Is Goods & Services Tax (GST) Simply Overrated?

Goods and Services Tax a Panacea for all woes?

Prime Minister Narendra Modi was in his element when he congratulated the country on the passage of the much-touted Goods and Services Tax (GST) Bill in the Upper House of the Parliament, claiming that the new tax regime will rid the country of tax-terrorism. The tax regime which was proposed about a decade back as the panacea that would clean up the messy and complex indirect tax structure of the country, is expected to give India’s GDP a fillip, apart from boosting exports. “Expected” is the word. While GST has become popular as a ‘One Nation-One Tax’ formulation, the realities of implementation may be more complicated than political negotiations in the Parliament. Truth is GST, for which the ruling administration has set a go-live date of April 1, 2017, is in no way a one-tax rule. As things stand, the Centre has agreed to subsume excise duty, additional excise duty, service tax, countervailing duty, surcharge and cess, and central sales tax into the waiting arms of GST. The States have agreed to give up VAT (sales tax), entertainment tax, luxury tax, taxes on gambling, octroi and entry taxes, cess and purchase tax. GST will thus replace all of these taxes. The all-important tax rate though remains to be agreed upon.

A wait of more than a decade came to an end on August 3, 2016, when the 122nd Constitution Amendment Bill, 2014 (popularly known as GST Bill) was passed by the Upper House of the Parliament of India. This is apparently the country’s biggest tax reform since Independence.Some achievement therefore for the Indian democracy. The new tax regime, which subsumes all indirect taxes such as sales tax and excise tax, is expected to bring down tax rates in India, while converting the country into a big single market. In short, now, seamless flow of goods and services will occur across 29 states and 7 union territories! Many believe the landmark Goods and Services Tax Bill (GST) passed by the two houses of the Parliament – after years of back and forth by the ruling party and main opposition (both the present ruling and main opposition parties have supported and opposed the Bill depending on whether they were in power or in the opposition) – is a key step that would catapult India into the big league in global supply chain. The implementation of the Bill is expected to ease India’s cumbersome tax system, help goods move seamlessly across state borders, curb tax evasion, improve compliance, increase revenues, spur growth, boost exports, and attract investments by improving ease of doing business in India.

In short, GST when implemented, is expected to perform miracles. But, can it really? And considering that the Bill still needs to be ratified by at least 13 more state legislatures (over and above the three states Assam, Bihar and Jharkhand,which had already passed the bill, as on August 22, 2016) before the President of India can notify the GST Council to decide on the new tax rate and other issues with respect to GST, will it be a easy journey for the GST to the finish line?

India is by no means the first country to experiment with a unified tax regime.160 countries already have some form of GST or a value added tax. What makes GST in India special is that as opposed to a federally administered regime, the Union and state governments will jointly administer India’s dual GST. This means it will be a set of many different taxes – a GST for each of the 29 states and two union territories (SGST), a Central GST (CGST), and an Integrated GST (IGST; which will be a combine of CGST and SGST on inter-state supplies of goods and services). That surely is not as unified as it seems.

Interestingly, India will be one of the very few countries with a dual GST regime alongside Canada and Brazil. The all-important rate is yet to be finalised, with the final standard rate possibly lying between 15% to 27%, though 18% is the rate that seems to be gaining a sort of consensus amongst pundits. The problem though is that the pundits won’t decide the rate! GST rate will be decided in the coming months by a GST Council that will prise the Finance Minister with a representative from each state government. As such it will be negotiated amongst the Union and state governments that will jointly administer the GST regime. It will still remain complex and difficult to implement, but would surely make life easier for businesses by cutting down, or rather combining, the many indirect taxes that companies file in India.

Foreign media has called GST one of the world’s most complex tax reforms that needs to be supported and serviced by state-of-the-art technology. And Infosys, the Indian software giant, has already started building a massive electronic

infrastructure – a GST portal (GSTP) – where taxpayers can register, make payments and file returns. It is expected that some 7.5 million businesses will be covered by the tax. But then there are several questions that have been doing rounds since the day the Bill was passed in Rajya Sabha. What will really be the impact of GST on India’s manufacturing and service sectors? What will be a realistic timeframe for its implementation? How difficult will the implementation process be given the dual nature? What would be an ideal timeframe by which benefits will be realised? And above all, what will be the impact on exports from key sectors?

 

The long queues of goods carriers at checkpoints should become a thing of the past with the implementation of GST. In India, trucks, according to some estimates, on an average, spend 48 hours per trip at various check-posts.

The long queues of goods carriers at checkpoints should become a thing of the past with the implementation of GST. In India, trucks, according to some estimates, on an average, spend 48 hours per trip at various check-posts. (Image Source: The Dollar Business)

 

