The Bane of Tax Evasion

Tax evasion of ₹ 2.01 lakh crore has been detected in the financial year, a marked improvement over the previous year. We should bear in mind that these statistics are of cases detected and may not reflect the full extent of evasion; we are not aware of any detailed gap analysis, of how much ought to have been collected.

So while encomiums are due, it is a matter of concern that despite the emphasis which GST laws on technology, such large scale evasion primarily driven by fake documentation continues to take place.

The Background

GST rests on the fundamental premise that value addition at each stage will be taxed with a set-off available for the taxes paid at the earlier stages of the manufacturing chain. In other words credit for the taxes paid is available which is available for discharging the tax liability. It is only the differential (between the tax liability and the input credit) which the Government gets in cash. The document which reveals the tax having been paid or the extent of credit available, is the invoice.

As economists Bird and Grendon have pointed out; “A VAT invoice is a check(sic) written on government.” This critical document automatically entitles the purchasing firm to a tax credit from the government. In an ideal system input tax credits should correspond to taxes paid by some other firm and there should be no room for over reporting or worse reporting something which has never occurred. But we do not live in an ideal world.

The Problem

GST has been dogged by the perennial issue of fake invoices; tax shown to have been paid when it is not; and input tax credit not due, being available. The obvious reasons why this flourishes is to set off GST liability; to claim cash refunds; to inflate turnover so as to avail bank loans or government contracts, to improve the valuation of the company; to reduce income tax liability; and to siphon off money or to mask clandestine sales.

From humble beginnings restricted to a state, it (these tax evasion activities) has now become a formidable, sophisticated criminal enterprise with pan India involvement of multiple layers. A firm issues invoices without supply of either goods or services or without any inward supply to non-existing intermediary firms; invoices getting issued for commodities and services not received.

Supply in many cases goes to existing firms who use the fake credit as also credit which is genuine, making detection even more challenging. This has become a field of specialization for many—and unfortunately even for some unscrupulous chartered accountants.

The Red Flags

There are several red flags which should alert enforcement officials. Multiple GST entities with common bank accounts, unusually high turnover in a short span, mismatch in the GST returns, Electronic Waybills (EWB) having no FASTAG indication, mismatch in the classification, vehicle movement different from EWB address, non-filing the monthly return but filing EWB, high utilization of credit receivables and payables beyond 180 days, cases where the entire liability is discharged by credit, are all possible indicators of a larger mischief. Generally, proprietorship concerns are more prone to such activities.

The Possible Solutions

With the emphasis on online free registration, validation if any can be possible only after the registration.

Getting Aadhaar authentication of the premises owner in case the firm is said to be operating from a rented premises, not permitting phone numbers to be changed unless there is a corresponding change in the Aadhaar linked phone number, insisting on validating bank account details while registering on the GSTN portal to plug fictitious bank details from being given, creating and sharing an all India data bases of cases detected are some solutions.

Similarly, focusing on entities dealing in goods which have been prone to such evasion—iron, copper scrap & alloys, pan masala, tobacco as also services like online gaming, banking and financial sectors, greater sharing and dissemination of intelligence are possible curbs.

Audit should be the first line of defense — they should be strengthened and skill upgrade of the audit teams should be a regular process.

Misclassification and undervaluation is another area of ​​evasion. A GoM (Group of Ministers) is currently engaged in merging rates — this will take time, effort and a lot more commitment then perhaps either the Center or States will be prepared for. But if the merging of rates does indeed take place, classification will become irrelevant. Thus if the rates are common, it matters little if it is bun or bun with cream. Compliance will become easier. This will also stop one possible avenue of evasion.

As Joel Slemrod has observed no government can announce a tax system and then rely on taxpayers’ sense of duty to remit what is owed. Enforcement is critical — and given the complexity, smart enforcement with smarter close supervision is critical. We can ill afford to have delinquent officials running amuck in the name of enforcement.

— The author, Najib Shah, is former Chairman, Central Board of Indirect Taxes & Customs. The views expressed are personal.

Read his previous articles here