Before the implementation of the goods and services tax (GST) on gold, it was widely feared that an increase in the tax rate would boost smuggling of the yellow metal, as traders would be tempted to evade tax.

From the looks of it, those fears are coming true.

Illegal business in gold has become widespread ever since GST has kicked in, points out Ahammed M.P., chairman of Malabar Gold and Diamonds.

The view is echoed by economists and taxation experts.

“Given that we are the second largest consumer of gold and gold imports have remained muted in recent months, it indicates that gold transactions are taking place through unorganized channels," says Madan Sabnavis, chief economist at CARE Ratings Ltd.

Sachin Menon, head (indirect tax) at KPMG India, says, “Increased seizures by tax officials, especially at major airports clearly indicate that illegal trade of gold has been on an upswing not only in South India but in other parts of the country as well." The reference to the south is because of a report in the Deccan Chronicle newspaper last month, which said that a surge in unofficial gold imports is taking a toll on revenues of Telangana and Andhra Pradesh.

On a conservative calculation, each Telugu-speaking state is forgoing ₹ 500-800 crore in revenue, as the yellow metal is sold in the grey market avoiding taxes, said the news report citing a senior government official.

To be sure, this phenomenon is not restricted to the south. Recently, the Directorate of Revenue Intelligence seized 32kg of gold worth ₹ 10.32 crore, one of the biggest seizures of smuggled gold in the recent past, in east and north-east India.

The problem, however, seems to have less to do with the tax rate— GST on gold is, at 3%, much lower than the import duty of 10%. The issue, it appears, is more to do with ensuring compliance.

For instance, traders are taking advantage of a loophole in the rules for buying old gold jewellery. Since there is a GST exemption on purchase of old gold jewellery from an unregistered individual, the gold jeweller can import gold through illicit channels and show that in his books as purchase of old gold and evade tax. This is primarily conducted in jewellery purchases of less than ₹ 2 lakh where declaring the permanent account number (PAN) is not mandatory for the consumer.

Official gold imports have declined on a year-on-year basis so far in 2018 (see chart). In a situation where bank deposit interest rates are low, gold becomes an attractive asset, says Sabnavis of CARE Ratings. Sure, some money has shifted to the equity markets and mutual funds. But the fact that gold imports have fallen suggests demand for the yellow metal is being met elsewhere.

Even as GST was meant to transform the gold market into an organized one, too much regulation (mandatory declaration of PAN for purchases over ₹ 2 lakh) tends to give way to migration given the nature of the metal (classic route to park black money apart from real estate), points out Sabnavis.

What can help? If a proper tracking system is in place, it is easy to find out the movement of gold from the suppliers through jewellery makers to customers’ end, reckons Ahammed of Malabar.

A proper tracking system also detects the source of transactions and makers of the product, and ensures tax compliance, BIS (Bureau of Indian Standards) hallmarking, etc.

In sum, a number of pieces need to fall in place for organized trade in gold to grow. Implementing GST alone won’t do the trick. On the contrary, moving one piece, while ignoring others, is clearly backfiring.

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