BUSINESS MADE EASY

One factor where the industry has clearly been in consensus is that GST being a destination based tax (where the tax is not applied at the point of production but at the point of supply or consumption),will make life easier for businesses in India. Companies will not have to file tax returns with multiple departments, but there will be just one web-based form to file tax returns. The country will finally become one common market, with uniform pricing across states, and optimal allocation of resources, making our goods more competitive. “Undoubtedly the most significant reform since the liberalisation in 1991, GST will transform India’s economic landscape. Unifying the $2 trillion economy and its 1.3 billion people under a uniform tax code, makes our country one of the most attractive destinations for business. I am confident that this game-changing legislation will propel India into a $20 trillion economy in the decades to come,” says Anil Agarwal, Chairman, Vedanta Group. Apart from this, there will be a very strong positive impact on the logistics sector. There is no one in India who has not seen the serpentine queues of goods carrying vehicles  standing at inter-state check posts for inspection and payment of taxes. Even Shaktikanta Das, Economic Affairs Secretary, Ministry of Finance, GoI, is on record saying that trucks on an average spend 48 hours stranded at different check-posts every trip. The GST in ‘one fell swoop’ will remove these barriers, thus making India a preferred destination for business. “GST will revolutionise logistics with unified and simplified structure versus multiple taxes at various levels. It will lower the inventories and working capital, reduce documentation, improve asset utilisation, ensure higher turnaround time and efficiencies. We expect the industry to move away from pure vanilla warehousing needs to contract logistics,” Prakash Tulsiani, Executive Director & COO, Allcargo Logistics, tells The Dollar Business.

 

EASE OF DOING BUSINESS, A REALITY!  CENTRAL TAXES SUBSUMED

  • UNDER GST
  • Central Excise Duty (including additional excise duties)
  • Service Tax
  • Additional Customs Duty (CVD)
  • Special Additional Duty of Customs
  • (SAD)
  • Central Sales Tax and cesses

STATE GOVERNMENT TAXES SUBSUMED UNDER GST

  • Value Added Tax
  • Sales Tax
  • Octroi and Entry Tax
  • Purchase Tax
  • Luxury Tax
  • Taxes on lottery, betting and gambling
  • State cesses and surcharges
  • Entertainment Tax

 

IMPACT OF GST ON BUSINESSES

Sourcing: Inter-state procurement will become easier;Manufacturers get the option of consolidating supplies from vendors;Additional Duty/CVD and Special Additional Duty components of Customs Duty to be subsumed.

Distribution: The new regime will allow consolidation and optimisation of warehouses;Current arrangements for distribution of finished goods to change;Current network structure and product flows may need review and possible alteration because of removal of Excise Duty.

Pricing and profitability: Tax changes resulting from the GST structure would require repricing of Products. Prices could both increase or decrease; Margins or price mark-ups would also need to be re-examined.

Cash flow: Removal of the concept of Excise Duty on manufacturing can result in improvement in cash flows and inventory costs as GST would now be paid at the time of sale/supply rather than at the time or removal of goods from the factory.

System changes and transaction management:  Potential changes to accounting and IT systems in areas of master data, supply chain transactions, system design;Existing open transactions and balances as on the cut-off date need to be migrated out to ensure smooth transition to GST;Changes to supply chain reports (e.g., purchase register, sales register,services register), other tax reports and forms (e.g., invoices,purchase orders) need review;Appropriate measures such as training of employees, compliance under GST, customer education and tracking of inventory credit are needed to ensure smooth transition to the GST regime.

 

DUAL-GST: WHO GETS WHAT

TRANSACTION NEW SYSTEM OLD SYSTEM COMMENTS
Sales within the state State GST & Central GST VAT & Excise / ST Under the new system, a transaction of sale within the state shall attract two taxes: SGST (which goes to the State), and CGST (which goes to the Centre)
Sales outside the state Integrated GST CST & Excise / ST Under the new system, a transaction of sale from one state to another shall have only one type of tax, the IGST – which is collected by the Centre

 

NOT SO EASY

Sounds good. But then it won’t be an easy run to the finish line for GST. And the reason is simple! The dual nature of India’s GST regime is expected to make implementation a complex problem, and rob off some of the key features of ease of doing business.

Canada and Brazil, both have a federal administrative structure similar to that of India and have opted for the dual GST route. For instance in Canada, the dual GST route obviously cleared up the conflict between states and the Union government in terms of revenue generation and tax collection, and allowed for a consensus to be formed. But then, Canada owing to the dual nature of its GST has not been able to unify the nation as a common market, with different taxes in different provinces still in effect.

In India, though the scrapping of the proposed additional 1% inter-state tax has cleared the air considerably making businesses happy, the states still need to agree on a common rate. And while

states like West Bengal and Bihar will be happy with a low tax rate, many like Tamil Nadu are expected to ask for a much higher rate. At the high-end, some states have even asked for a GST rate of 27%. But then, experts believe, a tax rate that high can completely negate the positive effects of GST. “The current combined Centre and state statutory rate for majority of the commodities works out to be 26.5% (CENVAT : 14%, and VAT: 12.5%). Once GST is implemented, the same is expected to reduce to a standard rate to about 18-21%. This will naturally be beneficial for the end users. But if the tax rate goes beyond 18-21%, a lot of the benefits of GST will be lost,” says Harpreet Singh Malhotra, Chairman & Managing Director, Tiger Logistics. And then there is the issue of tax refunds from state governments, with some states known to be tardy with refunds. Rakesh Shah, Director, Nipha Group, a Kolkata-based exporter of engineering goods, while speaking to The Dollar Business on the dual-GST sytem says, “This is the biggest drawback of the GST regime from our perspective. Some state governments do not have a great track record of refunding taxes and there is nothing in GST so far that makes us believe that they will change their behaviours.”

There is another fear – inflation.

