The unabsorbed input tax credit dilemma in the Goods and Services Tax is something that the Council needs to address urgently

In the backdrop of the collection under the Goods and Services Tax (GST) not coming up to the expected level and the consequential inability of the Central Government to meet its obligations towards compensation to the States as committed under the GST Compensation Act, 2017 (it provides for compensation for five years i.e. till 2021-22 to be calculated as the difference between actual collection and the revenue it would have got with growth at four per cent over the 2015-16 level), the GST Council is undertaking a comprehensive review of the existing rate structure and the implementation mechanism.

Meanwhile, a contentious issue that mandarins in the GST Council will need to urgently look at relates to the treatment of the accumulated input tax credit which does not get automatically set off against output tax liability. At the core of the GST architecture is a feature that allows a producer/supplier to claim credit for the tax paid on inputs across the value chain. This helps in eliminating the cascading effect of tax-on-tax, thereby reducing the cost of products to the consumer (the erstwhile dispensation of central excise, value added tax [VAT] and a host of local duties that were afflicted by the cascading effect).

An anomalous situation may arise if the producer/supplier does not have corresponding output tax liability to provide for setting off accumulated credit on input purchase. Indeed, this anomalous situation is currently faced by telecom companies. They have made heavy investment in augmenting the infrastructure (needed to provide speed and quality services) even as there has been a steep drop in their revenue; courtesy tariff plummeting to record lows due to the intense competition after the entry of Reliance Jio in 2016.

This increased accumulated credit on their input purchases and reduced their GST payments to the Government (primarily due to low tariff/sale price), thereby reducing and eliminating the potential for automatic offsetting of dues. They are unable to claim refund of the taxes paid on inputs as the GST law mandates corresponding output tax liability which is insufficient. The unabsorbed input tax credit works out to a whopping `36,000 crore. The situation in fertilisers is broadly similar. Given the critical role of fertilisers in ensuring food security, the Government controls their maximum retail price (MRP) at a low level, unrelated to the cost of production and distribution and reimburses the excess as subsidy to the manufacturers. In case of urea, the MRP is 25 per cent to 50 per cent of the cost whereas in the case of non-urea fertilisers, the price is 70 per cent to 75 per cent. The balance amount is given to farmers as subsidy.

Coming to the tax structure, fertilisers attract five per cent GST, even as the tax on raw materials and intermediates used in their manufacture is much higher. Natural gas (it accounts for about 90 per cent of urea production) is at present “zero rated” under GST implying that it continues to attract excise duty (ED) and VAT as in the past. Even as ED on gas is “nil”, VAT varies from State to State with a low five per cent in Rajasthan and 21 per cent in Uttar Pradesh. Besides, some States impose local levies. For example, the “purchase tax” in Gujarat applies to that portion of inputs used for making urea that is sold outside the State.  Nearly, one-third of gas consumption by fertiliser plants is imported as LNG (liquefied natural gas) attracts customs duty (CD) at 2.5 per cent. Imports of ammonia, phosphoric acid and sulphur — raw materials and intermediates used in manufacture of non-urea or phosphate and potash fertilisers — attract CD at five per cent (on rock phosphate, it is 2.5 per cent). On the other hand, ammonia and phosphoric acid attract GST at 18 per cent and 12 per cent respectively (initially, GST on phosphoric acid was 18 per cent but was brought down to 12 per cent in January 2018).

The process of fertiliser manufacture is power-intensive. Electricity generation and distribution is also excluded from the ambit of the GST. However, it is exempt from levy of Central VAT (CENVAT) and VAT. Further, under the Constitution, entry 53 in the State list of the Seventh Schedule empowers States to impose tax (or electricity duty) on sale and consumption of electricity, except when consumed by the Union Government or the Railways.

Let us now look at the implications of the above tax structure for input tax credit. First, gas being virtually outside GST, gas companies viz. Oil and Natural Gas Corporation (ONGC), Oil India Limited (OIL) and so on, can’t claim credit for the taxes paid on their purchase of inputs, consumables and equipment leading to higher price. The price of gas to fertiliser producers (delivered at factory gate) further increases due to VAT (which in some states such as UP is 21 per cent) besides a host of local levies wherever applicable.

In case of electricity — it being outside GST and exempt from levy of CENVAT and VAT — this results in a situation whereby power companies  don’t get any credit for taxes paid on inputs viz. equipment, stores and so on, used in its generation and distribution. This results in higher cost of electricity, that is further exacerbated by electricity duty imposed by States for which no offset is available. We thus have an anomalous situation, whereby on one hand taxes paid on inputs (primarily gas and electricity) used in the manufacture of urea are high with a built-in cascading effect. On the other hand, the tax liability on the output (urea) is low not just because of much lower GST at five per cent but also due to lower MRP. Likewise, tax paid on raw materials and intermediates (mainly ammonia and phosphoric acid) used in the making of non-urea fertilisers is high even as tax on output is low for the same reason. This inevitably results in unabsorbed input tax credit as output tax falls far short of input tax.  

Considering the adverse effect of reimbursing the unabsorbed input tax credit on tax collection, particularly at the current juncture when the exchequer is facing a huge shortfall, the Government may not be inclined to sanction it (in case of telecom service providers) or delay as for fertiliser manufacturers. But, the adverse impact of rejection/delayed release on service providers/manufacturers can’t be brushed aside either. What then is the way forward?

Ideally, the Government should maintain tax on the final product at the same rate (or higher) than the rate on raw materials/intermediates so that there is sufficient tax liability on the former to enable automatic neutralisation of the tax paid on the latter.

Accordingly, it should levy GST on gas (by removing the current zero rate status) and bring electricity under GST and tax both at five per cent, i.e. the same as on fertilisers. GST on ammonia and phosphoric acid should also be brought down from the existing 18 per cent and 12 per cent respectively to five per cent on each. While making these changes may take some time (particularly in view of resistance from States), in the meanwhile, the Government should take steps to promptly release pending un-availed input tax credit to fertiliser manufacturers. The position in case of telecom service providers, however, is different.

Here, the output tax liability is insufficient to fully offset the input tax mainly because of the rock bottom tariff due to “unhealthy” and “destructive” competition (this was not mandated under any law or Government regulation) unlike fertilisers where as matter of conscious policy, the selling price is controlled at a low level to make them affordable to farmers. Nevertheless, it can’t be denied that service providers have incurred excess input tax credit and not refunding the same will go against the very spirit of GST.

The pending excess input tax credit of `36,000 crore may be refunded to the telecom service providers. With tariff being increased by all service providers and even the sector regulator Telecom Regulatory Authority of India (TRAI) contemplating a floor tariff (to bring a semblance of discipline to the market) hopefully, such a situation may not unfold in the future.

In fertilisers with the changes in tax structure — as proposed — and move towards direct benefit transfer (DBT) of fertiliser subsidy which will lift the MRP, the output tax liability will be in sync with tax paid on inputs.

Notwithstanding the above, situations of mismatch can’t entirely be ruled out. To address these, the Government should consider amending GST law to allow refund of excess input tax credit and eventually match the output tax liability. Meanwhile, it should intensify efforts (including use of data analytics) to identify and crack down on fake claims of input tax credit to shore up its revenue.

(The writer is a New Delhi-based policy analyst.)