Demonetisation, Modi and More

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“So long.”

In a massive move, Prime Minister Narendra Modi announced the demonetising of Rs 500 and Rs 1000 currency notes. According to Investopedia, demonetization is the act of stripping a currency unit of its status as legal tender. The idea behind the effort, as Modi suggested in a long preamble before his announcement, is to attack corruption and make black money harder to use.

This isn’t the first time India has demonitised its currency. In 1946, the Reserve Bank of India actually banned Rs 1,000 and Rs 10,000 notes, primarily to deal with unaccounted money. These were then reintroduced with a Rs 5,000 note in 1954, before they were once again demonitised in 1978.

The aim of taking the Rs 500 and Rs 1,000 notes out of circulation is to reduce the amount of illicit money in the economy. Simply put, many economists believe that high-value notes make it much easier for black money to move around the country, without necessarily being beneficial for law-abiding citizens or the poor. Next government also wanted to eliminate fake currency and dodgy funds which have been used by terror groups to fund terrorism in India. The move is estimated to scoop out more than 5 lakh crore rupees black money from the economy.

However the honest taxpayers need not to worry. Even if you have Rs 10 lakhs as cash with you and you can prove its legitimacy, you don’t need to worry. The surprise move by government is a disaster for people who have accumulated lakhs and crore of unaccounted cash under their pillows and mattresses. The winter is coming and these worthless pieces of paper can provide the corrupt some ephemeral warmth.

The timing of this announcement seems obvious, in hindsight. With the massive rollout of the Pradhan Mantri Jan-Dhan Yojana (PMJDY) in India, citizens’ access to bank accounts is nearly complete. A demonetization move would have been impossible if low-income households were unbanked. PMJDY has provided them with free bank accounts, which will also be used to transfer government payments. The need for honest people to stash cash in mattresses, therefore, has diminished. This move by the PM has also followed the income disclosure scheme where people were given a window of opportunity to declare their wealth amassed through various means. It was an appropriate time, therefore, to make credible the threat of a crackdown on black money and corruption within India.

Of course, actually implementing this is something of a mammoth task. Modi explained how the country is planning to carry out this massive operation over the next few months, as millions of Indians will attempt to exchange their old notes. It will stretch the capabilities of the financial system, which already does not extend across the country, and the interim period will also see many attempts by those holding on to black money to turn their cash into legal tender. The effort also depends heavily on Indian authorities actually delivering on the promise to make it easy for people to turn their old currency into smaller denominations. After this, the government plans to reintroduce a new Rs 500-denomination note, with limited circulation.

The biggest sufferers would be unorganized and informal sector as they predominantly deal with cash. Other loser would be mid-cap and small- cap companies which collect and make payments in cash. This pain will continue till this stock of cash is replenished by the banking system, which can be a quarter or two.

On inflation, the price level is expected to be lowered due to moderation from the demand side, according to CARE Ratings research paper. Some economists say that lower money supply would lead to deflationary pressure with too little money chasing too many goods. However, on the contrary, some economists believe that the move might work the other way round and help curb inflation with lower money supply as unaccounted money would be taken out of the system. In the long run, this is a significant positive shock to the Indian economy and society. If substantially implemented, this will send a strong signal about India’s anti-corruption drive and is very likely to improve the country’s reformist stance.

In spite of the initial hiccups and disruptions in the system, eventually this change will be assimilated in the system and is to eventually prove positive for the economy in the long run. Whether this would eventually boost economic activity that is remains to be seen. But, orders of magnitude are very difficult to establish and hence, any claim of such improvement in formal economic activity with consequent beneficial tax impacts and other social economic multipliers must be deemed wholly speculative at this stage. This move by the government along with the implementation of the GST will eventually make the system more accountable and efficient.

 

This article was written by Varnita Deep (PGDM, Batch 22, XIME-B

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A Layman’s View of the Goods and Services Tax

GST
(Source: FosterGem)

 

The Goods and Services Tax (GST) is the biggest reform in India’s indirect tax structure since the economy began to expand 25 years ago. At long last, a dream is set to become reality. The 122nd Constitution Amendment Bill came in Rajya Sabha with a broad political consensus (And the “good wishes” of the Congress Party), which holds the crucial cards on its passage.

 

GST is a single indirect tax for the whole nation, which will make India a unified common market. GST is a single tax on the supply of goods and services, right from the manufacturer to the consumer. Credits of input taxes paid at each stage will be available in the subsequent stage of value addition, which makes GST essentially a tax only on value addition at each stage. The final consumer will thus bear only the GST charged by the last dealer in the supply chain, with set-off benefits at all the previous stages.

 

In other words, the prices that we pay for goods and services have the taxes embedded in them. Mostly, the consumers are not even aware of or they ignore the tax they pay for things they buy. This is because there are plethora of indirect taxes such as sales tax, excise and VAT, which leads to increased complexity. The GST seeks to untangle this knot and subsume all in one single tax, thereby making India an economically unified market.

 

The Empowered Committee of State Finance Ministers, which deliberated on the tax and its implications, has recommended what taxes are to be subsumed in the GST:

 

In the Central Taxes:

1) Central Excise Duty;

2) Additional Excise Duties;

3) The Excise Duty levied under the Medicinal and Toiletries Preparation Act Service Tax;

4) Additional Customs Duty, commonly known as Countervailing Duty (CVD);

5) Special Additional Duty of Customs – 4% (SAD);

6) Surcharges, and

7) Cesses.

 

Among the State Taxes and Levies:

1) VAT / Sales tax;

2) Entertainment tax (unless it is levied by the local bodies);

3) Luxury tax;

4) Taxes on lottery, betting and gambling;

5) State Cesses and Surcharges in so far as they relate to supply of goods and services; and

6) Entry tax not in lieu of Octroi.

