gst in india  


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GST NBFCs - Discussion points

Based on the GST models introduced in various Countries, and the budget speeches/ press releases by the Finance Ministry, the following should be examined.

Fee-based

Currently, the fee-based activities are being taxed under the indirect tax regulations in India, based on the nature of such activities. The principle of taxation being followed is that there is an effective value addition ie provision of services/ service product which occurs, and hence, such activities should be taxed.

Similarly, where such activities form a service product of the actual production process, and there is an element of value addition at this stage, these activities could be taxed under GST.

Fund-based activities

As discussed earlier, under the current indirect regime, these activities have not been brought into the purview of taxation, with special mention to exclusion of ‘interest’ under the Service Tax regulations.

With the advent of GST in the future, there has been a debate on whether such fund-based activity should be made liable to tax. In this regard, some of the points which can be considered for such a debate are discussed below.

  1. Whether ‘provision of capital’ qualifies as service, having the essential nature of service?
  2. The principle of a Value Added Tax on goods and services is to levy tax on the value added at each level of production of such goods and services. In the current scenario, the question arises whether activity of the NBFCs (providing capital) would constitute a ‘service’.

    The term ‘provision of service’ suggests an element of value addition, where the recipient receives a service product. However, a fund-based activity like lending/financing in itself is not part of production of goods and services, but it is factor of production which is used to generate goods/ services.

    This debate is open-ended and requires analysis of various factors which interplay in this issue.

  3. Whether capital constitutes an active or passive factor of production?
  4. Capital in its traditional form has been the actual money which flows into the production mechanism. As such money is used for purchases/ investments which are then used for the actual production mechanism. Based on this characteristic of capital, some economists consider it to be a passive factor. In case tax is levied on lending/ financing activities, the consideration on which such tax would have to be imposed would be the interest component received by the service provider. Generally, the return on such activity is considered to be a compensation for the ‘time value of money’ (the return required for someone to be indifferent about whether to spend now or some time in the future). Thus, taxing the time value of money within the GST base would amount to tax on compensation or in other words tax on income.

    Further, where capital is used in active income generation (as permitted under the NBFC license) through trading, securitization or investments, there is no element of service which is being rendered. These transactions are generally not subject to indirect taxes currently and in our view, should not be taxed under the proposed GST.

  5. International practices
  6. As discussed earlier, the principle of GST taxation followed by many countries, is to levy tax on all activities, and then to provide exemption to specific categories. This methodology seems to bring in an efficient taxing mechanism. For the scenario in India, this methodology may prove effective as the exemptions provided could be broad based and the financial sector itself will bring in a demarcation of the taxable and exempt business.

  7. Sometimes Fee-based activities are linked with fund-based activity
  8. As discussed earlier, fee based and fund based activities are sometimes intrinsically linked to each other. Bifurcation of these may not be possible at all times. Where a transaction contains both such activities (for example loan transaction which involves fee-based income ie processing fee and the fund-based income ie interest), the entire process would be considered as a single transaction. Further, where bifurcation is not possible, the entire transaction may be liable to tax on this ground, thus effectively taxing the fund-based activity.

    An option that could be explored is to tax only pure fee-based activities like advisory and consultancy.

  9. Impact on Indian economy
  10. Levy of tax on the fund-based activities, would result in higher interest rates due to increase in cost of funds maintained by the NBFCs. This would inturn result in increase in cost of funds raised by any business.

    This would impact a taxable business which can avail the input credits on such tax in terms of cash flow. Where the business is not able to avail credits, the entire tax would be a cost to its business. This, would in turn, affect margins of businesses, resulting in slowing growth of the business. This could have a significant impact on the economy as industrial growth may experience a slow down owing to increase in the cost of raw materials and high cost of funds. Further, given the current economic slow down, the impact of such a tax could be negative, at least in the short term.

    For end consumers who avail financing facilities for personal consumption or for purchase of goods/ house, a taxable interest mean higher EMI payments, which, in turn, may be a deterring factor for consumers to buy consumer durables on installment payment basis. This could, in turn, affect consumer durable companies as well as financing companies.

    Further, the impact would also be on loans/ credit facilities granted for the weaker section of the society. The aim of the Five Year Plans by the Indian Government which is generally focused on improvement of the weaker sections/ small scale industries/agriculture/ mid-sized domestic industries/ domestic markets etc may be impacted.

    A few examples of the impact provided was experienced in the past, where the RBI increased the Repo Rates (the rate at which the RBI lends to banks) and Reverse Repo Rates (RRR- the rate at which the RBI borrows from the banks) by 25 basis points each, the main objective of the hike was to contain inflationary pressures arising out of the fuel price hike.

    Further, where European Union and other countries are refraining from taxing certain parts of the financial sector, taxing the entire sector in India, could be detrimental to the economy.

 

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