Exempted Supplies under GST :- First Chapter

Exempted Supplies under GST :- First Chapter.

1. Introduction to Exemptions

The word exemption as commonly understood means a privilege. It can also mean freedom from fetters.According to P Ramanatha Aiyar’s Law Lexicon (Fourth Edition as Revised by Shri. Shakil Ahmad Khan) the word “exempt” means putting a person beyond the application of law. It further says that when the word exempt or exemption is used in taxation parlance it means – (i) precluding from being chargeable and (ii) immune from a liability, obligation or penalty.

Exemption and non-liability are normally different from each other. For instance, while computing the gross turnover :-

(a) exempted turnovers are includible in gross turnovers and thereafter subject to a deduction; and

(b) in case of non-liability the question of inclusion in gross turnovers does not arise.

A levy or charge to tax is imposed by a taxing statute. The very same statute could also provide for
exemption. Over the last 2 to 3 decades the word exemption has been colloquially used in taxing statutes in many ways – for example – Non-Taxable, Negative list, ‘NIL rated’ etc. It is common for people to understand that zero-rate means exempt which is incorrect. Exemption may also be understood by some as a situation when a statute provides for certain thresholds before the taxability arises. Many a times, the tax payers confuse concessional rates with exemptions.

Normally, it is the State and / or the Central Government (or in appropriate cases Union Territories) which grant exemptions. Such, exemption can be – granted (i) conditionally (ii) generally (iii) through Government orders (iv) under special circumstances (v) through notifications (vi) by way of circulars (vii) by way of tax holidays (viii) to specific class (or kind) of goods and / or services (ix) to specific class of persons (x) for a specific time frame or with a cap on value (xi) to specified transactions etc. It can also be granted in any of the said combinations since it is the prerogative of the Government.

Exemption provisions or rules ought to be enacted / administered and also read strictly. In case of any
ambiguity the intention of the Legislature ought to be strictly borne in mind and given effect to. Generally, the language employed in the construction of an exemption statute must be (i) unambiguous (ii) clear (iii) strictly interpreted (iv) within the powers of the legislating / issuing authority and (v) cater to the intent of the legislature etc.

Exemptions could be granted prospectively, or in certain situations / circumstances retrospectively. Any such enactment must be within the Constitutional framework while bearing in mind the Legislative delegation. Referential legislations in respect of grant of exemptions must be generally avoided considering their complexity. Exemptions which commence during a year must be so enacted to take care of “pipeline transactions”. Exemptions with sunset clauses must be properly framed. The GST laws also provides for exemptions. This booklet discusses several aspects of such exemptions.


2. Brief history of exemptions under the erstwhile laws

It is important to understand the scheme of taxation of the Government (State or Central) to understand the nuances of exemptions. Normally, goods and / or services relating to traditional, social and economic importance, daily needs / necessities and Government policies qualify for the exemption.

For example, under the Service Tax Regulations while clinical services and education services found favour for grant of exemption, many of the State Governments may have been granted exemption in respect of sale of life saving drugs or books meant for reading. Similarly, many States, may have granted exemptions in respect of sale of food grains while agricultural services stood exempted.

The Constitution itself provided safeguards from the levy in respect of certain goods / services from the wrath of taxation like for instance Electricity, Newspapers etc. Apart from the nature of exemptions cited in the introductory part of this Booklet, broadly, exemptions (among others) granted by the State or Centre under the erstwhile laws could be traced to the following :

(a) Public interest or general public good.
(b) Goods of traditional, social and cultural importance, daily needs etc.
(c) Growth of a particular class or kind of industry in a particular area in a State or union Territory.
(d) Development of a State / Union Territory resulted in trade wars and grant of exemptions.
(e) Objectives or policies of a State / Union Territory resulted in grant of exemptions.
(f) Imports of goods and / or services were granted exemptions to make exports competitive thereby
resulting in foreign exchange earnings.

Exemptions were also granted to several classes of goods and / or services bearing in mind trade compulsions between Countries.

