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A Confused Taxation Narrative

R Kavita Rao ( is with the National Institute of Public Finance and Policy, New Delhi.

The Union Budget 2018–19 was presented against the background of a slippage in the fiscal deficit levels. The government has reiterated its commitment towards fiscal consolidation. In this context, an attempt is made to understand the tax revenue numbers for 2017–18 and 2018–19. The analysis suggests potential shortfall in the revenues budgeted for 2018–19.

The Union Budget 2018–19 has been challenging for the finance minister to balance. On the revenue side, the change in the indirect taxes regime with the introduction of the goods and services tax (GST) just seven months before the presentation of the budget introduced uncertainties in the calculus. On the expenditure side, the fact that this is the last budget this government presents, coupled with the fact that the government has positioned itself as one focused on infrastructure and capacity creation has resulted in announcements which, it is argued, are not adequately funded. This article focuses on the revenue side of the budget to understand what the likely realisations in receipts this year are going to be and how to understand the budget estimates for the next year.

Trends in Revenues

There is a change in the regime of taxation in the country with the introduction of GST. To understand the trends in revenues, it is important to examine the various heads of revenue and identify the revenues that would accrue to the union government. The revenue realisations under GST are clubbed into four heads: central GST (CGST), state GST (SGST), integrated GST (IGST), and cess.

The revenue from CGST accrues to the union government, and SGST would accrue to the states. Turning to the other two heads, the revenue flows can be understood as follows: the cess has been introduced as a mechanism to collect revenue which will be used to compensate states for any loss of revenue. The revenues from cess are reported in the receipts of the union government and on the expenditure side, a corresponding entry transfers these resources to reserve funds. The compensation paid to the states is then withdrawn from reserve funds. Thus, in terms of the revenue accruing to the union government for spending on its budget heads, the cess does not contribute to revenues. In other words, for undertaking an analysis of trends, it is important to exclude this head of revenue from the total revenues for the union government.

The other important head to understand is the IGST. This tax is structured as a mechanism to transfer taxes from the exporting state to the importing state. As per the constitutional assignment, the tax is levied and collected by the union government. The tax is payable on every transaction where the supplier and the buyer are in two different states. In the exporting state, the exporting dealer collects IGST and pays the same after taking credit for IGST, CGST and SGST paid on purchases. In the importing state, the importing dealer can claim credit for IGST on purchases against taxes collected on supplies, which can be IGST, CGST, or SGST. To understand the revenue collected under IGST, transactions which can be subject to IGST need to be understood. There are broadly two kinds of transactions:

(i) Transactions between two registered GST dealers: in these transactions, IGST is deposited by one dealer and the second dealer, the buyer would claim credit for it. In other words, over time, no revenue should remain from such transactions.

(ii) Transactions between a registered seller and an unregistered buyer: in these cases, while the tax would be collected and deposited by the seller, there is no agent to claim credit for the same. In other words, the revenue from such transactions would remain within the head of IGST.

The revenue that is reported in IGST at any given time would be the sum total of IGST on business-to-business (B2B) transactions, on which credit has not yet been claimed and IGST on business-to-consumer (B2C) transactions. Since it is expected that in B2B transactions the buyer would claim credit at some time, the revenue cannot be allocated to any government, or if allotted, it should be allotted to the union government, since the responsibility of honouring the input tax credit claimed would rest with the union government. On the other hand, in case of B2C transactions, the union and state governments should be allocated equal shares in the total revenue. In the IGST Act, 2017, Section 17 discusses the provision for allocation of unclaimed balances: Sections 17(1)(c) and 17(1)(f) suggest that for registered taxpayers, IGST credit will be considered unutilised balances if they remain unutilised on the due date for submission of the annual return for the year concerned. At this time, these balances can be apportioned between the union and state governments.

In other words, while the law provides that the union government need not allocate the unclaimed balances immediately, by appropriating these revenues within central finances the government pre-empts the revenues in subsequent years and thus, undermines the revenue accruals in the next year. Box 1 presents a few illustrations. The need to provide credit next year/distribute the unclaimed credits next year would place pressures on government finances in 2018–19.

Since GST was introduced in the middle of the financial year, to understand the trends in revenue collection, the entire set of indirect taxes is considered a group of taxes. Table 1 presents the revenues from indirect taxes in the last three years. As discussed, the revenue from cess is excluded from the analysis. Once these numbers are excluded, the revised estimates of gross collections of indirect taxes are lower than that bud­geted for 2017–18. Now turning to the treatment of IGST and its implications on the budgeted numbers, as argued earlier, there is nothing illegal about the union government appropriating the receipts from IGST. However, as illustrated by the examples in Box 1, this would result in some outflows from the central government budget in the next financial year. Looking at the numbers for CGST for 2017–18 and 2018–19 (taking average monthly numbers),1 the budget suggests a growth of over 80% in CGST. However, considering the fact that IGST has been appropriated in 2017–18, and credit for IGST needs to be provided in 2018–19, these amounts need to be generated over and above the CGST collections. This is all the more important since the IGST collections in 2018–19 are budgeted at a much lower figure of ₹50,000 crore. Incorporating 50% of IGST as the compensation/credit needs in 2018–19, the realisation from CGST needs to be higher at ₹52,904 crore or a growth of 91% over the average monthly CGST collections in 2017–18.2 Here the fact that the union government has treated IGST collection as regular revenues and allocated 42% to the states as a part of tax devolution following the Fourteenth Finance Commission recommendations adds to the worry since states too would have additional revenues in the current year and face a shortfall in the next year.

