India’s biggest tax reform is at the cusp of its legislative birth. We believe implementation of the Goods and Services Tax (GST) would be a boon for India Inc. as a whole, since it would simplify and rationalize taxes, shift trade from the unorganized to the organized segment and improve efficiency in the system. We believe that four key themes would emerge, which might have a significant impact on India Inc.:
Change in effective tax rates for various products and services
There exists wide variability in the current effective indirect tax levies across sectors, primarily on account of different classification of goods and services, exemptions/concessions available to various goods/services under different statutes, and cascading impact of taxation, which brings inefficiencies in the system. GST is likely to bring a change in effective tax rates for most sectors. However, this would have a material implication only for those companies (a) that have the pricing power to retain the decrease or do not have the pricing power to pass on the increase in effective tax rates, or (b) where increase / decrease in consumer pricing would impact volume growth, and hence, corporate earnings.
Availability of seamless input credit across the value chain
Under the current regime, the taxes levied by different levels of government / different states are not allowed to be set off against each other. Unavailability of input credit makes the current system complex and inefficient, resulting in increased cost for businesses. This is likely to get addressed under GST when the plethora of multiple taxes is subsumed under a single tax.
Shift of trade from currently unorganized segments to organized segments
India has significant presence of the unorganized sector. A National Commission for Enterprises in Unorganized Sector (NCEUS) report estimates that in 2005, out of the 485m persons employed in India, 86% or 395m worked in the unorganized sector, generating 50.6% of the country's GDP. GST implementation is expected to narrow the large indirect tax differential between the organized and unorganized players. This would be achieved by ensuring better compliance and enforcement by (a) reducing the threshold limit for exemption from indirect taxes (to INR2.5m under GST from the current INR15m under excise), (b) tracking the flow of GST credit in the entire value chain using technology platforms, (c) ensuring availability of seamless input credit, and (d) reducing the overall effective tax rates.
Re-jig in supply chain management
Currently, decision making in supply chain management is based not only on business requirements but also on tax planning. The current legal framework exempts CST if interstate movement of goods is for stock transfer and not for sale. Consequently, in several sectors, companies open various depots and appoint C&F agents to avail this exemption and incur additional costs. Under GST, since CST is subsumed, supply chain management would become a pure play of business requirements. In several sectors, we expect consolidation of the current supply chain, leading to reduction in operational cost on the one hand and lower inventory carrying cost on the other. Logistics would emerge as a big sector, with consolidation in the industry. Implementation of GST may also be slightly negative for CV manufacturers, as this would help ease bottlenecks in logistics, especially time spent at check posts for local taxes. This would increase the on-road time for the fleet and enhance fleet productivity, diluting the need for fleet expansion and reducing CV growth over the medium term.
Our analysis (assuming a standard rate of GST of 18%) suggests that the autos, consumer, logistics, multiplex, light electrical, media and cement sectors are likely to be positively impacted, while the consumer (cigarette), print media and auto CV sectors may be adversely impacted.
GST will be a destination-based tax on a comprehensive base of goods and services across the value chain. It aims to address the complexities in the current multiple taxation regime. It will subsume the plethora of indirect taxes levied by various levels of government and help to (a) lower the tax incidence on organized manufacturing, (b) expand the narrow tax base, and (c) provide ease of doing business.
GST will facilitate a seamless flow of input credit across the entire supply chain. Introduction of GST will rationalize the tax content in product price, enhance the ability of business entities to compete globally, and possibly trickle down to benefit the ultimate consumer. Better compliance should address instances of tax evasion by expanding the base.
Considering the federal structure of government, it will have two components – CGST and SGST. While CGST will be levied and collected by the central government, SGST will be levied and collected by the state government in whose jurisdiction the goods / services are consumed. The RNR Committee appointed by the government has suggested 15-15.5% RNR, with a high rate of 40% on demerit goods, low rate of 12% on essential goods, and a standard rate of 16.9-18.9% depending on the choice of exemptions and rates of tax on precious metals.
Under the current regime, the effective tax rates on goods are significantly higher than on services. GST aims to tax goods and services at a common rate, thereby rationalizing the effective tax rates for goods and services. Further, tax cascading and availability of seamless input credits across the value chain would help lower prices. GST aims at broadening the tax base by lowering the threshold limit for applicability of indirect tax, permitting the center to levy taxes on sale of goods and the states to levy taxes on rendering of services, and rationalizing the various exemptions available under the current regime.
On the macro front, we expect GST to have a neutral impact on government revenues initially (but should be accretive over time), while the reported CPI is likely to remain stable. However, consumers may feel the pinch due to rising taxation on services.
Game changer in the longer run: Approval of the GST constitution bill amendment will be the next trigger for the financial markets though its initial impact on economic activity will only be mildly positive. It is unlikely to impact inflation adversely, but could boost economic activity (subject to effective implementation). Over the longer term, it holds the potential to boost economic activity substantially, improve the government’s revenue, and help achieve better transmission of prices.
Revenue neutral initially, but accretive over time: Assuming that GST rate aligns with the revenue neutral rate, as is intended, the effective tax rate will come down, which will broadly offset the increase in tax base (since exemption list will be pruned) and most of high-taxes items will be excluded from GST (at least initially). However, as GST will help reduce tax evasion, prune exemption list and improve compliance, the receipts will increase over time. We also believe that the fear among states to lose out on revenue is misplaced.
Unlikely to raise CPI but to hurt Indian consumers: As far as the impact of GST on inflation is concerned, a moderate GST rate will help reduce wholesale price index (WPI), while the impact on consumer price index (CPI) will be limited. However, since services constitute a larger share in the consumption basket than in CPI, Indian consumers are likely to feel the pinch of higher prices of services after GST is implemented.
There are two key concerns in the proposed GST. Firstly, the 1% additional tax, if approved, may defeat the entire purpose of creating a unified market. Secondly, the exclusion of crude oil and petroleum products from GST in the initial period makes us skeptical of their inclusion later. This is because the central government’s support to compensate the state governments for revenue loss will expire after five years.