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Mahesh Jaising BMR & Associates LLP
Mahesh Jaising is a partner at BMR & Associates LLP
The Indian Parliament has passed legislation to introduce a Goods and Services Tax. This will replace a raft of existing sales and other indirect taxes and aims to simplify the tax environment for businesses, the following article reviews the main provisions and the affected sectors.
With the Constitution Amendment Bill (the ‘Bill) having been passed unanimously through the Upper House of the Indian Parliament on Wednesday, Indian indirect tax has come a long way in rationalizing its tax structures. The Government's idea of a unified single tax reform, critical to enhance ease of doing business in the country, is expected to create a single unified market across India, allowing the seamless movement of goods and services across the country.
Industry experts also believe that while in the long run, Goods & Services Tax (‘GST’) will have a positive impact on inflation and government finances, in the near term, inflation is likely to go up and Central Government finances are likely to be strained due to the need to pay compensation to State governments.
The impact on pricing and, consequently, profitability is largely a function of the rate of the GST. It is expected that some companies will gain more as the GST rate will be lower than the current tax rates they pay, while others will lose as the rate will be higher than the present effective rate. While the rate of GST is yet to be decided, industry observers have assumed an 18% rate recommended by a Government panel in estimating the impact of GST on their businesses.
From an end-customer's outlook, the indirect tax cost applicable on most goods is currently on the higher side, attracting an excise duty of 12.5% (on the factory price) and a VAT of 12.5% to 15%, depending on the State. Additionally, there is also a cascading of taxes on account of the levy of CST, input tax credit retention under the VAT laws, levy of entry tax/ octroi/ local body tax, etc up to the time the product reaches the end customer. A combined effect of the above leads to an effective cumulative indirect tax rate of 23% to 27% in the hands of the end customer.
Assuming that the standard rate of GST is 18%, it is expected that for most goods there should be a reasonable reduction in the overall indirect tax cost. Such reduction in indirect tax costs can lead to reductions in production cost and an increase in baseline profits. Alternatively, such reduction in costs may also provide headroom for price reductions, benefiting end-users.
However, there may some other goods such as medicines, textiles, edible oil, and low value footwear, where the rate of excise duty is nil or significantly lower and Value Added Taxes in most States is 5%. As a result, the overall effective tax costs for these goods, after factoring the non-creditable taxes, is about 5% to 7%. If these goods are proposed to be taxed at the standard GST rate of 18% (or even at the lower GST rate of 12%) there could be a significant increase in costs for the end customers.
From a services standpoint, the service tax rate currently applicable is 15% (inclusive of cesses). Under the GST regime, this rate may go up to 18%. For a business customer, GST would be (generally) creditable and hence would not result in increase in cost. However, for an end customer, there prima facie appears to be an increase in indirect tax costs. In this context, it is worthwhile to note that there are several non-creditable taxes such as VAT/ CST on procurements made to render the output services. Under GST, although the output taxes would increase from the current rate of 15% to an effective rate of 18%, it is expected that all non-creditable taxes forming part of the procurement costs today should become creditable and this is expected to marginally offset the increased rate of taxes on the output side, specifically for those service sectors that are capital goods/ inputs intensive.
Having discussed the likely overall impact of GST on goods and services, it is now pertinent to briefly examine the key sectors and the manner in which GST might impact them.
The FMCG sector could generate savings in logistics and distribution costs, given that the need for reduction in warehouses and multiple sales depots. Currently, it is estimated that FMCG companies pay indirect taxes approximating to almost 23-27%, including excise duty, VAT and entry tax. Given a GST of about 18%, this could yield a significant reduction in taxes.
However, if the recommended 40% “sin/demerit” rate of GST is made applicable for products such as aerated beverages and tobacco products, the prices of such products may increase substantially.
GST is expected to be a huge game changer for the real estate sector. This is primarily on account of the fact that presently, there is an overlap of VAT and service tax on certain portion of works contracts, ranging from 120-145%, depending on the kind of contract and consequent disputes around this with both the central and state authorities; this is expected to be addressed under GST. Also, while the excise duty paid on procurements such as steel, cement and other materials used in construction presently becomes a cost in the system, GST paid on the said materials may be available as a credit, thereby reducing cost of construction. Further, with CST, entry tax and octroi being subsumed into GST, these will no longer be a cost in the hands of the contractor. Hence, contract prices should come down, which in turn should benefit the developers and, more importantly, buyers of real estate, i.e., the common man and woman.
More importantly, the issue of different tax structures being followed by developers across states or within the same state, should be addressed under the GST regime, with the proposed uniform tax structure. This should ideally benefit the sector as a whole, reducing tax disputes, in addition to tax costs.
GST should help create a single unified market across India allowing the seamless movement and supply of goods to every part of the country. It will also eliminate the cascading effect of taxes on customers which will bring efficiency in product costs. This is likely to benefit the e-commerce segment immensely, given that their business model is dependent on connecting vendors and customers located across geographies.
While the idea of GST is expected to benefit the sector, the proposed mechanism of collection of tax at source (“TCS”) is likely to create a differential treatment for sales online vs offline, in addition to increased working capital requirements for sellers and additional administration and documentation workload for e-commerce firms. It is hoped that this provision is not finally brought in.
The media sector is currently plagued with service tax as well as entertainment tax. GST is expected to bring a major change in this regard, and uniformity in businesses. Taxes could go down on account of a uniform tax rate.
Multiplex chains will save on revenues as there will be a more uniform tax, unlike the current high rate of entertainment tax levied by different states, possibly resulting in a lower average ticket price, increasing ticket collections.
Also, the debate of taxation of transactions relating to content/ IP being taxable as intangibles under service tax vs VAT and possible double taxation issues thereon, under the current law, should also be addressed.
The automobile industry is currently burdened with excise duties ranging between 12.5% and 30% and VAT ranging from 15-20%. However, it is likely that under GST, luxury cars could be exigible to a higher ‘sin’ rate of tax at about 40%, applicable to demerit goods vis-à-vis a standard rate of 18%. Also, there could be an ambiguity in respect of the criteria for qualification as luxury cars. Further, it is expected that issues relating to valuation of goods that are currently being faced in the industry are also likely to mellow down.
Knowledge of the proposed GST rate is a critical need for this industry in order to determine appropriate pricing structures in the new regime.
As an overall observation, while GST promises to usher in an era of a unified indirect tax regime, integrating India into a single homogenous market and, more importantly, to solve the myriad issues faced by taxpayers today, the finer nuances of GST, such as transition and implementation remain to be seen. Given that the Bill has been passed in the Upper House of the Indian Parliament, the target for roll-out of GST on April 1, 2017 appears to be well within reach.
As a result, it is essential that the Government, as well as the industry, prepares itself to transition into GST on time. Companies must make sure that their key areas of impact must be identified, primarily under the categories of Operational impact, Financial impact and Infrastructural impact. It is advisable that stakeholder discussions/ training sessions are conducted for their staff, supply chain/ logistics structures are reviewed, customer contracts and vendor relationships are re-examined, cost patterns are re-evaluated and a GST-ready ERP/ IT system is set up. While companies may face initial hiccups transitioning into a more complex tax mode, what is expected to follow is an era of overall economic development.
Authored by Mahesh Jaising, Partner, BMR & Associates LLP with inputs from Deni Shah, Director and Shankar Sreenivasan, Senior Associate. Views expressed are personal
Copyright © 2016 The Bureau of National Affairs, Inc. All Rights Reserved.
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