Imagine a class with half the students very boisterous and naughty with little respect for school rules. The other half of the class that follows all the instructions diligently also gets punished for creating a racket, when the principal makes his customary rounds around the school. To avoid the punishment, the goody-goody bunch must make sure that the mischievous ones behave properly.
The situation is similar under the soon-to-be implemented Goods and Services Tax (GST) regime. Every business has to ensure that its suppliers, of both goods and services, are paying the right amount of taxes on time. This is accomplished through the reverse charge mechanism.
What is it?
The GST has to be typically paid by the supplier of goods and services. But in some cases, the liability to pay the tax falls on the buyer. This reverse charge is, however, applicable only under certain circumstances. The most common instance is when a business buys goods or services from a supplier who is not registered to pay GST.
Let’s assume that business A that is GST-compliant buys goods worth ₹100 from business B that is not registered to pay GST. If the GST on the goods supplied is ₹5, then business A, instead of business B, will have to pay ₹5 to the Government. Business A can, however, claim input tax credit of the GST payment of ₹5, when it sells the goods to its client.
Besides purchases from an unregistered supplier, the reverse charge kicks in in other circumstances as well. An importer is liable to pay the GST under the reverse charge mechanism. Also government departments making payments to vendors above a specified limit (₹2.5 lakh under one contract) are required to deduct tax (TDS) and e-commerce operators are required to collect tax (TCS) on the net value goods or services supplied through them.
Why is it important?
The best part about GST is its self-policing mechanism. The Centre is trying to check tax evasion and expand the tax net through couple of clauses in this tax regime. First, seamless flow of input tax credit is possible only when all the suppliers of a business pay GST. So each business will make sure that its suppliers have paid the GST so that they can take input tax credit.
Reverse charge is an additional check. By putting the burden of paying the tax on the buyer, in cases where the supplier does not pay GST, the Government is gently coercing all businesses to sign up for GST.
The major hindrance for the tax department in going after tax evaders is shortage of man-power. With all resources being allocated to chase large tax evaders, its difficult to check the small evaders. This self-policing mechanism is, therefore, expected to do the trick for the government, helping it grow the tax base as well as tax collection.
Why should I care?
If you run a business, you need to hurry and ensure that all the entities who supply you goods and services are registered for GST. If they aren’t, you will have to pay the GST on their behalf. This will increase your paper-work and can cause cash-flow issues as well.
If you are toying with the idea of escaping the GST net by misstating your turnover, to show that it is below the threshold limit, or through some other means, think again. With the reverse charge falling on the buyer, your order book might shrink as companies would prefer to deal with only those entities who are registered for GST.
The bottomline
It’s time to reverse wrong strategies and get GST compliant