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GST exemption limit for SMEs could have been higher at Rs.1.00 Cr

Why GST exemption limit for SMEs

Why should Government have a higher threshold exemption limit for GST ?

Centre and the states are working closely to roll out GST as per schedule i.e, 1st April 2017. GST Council which comprises of Central and State Finance Ministers is meeting every month to decide on the key issues. The council agreed upon exemption limits – a key issue for SMEs (Small and Medium Enterprises) .

(The three-day meeting this week  (18-20 Oct) ended without a final agreement on rates. )

So far, Centre and most of the states have an SME policy but the result is tax policies that are haphazard,  and confusing. For instance, a small manufacturing business is subject to following taxes

  1. State VAT – for within State invoices
  2. CST – for outside State invoices
  3. Excise Duty – depending on item and turnover
  4. Service Tax – on services irrespective of the State business is conducted in
  5. Entry Tax – for purchases made from outside the State

and some other taxes such as Octroi, Cesses etc

The current taxation system is disjointed with different rules and procedures. For eg: Excise duty becomes applicable on production, whereas VAT is applied at sale but goes to the producing State.

C-form required to apply CST to inter-state sales itself is a huge operational burden for small business as it becomes available only at the end of the quarter and not at the time of sale.

None of the tax agencies (central or state) communicated to each other in the past, as a result there has not been any  comprehensive tax policy for MSEs, which would take all direct and indirect taxes into account and provide a clear, low-compliance-cost, fair policy option.

GST provides an excellent opportunity in fixing the current mess and making it easier to conduct business, particularly for small business by easing the rules and reducing the compliance costs. However, it seems the council has let an opportunity go by fixing the exemption limits too low at Rs.  20 Lakh for  exemption and Rs.  50 Lakhs for Composition scheme.

Our recommendation is that GST limits should have been fixed at a higher rate of

Exemption Limit – Up to a turnover of Rs. 1.00 Cr

Composite Scheme – Up to turnover of Rs. 2.00 Cr

This is based on three considerations: tax revenues, compliance costs, and corruption.

The main reason why states say they want a low registration threshold is to ensure revenue is not lost. The argument is surprising because states have a guarantee from the centre for compensation to any loss in revenue. Moreover,  It is worth noting that GST is a value added tax. So even if a business is not registered, it is paying the GST embedded in the inputs that it purchases, just as final consumers do.  If it were to be registered and fully compliant – and full compliance is critical, just being registered will not help – then it would, in addition, pay an incremental amount of tax on its own value added, and that is the potential revenue loss.  But how much would that so-called revenue loss be?  We can get a sense of the small scale of the problem when we look at the data of the income tax department:

Distribution of taxpayers by sales turnover, 2012-13
Range of Turnover – Rs.Number of taxpayersPercent of totalTotal Turnover
Rs. Crore
Percent of Total Tax
0 to 10 lakh643390368.20%849640.40%
10 to 25 lakh6828597.20%1117510.50%
25 to 40 lakh3259743.50%1036620.50%
40 lakh to 1crore6682907.10%4466712.00%
1 to 2 crore5030935.30%7128373.20%
2 to 5 crore4270394.50%13412136.00%
5 to 10 crore1869312.00%13077525.80%
10 to 100 crore1855032.00%469202620.80%
Above 100 crore183160.20%1372610860.90%
 TOTAL9431908100.00%22526984100.00%

Source : thewire.in – Rajul Awasthi

This data is taken from the Report on the Revenue Neutral Rate and Structure of Rates for the Goods and Services Tax, 2015, Ministry of Finance, Government of India, Annex 3 (RNR report).  It is fair to assume, as has been done in the RNR report, that this would be the GST taxpayer universe.

As we can see from the table, the vast majority of potential GST revenue would come from the top two brackets, i.e., ‘above Rs. 100 crore’ and ‘between Rs. 10 crore and Rs. 100 crore’.  These two brackets have only 2.2 percent of taxpayers, but would potentially contribute over 80 percent of tax revenues.

The number of small businesses with turnovers below Rs. 1 crore is  86 percent of all potential taxpayers, however, their total turnover amounts to just 3.4 percent.

GST exemption threshold at Rs. 1 crore, will ensure a large number of small businesses don’t have to face the daunting task of complying with the GST and more so, it will significantly reduce the compliance costs for the Government.

It is also inline with the stated maxims of Startup India, Standup India and Minimum Government, Maximum Governance of our Hon. PM

The option to voluntarily register for the GST will of course be available to those firms who would like to do so to be able to claim credit for input taxes they may have paid on their purchases

One questions likely to be raised is– what will happen to all the SMEs under the turnover of Rs. 1 crore?  Will they slip out of the tax net and become informal?  Several states are likely to raise this issue, concerned as they are with losing out on the number of taxpayers.  It is to address this concern that I suggest a flat fee to be charged from all businesses with a turnover between Rs. 25 lakh and Rs. 1 crore.  This flat fee could be decided by the states individually but I would recommend a moderate amount, say Rs. 10,000, which is what was implemented in Bihar (although they still called it a tax) under the Laghu Kardata Yojana, 2010.  I am implicitly assuming that all enterprises below a turnover of Rs. 25 lakh are micro.  This is justified in two ways.  First, under the income tax the threshold limit is now Rs. 250,000.  If we assume that on average the net income of businesses is about ten percent of turnover then firms with turnovers below Rs. 25 lakh will have a net income below the income tax threshold.  Second, if we go by the definition of the Ministry of MSME, and assume a return of 10 percent on investment, then micro enterprises with an investment below Rs. 25 lakh will have an income below Rs. 250,000 which is again lower than the income tax threshold limit.

The second consideration is the issue of compliance costs.  It is known worldwide that a value added tax like the GST is disproportionately burdensome for MSEs.  Various compliance cost surveys done by the World Bank Group, from Bihar to Colombia to Ukraine, indicate that compliance costs for small businesses can be extremely high, sometimes even more than the amount of taxes they pay.  There are many cost elements in the compliance cost set which don’t vary proportionately with size of firms – salary of accountants, fees of tax lawyers, bank fees on financial services, etc.  Government has addressed this issue to a large extent my making the  entire GST compliance framework  to be IT based, and inviting private partnership in the form of GSPs – GST Suvidha providers who can make user friendly app which would be very helpful to the  small businesses.

Finally, there is the question of corruption.  Having a huge number of registered small firms on the roster who are finding it difficult to comply is a recipe for building a corruption-prone regime which only serves to perpetuate the “inspector raj” culture.  On the other hand, selling a business permit with a fixed, simple, flat fee, is easy to administer and comply with and it provides businesses a legitimate right to carry on business and ensures they don’t have to operate in the shadows.

On August 15, 2014 at the Red Fort in New Delhi, Prime Minister Narendra Modi addressed the nation, and the world, in his maiden Independence Day speech; “Come, make in India” he said. “‘Come, make in India”, “Come, manufacture in India”.  In September 2014 the scheme was formally launched and is one of the flagship programs of the government.  In India, however, where it is the millions of micro and small enterprises (MSEs) which form the backbone of the economy, Make in India can only be fully successful when MSEs can operate successfully.  It is imperative to create an MSE-friendly business environment, and that includes a simplified, easy to comply with tax regime which does not impose huge deadweight compliance costs that cripple the productive capacity of these small but vibrant enterprises.

 

 

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