 

THE INFLATION BOOGIE

The proposed tax regime has raised fears of inflation at a time when CPI has shot up beyond the official tolerance level of 6%. Outgoing RBI Governor Raghuram Rajan has cautioned the industry that there could be a generalised inflationary effect on the economy due to price adjustments after implementation of GST.

However, the Governor has also clarified that he expects the inflationary pressure to be negligible. Citing the example of Malaysia, he said that the inflation in Malaysia was both negligible and short-lived and this is expected in India as well due to a one-time price adjustment of goods and services.

Potential inflation will depend significantly on the final rate of GST and the basket of goods and services that will be exempt from GST. Meanwhile, RBI Deputy Governor Urjit Patel has pointed out that about 55% of the items that form the Consumer Price Index (CPI) will be exempt from GST, making the inflationary impact negligible. Even a Nomura report estimates GST to impact headline CPI inflation by just 20-70 basis points (bps) and core CPI by 10-40 bps in the first year of implementation. And that would exbe on account of higher prices of electricity, clothing and footwear, healthcare, medicine, and education after accounting for input taxes.

Food items like cereals and vegetables are expected to become more expensive. Essential items like health services and medicines will also become expensive as they presently are subjected to lower tax rates, even if GST rate is capped at 18%.As of now, products like alcohol and petroleum have been kept out the GST ambit; clarity is yet to emerge on whether there will be more exemptions. With various industry bodies lobbying for exemptions or lower rates, it is plausible that we will see more products and services being exempted. That being said, in the past, countries (like Malaysia and New Zealand) which have opted for GST have been known to face high inflation and slowdown in consumption initially.Whether history will be repeated in India depends on a host of factors, the most important being the standard rate of GST finally agreed upon.

 

GST rates in high income and emerging countries

 

EXPORTS TO CLIMB?

If GST improves ease of doing business, can exports be far behind? With uniform taxation and cost efficiencies owing to reduced time and costs in transportation, one obvious effect would be that ‘Made in India’ products would now be more cost competitive in the global markets. “In the previous tax regime, our exbe ports were sagging, since we also exported a major portion of taxes. Indigenous manufacturers failed to capitalise owing to double taxation. All this will change post GST. And eventually exports from the country will increase,” says Nihal Kothari, Chairman, National Council on Indirect Taxes, ASSOCHAM and Executive Director at Khaitan & Co. And he is right! We have examples of GST boosting an economy’s exports. For instance, New Zealand implemented GST in CY1986 and saw it exports jump from $5,880 million in CY1986 to $7,195 million CY1987, a growth of 22.36%. Similar was the case with Australia, which implemented GST regime in CY2000. Australia’s exports grew at a CAGR of 7.9% from $63,870 million in CY2000 to $86,565 million in CY2004.The present system of differential multiple tax regimes across sectors of production and locations leads to distortions in allocation of resources as well as supply chain and warehouse structuring.

 

There is a tendency of manufacturers to locate manufacturing facilities as well as warehouses in states or locations that offer better tax structures regardless of their suitability in terms of other resources. With regard to India’s exports, this leads to lack of international competitiveness of the sectors which would have been relatively efficient under distortion-free indirect tax regime. Add to this, there is a lack of full offsets of taxes loaded on to the FOB (Free On Board) export prices. This results in export competitiveness further getting negatively impacted. Efficient allocation of productive resources and providing full tax offsets, as envisaged under the GST, is therefore expected to result in gains for exporters. According to a paper on GST by the National Council of Applied Economic Research (NCAER) submitted to the 13th Finance Commission, gains in exports are expected to vary between 3.2% and 6.3% (while imports are expected to rise somewhere between 2.4% and 4.7%). Sectors which are expected to see a substantial increase in exports include textiles and readymade garments, beverages, industrial machinery for food and textiles, transport equipment other than railway equipment, electrical and electronic machinery, and chemical products. Further, while agricultural machinery, metals and railway transport equipment are expected to gain moderately, exports is expected to decline when it comes to agricultural commodities, iron and steel, cement, wood and wood products except furniture.

 

GST will provide the much-needed boost to India's automotive industry, primarily because of the removal of cascading that is expected with the new tax regime.

GST will provide the much-needed boost to India’s automotive industry, primarily because of the removal of cascading that is expected with the new tax regime. (Image Source: The Dollar Business)

 

FATE OF FTP SCHEMES

A mixed bag of good and bad news could therefore be on offer for India’s exporters.And it will be that way with some sectors emerging as winners, while others losing out on a few advantages. However, what can be a bigger cause of worry for exporters is the ambiguity with respect to various export promotion schemes allowed by India’s Foreign Trade Policy (like MEIS, SEIS, EPCG, DBK, Advance Authorisation, etc.) during the initial GST implementation phase. Exporters are allowed to claim refunds on Central Excise, Customs duties and Service Tax against various scrips issued by the Ministry of Commerce. Since Central Excise and Service Tax will be subsumed under GST, exporters may face problems in encashing the much-needed incentives that have been structured to support exports.Asks Shah of Nipha Group, “Exports are zero rated, but GST retains the refund system at the final stage which will mean increased blockage of funds. A number of current export promotion schemes will wither away or get diluted. Similarly, what will happen to our dues during the transition from the current system to GST? How will they be treated?”

