Traditionally, Indirect Tax policy makers have accorded the Small and Medium Industry favourable tax treatment. This favourable treatment was provided on the premise that small scale units use lesser amounts of capital per unit of output and also provide more employment per unit of output. There is however not much evidence to establish that small scale Excise exemptions in the past have really helped in the growth of the small scale sector. Notwithstanding all this, the new GST law does protect the small scale duty benefits. The GST council which is the joint policy formulating group consisting of both the Centre and the States have accepted an annual threshold limit of Rs 20 lacs turnover up to which the GST will not be payable. Beyond Rs 20 lacs, for another additional Rs 30 lacs annual turnover, the GST rates would be a flat 1-2% based on self-certification of the turnover, or on the basis of the turnover declared in the financial accounts of the company.
While the very small units are provided duty benefits or duty concessions, the GST does bring in the small and medium units under a tight regulatory regime which would be IT driven. Every unit paying the GST must have a GSTN number after registration. Smaller units who are under the compounding scheme with a turnover of between Rs 20 and Rs 50 lacs would require to be registered with a GSTN number.
There is now growing evidence that the small scale exemptions in the past did not really incentivise the small scale units to grow but encouraged fragmentation in order to remain below the threshold level of exemption. The big difference in the GST is that the entire value chain from raw material to retail has become integrated for the purpose of taxation. The Constitutional Amendment Bill empowers Centre to tax trading and the States to tax services. The Constitutional Amendment really ushers in the dual VAT. In the GST scenario, the decision to remain small would become counter-productive as units under reporting transactions would suffer from blocked credits. Today with the integration of value chain for taxation, units would be eligible for credits for input goods, input services and imported capital goods. Many of them carry central duties, which the State VAT paying traders hitherto could not utilise. We can therefore see in the GST scenario, more and more units in the informal sector pretending to be small, forced to enter the formal duty paying segment. This would have significant revenue consequences, as this would also result in smaller units having to report higher incomes to the Direct Tax department in view of the synergy between Direct Tax and the Indirect tax department established by the common PAN registration number.
It is also important to make a distinction between the Small and Medium industries in the goods sector and their counter parts in the Service sector. The exemption threshold in the Service sector was only Rs 10 lacs compared to a turnover threshold of Rs 1.5 crores on the goods side. Therefore, there has been less incentive to fragment and remain small in the services sector compared with the goods sector.
The GST scheme announced by the Government spells out a clear design of the dual control regime. This really covers the whole area of compliance verification. The compliance verification has broadly three prongs, namely return scrutiny, audit and anti-evasion. It is now agreed that small units manufacturing goods beyond 1.50 crores annual turnover will have to deal locally with the State Government, the small service providers on the other hand will have to deal with the Centre, whom hitherto they have been dealing with. The small and medium units have therefore been protected from the vagaries of dealing with both the Central and the State indirect tax departments which is a big relief.
Finally where does all this leave the small and medium industry in the GST era? The self-policing mechanism provided by the design of the GST and the tracking of every transaction by the GSTN system will ensure a more level playing field for all units whether big or small. The GST philosophy represents a shift in tax thinking which is that tax incentives must be relied upon less and less to encourage particular segments of the industry. The tax rates must be low with fewer exemptions covering a larger tax base. Recent studies by the IMF and the World Bank have shown that tax incentives do not confer any real benefit but merely distort the resource allocation. Small and medium units would be better off if there is greater ease of doing business which would require easing of the regulatory mechanisms, loosening of the labour laws and greater access to bank credits. Expenditure switching from tax incentives to infrastructure spending could benefit small and medium units more than tax incentives. Perhaps this new thinking in the GST may end up helping the Small and Medium units even more.
(This article first appeared in the Hindu Business Line dated 11 October 2016)