Direct taxes: The revised estimates for 2017–18 for personal income tax remain unchanged from the budget estimates. The budget estimates for 2017–18 imply a 21% growth in personal income tax collections and 11% growth in corporate income tax. It can safely be assumed that the sharp increase in personal income tax collections might have been expected from improved compliance/enforcement following demonetisation. The revenue collections till December 2017, however, seem to belie these expectations. Table 2 presents a comparison of the revenue until December and the corresponding full year collections for the period 2014–15 to 2016–17 and uses these ratios to infer a rough and ready forecast of revenues in the major heads in direct taxes: corporation tax and personal income tax. The table suggests that while the government could meet its revised estimates of corporate tax collections, it could fall short of on the personal income tax front. In other words, this rough estimate suggests that for 2017–18, there could be a shortfall in direct tax collection as well. While such a shortfall would not alter the fiscal deficit by much in 2017–18, it would render the targets for 2018–19 that much more difficult to achieve: a 29% increase in personal income tax or in other words a buoyancy of over three.

Raising New Revenue

In this context, the budget seeks to augment revenues from two major policy initiatives: a long-term capital gains (LTCG) tax and an increase in customs duties on a range of commodities. While these are expected to garner some additional revenues for the government, they need to be analysed in terms of the likely impact on the economy. While a detailed analysis is beyond the scope of this note, in what follows, an attempt is made to some possible dimensions of this.

The LTCG on shares purchased from registered stock exchanges was replaced with a securities transaction tax (STT) in 2004. It was argued that this would greatly simplify the tax regime and reduce evasion. It may be recalled that there was a lot of discussion on round-tripping of investments into India through the Mauritius route which utilised the Double Taxation Avoidance Agreement (DTAA) provisions and paid no tax either in India or in Mauritius on such transactions. The STT was introduced in a sense to plug this loophole. With the modification of the Mauritius treaty, the need for an STT has been reduced as also the need for an LTCG free regime.3 The budget introduces a tax on LTCG for two reasons. In the memorandum to the provisions in the Finance Bill, it is argued that the exemption has incenti­vised investments in financial instruments and thereby disincentivised investment in manufacturing. And second, it is argued that this provision has resulted in signi­ficant base erosion.

The government should be complemented for the reintroduction of the tax and thereby resetting the balance in taxes, between taxation of wage income, and of capital income. It may also be argued that an exemption on LTCG could have been encouraging more capital intensive technologies and a reintroduction of the tax could reset the balance at the margin in favour of labour inputs. These are effects that will need to be assessed in time to come. There are however two issues that need to be raised at the present juncture:

(i) The introduction of LTCG tax is an important policy change. It could have been used as an opportunity to rationalise the tax regime instead of just introducing another levy. For instance, the rationale for retaining STT alongside taxes on short term and long term capital gains needs to be re-examined.

(ii) Why do the provisions vary if the transactions are out in an International Financial Service Centre? The existence of two regimes within the country can open up the scope for round-tripping of investments. It also raises questions about the very rationale for the introduction of the new regime when alternatives are carved out at the same time.

Turning to the change in the customs duties regime, once again, while it is possible that these changes would encourage the Make in India programme, it is important to explore the kinds of businesses that are sought to be incentivised. This takes us back to the planning era, where some sectors were provided a “privilege.” The selection of sectors or activities to be incentivised would differ depending on the underlying rationale for providing the incentives. The arguments for incentivising could range from encouraging investment and employment in the domestic economy or to create capacities for exports, to meet the needs of the domestic economy or to encourage development of sunrise industries. The difficulty with this approach of providing protection is the implicit notion that the government is well placed to know which are the “right” sectors that deserve such an intervention. The sectors selected for the “privilege” are distributed all across the chapters ranging from fruit juices, perfumes and toiletries to mobile phones and motor parts to tyres for buses and trucks. In other words, there is no discernible focus on a few sectors. The wisdom backing the choice of these sectors is not revealed in the budget documents. But the need to raise revenue is evident, more so with the introduction of the social welfare cess over and above the basic customs duty. While this could have been an interesting opportunity to undertake strategic intervention in the economy and encourage investments in some sectors, in the absence of such an articulated position, it appears to be a revenue raising initiative which rolls back the consistent effort made open up the economy and encourage competition.


1 The CGST monthly collections are average for eight months in 2017–18 and for 12 months in 2018–19.

2 Assume 50% of  ₹1,61,900 crore will need to be distributed as credits or as revenues to the states. The revenue from IGST in 2018–19 is ₹50,000 crore. The additional revenue required would therefore be ₹30,950 crore or ₹2,579 crore per month.

3 It may be argued that there still exist some alternative routes for such investments to avail of no tax or low tax options, but with the initiatives to rein in tax havens and to reduce the scope for base erosion and profit shifting, the time would seem ripe to act on this front.

Updated On : 7th Mar, 2018


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