Manufacturing industry has been a growth driver for various developed countries in the past but India’s manufacturing sector has always been a lackluster performer. India’s complex tax structure can partly be blamed for the stagnant growth of this industry. Government knows the importance of this sector and has therefore taken several steps in the recent past to make India a manufacturing hub at global level. The new GST regime is also a step which will act as a catalyst for driving growth of manufacturing industry. It will have a far-reaching impact on business avenues, compelling organisations to realign bottlenecks such as production cost, production time, supply chain, compliance, logistics, etc. with the changing indirect tax structure.
There are still a lot of gaps in GST Act so it is difficult to make predictions about its impact on industry. However, using the information available we have done impact analysis of GST on manufacturing industry.
GST will demand businesses to set-up mechanism for meeting the requirements of GST. Increased compliance will close loopholes in the tax framework but increase costs initially for businesses. Once businesses adapt themselves to meet the requirements of GST, compliance costs will come down drastically.
States come up with various lucrative investment promotion policies to lure businesses into setting up their units. These incentives are generally offered in the form of tariff incentives like lower tax rates, refund or deferment of taxes, etc. and non- tariff incentives like economical land lease terms, lower electricity duty, etc. In GST regime, states may not be given such flexibility to ensure uniformity. There is no mention of the future of current incentives in the Model GST Law.
In the present situation the producer state is credited with central sales tax on inter-state sales. GST may turn out to be biased towards consumption states as tax credit will only be available to such states. Producer states will have a lower financial incentive to offer such concessions, as GST will only be credited to the state where the supplies are consumed. This would lead to a loss of revenue for the producer states and therefore such states may not be in a financial position to continue offering such incentives, even though there may be other compelling reasons such as generation of labour, improvement of infrastructure, market creation etc. However, it seems likely that future incentives may only be non-tariff based.
Manufacturing units enjoy exemption of taxes based on their location in specified backward areas, capital investment etc. There is no clarity under the Model GST Law on the treatment of such area based exemptions. Given this uncertainty, companies should make a representation to the Government for appropriate compensation for the unutilized portion of such incentives.
Current tax regime does not tax transfer of stocks while GST will tax this exchange by considering stock transfers as supplies. Although Input Tax Credit will be available to be claimed but its realization will only occur once the final supply is concluded. This may impact manufacturing segment in a major way due to interruptions in cash flow. Companies will have to rebuild their supply chain strategies in order to handle the situation.
Currently, free supplies are not taxed under VAT. However, Model GST Law states that certain transactions without any consideration will also be treated as supplies and therefore taxed. Similarly, GST may also be applicable on free samples.
Under the present indirect tax regime free supply of goods are not subject to VAT. The Model GST Law stipulates that specific transactions without consideration would also be treated as supplies. Accordingly, free samples may be subject to GST, leading to increase in overall costs.
The Model GST Law stipulates that post supply discounts are to be excluded from the transaction value, provided such discounts are known at or before the time of supply of goods and are linked to the invoices for such supply. Companies may need to analyse existing post supply discounts/incentive schemes where the quantum of discount is not known at the supply stage. Example, secondary market incentive schemes, volume based discounts etc.
Input Tax Credit is arguably the most important feature of GST but it isn’t something new for the taxpayers. Under the present system of indirect taxes, manufacturers are allowed to claim most taxes levied on inputs. However, they are not allowed to claim Central taxes paid against State taxes and vice-versa. This often leads to a situation where manufacturers are unable to claim excess credit of central or state levies. Not just this, even Central Sales Tax paid on inter-state procurements is also not creditable and are costs for the companies.
Another issue faced currently is the cascading of taxes at the post manufacturing stage. Dealers, retailers etc. are subject to taxes on their input side which are not creditable (service tax on input services, excise duty on capital goods). This leads to an increase in the cost of goods, ultimately affecting the competitiveness of Indian manufactured goods vis-à-vis imports.
All of the above issues are addressed under the Model GST Law, which permits tax set offs across the production value-chain, both for goods and services. This will result in a reduction of the cascading effect of taxes and bring down the overall cost of production of goods.
Manufacturing sector often struggles with litigations in the current indirect tax regime. These litigations are mostly based on classification disputes. Different products are taxed at different rates while some are exempt from tax under excise and VAT legislations which makes compliance difficult for manufacturers. It is expected that replacing current indirect tax structure with GST which is based on the principles of a simplified rate structure and minimization of exemptions will significantly reduce disputes arising from classification of products.
Businesses structure their supply and distribution models in a way that it minimizes their tax liability arising at various levels of value addition. Transition to GST should hopefully result in such decisions being taken to optimize business efficiency (as opposed to indirect tax efficiency). Example, currently warehousing choices are often based on arbitrage between VAT rates in different States/ between applicable VAT and CST rates. With the advent of GST, it is hoped that such warehousing and logistics decision would be based on economic efficiency such as costs and locational advantages vis-a-vis key customers. However, a key hindrance could be the proposal to levy a 1% origin tax on inter-state supplies.
Government has planned to exclude five petroleum products from GST. These products are high speed diesel, petroleum crude, natural gas, motor spirit and aviation turbine fuel. On these products, government will continue to impose excise duty and state VAT. Industries which consume petroleum products as their main input (such as the fertilizer industry which use natural gas as an important input) will be impacted by this exclusion.
Despite some hiccups, GST coupled with “Make in India” initiative will positively impact manufacturing sector in India. It can boost Indian manufacturing industry which can ultimately drive GDP growth.