Faced with the very real prospect of downward economic mobility, some Indian traders say they are likely to tiptoe around the Goods and Services Tax (GST), touted as the most effective way for a government to collect indirect taxes. The new tax regime was implemented in India from July 01.
Under the new regime, it will be risky for traders to conceal income: They will be tracked much more closely. Those with annual turnovers of Rs20 lakh or more are required to secure a GST number, link up to the GST Network, and submit their purchase and sale invoices to the tax authorities. Yet traders admitted that some of them will attempt to slip through the GST Network, because two conditions that allowed some of them to avoid taxes earlier still exist.
Until now, some traders have managed to avoid paying their dues because of the connivance of corrupt officials. These officials are unlikely to mend their ways overnight, nor will their political masters. Electoral politics demands heavy expenditure, of which the primary source is the undeclared income of individuals and firms. This, said traders, will prompt them to work around the GST using a variety of strategies.
In the end, of course, it is the final customers who will pay these indirect taxes.
Getting past the GST
To understand the ways traders can get around the GST system, it is necessary to first understand how GST works. To do so, there is no getting away from GST jargon and arithmetic.
Assume a business chain involving a manufacturer, distributor, wholesaler, and retailer who trade in aerated drinks, a category of products that attracts 28% GST, the highest slab. Imagine that the manufacturer prices a pack of this drink at Rs100, before tax. Including tax, the price of this pack comes to Rs128. The manufacturer eventually pays the Rs28 tax to the government.
The GST is calculated on the value added at every stage through which a product passes until it reaches its final destination: the customer.
The manufacturer sells the pack onwards to the distributor. The distributor prices the pack at Rs102. He can afford to do this despite the fact that he bought the pack for Rs128 because when he sells the pack onwards to the wholesaler, he will also charge his customer 28% GST. The GST will be calculated on the cost price of Rs102, and not on the price of Rs128 that the distributor paid the manufacturer while buying the pack. After applying 28% GST on Rs102, the cost of the pack in the hands of the distributor will go up to Rs130.56, including Rs28.56 as tax. The wholesaler picks up the pack from the distributor at this cost.
When it is time for the distributor to pay the government the tax he charged while selling to the wholesaler, he will deduct the Rs28 he paid as tax to the manufacturer while buying the pack. The deducted amount is what in GST jargon is called input credit. Thus instead of paying the government Rs28.56 as tax, the distributor only pays 56 paise (Rs28.56 minus Rs28), which is called his output credit. The distributor’s net profit per pack is Rs2.
The wholesaler will sell the pack onwards to the retailer, pricing it at Rs105, before tax. The 28% GST on a pack of the drink now works out to Rs29.40, and the selling price, including tax, climbs to Rs134.50. The retailer pays Rs134.50 to the wholesaler while buying the pack from him.
However, when it is time for the wholesaler to pay the government the Rs29.40 tax he charged while selling to the retailer, he will deduct the Rs28.56 he paid as tax to the distributor while buying the pack (his input credit). Thus, the wholesaler will only pay the government 84 paise as tax (his output credit).
The retailer adds Rs5 to the cost price of the pack, which goes up to Rs110. Applying 28% GST, the tax works out to Rs30.80. The price, including tax, at the retailers’ is Rs140.80. The customer buys it at this price.
However, when it is time for the retailer to pay the government the Rs30.80 tax he charged while selling to the customer, he will deduct the Rs29.40 (input credit) he paid as tax to the wholesaler while buying the pack. Thus, the retailer will only pay the government Rs1.40 as tax (or his output credit).
Possibility of cash trails
The GST norms demand that sale invoices of the preceding month should be filed by the 10th of each month and all purchase invoices by the 15th. From the 20th, traders will be informed of their tax liability or refunds due to them. A trader’s sale and purchase invoices must match, or the GST Network will flag him.
The example given above presumes that everyone in the chain will report their transactions. But a good many are likely not to because they will want to save their income from getting a severe shave.
A market observer explained, “In pre-GST days, a trader would have been showing [on the record] just Rs60 lakh of his turnover of Rs1.80 crore. For him to completely switch over to the GST would mean showing Rs1.80 crore as his annual turnover. This will increase his income-tax liability.”
To protect their incomes, some traders are likely to invent a cash trail that will duck away from the GST network.
Under the GST, those with an annual turnover of less than Rs20 lakh do not require a GST number if they do not engage in inter-state sales. Again, a person with a GST number can sell goods worth Rs2.5 lakh per month to a person who doesn’t have a GST registration. It is not the seller’s responsibility to ascertain the identity of the purchaser without a GST number. His sales are genuine, his bills too are—and he will report his sale invoice to GST so that it matches with his purchase invoice.
However, the clause allowing a person with a GST number to sell goods worth Rs2.5 lakh a month per unregistered person can be exploited.
In the example above, the distributor can legitimately sell one pack of the aerated drink at Rs134.50 (to the tune of Rs2.5 lakh) to the wholesaler, who will claim he does not have a GST number as his annual turnover is less than Rs20 lakh. Since the distributor’s deal is legitimate, he can claim input credit as before.
But the name under which the wholesaler’s bill for Rs134.50 has been issued could be fictitious. The wholesaler’s purchase, therefore, disappears from the audit trail. No doubt, the wholesaler foregoes input credit, but he will not have to pay GST either, and, therefore, not submit purchase and sale invoices. This means he need not show Rs2.5 lakh worth of the aerated drink purchases in his turnover.
The wholesaler will sell the aerated drink pack onwards to the retailer in cash, without a bill. Since the wholesaler does not have to pay the GST (as he claims his annual turnover is less than Rs20 lakh), he can sell the pack to the retailer at a discount of 84 paise, the amount equivalent to the tax the wholesaler would have otherwise had to pay the government as the GST per pack. Likewise, the retailer can sell the pack onwards to the consumer in cash, without a bill, at Rs1.40 cheaper than packs on which the GST is charged.
They need not sell the pack cheaper. Just escaping the GST alone makes sense as it will enable them to suppress their overall turnovers and income.
Dealers handle products manufactured both by the organised and unorganised sectors. The organised sector usually has systems in place. But goods stocked from the generic or grey market will likely be transacted in cash, without bills, stretching the cash trail further.
Other methods of keeping turnovers low are age-old. A person with a turnover of Rs80 lakh could float three other entities in the names of family members to ensure he does not cross the Rs20-lakh limit. Since each can purchase goods worth Rs2.5 lakh without a GST number, the four entities together can purchase goods worth Rs10 lakh a month in cash and be invisible from the audit trail.
Entities with a turnover of less than Rs20 lakh could surface with the specific purpose of making purchases in cash.
Even as their income is threatened with erosion, to become GST compliant, traders will incur additional expenses on computers, GST-compatible software and a full-time accountant. November’s currency demonetisation had already slowed down the market, which is likely to decelerate further because of the GST for at least a month or two. The losses already suffered are likely to make the search for cash trails relentless.
The data sets that the GST Network will generate should make it easier to notice tax evasions. Punitive measures are far more severe now. But will suspected evaders have tax inspectors book them or will officials use the information to make money, thus, bringing back inspector raj?
Former union minister Yoginder K Alagh was right when he wrote recently, “Markets work with supply elasticity, not the danda [stick].” Faced with a sharp erosion of their income, traders say they will find ways to fight back.