What is Reverse charge in GST? Impact of reverse charge mechanism on small businesses

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Who thought what was started as an untested measure to collect service tax could be one of finest decision to establish its existence. In the past, the government has already brought a tax collection system through verifiable source as known as Tax Deducted at source(TDS). This system was, of course, successful and it further contributes to the foundation of reverse charge mechanism. There was an amendment in the finance act 1994 with the introduction of a new section 68(2) to make provision for reverse charge i.e to make the person receiving the service liable to pay the tax. This was applicable to Good transport agency services only. The basic idea was that these uneducated transport agency owners were not able to clear their service tax dues. The concept of GST reverse charge is explained below

History of Reverse Charge (Tax shift) mechanism

Earlier, there were seven classes of persons, who were required to pay service tax in reverse charge mechanism under Rule 2(1)(d)(iv) of Service Tax Rules, 1994. This rule drew power from Section 68(2) of the  Finance Act, 1994. This section was amended and the Central Government was empowered to notify the extent of service tax which shall be payable by such a person and the remaining part to be paid by the service provider.

In case Mutual Fund Distributors provide taxable services in relation to the distribution of Mutual Fund, it was the duty of  Mutual Fund or the Asset Management Company receiving such service to pay service tax. Further Finance Act 2012 introduced partial reverse charge mechanism to collect service tax. The intention was to curb tax evasion by making both service provider & service receiver responsible for the payment of service tax. Further, there was again an amendment in the finance Act 2015 to this mechanism as it substitutes the words “service recipient” with the words “person other than the service recipient.

The idea was to impose service tax collection liability from Aggregator. The aggregator in layman terms means a web-based intermediary. For example, in case of Ola cabs, the service provider is the driver, whereas service recipient is the customer who rides in that cab, however, OLA (the aggregator) is in the better position to control the activities of both. Hence it was a great decision to put service tax imposition on the aggregator.

GST Reverse Charge mechanism

The concept of charging tax on a reverse charge basis is not new. Reverse charge mechanism existed in the previous service tax regime also. However, the concept of reverse charge on the supply of goods is new. It is very important to note that GST, being an indirect tax, the supplier has to shift the burden of tax ultimately on the recipient. Under this reverse charge mechanism also, the burden is on the recipient. However, the compliance requirement such as obtaining registration under GST, depositing tax, the filing of returns etc has been shifted from supplier to recipient.

So this means any person who is liable to pay tax under reverse charge has to compulsorily register himself under GST which was not in the service tax regime. However, under GST, this recipient of supply ( Either goods or services) is liable to pay tax only in cases specifically provided by section 9(3) and in other cases provided by section 9(4) of the CGST Act. It is very interesting to see that there are two different provisions to recover GST from the recipient of the supply. You all already know that Reverse charge mechanism is a not nearly as new as our recollection of service tax being required from the service recipient.

Current scenario of GST Reverse charge

Under GST, Reverse Charge shall apply in 3 situations –

  1. An unregistered dealer selling any goods/services to a registered dealer – In such a case, the registered dealer has to pay GST on the supply on behalf of unregistered dealers.
  2. CBEC has issued the list of services under section 9(3) of the CGST ACt, where the reverse charge is applicable. Example- Purchase goods like cashew nuts, tobacco leaves etc from Agriculturist. Services include individual advocate, services supplied by an insurance agent.
  3. Services through E-commerce – If an e-commerce operator supplies goods/ services to the recipient, then this e-commerce shall have to pay GST. For example, Ola has to pay GST on drivers’ services on the reverse charge basis.

Important Points under GST Reverse charge

    1. Input Tax credit is available to the recipient for reverse charge payment to the government.
    2.  The reverse charge mechanism also applies to payments made in advance.
    3. Persons have to compulsory register themselves while dealing with notified goods/services under section 9(3) or section 9(4) under GST.
    4. Under RCM, the taxpayer must deposit GST on every 20th of next month to the credit of the government
    5. There is be no auto-generation of details of GST under RCM in GSTR 2.
    6. The recipient has to do self-invoicing as the supplier cannot issue tax invoice.
    7. The registered individuals under composite scheme also come under the reverse charge. Here also they will not get input tax credit.

Impact of GST Reverse charge mechanism on financial advisors

This Reverse charge provision is inconvenient for small & independent Financial Advisers and other small traders. The implementation of reverse charge mechanism has been deferred until 30th June 2018. This move is aimed at benefiting small businesses and reduce compliance costs. The distributors who have already registered under GST can cancel it to avail the benefits of RCM.  But they must earn less than Rs. 20 lakh. Some of the mutual fund funds distributors have voluntarily registered in order to get the input tax credit benefit. But soon after suspension of Reverse charge u/s 9(4), they are now going to cancel their registration. However, they will have to wait for a year to cancel it. The distributors that earn less than Rs. 20 lakh do not have to pay GST. Clarification is awaited on whether these distributors get any refund of the GST paid so far under RCM.

Heavy Compliance

Every person registered under the GST has to file three monthly returns namely- GSTR-1, 2 & 3. In GSTR-1, a registered person has to furnish details of supplies made and income thus generated. In GSTR-2, details of purchases made in the previous month have to be provided. The third return, GSTR-3, will auto-populated on the basis of the first and second return. The third return is for the computation of the net monthly GST liability. This return filing procedure remains the same, even for Independent Financial Advisors.

GST Reverse Charge u/s 9(3) to be Soon Applicable

Currently, reverse charge in case of unregistered dealers is suspended until 30.06.2018. This is in line with GST council recommendations date-10th March 2018. This will surely benefit small businesses. However, there were a lot of discrepancies found during the initial audits and GST revenue collections. The study found that most of the small business units have underreported their turnover. This is helping them to take the advantage of the composition scheme ( paying tax at a flat rate).

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