GST Impact: MSMEs learn to deal with reverse charge mechanism the hard way

Larger firms are pruning vendor lists, weeding out small suppliers who are yet to register under GST

The new indirect tax regime is having the effect akin to setting a cat among pigeons for thousands of micro and small businesses across the country. This is largely on account of a provision to collect and pay tax on behalf of unregistered vendors and suppliers under the reverse charge mechanism (RCM). A concept borrowed from service tax, RCM is now applicable also to supply of goods. However, higher compliance costs, including larger working capital requirement, is causing a shakeout in the procurement chain of businesses, with smaller businesses, operating largely in the unorganised space, losing out.

Consider this:

- Large FMCG companies have started pruning their vendor list for sourcing products and services, weeding out small suppliers who are yet to register under GST. Those remaining – barely 10 per cent of their vendor universe – have been put on notice

- In the textile hub of Tirupur, many companies are discouraging supplies from household units, managed by family members on a part -time basis

- Larger textile and leather making units in Tamil Nadu are looking at starting job work activities in-house, as against the usual practice of outsourcing these to micro and small units. The trigger is the 18 per cent tax on job works that larger units will now have to bear, under reverse charge mechanism, when they source from these micro units
 
Textiles & leather clusters

In Tamil Nadu’s textile hub of Tirupur, roll out of the new indirect tax regime over the last two weeks has resulted in transactions coming down to almost 25-30 per cent. The impact is more visible on the large number of household units.

Around 25 per cent of units in Tirupur – 50,000-odd households - work as suppliers for large companies, says Raja M Shanmugham, president of Tirupur Exporters Association (TEA).

Registering under GST would also be tough for many of these micro units, considering they may not have all the documents or wherewithal to complete the procedure, say local industry players.

Many large companies, which have been giving job works to these units, are looking at setting up their own units for such activities.

Shanmugham says job works attract 18 per cent GST as compared to the five per cent tax for processes up to compacting. “Activities like embroidery, stitching is in 18 per cent slab, which is a great anomaly,” he says. The Association has requested the central government to look into this issue.

The suppliers who source from unregistered small units point out that they also have to foot the tax upfront where as they will get the money from the buyer only after three to four months.

Owner of one large unit concedes that he has taken a list of his suppliers and asked all those who were not registered under the GST to get registered or face the risk of their contracts getting cancelled.

Currently, 90 per cent of large and medium sized units in Tirupur have complied with the GST registration requirements.

The situation is similar for small units in the leather industry. In Vellore district in Tamil Nadu alone, there are around 200 such units focusing on the job work for the shoe industry. Faced with heat from suppliers to get GST-registered, most of these players say that they may find it difficult to sustain over a period of three to four months. Many of the micro units have a single owner-cum-employee are not able to fully comprehend the tax filing mechanism.

Larger players are coming out with ingenious ways to bypass the compliance requirements without a break in the input tax chain.

Owner of a large unit said his company has put some intermediary from the organised sector to take supplies from unregistered buyers. This will insulate him from direct compliance impact of RCM. This would also help him to ensure buying from the same vendors who meet the necessary compliance requirements for exports.

Many large units in the leather sector too are willing to invest in bringing in the job work in-house to avoid compliance related issues.

Chemical clusters

In the chemical clusters of Gujarat in and around Ahmedabad, Vadodara and Surat, most of the players have already migrated to organised procurement.

Rupen Patel, proprietor of a small-scale textile unit in the walled city area of Ahmedabad says RCM was a big deterrent for his unit to continue procurement of chemicals for processing from the unorganised players.

He began negotiations in June for procurement of chemicals for processing from organised players. “We had to stall our procurement and production for at least a fortnight before we made the transition,” says Patel. This has, of course, an impact on margins due to re-negotiations with fresh suppliers. But it was important for availing benefits of input tax credits, he says.

Most small chemical units in Vadodara are aware of the composite levy scheme under GST. “We are a very small unit with limited manpower. It is taking us some time to set things in order,” says owner of a unit, but he plans to opt for the scheme by end of the month.

The other issue that the industry is facing is in terms of exports. According to Dilip Shah, a merchant exporter of chemicals, smaller players are facing working capital constraints. Merchant exports attract tax while manufacturer exports do not under GST. “We have made representations to the government on merchant exporters to be treated at par with good manufacturing exporter,” he says.

Small business owners complain of finding it hard to raise working capital to meet the additional requirements to get GST-enabled.

FMCG

Most large FMCG companies have sent out strict circulars to their vendor partners to get GST registered. So the issue of dealing with unregistered vendors is lower here. Conversations with multiple companies and stakeholders reveal that larger players have been able to prune their vendor universe, drastically bringing down their dependence on unregistered players.

“The problem for us comes with those people who are outside our vendor ecosystem," says Sunil Kataria, business head, India and SAARC, Godrej Consumer.

Kataria is referring to the wholesale channel that remains largely unorganised, accounting for 35-40 per cent to an FMCG company's sales. Firms are now working with them through their distributors to convince them of switching to a GST regime. At a broader level, says Sumit Malhotra, managing director, Bajaj Corp, companies are also trying to reduce their dependence on the wholesale channel, pushing their own distributors to reach retailers directly.

“Demonetisation was a wake-up call for companies to reduce their dependence on the wholesale since this channel tends to be cash-led," says Malhotra. "This effort will now gather steam post GST, " he adds. Already most FMCG companies have increased payouts and incentives to distributors in their bid to push them to reach retailers directly. Companies on their own have also increased their direct distribution effort, putting more field staff in place to reach retailers.