In the backdrop of tax collection under Goods and Services Tax [GST] not coming up to the expected level and consequential inability of the central government to meet its obligations towards compensation to the states as committed under the GST Compensation Act [2017] [it provides for compensation for 5 years i.e. till 2021-22 to be calculated as the difference between actual collection and the revenue they would have got with growth @14% over 2015-16 level], the GST Council has undertaken a comprehensive review of existing rate structure and the implementation mechanism.
Meanwhile, a contentious issue that mandarins in the Council will need to urgently look at relates to the treatment of the accumulated input tax credit which does not get automatically set-off against output tax liability. Something at the core of the GST architecture is that it allows producers to claim credit for the tax paid on inputs across the value chain. This helps in eliminating the cascading effect of tax-on-tax thereby reducing the cost of products to the consumer [the erstwhile dispensation of central excise, VAT and a host of local duties was afflicted by cascading effect].
But, an anomalous situation may arise if the producer/supplier does not have corresponding output tax liability to provide for set-off of accumulated credit on input purchase. Indeed, this anomalous situation is currently faced by telecom companies. They have made heavy investment in augmenting infrastructure [needed to provide speed and quality services] even as there has been steep drop in their revenue; courtesy tariff plummeting to record low due to intense competition after entry of Reliance Jio in late 2016.
This increased accumulated credit on their input purchases and reduced their own GST payments to the government [primarily due to low tariff/sale price], thereby reducing and eliminating the potential for automatic set-off of dues. They are unable to claim refund of the taxes paid on inputs as GST law mandates corresponding output tax liability which does not exist. The un-absorbed input tax credit works out to a whopping Rs 36,000 crore.
The situation in fertilizers is broadly similar. Given the critical role of fertilizers in ensuring ‘food security’, the government controls their maximum retail price [MRP] at low level unrelated to cost of production and distribution and reimburses the excess as subsidy to the manufacturers. In case of urea, MRP is 25% to 50% of the cost whereas in case of non-urea fertilizers, the price is 70% to 75%. The balance amount is given to farmers as subsidy.
Coming to the tax structure, fertilizers attract GST @5% even as the tax on raw materials and intermediates used in their manufacture is much higher. Natural gas [it accounts for about 90% of urea production] is at present ‘zero rated’ under GST implying that it continues to attract excise duty [ED] and value added tax [VAT]. Even as ED on gas is ‘nil’, VAT varies from state to state with a low of 5% in Rajasthan and high 21% in Uttar Pradesh. Besides, some states impose local levies; e.g. ‘purchase tax’ in Gujarat on that portion of inputs used for making urea that is sold outside the state.
Nearly, one third of gas consumption by fertilizer plants is imported as LNG [liquefied natural gas] which attracts customs duty [CD] @2.5%. Import of ammonia, phosphoric acid and sulphur – raw materials and intermediates used in manufacture of non-urea or phosphate and potash fertilizers attract CD @5% [on rock phosphate, it is 2.5%]. On the other hand, ammonia and phosphoric acid attract GST @18% and 12% respectively [initially, GST on phosphoric acid was 18% but was brought down to 12% in January 2018].
The process of fertilizer manufacture is power intensive. Electricity generation and distribution is also excluded from the ambit of GST. However, it is exempt from levy of CENVAT and VAT. Further, under the Constitution, Entry 53 in State List of the Seventh Schedule empowers States to impose tax [or electricity duty] on sale and consumption of electricity, except when consumed by the union government or Railways.
Let us now look at the implications of the above tax structure for input tax credit. First, gas being virtually outside GST, gas companies viz. Oil and Natural Gas Corporation [ONGC], Oil India Limited [OIL] etc can’t claim credit for the taxes paid on their purchase of inputs, consumables and equipment leading to higher price. The price of gas to fertilizer producers [delivered at factory gate] further increases due to VAT [which in some states such as UP is 21%] besides a host of local levies wherever applicable.
In case of electricity, this being outside GST and exempt from levy of CENVAT and VAT, this results in a situation whereby power companies don’t get any credit for taxes paid on inputs viz. equipment and stores etc used in its generation and distribution. This results in higher cost of electricity. This is further exacerbated by electricity duty imposed by states for which no offset is available.
We thus have an anomalous situation whereby on one hand taxes paid on inputs [primarily gas and electricity] used in the manufacture of urea are high with built in cascading effect on the other, the tax liability on the output [read: urea] is low not just because of much lower GST @5% but also due to lower MRP. Likewise, tax paid on raw materials and intermediates [mainly ammonia and phosphoric acid] used in the making of non-urea fertilizers is high even as on tax on output is low for the same reason. This inevitably results in unabsorbed input tax credit as output tax falls far short of input tax.
Considering the adverse effect of reimbursing the unabsorbed input tax credit on tax collection particularly at the current juncture when the exchequer is facing huge shortfall, the government may not be inclined to sanction it [in case of telecom service providers, Bihar’s Deputy Chief Minister, Sushil Modi has already rejected the demand] or delay as for fertilizer manufacturers. But, the adverse impact of rejection/delayed release on service providers/manufacturers can’t be brushed aside either. What then is the way forward?
Ideally, the government should maintain tax on the final product at the same rate [or higher] than the rate on raw materials/intermediates so that there is sufficient liability on the former to enable automatic neutralization of the tax paid on the latter.
In case of fertilizers, it should bring gas and electricity under GST and tax these @5% i.e. the same as on fertilizers. GST on ammonia and phosphoric acid should also be brought down from existing 18% and 12% respectively to 5% on each. While, making these changes may take some time [particularly in view of resistance from states], in the meanwhile, the government should take steps to promptly release pending un-availed input tax credit to manufacturers.
The position in case of telecom service providers however, is different. Here, the output tax liability is insufficient to fully offset the input tax mainly because of the rock bottom tariff due to ‘unhealthy’ and ‘destructive’ competition [this was not mandated under any law or government regulation] unlike fertilizers where as matter of conscious policy, the selling price is controlled at a low level to make them affordable to farmers. Nevertheless, it can’t be denied that service providers have incurred excess input tax credit and not refunding the same will go against the very spirit of GST.
The pending excess input tax credit of Rs 36,000 crore may be refunded to the telecom service providers. With tariff being increased by all service providers and even the sector regulator Telecom Regulatory Authority of India [TRAI] contemplating a floor tariff [to bring a semblance of discipline to the market] hopefully, such a situation may not unfold in the future. In fertilizers with the changes in tax structure – as proposed – and move towards direct benefit transfer [DBT] of fertilizer subsidy which will help lifting the MRP, the output tax liability will be in sync with tax paid on inputs.
Notwithstanding the above, situations of mismatch can’t entirely be ruled out. To address these, the government may consider amending the GST law to allow refund of excess input tax credit and eventually match the output tax liability. Meanwhile, it should intensify efforts [including use of data analytics with alacrity] to identify and crack down on fake claims of input tax credit to shore up its revenue.