Indirect taxes in India: time for reform?

• Author: Shantakumar, Arya

In January 2015, President Barack Obama traveled to India for a three-day state visit and was a guest of the government for India's Republic Day celebrations. The president's trip symbolizes the increasingly important role the subcontinent plays in the global economy.

In recent years, India has experienced rapid economic growth due in part to a liberalization process that started in 1991. Since then, India has become one of the world's most attractive investment destinations. But, despite India's progress, it still has a complex indirect tax system with separate, sometimes overlapping, taxes administered by various federal, state, and local jurisdictions. Understanding that a complex tax regime is an obstacle to economic growth, India has been debating a fundamental reform of its indirect tax system. In December 2014, the newly elected government of Prime Minister Narendra Modi introduced to the Parliament a long-expected proposal for a constitutional amendment necessary to implement a more integrated federal-state indirect tax system. This item provides an overview of the current indirect tax system in India before highlighting the proposed changes, which, if adopted, would become effective in April 2016.

Overview of the Indian Indirect Tax System

The Indian indirect tax system can be broadly divided into two categories: federal taxes and state taxes. Federal taxes are imposed on manufacturing activities (central excise duty (CENVAT)) and sales of services (service tax); state taxes are imposed on the sale of goods within a state (a value-added tax (VAT)). Additionally, taxpayers may be subject to other indirect taxes, such as octroi (an entry tax on goods brought into a state for use) and luxury taxes. Thus, depending on its activities and location, a taxpayer may be subject to several indirect tax regimes.

Federal Taxes

Central excise duty (CENVAT) on manufacturing: CENVAT, commonly known as the "excise duty," is a federal tax levied on the manufacture and production of goods. Any person who is engaged in the manufacture or production of "excisable goods" is subject to the excise duty. Only goods identified in the law are subject to excise duty. These goods may include any article, material, or substance that is capable of being bought and sold for a consideration--such goods are deemed to be marketable. Manufacturing or processing is any process incidental or ancillary to the completion of a manufactured product, including packing, labeling, and applying a treatment to the product to make it marketable.

The excise duty is based on either the transaction value or the maximum retail price. Liability for the excise duty is imposed on the manufacturer, which may or may not be the owner of the goods. The manufacturer includes any person under whose direction, control, and supervision the manufacturing activity is carried out. The excise duty is...