The 37th GST Council meeting noticeably occurred in the backdrop of plateauing rates of compliance and frauds involving fake invoicing. The recent Comptroller Auditor General (CAG) audit report highlighted that non-filing of Form GSTR-1 was a critical issue. This is because supplies declared in GSTR-1 provided the Income-tax department invoice-level details to verify the turnover declared in GSTR-3B, which is merely a summary return.
Aiming to incentivise compliance and to check fraud, the GST Council suggested “imposition of restrictions on availment of Input Tax Credit. where supplies had not been declared in the relevant return filed by the vendor. The industry was therefore, left guessing as to exactly what restriction would be put in place.
This aspect has been made clear by the issuance of a recent notification whereby the amount of input tax credit pertaining to undeclared supplies has been capped at 20 per cent of credit pertaining to declared supplies. Curiously, this restriction was first to be introduced in the new GST return mechanism (set to be introduced from April 2020). It, however, seems that the government is seeking a ‘trial run’ of the credit cap as it has also been applied through an amendment to the existing GST return (GSTR1/GSTR-3B) mechanism.
To illustrate the financial implications of the credit cap, below is a tabulation of the possible scenarios in the credit pool.
|Total credit available pre-amendment||Credit pertaining to declared supplies||Credit pertaining to undeclared supplies||Credit cap (20% of credit of declared supplies)||Total credit that may be availed of post amendment||Credit deferred|
Deferment of the credit (which otherwise is available for utilisation) will need to be compensated through cash payment of output tax resulting in unnecessary blockage of working capital and further cascading of costs in the value chain. Setting aside the financial impact of the credit cap, the parameters for ‘matching’ too are extremely uncertain. Few cases of the potential issues arising from this include:
The unanswered question that looms over the entire exercise is whether the imposition of harsh consequences on the recipient, for default of the supplier, is legal in the first instance and is it in a way penalising compliant assessees? The insertion of this restriction into the rules, rather than the act per se, may itself invite further legal challenges.
As a policy measure, the restriction implies greater compliance cost for large businesses and potential loss of credit. This may involve a gradual shift of procurement from small business vendors out of fear of default. This may have undesirable consequences in the current economic scenario, wherein the government is actively seeking to provide a boost to the MSME/SME sector.
While there is no doubt that stricter compliance and circumventing fraud is absolutely necessary, there are reasons to believe that restriction of credit may be a drastic measure, which will have greater drawbacks than benefits.
It is desirable that the government, in its endeavour to build trust, evolves robust technological solutions for matching of credit and engage in greater outreach for improving compliance. A holistic solution would work better than a ‘fatal’ cure.
(A version of this article appeared in The Hindu Business Line on October 24, 2019)