Office of the Directorate General of Foreign Trade (DGFT), Ministry of Commerce, GoI, is aware of the issue. D. K. Singh, Additional DGFT, while speaking to The Dollar Business says, “Under the current system, one can pay Customs Duty, Central Excise Duty and Service Tax. But, since Central Excise will be replaced by other taxes such as IGST and SGST under GST, it may not be a smooth transition for our exporters. So, we have requested the Finance Ministry to reconsider and allow us to maintain the scrip.” As per him, the matter is currently under examination by the Ministry of Finance.

The current indirect tax regime provides for lower or no Customs Duty on imports for importers who use those imports in producing goods that are subsequently exported. However, under GST, imports would be subject to IGST (CGST plus SGST) and any exemptions or additional levy will not exist. This would provide level-playing field to domestic manufacturers against importers.

In case of special economic zone (SEZs), the various exemptions provided under different schemes would be limited in their applicability to export duty only. Exports or deemed exports would be zero rated, but sale to domestic tariff area (DTA) would be taxable. Exports from these special zones though will get a leg-up by being more cost competitive, owing to reduced logistics costs.

 

ON THE FAST LANE

GST has the potential to revolutionise the logistics industry. India’s trucking and logistics sector will realise its worth once GST is implemented at the ground level. Experts believe that the tax procedure will get reduced dramatically and the cost of holding inventory will fall by 50%, since stock would no longer need to be piled up in various warehouses. Analysts estimate that the logistics sector will witness up to $200 billion in savings annually with GST, thanks to faster movement of goods and minimum idling, which have troubled the industry for long now.

Explaining the issue of idling, Harpreet Singh Malhotra, CMD, Tiger Logistics says, “Prolonged delays at toll booths and extra fuel usage due to regular idling were resulting in annual losses of more than Rs.1,00,000 crore. Such delays don’t just burn money, they slow down business too.” According to Malhotra, while trucks in US are said to cover a distance of 800 km every day, in India they cover only 280 km a day. There is no surprise in the fact, because where average US truck speeds exceed 89 kmper hour on highways, 12.7 km per hour is considered good as long-distance average in India. “Once GST gets going, these challenges will become a thing of the past,” adds Ramesh Agarwal, CMD, Agarwal Movers Group.

According to logistics experts, the Indian logistics industry spends around 14% of the GDP every year on different types of cost incurred in logistics operations.The amount of cost incurred is very high in comparison to the logistics cost incurred in different nations. This scenario is expected to change once GST is in place. In fact, 3PL logistics market in India is expected to be worth $301.89 billion by 2020. This growth is based on expectations that GST will soon be implemented and logistics companies can optimise their operations to reduce cost and increase margins. RAVI RAMU MD & CEO,VBHC Value Homes “Affordable housing requires an ease of doing business for both the builder and the buyer. GST is a giant leap in this direction. We are delighted at the prospect of dealing with easily understood and implementable indirect tax laws. The marginally higher incidence of indirect taxes through the introduction of GST, if any, will be more than compensated for by the savings in time and effort in operating a far simpler law.”

“GST will convert a diversified tax regime into one uniform tax rate making India a single market place. This would facilitate seamless transportation of goods across borders with a significantly lower transit time, thereby stepping up demand for logistics services.The GST Bill will also lead to higher vehicle capacity utilisation resulting in increased efficiencies at every node of the logistics ecosystem. Overall, this is a positive move that will generate growth opportunities for organised players within the logistics industry,” says Abhishek Chakraborty, Executive Director, DTDC Express Limited. Apart from simplifying the tax structure, GST will bring in huge relief to several players at the operational level as they can now do away with fixed costs of maintaining warehousing across various locations in India. “The fixed warehousing overheads of companies across industries will decrease by 30-32% and that will make them more competitive in the international market. Portable and virtual warehousing will become a viable option for many companies. It will also enhance their operational efficiency,” says Agarwal of Agarwal Movers Group. Although various logistics players and experts are expecting a short-term inflationary impact on exports, consensus is that GST will, in the long run, increase competitiveness of Indian exporters.

 

IN AN AUTO MODE

India’s automobile exports contracted 9.7% during the first quarter of this fiscal, with shipments of three-wheelers nose-diving as much as 46.6%. Last year, however, overall exports from the sector grew marginally at 1.91% over the previous fiscal, with commercial vehicle segment leading the exports growth. Come today, the automobile industry seems to be thrilled with the notion of a simplified tax regime. “The current tax structure on automobiles is riddled with complexities,” says Vivek Mishra, Partner & National Leader – Indirect Tax, PricewaterhouseCoopers.

HOW GST WILL WORK: AN EXAMPLE (SMALL CAR)
CURRENT GST
Manufactures’ price (Rs.) 3,00,000  3,00,000
Total taxes at manufacturing stage
(*includes excise duty, infra cess, VAT, octroi)
1,41,690
(47.23% total tax)*
54,000
(18% GST)
Cost to dealers 4,41,690 3,54,000
Margin @10% 44169 35,400
Sale price for dealers 4,85,859 3,89,400
VAT/GST 60732
(12.5%)
70,092
(18%)
Net VAT/GST (after claiming credit) 12,558 16,092
Price to retail customers 5,46,590 4,59,493

 

Currently, automobile sales are subject to six different types of tax at various rates which include Excise Duty, Infrastructure Cess, Octroi, VAT, Motor Vehicle Tax/Road Tax and Tax Collected at Source (TCS). What’s more? The variation in each of these tax rates, according to vehicle type, engine size and ground clearance, further compounds complexities. GST, once implemented, will remove the cascading effect of taxes and put Indian automobile industry on a stronger growth trajectory.

