Differential GST rates on services is a bad idea

More than 50% of India’s GDP comprises the sector and this will have a significant impact on the economy

There have been some media reports about the government thinking on having differential GST rates on services, depending on its classification as luxury, standard and basic services. In such as situation, services which are classified as ‘luxury’ would attract a higher rate, followed by those under ‘standard’ and then ‘basic’. If indeed this is the thinking, then it comes as a rather unpleasant surprise to the industry.

For goods, a multiple rate structure (0, 5, 12, 18 and 28%) has been worked out, primarily to align with existing rates, a combination of excise duty and VAT, in most cases. Here also, the categories of 5% and 28% have been recently introduced, with an objective that effective rate of tax on few products (which are currently in the range of 5%-7%), does not increase substantially and the government does not lose the revenues as a result of this new category.

While this kind of a rate structure may be a necessity for goods but a similar logic for services doesn’t exist at all. To start with, the government has always been maintaining that services would have a single rate of GST, around 18%. This is in line with the existing service tax laws, wherein all services attract a uniform rate of 15% (including cesses). For certain services such as road transportation, real estate and aviation, effective rate is reduced by providing abatement from the value itself. This has been the practice right from the beginning, when service tax was introduced in 1994. A multiple rate structure on goods compromises the system, having a similar rate structure for services will result in several more complications. For goods, the differential rate structure is relatively easier.

For example, one can argue that bigger cars ought to attract a higher rate as they are largely used by more affluent sections of society. However, for services, this distinction is much more difficult. For example, if restaurants attract a higher rate, then it will apply to all eating joints, which of course would be inflationary.

To avoid that, a distinction must be made by either defining the value of the meal or category of service provider (for example, restaurants in five-star hotels). In either case, it would be difficult to implement and could lead to innovative ways of tax avoidance. Further, the classification for goods would be based on harmonised system of nomenclature , which is already being used under excise and customs laws and is much more precise than classification of services, which is likely to be much broader, like consulting, IT, accounting etc. Therefore, if there is a particular kind of consulting service, which is proposed to be kept under a higher tax bracket, it needs to have a specific and precise definition. Internationally, multiple rate of tax on services is typically unheard of. Industry would also be concerned that if a higher rate of tax is introduced. More than 50% of our GDP comprises services and this will have a significant impact on the economy. We have bent the GST framework a lot from where we began in 2008. Differential GST rates on services might just break it all together.