The GST zero rate bait

Dated 8th October, 2014

What is the political compulsion for keeping GST on petroleum products at zero initially ?

States are apprehensive of losing their autonomy over raising tax revenue by tweaking VAT on petroleum products once the proposed new indirect tax regime is introduced. Taxes on petroleum are easy to collect and, therefore, losing the autonomy to alter the rates would limit the states’ revenue-raising options. States are resisting forgoing this taxation power until the GST regime stabilises and its revenue implications become clearer. To win the states’ consent, the central government had to agree for a zero GST on petroleum products in the initial years of the new indirect tax system. Existing Union and state taxes on these items would continue for a limited period while the rest of the economy embraces GST. States, on the other hand, dropped their demand for excluding petroleum products from the purview of GST through an exemption specified in the Constitution itself.

What is the benefit of such a compromise ?

Keeping petroleum products within the GST chain but at a zero rate ensures that when the GST rate for other products and services is administered for petro products, no constitutional amendment is required. It promises administrative ease. However, applying zero GST on these items while subjecting them to the existing central and state taxes perpetuates the cascading effect of split taxation. However, such inclusion also reduces the uncertainty for companies producing multiple products using petroleum and non-petroleum raw material inputs.

Which are the industries that will be affected by the zero GST on petroleum products ?

Besides crude, states do not want GST on four other petroleum products—petrol, diesel, natural gas and jet fuel. While crude oil is one of the raw materials for a number of downstream industries including petrochemicals, synthetic textiles, plastic, polymers and glass, diesel and jet fuel are used in the transportation and aviation sectors. Natural gas is used in the production of cooking gas and urea (a widely used fertiliser) and as a fuel in power plants. If the current levies on these five items such as central excise, customs duty, central sales tax (CST) and state-level value-added tax (VAT) are retained, producers of their downstream products as well as services and utilities that use these fuels would not be able to claim credit for those taxes to meet the GST liability on their final output.

At present, VAT is levied on crude sold within the state by a producer and CST on sale to a refinery outside the state. (Crude attracts certain cesses on production and import but no other duties.) Petrol, diesel and jet fuel attract both import duties (basic plus additional) and excise duties. VAT and CST are also applicable. Had these products been brought under GST, on a par with other products, credit for the input taxes (other than basic customs duty, which is not subsumed into GST) would be available in paying the GST on downstream products. In the absence of such credit facility, the petrochemical industry, including synthetic textiles, which move into GST, suffer on the account of the tax component that gets embedded in raw material cost. Big players in this sector such as Reliance Industries, GAIL, India Glycols, Haldia Petrochemicals and Indo Rama Synthetics will not get credit for the taxes paid on fuels and feedstock. The cost of petrochemical feedstock such as naphtha and furnace oil that would face cascading effects on tax will, in turn, adversely impact the cost of downstream products such as ethylene, propylene, butadiene, various plastics, industrial chemicals, paints, dyes and synthetic fibre precursors.

The same would be true for many other downstream industries that use ethylene or propylene for producing items ranging from detergents and packing materials to synthetic textiles and fashion accessories.

How would this tax distortion impact the industry and the consumer ?

High tax incidence on the account of cascading of taxes keeps the cost of feedstock high, which is not good for fresh investments in the petrochemical industry which have an annual turnover of over $110 billion. Considering the widespread use of petrochemicals, tax cascading can also have a bearing on inflation.

What are the other compromises being adopted in the design of GST ?

Although GST is a destination-based consumption tax in the sense that proceeds of taxes on inter-state transactions would go to the consuming state, some states that have a strong manufacturing base have been asking for a share of such taxes under the new system too. They demand that a small part of the central government revenue from inter-state trade be paid to the exporting state upfront. This would make GST a mix of both origin-based and destination-based tax, which is very rare.