All taxes on input paid will also be offset with the output liability of GST. Owing to different types of indirect taxes collected by the Centre and States separately, taxes paid on some of the input costs currently cannot be set-off against the final tax. Some of the common examples include Service Tax paid on certain inputs such as rent, IT, freight, etc., and lower tax credit on outsourcing activities, etc. This is likely to change once GST is implemented. Further, since CST will be subsumed in GST, manufacturers will no longer be required to have warehouses at multiple locations across states. The 2% CST, which currently is a cost to the manufacturer, will become a part of IGST, and the manufacturers will not be liable to pay this origin tax.

Under the current regime, Excise Duty on vehicles is categorised into four slabs, in which smallest duty is applicable on smaller cars. But within the GST framework, taxes levied by the Central government such as Excise Duty and by state governments as Sales Tax would be subsumed into one tax uniform tax.

If the proposed tax rate of 18-20% is approved, the prices of vehicle are expected to decrease by almost 8-18%, and a reduction in automobile cost structure will not only fuel demand for automobiles in the domestic market but will also make India-made vehicles more cost-competitive in export markets.

The industry expects a dual tax structure for small and big cars to be announced when the government is ready with the final GST laws. “According to a report by the Committee on Economic Affairs, the proposed GST rate on SUVs is 40%. Therefore, SUV prices may increase slightly. But for all other cars, there will be a significant reduction in rates,” says Mishra.

The current indirect tax provision categorises cars into four segments, with all attracting different sets of tax rates.

While small cars (less than 1200 cc) attract a total of 27.6% tax (Excise Duty 12.50% + Cess 1.1 % + VAT 14%), medium cars (1200 cc – 1500 cc) attract 39.1% tax (Excise Duty 24% + Cess 1.1 % + VAT 14%). Luxury cars (beyond 1500 cc) and SUVs (also beyond 1500 cc), on the other hand, attract 42.1% (Excise 27% + Cess 1.1 % + VAT 14%) and 45.1% (Excise Duty 30% + Cess 1.1 % + VAT 14%) respectively.

Therefore, cars manufacturers end up paying tax in the rage of 27.6% (minimum) to 45.1% (maximum). If the proposed GST rate of 18-20% is accepted, small as well as big cars, excluding SUVs for which 40% rate has been discussed, will become cheaper and fuel the growth of the auto industry.

While the automobile industry is betting big on the new indirect tax regime, it has apprehensions over the tax rate. How will the new rates be decided? Will there be a uniform rate for all size of cars? Will they all fall under the same 18-20% tax rate bracket? The question seems to be more about whether the government will decide rates based on efficiency or the capacity of cars.

Nevertheless, if the industry’s predictions are anything to go by, automobile exports will be a major gainer from the new tax arrangement. The GST will help relax the burden of double taxation, unravel complexities and enhance ease of doing business for export-oriented automobile manufacturing hubs. However, the major challenge for the exporters will be to effectively manage their cash flow amid this shift from an exemption-based tax system to a refund-based system.

The GST system would also encourage Indian vehicle manufacturers to produce cars of international standards.

Under the current regime, a manufacturer has to comply with a labyrinth of taxes, which act as huge hurdles and add costs at each stage. Foreign investors are reluctant to invest in India, primarily becauseof the country’s regulatory and bureaucratic complexities. In the absence of GST, not only Indian car-makers but foreign too have to waste energy in their operations. A successful enactment of the new indirect tax regime would have a transformative effect on FDI in India.

GST will also lessen overall production cost and hassles, thereby encouraging domestic as well as international car manufacturers to expand their businesses and make Indian products more qualitative and competitive across the world.A very similar situation is applicable to the engineering and capital goods manufacturing sectors.VINEET BAID CEO, Falcon Autotech “It is certain for businesses to welcome the GST Constitutional   Amendment Bill. Businesses will now re-design the supply chains for removing the taxation bias from the supply chain design.This reshaping of supply chains by other sectors is set to favour the logistics sector by thus creating multiple opportunities. Consequently, we anticipate a sharp increase in the demand for warehouse automation, larger warehouses, high tonnage trucks and logistics management software. Supply chain consultants will see high demand for network planning and optimisation projects.Overall, we are expecting to see organized warehousing to witness significant upsurge.”

 

ENGINEERED SUCCESS

According to a Care Ratings report, “the complexity in the Engineering Goods sector is that companies are involved simultaneously in manufacturing of goods and rendering of services. For example, a company engaged in manufacturing of transmission towers also does EPC (Engineering, Procurement and Construction Services) of entire transmission lines which not only involves manufacturing of transmission towers but supply of bought out items and rendering of services. The EPC players pay service tax at present while the manufacturers pay excise duty. Introduction of GST is expected to improve the prospects of engineering, capital goods and power equipment (ECPE) sector by simplifying the tax structure.” And not to say the industry too has embraced the GST regime with both hands and hopes that it will transform the sector. Arvinder Pal Singh, Owner of Perfect Vibrator Company, a Delhi-based manufacturer of construction machinery parts, says, “GST is good for our industry. GST needs to be implemented as there would be a common tax. If there is one tax system, it will help in setting up the company anywhere in the country and also facilitates ease of doing business.” B. Ashok Rao of Rajeev & Co, manufacturer and exporter of ball valves, holds similar views. “GST will help in bringing down the cost of production in manufacturing of goods. The major advantage is that it facilitates inter-state trading which was earlier quite cumbersome due to various levies at different levels and in different states.”

