How GST is hurting this set of Indian SMEs, global competitiveness lost

Post GST, tax rates on intermediary services have gone up significantly, thereby eating into the margins of SMEs. (Representational image)

• By Abhishek A Rastogi and Pratyushprava Saha

Trade, Imports, Exports for MSMEs: Small and medium enterprises (SMEs) acting as intermediaries or agents of businesses in India are facing acute financial crises on account of depleting margins on their businesses. Most of these intermediaries earn commissions by facilitating sales on behalf of foreign principals supplying goods to customers within and outside India.

Losing Competitive Advantage

Post the goods and services tax (GST), tax rates on intermediary services have gone up significantly, thereby eating into the margins of these SMEs. They also tend to lose out on the competitive advantage against intermediaries in other countries who are not taxed as their services are treated as exports. While there is pressure on India from the World Trade Organisation to cut down on tax standard operating procedures (SOPs), the GST Council should seriously consider granting an exemption to genuine exporters of services which may not violate international trade norms.

It was recently clarified that even the export of information technology (IT) and IT-enabled services (ITeS) can come under GST net as they qualify as ‘intermediary’ services. One must understand that a major segment of the IT and ITeS industry comprises startups and SMEs. This move will not only impact business revenues but also block several crores worth of tax refunds against the export of services, given as an incentive for earning valuable foreign exchange for the country. Intermediary services have a significant impact on the economy. Naturally, several High Courts are examining the constitutional validity of the taxation of intermediaries under GST. We are arguing writs on this issue before the High Court of Gujarat.

GST, being an indirect tax, must be borne by the end consumers and is zero-rated in case of exports. However, Section 13(8) of the Integrated Goods and Services Tax Act, 2017 (IGST Act), creates a deeming fiction for intermediary services exported out of India and attempts to tax them at 18 per cent. Constitutionally, taxes cannot be exported out of India. Besides, it makes Indian SMEs less competitive in the global market. As a result, many chose to absorb the tax cost in their business. Many Indian companies are, therefore, compelled to shift overseas due to such unfair treatment under Indian laws. The move is effectively disincentivising exports and losing out on business revenues.

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Arbitrary, Unreasonable Restriction

Section 13(1) of the IGST Act provides for determination of Place of Supply where the location of the supplier or the location of the recipient is outside India. Section 13(2) of the IGST Act provides that the Place of Supply of services shall be the location of the recipient of the services. Section 13(8)(b) of the IGST Act seeks to create an artificial deeming fiction to treat exports by intermediaries as services supplied in India, to tax exports. The conflict between Section 13(2) and Section 13(8)(b) of the IGST Act is resulting in an absurdity in law, as the exception carved out in Section 13(8)(b) runs contrary to Section 13(2) thereby vitiating the core purpose and principles behind incentivising exports.

Levying GST on the export of services is not only arbitrary but also an unreasonable restriction on the fundamental right to carry on trade under Article 19(1)(g) of Constitution of India, 1950 (Constitution). Article 286 of Constitution restricts the taxation of sale or purchase of goods or services which takes place outside India or on the export of goods or services out of India. Taxation of intermediaries exporting services to customers out of India against foreign exchange is, therefore, a tax levied and collected without authority of law and therefore, violates Article 265 of the Constitution.

The economy is going through a genuine slowdown, a global recession is impending, and the economy is earnestly looking out for a breather. The traditional manufacturing industry is riddled with temporary shutdowns and layoffs. The service industry, represented by a bulk of SMEs, has great potential to emerge as an essential growth driver for the Indian economy and is generating much-needed revenue and employment for the country in a difficult time. This industry must be adequately supported to stay afloat. The GST Council must review the taxation of exporting intermediaries as this predatory levy on exports may well be the final nail in the coffin for many financially vulnerable indenting agents in India.

(Abhishek A Rastogi is Partner and Pratyushprava Saha is Senior Associate at Khaitan & Co. The views of the author(s) in this article are personal and do not constitute legal/professional advice of Khaitan & Co.)