Classification under Goods and Services Tax – Complete Guide
Classification under Goods and Services Tax: Across the Globe under various GST regimes, classification as a subject is not a complex issue for the simple reason that across the Globe, most economies have a two rate GST structure. Under such structure, the two rates are Merit Rates and Demerit Rates. All the items under the ambit of GST are classified under given two rates only. The merit rate is the rate which is closer to 5% tax bracket and demerit rate is the rate which is within the bracket of 16% to 20%. Hence disputes for classification under GST are less or minimal.
Classification under Goods and Services Tax
Under the Indian environment, the GST is also indigenous. Hence the issues relating to classification which are not prevalent across the world are applicable in India. There are various reasons which add up to the complexity under the classification in India. One major reason for same is the multiple GST Rate structure. Today, Indian GST has 8 different types of GST Rates namely 0%, 0.25%, 1%, 3%, 5%, 12%, 18% and 28%. Since the industry structures are different and exemptions add to this complex web of multi point rate structure, a situation of arbitrage due to classification arises. Some reasons for such multiple rate structure are:
Principle of Equivalence and size of revenue collection
In the context of Indian economy, the size of tax collection from Direct and Indirect Taxes is an important factor for economic prosperity. In developed countries the dependence on tax revenues for Governments is only up to 18% to 22% from total collections, whereas, the benchmark of tax collection dependence in developing countries is between 52% to 54% from total revenue collections. However, in India, dependence on tax collections by Governments is significantly high and ranges from 60% to 64% from the total revenue collections
Since tax collection contributes significantly to the government revenue, when migration to Goods and Services Tax happened from Central Excise, Service Tax and State VAT regime, there was an anxiety that tax collections should not dip from current levels under GST and ambition of collecting higher tax was obviously pivotal.
Thus the challenge of collecting steady or higher revenue bounded Government to keep the rate of tax at certain levels and it was backed by the Principle of Equivalence. According to this principle, the rate of tax under GST should be within the deviation of up to 3% (either at the higher or at the lower side) from the rate of tax which was applicable cumulatively under Central Excise, Service Tax and State VAT. The rate of taxes under the erstwhile regime was multi fold and chaotic.
Hence with a view to maintain the rate of taxes which were under the erstwhile indirect tax regime, the rates of tax under GST is multifold applicable on different classes of items (be it goods or services) differently.
2. Political Factors
The ideal GST structure in India would have been a 3 layered rate structure comprising of merit rate, demerit rate and standard rate (or mid-point rate). The merit rate would have been ideally an exemption rate whereas demerit rate would have been around 20% (which is now 28%) and mid-point rate around 12% to 15%. But since the consensus formed in Parliament was for a GST rate not greater than 18% the government could not keep items above 18% and if items were pegged to 12% (i.e. midpoint rate) then to offset the revenue deficit more items were pegged to 28% GST Rate. Due to this the rate of 28% had more than 250 items. With increase in political pressure, almost 200 items were taken out of 28% rate subsequently.
In multiple Tax Rate structure, there is always a certain amount of arbitrage created between the tax payer and the tax collector for classification of items. Example the tussle to classify items between the rates 18% or 28% shall be always on the cards. Since the Government in India as explained above, is heavily dependent on the tax collections as its source of revenue, they will always be tempted to classify items at the rate bracket of 28% and for tax payer the situation will be vice-versa. The 10% gap between the rates opens the flood gates for litigation and divergent interpretations. In fact tax rate gap of 7% between 5% and 12% rates is also significant.
Classification disputes are not new in the Indian Taxation system. According to an estimate, currently around 11200 cases are pending before the Supreme Court of India which are pure classification issues under erstwhile Central Excise, Service Tax and VAT regime. Hence India has 70 years of History in the disputes over classification of items under tax legislations.
Various Steps in Classification of Goods or Services
Since classification and its principles are of considerable importance for taxability and other allied purposes for goods and services, it is important to understand the process flow which should be followed to identify the correct classification, rate of tax and HSN Code for various items. Various provisions of law which are of assistance in this regard are as under:
- Definition of ‘Goods’ and ‘Services’
- Activities listed in Schedule-II
- Activities listed in Schedule-III
- Identification of Composite Supplies or Mixed Supplies
- Identification of HSN Code from the rate notification
- Applicability of Principles of Interpretation applicable on Customs Tariff Act 1975 now made applicable vide Notification No 01/2017-CT (Rate) dated 28.06.2017.
- Understanding the Service Code (Tariff) applicable on services in accordance with Annexure to Notification No 11/2017-CT (Rate) dated 28.06.2017.