Taxation is the most important and major source of revenue collection by the government of a country. Almost every country in the world levies taxes in one form or another, and the revenue generated through taxation is used in the development and improvement of the economy and infrastructure of the country. The cost of running a country like India, which is not only swarming with people, but also occupies a significant geographical area, is more than what we can think of. Thus, collection of tax is not only vital, it is inevitable. A widespread controversy arose in the country, during the early months of 2017, when the existing government came out with a new set of taxation, called the Goods and Services Tax, or GST for short. The 101st amendment to the Constitution gave way to the Goods and Services Bill, and the tax itself came into effect from July 1, 2017. It was set to replace the existing taxes which were levied by the central and state governments and brought all under one name. Since then, it has been studied, implemented, and criticised on several grounds, and many terms and mechanisms have been put under scrutiny. One such process is the Reverse Charge Mechanism under the GST, which, to a layman, wouldn’t make any sense. In order to understand such instruments, it is first necessary to understand the GST and how it works.
The Goods and Services Tax
The Goods and Services Tax is imposed on the supply of goods and services, instead of their production. It is a destination-based and staged tax, because it is imposed at every level of production and collected at the consumption level. It has five different percentage slabs of collection – 0%, 5%, 12%, 18% and 28%. Many commodities such as petroleum and alcohol have been kept out of the ambit of GST, and certain items have different rates, such as 3% for gold. Few items like luxury cars and tobacco products carry 28% GST along with an extra 22% cess. GST is levied on all kinds of transactions, like sale, purchase, transfer, barter, import, lease etc.
India is not the first one to implement GST, countries like France and Canada already have a successful GST regime. India adopted the Canadian system of dual GST, which meant that there would be a Central Goods and Services Tax (CGST), and a State Goods and Services Tax (SGST). Transactions within a single state carry both, CGST and SGST, whereas for inter-state transactions, an Integrated Goods and Services Tax (IGST) is levied.
Normal Charge Mechanism under GST
To understand what reverse charge mechanism works, we first need to understand what normal charge mechanism is, which is just the opposite of reverse charge mechanism, or RCM.
Normal Charge Mechanism, or NCM, states that during a transaction, be it of goods or services, the supplier of goods/services is responsible for the collection of GST amount from the buyer and subsequently depositing it with the government, through filing his GSTR 1 Return. GSTR 1 is a statement of outward supplies which is to be furnished monthly by normal and casual registered taxpayers. It contains the details of outward supply of goods and services.
Normal Charge Mechanism may become clear from the following illustration:
Illustration: A, a supplier/seller of goods, sells his goods to B, a recipient/buyer. B makes the payment to A, of Rs. 118, where Rs. 100 is the value of goods and Rs. 18 is the charge of 18% GST. Here, A takes the amount due as GST and deposits it with the government, i.e. the amount of Rs. 18.
Similarly, in the case of services, the service provider is responsible for the collection of GST and deposit it with the government through filing his GSTR 1 Return. The liability is of the seller/service provider to collect the tax and pay it to the government.
Reverse Charge Mechanism under GST
Section 9(3) and (4) state the Reverse Charge Mechanism, or RCM, under the GST Act. Reverse Charge Mechanism states that during a transaction, in case of certain goods and services, the recipient of goods/services is responsible for depositing the GST amount with the government through filing his GSTR 1 under RCM. In this case, the recipient does not pay the tax amount to the seller, therefore the seller has no liability of depositing the tax amount with the government, and it is the recipient of goods/services himself, who is liable to deposit the tax amount of GST with the government. The following illustration makes it clear:
Illustration: A, a supplier of services, supplies a particular service to B, for which B makes the payment, of Rs. 100. Here, B does not pay any percentage of tax to A, but simply pays the value of the service which was supplied by A. But this does not mean that the service is exempted from tax. B will deposit the tax amount with the government through filing his GSTR 1, which will be an input tax credit for B.