 

For Example :

Assume that the cost of raw material is Rs. 100.00. The tax rate is assumed to be 10% for all taxes.

 

Under the CENVAT System:

On the Rs. 100.00 raw material, the manufacturer pay Rs. 10.00 as tax. The manufacturer adds Rs. 20.00 value. To this the manufacturer adds Rs.2.00, which is the CENVAT or Central Value Added Tax. In the example, the CENVAT is assumed at 10% of the Rs. 20.00 value added by the manufacturer. So the cost for the retailer is Rs.132.00 [Rs. 100.00 (Raw Material) + Rs. 10.00 (Tax on Raw Material) + Rs. 20.00 (Manufacturer Value Addition) + Rs. 2.00 (Tax on the Value Addition)]. When the retailer sells it to the consumer, he adds his own margin at Rs. 20.00. This takes the price to Rs. 152.00. Add 10% Sales Tax to this, which increases the price to Rs. 167.20. Thus the final price the consumer pays will be Rs. 167.20. Of this final amount, the taxes paid by the consumer is Rs. 27.20.

 

Under GST:

In GST, a Value Addition Taxation system is followed. This means each person pays tax only on the Value Added at that point. In our example, when the retailer sells the tax is applied only on the margin of Rs. 20.00 and not on the Rs. 132.00 which is the cost paid to the manufacturer. So the tax the consumer pays is considerably (~48%) lower at Rs. 14.00 [Rs. 10.00 (The tax paid by manufacturer when the raw material was bought) + Rs. 2.00 (The tax on the manufacturer’s Value Addition) + Rs. 2.00 (The tax paid on the margin of the retailer)]. The ultimate effect is the reduction of the end consumer’s (The common public’s) tax burden.

 

In other words, under the current CENVAT system, there is a cascading effect or double taxation i.e. the consumer pays tax on the tax already paid by the manufacturer. The GST circumvents this problem completely. Below is another example of a fully worked-out difference between the CENVAT system and the GST system.

 

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(Source: ICICI Bank Research)

 

Know your GST

 

The GST Council

The GST Council will consist of the union Finance Minister (chairman) and MoS in charge of Revenue; Minister in charge of Finance or Taxation, or any other Minister, nominated by each state. Decisions will be made by three-fourths majority of votes cast; Centre shall have a third of votes cast, states shall together have two-thirds mechanism for resolving disputes arising out of its recommendations may be decided by the Council itself.

 

 

The Levy of GST

Both Parliament, state Houses will have the power to make laws on the taxation of goods and services. Parliament’s law will not override a state law on GST exclusive power of The Centre to levy, collect GST in the course of interstate trade or commerce, or imports. This will be known as Integrated GST (IGST). Central Law will prescribe manner of sharing of IGST between Center and states, based on GST Council’s views.

 

What’s Out of GST?

Alcoholic liquor for human consumption, Petroleum crude, high speed diesel, motor spirit (petrol), natural gas and aviation turbine fuel (The GST Council will decide until when).

 

And What’s In?

Tobacco and tobacco products (The Centre may impose excise duty on tobacco).

 

What has happened so far?

Budget 2006-07: GST by April 1, 2010, announced. Subsequently, Empowered Committee (EC) of state Finance Ministers tasked with drawing up road map and design.

April 2008: EC, headed by the then West Bengal Finance Minister Asim Dasgupta, submits report to the central government, which offers its views and comments in October and December of that year. Joint working groups are then set up to examine options on exemptions and thresholds, taxation of services and inter-state supplies etc.,

November 2009: EC releases its First Discussion Paper.

March 22, 2011: The Constitution (115th Amendment) Bill is introduced in the Lok Sabha; is referred to Parliamentary Standing Committee on Finance, which submitted its report on August 7, 2013. Bill lapsed as term of the Lok Sabha ended in 2014.

December 19, 2014: Constitution (122nd Amendment) Bill introduced in Lok Sabha.

May 6, 2015: Constitution Amendment Bill passed by Lok Sabha.

May 12, 2015: Bill referred to a 21-member Select Committee of Rajya Sabha headed by Bhupender Yadav.

July 22, 2015: The Committee submits its report.

Monsoon and Winter Sessions 2015, Budget Session 2016: Bill not tabled in the face of opposition led by the Congress and persistence of sticking points.

 

What’s Ahead?

The President shall constitute the GST Council. The GST Council shall make recommendations on:

1) Taxes to be subsumed
2) Exemptions
3) Model GST laws, Principles of Levy, etc.
4) Threshold for exemption
5) Rates, including floor and bands
6) Special rate/rates for specified period
7) Date from which GST to be levied on crude, high speed diesel, natural gas, aviation turbine fuel and petrol
8) Special provisions for the Northeast, J&K, etc.

 

Parliament will pass a legislation on Central GST (CGST) and Integrated GST (IGST). All the 29 states and 9 UTs will be asked to pass their state GST (SGST) Acts. Dates of implementation of CGST, SGST and IGST have to be negotiated and synchronized.

 

Some States will initially act up. The GST will give them short term losses. For instance, the aggregate tax amount collected by the Tamilnadu and Maharashtra governments under the current CENVAT and State Taxes system is much higher than what they would get out of GST once it is implemented. This is owing to the fact that these states are net manufacturers of goods and services. The Centre has promised to compensate such states with a higher percentage of the net tax proceeds. Hopefully, that will calm them down. Gradually, they too will be brought under the broad umbrella of GST.

 

This article was written by Varnita Deep (PGDM, Batch 22, XIME-B)