Millions of Indian Businesses Will Soon Try Something New: Paying Taxes

India is bracing for a dramatic but risky overhaul of the country's tax system that authorities hope will draw millions of businesses into their tax net and boost the economy.

The initiative, set to kick off on July 1, aims to streamline India's cumbersome network of state and federal levies and ease commerce across state borders.

It is a big part of a larger effort, including the cancellation of large-denominated currencies last year, to improve tax collection from companies that make up India's huge informal economy. Some estimate the new system will add nearly 1 percentage point to India's GDP growth within a few years.

But the risks could drag on short-term economic growth, experts say. Among the hurdles are getting millions of companies to register, educating them on how to file online, poor internet connections and widespread tax avoidance. The design of the new nationwide Goods and Services Tax--which replaces a value-added tax and other levies--also is more complex than many expected.

A chaotic rollout could roil an economy still hobbled by a cash shortage caused by the elimination of the bank notes in November.

"This is one of the biggest changes we have undertaken since independence," said Neelkanth Mishra, India equity analyst at Credit Suisse.

The government says it will implement the tax on schedule, simplifying the tax structure and lifting the economy.

India ranks 172nd out of 190 countries in the World Bank's ease of paying taxes index. It has one of the worst tax-to-GDP ratios in the world, at 16.6%, versus an OECD average of 34%. That deprives the government of revenue for much-needed improvements to education, health care, sanitation, infrastructure and other state priorities.

The new tax has already registered 80% of the 7 million current VAT business payers, the government says, and it hopes to bring in most of the rest. The challenge, experts say, will be registering millions of other small and medium-size enterprises in India that aren't registered.

Among the more than 160 countries that use a value-added tax, India's is among the most complex. It has four tax brackets, exemptions for products like petroleum and additional levies on luxury goods. It will split revenue between states and the central government. The rules are the result of years of wrangling between political parties, states and central government in the world's biggest democracy, a country of 1.2 billion people.

Kunal Kumar Kundu, analyst at Société Générale, called it "the world's most complicated VAT framework," saying that compliance will likely be burdensome, particularly for small businesses. HSBC initially projected that the system would add 0.8% to India's GDP growth but halved its projection after the government announced the multiple tax brackets.

"It's not ideal," said Pranjul Bhandari, HSBC's chief economist for India.

The new system requires most businesses with annual revenue above 2 million rupees ($31,000) to upload their invoices every month to a portal that will need to be stable enough to accept billions of documents.

"I don't know whether [policy makers] know the complications in a small trade," said Biju John, a rubber dealer in the southern state of Kerala. "We are in rural areas, where internet connectivity is poor."

Businesses' invoices will be matched with those of their suppliers or vendors, who must provide their tax number before they can claim a credit. Analysts commend the use of peer pressure to make businesses comply.

"The government has made you the tax collector," Uday Pimprikar, a partner at Ernst and Young who specializes in indirect taxation told a seminar hall packed with business owners and accountants in Mumbai this month.

At scenes like this playing out across the country, merchants anxiously ask questions and voice hopes the government will delay implementation. Many businesses say they are still awaiting guidance on how the new tax will work.

"There are no clear insights given on how to process" it, said Parag Malde, owner of Jupiter Impex, a textile company in Mumbai.

As the registration deadline looms, some businesses say they plan to stop taking orders while the tax is implemented. Others say they will wait to see what happens.

"Even our accountants are clueless on how to comply with the rules," said Naresh Patel, owner of R&D Plastics in the western city of Ahmedabad. "It will likely be a painful transition for us."

Ankit Tanna, director of Mumbai-based printing company Printmann group, said his company sent three reminders to suppliers to register.

"We told them: 'If by June 15 we do not have a [tax] number from you, we will be discontinuing our orders.'"

Two of his staff have helped vendors register. "A teacher can only teach, ultimately," but it is up to them to comply, Mr. Tanna said.

Once in place, the system will create a single market, potentially allowing global companies like Unilever, Amazon and Nestlé to consolidate operations.

Wal-Mart India this month said it was setting up a new tax helpline for the mom-and-pop shops that buy goods from its wholesaling business. The company said it wanted to help all its partners make a smooth transition to the new system. Amazon said it was conducting tax webinars for sellers and had produced written and video guides for them.

But few expect implementation to be easy.

"India is trying to attempt what some of the leading economies do not have," said Abhay Laijawala, head of India equities research for Deutsche Bank. "Even the United States does not have" such a system.

Write to Corinne Abrams at corinne.abrams@wsj.com and Debiprasad Nayak at debi.nayak@wsj.com

MUMBAI -- India is bracing for a dramatic but risky overhaul of the country's tax system that authorities hope will draw millions of businesses into their tax net and boost the economy.

The initiative, set to kick off on July 1, aims to streamline India's cumbersome network of state and federal levies and ease commerce across state borders.

But the risks could drag on short-term economic growth, experts say. Among the hurdles are getting millions of companies to register, educating them on how to file online, poor internet connections and widespread tax avoidance. The design of the new nationwide Goods and Services Tax -- which replaces a value-added tax and other levies -- also is more complex than many expected.