Players in the engineering sector are proposing that the tax rate under GST regime should be kept at a minimum level as it will result in lowering the final cost of products. “Tax rate should be 18% as it will benefit the industry in keeping the cost of production low and in turn passing the benefit to customers in form of lower-priced product. The proposed 22-25% tax structure would be too high for the industry,” says Singh. Rao also supports the 18% tax rate adding that “there is no direct benefit of GST on exports but lower costs at manufacturing level can automatically promote trade at both national as well as international levels.”

The engineering sector, being the largest of the industrial sectors in India, is of strategic importance to the economy owing to its strong integration with other sectors. And as such it plays a pivotal role in the development of other industrial sectors of the economy. In fact, today, engineering sector accounts for about a quarter of the total factories and more than half of the overall foreign collaborations in the country.

Hence, the proposed tax rate and structure under GST for the industry should be such that it avoids   procedural difficulties for exporters and make their products competitive in export markets.

“Instead of first paying the taxes and then claiming credit for the same, the proposed enabling GST law should exempt exporters from the taxation net since the country does not want to export taxes,” says T. S. Bhasin, Chairman, Engineering Export Promotion Council (EEPC).

As per Bhasin, the turnaround time  for tax return processing needs to be sped up tremendously. “Even if we consider six months on average, engineering goods companies will require a huge additional working capital,” he says. Further, post GST, buyers too will have to ensure that their vendors have robust IT infrastructure and compliance process in place, so that vendors do not default on timely and appropriate payment of taxes.

 

RIGHT MEDICINE

When it comes to pharmaceuticals sector, another key foreign exchange earner for the country, the reaction to the passage of the Bill has been mostly positive.GST will not only simplify tax structure, but will also create a level-playing field for Indian pharmaceutical companies vis-à-vis foreign competition. “The biggest advantage to the industry would be that of reduction in transaction cost, with an immediate impact coming from the discontinuance of CST. The multistage taxation along with the inability to take full benefit of the CENVAT credit / refund has been an issue for the industry.

With central GST expected to be a single rate for goods and services, going forward credit accumulation may not be an area of concern,” states the report from Care Ratings. Furthermore, if the legislation provides for carrying forward of the unutilised credit this would be an additional boost to the industry.

However, there are concerns about drug prices, exemptions and compliance procedures. Some analysts have warned that there could be a mild inflationary impact of GST on prices of medicines over the next one-two years. “Currently, medicines are taxed at 5% to 7.5%, depending on the state they are being sold.

Post GST, our tax liability will increase to 12%. This will put further financial burden on our customers,” believes Rahul Thakral, MD, Biotic Healthcare.

Terming inverted duty structure “the biggest challenge” for the sector, Kanchana T. K., Director General, Organisation of Pharmaceutical Producers of India (OPPI), says, “inputs are taxed at 12.5% currently, while finished formulations are taxed at 6% from a Central Excise Duty standpoint. The difference is accumulated as a value-added tax credit (CENVAT), but no provision exists for refunds against accumulated CENVAT credits. The process of getting refunds under state VAT rules (where they exist) is also a long one.” However, suggesting a way out, Kanchana adds, “Specifically notifying the pharmaceutical industry under the model GST law and making the process of refund easier by automating it, would make a huge difference to drug manufacturers.” Well, a big first step in this direction is the provision in the draft GST which allows refunds in cases where the GST rate on inputs is higher than the GST rate on outputs.

Some industry experts even forecast a possibility of negative impact on pharma sector if rate exceeds 12% because, as per them, the impact on pharma is largely rate-dependent. Similar concerns are echoed by Thakral of Biotic Healthcare who envisage a rate range hovering somewhere between 10-12% to be optimal.

“Anything beyond, will negatively impact pharma industry,” he says.

 

NO SHINY GEM FOR ALL

Prime Minister Narendra Modi, in his speech post passage of the Bill in Parliament, described GST as one more pearl in India’s necklace. The metaphor may be apt when it comes to overall tax reforms, but India’s gems and jewellery industry is, however, circumspect about GST’s glitter. Almost all major stakeholders in the exports segment want the government to levy the minimum possible tax rate on the industry under GST.

The concept of Revenue Neutral Rate (RNR, a tax rate that allows the government to receive the same amount of money despite of changes in tax laws) is at the heart of the debate on calculating ATUL BANSHAL President, Finance and Accounts, M3M Group GST appears to be a benefactor for the real estate regime, primarily in light of the expected free flow of credit, which should translate into an increase in margins in the hands of the developer. Seamless and uniform transaction across states will help in cost rationalisation. GST should have a significant impact for commercial property developers, who today are burdened with high costs in absence of credit availability on construction services used for developing a to-be-rented commercial property. It is expected that under the GST regime, there   should be a smooth flow of credit and current restriction on construction related credits not being available for offset is expected to be removed. This would help reduce the project costs in the hands of the developer, which should further have a positive effect on rentals. If the credit restrictions continue, due to higher GST rates, the project cost are only going to get escalated further. Besides, it also appears beneficial to end-user or buyers. Uniformity in taxes will help the buyers as well. In the current scenario, several taxes are added up in the cost posing a great difficulty for an ordinary buyer. Implementation of GST will lead to uniformity in taxation rescuing an ordinary buyer from calculation traps designed by the statute.

the acceptable and feasible GST rate for the gems and jewellery industry and other industries for that matter. In fact, the government had published a report on RNR and the structure of rates for GST, prepared by a committee chaired by Chief Economic Advisor Dr.Arvind Subramanian in December 2015. A survey was then carried out by the National Sample Survey Organisation, based on the report. The survey found that the tax structure for the gems and jewellery industry had been formulated at a  ubsidised rate and, as a result of that, other industries are paying a price.

