by CA. Sandeep Choudhary
Section 16(2)(c) of the CGST Act provides that the recipient is eligible for input tax credit only if the supplier has paid tax. This is problematic, as the supplier may be unable to make the payment in time due to transient liquidity issues. Once the supplier has informed the govt that he has made the supply, the recipient should be allowed to claim credit. Since small entrepreneurs without access to organised credit are more likely to face such issues, they may get wiped out because of this provision.
Section 16(2)(c) of the CGST Act provides that the recipient is eligible for input tax credit only if the supplier has paid tax. This is problematic, as the supplier may be unable to make the payment in time due to transient liquidity issues. Once the supplier has informed the govt that he has made the supply, the recipient should be allowed to claim credit. Since small entrepreneurs without access to organised credit are more likely to face such issues, they may get wiped out because of this provision.
I had flagged this issue in a June 2016 post. Recently, it has been raised again by Tejas Goenka of Tally. In this post, I examine the backdrop for introduction of this provision.
Over the years, the CAG has been criticising the excise department for the fact that tax credit exceeds tax collected in cash. In this 2014 report (snapshot below), the CAG points out that CENVAT credit utilisation is 147% of cash collection (PLA). Note that the Govt does not respond by asking "And your point is?" but points in another direction.
When the office of CAG first highlighted that credit utilisation exceeds cash collection, there was hue and cry over people claiming false credit. Nowadays, it does not attract attention. But "Central Excise Receipts vis-à-vis CENVAT Credit Utilised" is a permanent feature of CAG report on Excise Department (click for CAG Reports for 2014, 2015, 2016 and 2017).
The point missed here is that any efficient tax credit chain, credit will naturally exceed revenue collected in cash. Let us take an example.
Suppose 'A' sells goods for Rs 2 Lakh plus tax to 'B', who after some processing sells it to 'C' for Rs. 2.2 Lakhs plus tax. 'C' adds some more value to the goods and sells to the final consumer for Rs. 2.4 Lakhs plus tax.
Taking the standard rate of 12.5%, A would have paid Rs. 25,000/- as excise duty. B took credit of this Rs, 25,000/-, charged Rs 27,500/- to 'C' and paid the difference Rs. 2,500/- in cash. 'C' took credit of Rs. 27,500/-. He charged his customer Rs. 30,000/- for tax and paid the difference of Rs. 2,500/- in cash.
The total tax collection by Govt is Rs. 30,000/- (Rs. 25,00 from A, and Rs. 2,500 each from B and C.) Total tax credit claimed is Rs. 52,500/- (Rs. 25,000 by B and Rs. 27,500 by C). Credit claimed is 175% of tax collection in cash, though no one has claimed credit incorrectly.
The reason is not difficult to decipher. Both B and C are claiming full credit of the tax payment of Rs. 25,000/- by A. Such a claim is integral to the basic design of tax credit chains.
When MODVAT credit was first introduced, there were significant restrictions on taking credit, market was fragmented and credit was often lost because traders in the business chain were not registered under excise law. Over the years, as the tax credit chain became more robust, credit utilisation started exceeding tax collected in cash.
Is there a false-claim problem in CENVAT credit? Maybe. But it's not an inference that flows automatically from credit- collection ratio. In the simple 3-supplier example above, you get a ratio of 175%. If there are more suppliers, the ratio will increase further.
You cannot infer 'false claims' by looking at credit- collection ratio. That ratio depends on a lot of things: whether credit chain is interrupted at any point, share of upstream and downstream supplier in value addition, number of layers of transactions in the chain, collection from. outliers (petro and tobacco products), etc.
Yet, excess of tax credit over tax collection in cash has been wrongly assumed to be necessarily evidencing false claims. CAG, excise authorities as well as parliamentarians in Standing Committees have all accepted this assumption unquestioningly year after year. And now tax credit is being linked to payment by supplier in GST. But what will happen when GST kicks in? Let's look at the current numbers.
CENVAT Credit utilisation as a proportion of cash collection peaked at 161% in FY 13-14 before falling to 108% in FY 15-16. The fall is attributed by CAG to the sharp jump in share of petroleum products in excise collections, from 48% to 69%. Notably, no credit is available on petroleum products. It may be reasonable to assume that for non-petro products, the proportion of credit utilisation to tax collected in cash continues to increase.
CENVAT Credit utilisation as a proportion of cash collection peaked at 161% in FY 13-14 before falling to 108% in FY 15-16. The fall is attributed by CAG to the sharp jump in share of petroleum products in excise collections, from 48% to 69%. Notably, no credit is available on petroleum products. It may be reasonable to assume that for non-petro products, the proportion of credit utilisation to tax collected in cash continues to increase.
In GST, as tax chains integrate across the trader-manufacturer divide as well as on interstate sales, the proportion of credit utilisation to tax collected in cash will rise dramatically. If we can touch 161% in the fragmented CENVAT regime, we may reach a figure of 500% in the integrated market GST envisages.
How will our Govt and CAG respond to the jump in ratio of credit utilisation in GST? Will they revisit their arithmetic and understand the truth about tax credit chains? Or will the Govt tighten the screws further: inspecting, scrutinising and auditing every taxpayer's record to discover its non-existing cash collection? It is difficult to be optimistic.
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