India to Compensate States for Revenue Lost Under GST

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By Siri Bulusu

Indian state finance ministers have approved a bill that will require the federal government to compensate states for any lost revenue caused by implementation of the new goods and services tax.

The Feb. 18 approval of the compensation bill by the GST council marks a crucial step that opens the door for passage of three other GST bills—the Central GST bill (CGST), the State GST bill (SGST), and the Integrated GST bill (IGST). The bill requires that India’s federal government compensate states for any revenue lost due to implementation of the GST for five years.

“States will have more trust in the [federal] government when it comes to negotiating the three GST bills after passage of the compensation bill,” Harpreet Singh, indirect tax partner at KPMG India, told Bloomberg BNA Feb. 12.

Introduction of the goods and services tax would overhaul India’s indirect tax system by consolidating taxes levied separately by the federal and state level governments under a single system. The new tax regime aims to facilitate flow of goods across state borders and create a single point of administrative control for taxpayers.

The compensation bill failed to pass in previous GST council meetings due to lack of clarity on the rate of compensation. State finance ministers raised concerns that an economic slump caused by demonetization could inhibit the federal government’s ability to compensate states.

Compensation Details

States will be compensated the difference between their annual revenue and the all-India state revenue average in base fiscal year 2015-2016, plus 14 percent of fiscal year 2015-2016 revenue average to make up for assumed growth rate on tax collection. Since GST isn’t expected to be implemented until July 1, the amount of compensation for the current year will be prorated.

The rate of 14 percent is the average assumed growth rate on tax collection for all Indian states.

Singh said the state finance ministers will approach the upcoming GST council meeting on March 4 with a more open mind and confidence that the federal government will keep its promises.

“The proposition the federal government has come up with is very reasonable and the states are happy,” Singh said.

Next Steps

The bill will be presented before India’s lower and upper houses for approval during the budget session of parliament before being ratified by the president.

Three GST bills—the Central GST bill (CGST), the State GST bill (SGST), and the Integrated GST bill (IGST)—are still being debated by the GST Council, but tax practitioners anticipate that they will pass without delay in the next GST Council meeting.

“The most important factor was whether the government was able to confirm that it could pay states from an identifiable source of income,” Santosh Sonar, executive director of indirect tax at BSR & Associates LLP, told Bloomberg BNA Feb. 21.

Sonar said the main points to be addressed include specifics of the dual administrative control over taxpayers between the federal and state authorities. The details of the computerized mechanism that is responsible for assigning taxpayers to an administrator hasn’t been determined.

Taxpayers with an annual turnover over 15 million rupees ($224,000) will be divided evenly between the federal government and states. Ninety percent of taxpayers with a turnover below 15 million rupees will be assigned to states by a computerized mechanism, with 10 percent administered by the federal government.

Tax practitioners expect the draft GST laws to be approved by the council in the next meeting so that the bills may be voted on by parliament during the current session of parliament. Failure to pass the laws during the current session would result in yet another delay of rollout of the pan-India tax regime.

To contact the reporter on this story: Siri Bulusu at correspondents@bna.com

To contact the editor responsible for this story: Penny Sukhraj at psukhraj@bna.com

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