A leading FMCG company has 23 warehouses across the country. It may not need more than five once the Goods and Services Tax, or GST, kicks in. It has begun consolidating its warehouses and has built a big one in a key North Indian state.
GST is still some time away — the Centre and the states are yet to decide on the rates, a draft law is not ready, the constitutional amendment is yet to happen — but companies are already trying to figure out its impact, and getting ready for it.
Companies have formed internal teams to understand how GST will affect their bottom line, working capital, supply chain, manufacturing, long-term contracts, and new investments. A few companies have also engaged tax consultants to help them make a transition to the new system.
“Everything they have been doing in the pre-GST environment could change,” said Rajeev Dimri, head of indirect taxes with BMR Advisors. Companies would have to figure out where to manufacture, where to procure from, and how to distribute and price their goods.
“GST is increasingly being seen as a business issue and not just a tax issue. In many board meetings, the preparedness for GST is being discussed and reviewed,” said Pratik Jain, executive director, KPMG India.
Indian companies have been living with multiplicity of taxes, though the effective tax rate has come down from 40 per cent to 20 per cent. Taxes often dictate a company’s decision where to manufacture and how to distribute its goods.
Companies set up manufacturing units in states which offer tax benefits. To have a more tax-efficient distribution, they set up warehouses across states. They don’t have to pay central sales tax (CST) if they do a stock transfer to warehouses.
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Many taxes, including CST, will be subsumed into GST. GST will also replace a bevy of other levies like excise, sales tax, value-added tax, entertainment tax and luxury tax.
Consequently, the need for having multiple warehouses will get diminished, though companies may choose to retain them for strategic reasons (say, for being close to their customers).
Satya Poddar, partner, Ernst & Young, said the procurement pattern would change. ‘‘Right now, people try to ensure that goods come with as little tax as possible. Once GST comes, the timing and place of procurement will change,’’ he said.
In the recent past, companies have set up manufacturing units in excise-free zones like Baddi in Himachal Pradesh. New units won’t get excise exemption, and it is not clear how the existing units will be treated for GST. Companies as well as states like Himachal and Uttarakhand are lobbying hard with the government to ensure their benefits are not diluted. “Companies will have to figure out how they can minimise the consequence of these investments,” said Poddar.
Currently, companies try to source their inputs from within a state as they get a set-off on the value added tax (VAT) charged by vendors. When they source from outside, the vendors charge CST, which cannot be set off. Under GST, companies will able to set off taxes paid on inputs, irrespective of where they are sourced from.
Consumer goods companies often run promotions where when you buy one, you get one free. In the current regime, if you give something free you can’t claim credits on the tax paid on the inputs. “Today, we have a fractured credit mechanism, which is spread over too many activities and too many states. I don’t get a credit for every tax I pay,” said Dimri.
Under GST, there will be no distinction among manufacturers, traders and service providers. At present, traders don’t get credit for anything other than state VAT. The world over, retailers get credit on the taxes they pay on creating infrastructure. In India, they don’t.
The change will be more complex for conglomerates. Take Larsen & Tourbo, which is into construction, manufacturing, and software. It will take two-three months just to understand the impact of GST on the company. Companies fear they may not get sufficient time if the government unveils the draft by December 31 this year and implements the new system on April 1, 2011.
The impact on working capital could be significant as all transactions, including stock transfers, will be subjected to GST. A company pays excise when it manufactures and ships its goods, and VAT when it sells them. When GST comes, it will have to be paid as soon as there is a stock transfer. But the company will be able to claim credit on the tax paid only when it finally sells the goods, which could take months. The company’s money will be blocked in this period.
“Many companies are grappling with the impact on working capital,” said KPMG’s Jain. Consider how it would impact a chemical major, which imports 80 per cent of its raw material. Currently, it pays Customs duty of 14 per cent (countervailing duty and special additional duty). But if import GST is 18 per cent, its working capital requirement could go up significantly.
Companies are working with their information technology vendors on the changes needed to capture a lot of data that would be required to claim credits. “Everything you purchase will be available as credit; accounting systems will have to be reconfigured to capture the data,” said Bobby Parekh, partner, BMR Advisors.
| BRAINSTORMING # Companies have formed internal teams to understand how GST will affect their bottom line, working capital and supply chain, among others # A few companies have also engaged tax consultants to help them make a transition to the new system # Indian companies have been living with multiplicity of taxes, though the effective tax rate has come down from 40% to 20% # Many taxes, including CST, will be subsumed into GST. GST will also replace a bevy of other levies like excise, sales tax, value-added tax, entertainment tax and luxury tax # Under GST, there will be no distinction among manufacturers, traders and service providers. At present, traders don’t get credit for anything other than state VAT |
Jain said this was the biggest worry for many multinational companies, who fear that they will not get enough time for upgrade.
Luxury tax, which hotels charge on the tariff, is another ticklish area. Currently, companies are not allowed to set it off against the other taxes they pay. As hotels will also adopt GST, companies will have to capture the data in their systems.
Many companies have long-term contracts in sectors like telecom and infrastructure. Road construction contracts, which are exempt from service tax, could be subjected to GST. Similarly, the taxes you pay on procurement from third-party service providers could be available as set-off. So, companies are looking at long-term contracts, examining the change-in clause, and how it will work. Similarly, for new contracts, they are factoring in GST.
Some companies are worried that the tax design may not be efficient. “There is a view that essential commodities should attract lower tax, but it is not clear how would they define essential commodities like tea, coffee, sugar, salt and edible oil, and where exactly the line would be drawn,” said Poddar.