In a nutshell, the survey findings were not in favour of the gems and jewellery industry. And the chances are high that incidence of tax on the industry will increase once GST is implemented.

Well, the industry is crying fowl over the findings! According to Sanjeev Agarwal, CEO, Gitanjali Exports, one of the key objectives of the survey was to ascertain luxury and non-luxury product categories and, unfortunately, while doing so, the survey categorised gold as a luxury product. “In my opinion, the analysis is flawed for some obvious reasons. For instance, there is a possibility that households with low or no literacy level might not have understood the significance of the survey and ended up providing inaccurate gold investment details which might have had an adverse effect on the outcome of the survey,” says Agarwal.

 

For telecom companies, the incidence of taxes will increase post-GST.

For telecom companies, the incidence of taxes will increase post-GST. (Image Source: The Dollar Business)

Moreover, as per Agarwal, the survey didn’t differentiate between rural households and households that are dependent on the agrarian economy. “The distinction is crucial given the fact that agrarian economy enjoys substantial tax benefits,” says Agarwal. In fact, a huge share of earnings in the agrarian sector is beyond the ambit of tax-net. In addition, the penetration is gold is higher than the penetration of bank savings account in the country, which inevitably, makes gold, an unofficial currency in the rural areas. So, the survey inference that says that gold is being heavily subsidized and benefits are accrued to the rich and wealthy is inappropriate, feel industry insiders.

In fact, the industry is unequivocal in its demand that GST should be levied at the lower slab. Gems and Jewellery Exports Promotion Council (GJEPC) has already submitted a preliminary report prepared by a Mumbai-based law firm, Economic Law Practice (ELP), after gathering feedback from various manufacturing segments of the industry like plain gold, diamonds and coloured gemstones. “Our key concerns are that supply and manufacturing side should not be overburdened with taxes, and getting tax input credit refund should be smooth. Above all, our exports should remain competitive, given the current global scenario,” says Sabyasachi Ray, Executive Director, GJEPC.

One shouldn’t forget that there are past instances of higher tax structures proving detrimental to the country in more ways than one. For instance, the 10% import duty on gold, although succeeded in reducing gold import through official channel, it has also encouraged smuggling of gold inadvertently. According to various estimates, almost 200 tonne of gold worth Rs.60,000 crore is smuggled into the country every year.

 

WEAVING MAGIC?

Textile is another industry on which GST might have a negative impact. While the final GST rates are yet to be announced, even at the 12% lower rate recommended by the Dr. Arvind Subramanian Committee, the textile sector is likely to be negatively impacted. In fact, the cotton value chain is likely to be the worst affected as it is currently attracting zero Central Excise Duty.

What’s more? Industry rating agency ICRA expects that “due to reduced tax advantage of cotton yarn vis-a-vis manmade yarn, there can be a gradual shift in the domestic textile industry towards manmade fibre.” For the uninitiated, India currently operates with a fibre mix of cotton: manmade of 60:40, as against global average ofof 40:60. “However, the degree of impact will depend on the final rates which will be applicable to the sector,” states the report.

But then, there are some positives as well. “GST will give a fillip to the outsourcing processes in textile industry.

It will translate to administrative ease and can help in significantly curtailing discrepancies and  aberrations in the taxation system. Corruption and black money laundering will also be curbed,”

says K. K. Lalpuria, Executive Director, Indo Count Industries Ltd., a company engaged in the manufacturing and export of cotton yarn, grey knitted fabrics and cotton made ups.

Further, with input tax credit chain becoming more transparent and integrated, the tax credit for exporters will become easier and full credit of indirect taxes can be claimed. But at the same time, the Duty Drawback scheme, which aims to provide credit of indirect taxes, will lose relevance under GST. While export products, where the current duty drawback rates are lower than the incidence on indirect taxes on inputs, will benefit under GST, sectors, where drawback rates are higher, will take a hit in profitability.

 

NOT BANKING ON GST

One sector that has viewed GST skeptically is the services sector. “There could be a decrease in consumption of services as the service tax will move northward from the current rate of 15%,” says Saravana Kumar, Chief Investment Officer, LIC Nomura Mutual Fund. For instance, tax rates for telecom service providers could move up to 18-22% from the current 15%, resulting a dip in profits. This increased tax could also pinch consumers at the bottom of the pyramid.

Further, GST is also being viewed by some as a “landmine of compliance”.Service providers will have to file over 30 returns every month based on their operations and geographic spread. There could also be issues on bringing credits under IGST. A case in point could be a transaction involving a Mumbai resident using Vodafone telecom services travelling to Bengaluru and making calls through an Aircel network. It remains difficult to determine and calculate the importer and supplier in such complicated transactions. Telecom service providers could also have challenges defining interchange costs (the amount that a telco pays a receiving network), besides finding it restrictive to market free and bundled services.

