Part five of a six-part series
The Goods and Services Tax (GST) would call for a fundamental redesign of the supply chain structures to make these simpler and more efficient.
At present, the distortions in supply chain are synonymous with complexities such as area-based exemptions, factory-gate price for the levy of Cenvat, tax barriers to inter-state trade and multiple levies at various levels, including the central sales tax, octroi, purchase tax and stamp duty. No credit is allowed for many of these levies, which leads to significant cascading of taxes. As a result, the decisions of the organisations about inventory and distribution management are guided more by tax considerations than operational efficiency.
Here are a few examples:
- Currently, supply chains are invariably designed to minimise the burden of the Central Sales Tax (CST) on inter-state sales. Since no credit is allowed for CST, manufacturers set up distribution centres in individual states where the consumers are located and make local sales from these centres.
- To avoid the non-creditable VAT on their inputs, service providers such as hotels, tour operators and transportation companies prefer to import their machinery and equipment and other inputs directly from abroad, without incurring the state VAT at the time of import.
- Octroi in Maharashtra discourages setting up of manufacturing and distribution centres within the municipal boundaries where the tax applies.
- Manufacturers will create business structures so that marketing and distribution costs are incurred beyond the factory gate where Cenvat applies. Application of Cenvat on the basis of the Maximum Retail Price (MRP) can have the opposite effect of encouraging manufacturers to incur costs prior to the factory gate.
- Companies that have set up manufacturing units in excise-free zones like Baddi in Himachal Pradesh look for ways to minimise Cenvat on their inputs, for which no credit is allowed. One way to minimise the input tax is to source the inputs internally, rather than procuring these from third parties. Area-based exemption creates incentives for vertical integration and discourages outsourcing of inputs.
GST aims to rationalise and simplify the consumption tax structure at both Centre and state levels. It is expected to replace almost all indirect taxes, eliminate exemptions, do away with the current multiple layers of taxation and follow the principle of destination, instead of origin.
The greatest virtue of GST is that it would make the supply chain tax-neutral. The final tax on a product would be the same, irrespective of the structure or location of its production, procurement of inputs, and the nature and complexity of the distribution chain. GST is charged on each transaction in the supply chain, with registered businesses receiving a credit for GST paid on purchases. The smooth flow of input tax credit provides the element of tax neutrality. For maintaining this neutrality, it would be important that no exemptions are provided (especially for business-to-business transactions) and full credit is made available for the tax paid on inputs in B2B transactions without any blockages to avoid cascading of tax.
The author is partner, Ernst & Young. Views expressed are personal.