Reverse Charge Mechanism is applicable only for certain goods and services, which are:
In case of goods,
- Where the supplier is an agriculturist, supplying cashew nuts which are unshelled and unpeeled
- Where the supplier is an agriculturist, supplying tendu leaves
- Where the supplier is an agriculturist, supplying tobacco leaves
- Where the supplier is a person who manufactures silk yarn from silk worms, supplying silk yarn
- Where the supplier is the State govt., Union Territory govt., or a Local Authority, supplying lottery, to a lottery distributor or agent
In case of services,
- Where the supplier is a person located in a non-taxable region, providing any service from that region, to a person located in a taxable region
- Where the supplier is a Goods Transport Agency, providing service, to certain specified institutions and persons
- Where the supplier is an Individual Advocate, or a Senior Advocate, including a firm of Advocates, providing service, to a business located in a taxable region
- Where the supplier is an Arbitral Tribunal, providing service to a business located in a taxable region
- Where the supplier is a person, providing sponsorship service, to a body corporate or a partnership firm located in a taxable region
- Where the supplier is the Central govt., State govt., Union Territory govt., or a Local Authority, providing services apart from certain specified ones, to a business located in a taxable region
- Where the supplier is the director of a company, providing service, to the company
- Where the supplier is an insurance agent, providing service, to an insurance business
- Where the supplier is a recovery agent, providing service, to a banking company or a financial institution
- Where the supplier is a person located in a non-taxable region, providing service by way of transportation from vessels carrying goods from outside India, to an importer
- Where the supplier is an author, music composer, artist etc., permitting the use of his copyrighted work, to a publisher, music company etc.
Reverse Charge Mechanism is not applicable if the aggregate value of goods and services supplied by unregistered suppliers to a taxable person does not exceed Rs. 5000 in a day.
Reverse Charge Mechanism is applicable on both inter-state transactions as well transactions within a single state.
In certain cases of e-commerce, tax is not collected either by the seller or buyer but deposited by the e-commerce operator. This will not be covered under the Reverse Charge Mechanism.
The rate of tax which is to be deposited is the rate levied on such goods and services. But if the goods or services are purchased at an exempted or nil rate then there will be no tax. GST Compensation Cess is also applicable under Reverse Charge Mechanism.
Overview of Reverse Charge Mechanism
Even though the Goods and Services Tax promised to boost the economy and provide a new and comprehensive tax structure for the country, it met with criticism nationally as well as globally. The technicalities of the implementation of the GST regime are omnipresent. It has too many complex provisions, and too many flaws when compared to GST regimes around the world. Businesses in India have complained of too many formalities and paperwork, and tax refund delays because of the same. In fact, when GST returns were filed in 2017 August, the system crashed because of such a large number of filings. The Reverse Charge Mechanism, in itself, generates confusion for registered taxpayers, and renders transactions difficult. GST is to be paid directly by the receiver and such person has to do self-invoicing for the purchases.
Overall, the taxation system under GST takes out the most from the middle and lower classes, and affects small businessmen and industries at large. Many changes have been brought about by the government since the launch of the Act, but they only go so far.
What is Normal Charge Mechanism under GST?
Normal Charge Mechanism, states that during a transaction, be it of goods or services, the supplier of goods/services is responsible for the collection of GST amount from the buyer and subsequently depositing it with the government, through filing his GSTR 1 Return. Like any other charge, the liability is on the seller to deposit the tax money collected by him to the government.
How does Reverse Charge Mechanism differ from the Normal Charge Mechanism?
Normal Charge Mechanism places the liability of deposition of GST on the seller of goods/supplier of services. On the other hand, Reverse Charge Mechanism places the liability of deposition of GST on the purchaser of goods/ recipient of services.
What are the goods on which Reverse Charge Mechanism is applicable?
The following goods carry reverse charge on them:
(1) Cashew nuts which are unshelled and unpeeled
(2) Tendu leaves
(3) Tobacco leaves
(4) Silk yarn
Only if the abovementioned goods are supplied by certain categories of sellers will the reverse charge be applicable.