Don’t link input credit to tax payment by supplier : GST View

The Goods & Services Tax is a game changer for the economy. The new tax regime promises to simplify tax compliance, eliminate tax on tax, make it easier to do business across states, reduce prices and dramatically increase the tax base.

Inspite of its enormous promise, the present drafting of the law and rules have problems which can cause disruption. Particularly, the small and medium businesses are vulnerable to these clauses, and are in potential danger of being driven out of business. There is still time to make corrections—and start the country on a journey of transformation with greater positivity. While the law and rules will definitely improve with time, eliminating these fundamental flaws early can make a big difference.

The most important of these flaws is the linkage of tax payment by a supplier, to the availability of input credit to the buyer—and not just the availability of a ‘matched genuine invoice’. The CGST Bill clearly states that input credit will be either denied or reversed if the supplier of the invoice fails to make the appropriate tax payment through a valid return.

The origin of this provision lies in the history of tax avoidance through false representations by a tiny fraction of businesses, and the fact that it was not feasible for the Government to systematically detect this and contain the problem. With the framing of this law, the Government hopes that the market will self­weed out the bad eggs—which is not wrong. What is wrong is not understanding the cascading consequences of doing this in practice and the issues it will create. While the effort for driving compliance will reduce, the consequences of businesses shutting down, and therefore collections dipping, have not been treated seriously enough.

Under normal business circumstances, a transaction gets completed when the goods or services are delivered, invoices received, and the payments made against them. An indirect tax regime requires the supplier to act as an agent of the Government to charge the tax on the invoice, collect it, and remit it. In a value added tax regime (like GST), the buyer avails the input credit of the tax thus paid on the invoice, which has been paid to the supplier in good faith as per the directions of law.

To prevent fraudulent claims, either of non­ existent invoices, or for amounts which are not as per the original invoice, the concept of invoice matching has been proposed in the law. It is a brilliant move. Not only will this almost completely eliminate fraud, but also act as an impetus to drive more taxpayers into the tax net.

However, the additional linkage of payment ruins the beauty of the system. A business can no longer assume that the transaction is over but will have to wait for 10 days after the return cycle (which is, 30th of the following month), to know whether it will be eligible to receive the input credit for the tax it paid.

Several market behaviours will emerge. Some will refuse to pay the supplier until the 30th of the following month, leading to abnormal increase in working capital needs. Some will refuse to pay the tax portion, leading to multi­step transactions and increase in both working capital needs as well as cost of doing business. Some will be asked for bank guarantees to cover the possible risks, and most

What it means for a small business

Small businesses typically suffer unevenness of cash flow. Even a one­week delay in payment throws their routine out of gear. A promising auction or offer for materials which would give them higher profitability, and they have to readjust their cash cycles for a few weeks to take advantage of it. A marriage in an employee’s family? The desire to help out comes at a cost of their cash flow management.

While the business will have no desire to cheat the Government out of its tax, it may still have difficulties in always meeting the compliance on time. And every such difficulty will expose its vulnerability to its buyers, who may opt to change their supplier and reduce their own risk.

A related provision is that the Government intends to make public a compliance rating. You will know before you buy, whether your supplier has a ‘good or poor’ rating. Since input tax credit is dependent on this quality of the supplier, buyers will avoid outfits with poor rating. This means people will do everything to avoid a poor rating.

The rating becomes poor not just because the business delayed the filing of data, but because it may be facing a delay in payments. Taken together, these provisions mean any difficulty faced by a small business may now be public knowledge. This will have a snowball effect as its buyers will play safe and avoid it. This will only increase the problem, leading to further payment delays, and/or further reduction of rating and losing more customers.

This will slowly, but with certainty, drive almost every small business to eventual closure. This is not the intent of the Government, it is simply an unexpected consequence of a good intent. It is also correctible, provided the causes, and the consequences, are appreciated.

What can be done In the past, it was not feasible for the Government to systematically mitigate the risk of fraud, since there was no practical human ability to keep track of and trace the culprits. However, GST gives extraordinary traceability. With invoice matching, false bills and wrong claims get eliminated. Yes, the problem of false companies continues. But with PAN and bank account linkage, it will be near impossible to commit fraud and remain undetected. An amendment to the proposed law to the effect of de­linking payment with input tax credit availability and connecting it to invoice upload and matching will make the desired law come alive and make it effective and useful for all.