Under the erstwhile laws, exemptions provided were the subject matter of several rounds of litigations. This is because the statute (among other factors / issues) was:

(i) ambiguous and there did not exist clarity;
(ii) not properly drafted resulting in classification issues;
(iii) so understood that the essence or intent of legislature was not captured correctly;
(iv) so understood by either party that resulted in incorrect interpretation or grant of exemptions;
(v) neither workable nor effective;
(vi) so drafted with too many conditions paving the way for - reading down, addition or substitution of words, providing natural or grammatical meaning, too many technical terms resulting in dilution of the language employed etc;

(vii) so drafted causing hardship, inconvenience, injustice to a class or kind of persons or infringed upon the freedom of trade;

(viii) causing anomaly or absurdity in the basic understating warranting judicial interference.

Despite the above issues that plagued exemptions, it must be said that the Governments have played a
pivotal role in the grant of exemptions resulting in growth of industry and economy. Importantly, there were several exemption provisions that were drafted by way of references to other Statutes, which resulted in uncalled for difficulty in interpretation. Compliances for the purpose of availment of exemptions was always a painful process under the erstwhile laws.

Exemptions granted under the erstwhile laws had an array of issues such as:

(a) Exemptions with input tax credits
(b) Exemptions without input tax credits
(c) Exemptions with restricted input tax credits
(d) Exemptions that came with conditions / compliance etc.

Trade and industry were very sceptical in availing exemptions under the erstwhile laws. This was because, denial of exemption on grounds that could be flimsy to highly technical interpretation resulted in extraordinary consequences for the trade. There are several instances where the tax consequences have been so great that the industry has failed to survive. Some of the words or phrases under the erstwhile laws that have resulted in huge litigations were “may”, “shall”, “must”, “should”, “prima facie”, “subject to”, “issue of Government order to be notified (in many cases words in GO are different from words in the notification)”, “public interest”, “promissory estoppel” etc. The list is endless.

There are several instances where the effective date of exemption notification itself has been question ed apart from questioning the intent of the Legislature. Thus, it would be fair to state that trade looked at an exemption notification with abundant caution and in several instances, had foregone the exemption simply because the consequences of availing an exemption and its denial at a later date had disastrous consequences. It was well understood that indirect tax laws contained clauses relating to collection of taxes, which were machinery in nature. So long as the consumer / customer could afford the impact of tax, or if the tax so charged was available as input tax credit in the hands of the buyer / recipient, the taxes stood passed on.

Nevertheless, it would be fair to state that despite all these, under the erstwhile laws exemptions have
played a key role in the growth of several classes of industries and resulted in enormous public good.

3. Impact of exemptions on the economy

There is a raging debate going on in India and across as to whether providing exemptions be it “direct tax” or “Indirect tax” would do good to the economy. There is also another school of thought that exemptions do no public good and in fact cause harm to the economy. The fact is that, Governments across the world realise that it is the single most important problem. Some economists opine that:

— the tax to GDP ratio will not go up until exemptions are reduced;
— exemptions push up the compliance costs;
— exemptions lead to unfair practices; and cause uncalled for litigation while legitimising tax avoidance;
— exemptions help the rich and affluent and large industries and do not result in achieving the desired results;
— exemptions cost the exchequer prohibitively; and
— exemptions hinder free trade while helping very few.

Exemptions granted by one country may affect the international trade of another country thus affecting the economies of different regions and countries. While debating on the economics of exemption the questions that often arise are:

(a) Should exemptions be restricted only for public good?
(b) Should exemptions be granted only in case of sunrise industries or industries in backward areas?
(c) Should exemptions be restricted to goods of daily necessities or for goods and / or services relating to traditional, social and cultural importance?
(d) Should exemption be granted only if it meets with the national objectives – say infra projects, health and education sectors etc.

The terms “exemption” and “exclusion” both refer to provisions that exempt some or all the value of goods or services from taxation. Exemptions reduce the taxable value to zero. Exclusions can do the same, or they can reduce the taxable value by a certain percentage or by a flat value. Exemptions and Exclusions affect the taxable value and not the rate. The fact is that an exemption directly impacts the exchequer;

whereas it is extremely difficult to lay down measures or mechanisms to ensure the achievement of the desired result. Any denial of exemption in respect of goods and / or services that affects the end price of a product or service of a consumer will most certainly reflect on the Government of the day. It is for this reason that economists are debating as to whether subsidy would be a better option as compared to exemption of either goods and / or service since the benefit would be traceable.

