fit for these businesses.
All said and done, GST will not be fool-proof. We will always find some smart-alecs finding some loophole to jump over the hurdles and race ahead. But the difficulty in finding the loophole will be high and the number of people gaining unfair advantages will be very low.
And obviously, this system means a lot of compliance. For businesses which were already in the net for various taxes like Excise, Service tax, VAT etc, the number of different laws to comply with would come down, but the complexity of GST will mean the cost of compliance would remain the same. The businesses which were completely evading taxes though will feel the pain in the short-term. This is one of the reasons why the Central Government wants GST rolled-out as soon as possible, so that the pains are forgotten by 2019.
GST, like demonetisation, would be another case of short-term pain for long-term gain. So be prepared for the usual suspects to rake all sorts of issues about GST just to stall it. They have done it in the past and will do it again.