The GST Bill is also leading CFOs of banks and financial corporations to ponder on the nature of business and areas that could be potentially hit. “For banks, the challenge could be further complicated as they may be construed as e-com operators for facilitating supply of services or goods through an electronic platform. This will result in an added obligation to collect tax at source. Under the present regime, there already exists litigation on whether banks or NBFCs are liable to pay taxes as dealers,” says Nihal Kothari, Chairman – National Council of Indirect Taxes, ASSOCHAM.

Even IT companies are wary of the GST. Some feel the proposed tax regime could lower the competitiveness of India’s IT sector. “Companies engaged in the supply of services on a pan-India basis, will have to seek registrations in 37 jurisdictions. Complex billing and invoicing requirements due to place of supply and valuation will hit the service sector hard in general and IT in particular,” says R. Chandrashekha, President, National Association of Software and Services Companies (Nasscom).

 

HURDLES GALORE

Well, GST comes with its own set of challenges. For most companies, overhauling the entire IT systems is the biggest challenge and this process could take anything between 6 to 9 months. While the government issued the first draft model GST law over a month ago, further details are awaited on aspects relating to compliance such as invoice formats and return details. “We anticipate several teething problems in transitioning to the GST regime. In the initial months, we anticipate that a parallel system for undertaking compliance will be required.

The complexities are far more for services companies, where a lot of ground needs to be covered to get clarity on taxation of pan India contracts involving multiple states,” says Mahesh Jaising, Partner, BMR & Associates LLP, a tax advisory firm.

Companies are even hiring experts to help them make a smooth transition from current tax regime to GST. For instance, FMCG major Emami has hired PricewaterhouseCoopers to assess the impact of GST regime on the company and chart a roadmap to realign company’s strategy accordingly. “Migrations from current regime to GSTN (Goods and Services Tax Network) will start from October 1, 2016,” says L. Badri Narayanan, Partner, Lakshmikumaran & Sridharan. Narayanan’s firm is an advisor to Infosys, the system integrator in the GST project. He shares that most suppliers’ data will be transitioned from Excise, Central Sales and VAT to GSTN, however, suppliers will have to request for registration for migrating to ISD (Input Service Distributor).

 

WHILE THE BILL HAS BEEN EMBRACED, ITS SUCCESS WILL BE DEFINED BY ITS IMPLEMENTATION

While most legal experts sound optimistic that the system will be operational by end of 2017, industry and technology experts opine that building a system from legacy could have potential barriers. Narayanan is hopeful that the GST network will be ready and operational by April 1, 2017, but the transition period could result in working capital issues for traders. “A trader is neither manufacturing nor providing services, and if he is not eligible for CENVAT credit within the old regime he will not be entitled to CENVAT credit on duty paid which he earlier received,” he explains.

A major change involving GST implementation is its compliance, which will necessitate robust systems and tracking of information. Since the entire process of tax has been revamped, the process of accounting and auditing will also undergo a change. Much of this change will occur on the systems that organisations use for compliance. “Entire ERP systems will need to be re-configured, and staff will have to be trained on GST aspects.

The onboarding of vendors could result in a big change. There is need of support from finance, procurement, legal, IT, and many other departments for positive outcome of GST, else the holistic picture may not be possible,” says Pratik Shah, Partner, SKP Business Consulting LLP.

As manufacturing becomes advantageous, organisations will be motivated to manufacture commodities themselves rather than procuring them. For service organisations, they will be compelled to think on operating back-office centres themselves. On the positive side, from the government’s perspective, GST systems across the globe have improved compliance, and in many-an-instance we’ve seen even a revenue neutral rate turning into revenue positive due to an expanded tax base.

 

Thus far, Indian exporter-manufacturers were at a huge disadvantage due to overlapping taxes. But with GST, hope is, matters will change for the better.

Thus far, Indian exporter-manufacturers were at a huge disadvantage due to overlapping taxes. But with GST, hope is, matters will change for the better. (Image Source: The Dollar Business)

 

MORE GOOD THAN BAD?

The successful implementation of GST will depend on its smooth passage in the states, and the formation of a GST council that drives consensus on rates, exclusion lists, applicability limits, principles of supply, special provisions to certain states, and a host of other rules and regulations. Even the time chosen for implementation will matter a lot when it comes to confusion and litigations.

“Full-fledged IT system should be in place so that there is no dispute in arriving at the losses incurred by states in the first five years. An April 1, 2017 rollout may affect the last quarter business of FY2017. Hence, implementation during mid 2017-18 would be ideal and preferable,” says Ashok P. Hinduja, Chairman, Hinduja Group of Companies.

Whatever be the implementation hassles and timeframe, the fact remains GST is a big step towards making India a unified market. The subsuming of major Central and State taxes in GST, complete and comprehensive set-off of input goods and services and phasing out of Central Sales Tax (CST) will not only reduce the cost of locally manufactured goods and services, but will also increase the competitiveness of Indian goods and services in the international market and give boost to Indian exports. That by our count is more good than bad.

 

Note: This article was Originally Published in The Dollar Business by TDB INTELLIGENCE UNIT September, 2016