It is important to understand that an exemption provided by the Centre may not affect the State (under the erstwhile laws) but it does so in a GST regime. It is for this reason that States have been seeking trimming of exemptions. The exemption does not solely cover information held by public authorities concerned with the management of the economy or economic development. Some examples of how exemption affects the economy are:

(i) As a major customer, employer and investor.
(ii) Planning – at both local and national level, for example, transport policies, airports.
(iii) Social, health, environmental policy – for example, public transport versus private car use.
(iv) Planning or managing the economy – through setting or influencing interest rates, taxation, currency rates, controls on public spending, etc.
(v) Political considerations – for example, trade embargos.
(vi) Intended investment strategies.
(vii) Finances of public corporations.

It is important to note that the Government cannot legislate for one person’s prosperity by granting an
exemption while taxing another. Exemptions derail the tax chain causing tax distortions and uneven
economic activity. Over the years exemptions have been granted by the States / Centre depending on the pulls and pressures of politics. It has definitely a damning effect on the economy. An important aspect of exemptions that has to be borne in mind is that somebody is paying for another’s gain. It is for this reason that there have been studies undertaken by the Government to provide exemptions only on a scientific and need basis rather than on the politics of the State or Centre. Given this situation one can expect that exemptions are short lived and will be pruned over a period of time

4. Grant of exemptions – International practices

Internationally, more transparent, less costly and more effective alternatives to exemptions are often made available to trade and industry. The most effec tive and transparent means adopted by several developed countries is that the government identifies the specific activities / goods that they deem worthy of support and provide direct subsidies. It is generally felt that the most effective method can be determined only after a careful examination on a case to case basis.

Some countries have created a special tariff or rate scheme for specified products and services. In
rationalizing the exemptions regime, it is necessary to agree on some basic principles. Most countries feel that it is important to establish administrative procedures which ensure proper monitoring and control of the exemption process, without unnecessarily interfering with the facilitation of trade.
Principles for Granting Exemptions

A. The best international practices seen are in respect of imports that are exempt from the obligation to pay import duties on:

(i)Raw materials and intermediate products used in the production for exports

(ii) Goods imported under aid-funded projects governed by international treaties and agreements
banning the payment of import duties.
(iii) Goods imported under diplomatic privileges governed by international agreements.

B. In addition, many countries exempt imports by:
(a) Government departments and certain government agencies.
(b) Entities granted special import privileges as part of an investment promotion program.

C. Exemptions are granted on goods and / or services in respect of tax free zones, religious bodies,
education, cultural, scientific, tourism and charitable purposes etc. It depends from country to country
as to the purpose for which such exemptions are granted.

D. International experience on tax incentives reflect that :
(i) Tax incentives / exemptions rank very low in the priorities of investors as compared to stability
and certainty in the tax regime.
(ii) Businesses which would have invested even in the absence of the incentives / exemptions.
(iii) Tax incentives / exemptions are usually biased in favour of large well-established entities for
whom the incentives are unnecessary when compared to smaller businesses for whom some assistance may be warranted.
(iv) It is understood that, WTO rules restrict the ability of governments to utilize tax incentives /
exemptions in the way in which they were employed in the past.

Overall, the feeling is that grant of exemptions in the absence of clear underlying principles is to invite rent seeking, revenue loss and distortion of economic incentives, making sustainable development a more difficult accomplishment.

5. Impact on pricing of outward supplies exempt from tax

Positive Impacts

•  No GST is levied on output prices and the goods or services become cheaper for the consumer.
•  The supplier is freed from the hassle of computing GST on output supplies considering its valuation, place of supply etc.
•  No record of taxes is required to be maintained by the suppliers
•  No hassle of matching of input tax credit to the consumer

Downside

•  ITC on inputs becomes part of cost of supplier thereby becoming an invisible barrier to the seamless credit in the value chain
•  GST on input supplies of the supplier is still to be borne by the consumer and thus, some GST is inherent in the price of the exempt goods or services.

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