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GST impact on economy - Part 2

GST impact on economy - Part 2
Highlights

Industrial sector mainly consist of Manufacturing, Construction, Mining and Utilities

Impact on Industries

  • Industrial sector mainly consist of Manufacturing, Construction, Mining and Utilities (electricity, gas water etc.).
  • Manufacturing is the main sub-sector among these and we shall analyze the impact of GST on Manufacturing.
  • The share of Manufacturing in GDP is stagnant at 16%, however the share is 42% in China.
  • Some of the reasons for such a low share are multiple indirect tax legislations which have led to significant compliance and administrative costs, classification and valuation disputes.
  • So, tax reforms are critical and necessary to give a boost to an already flagging sector.
  • There will be reduction in tax burden on majority of manufactured goods post GST implementation.
  • A look at important components of manufacturing like automobiles sector reveal that effective tax rate would reduce in Automobile sector the biggest benefit would go to SUV segment.
  • Under FMCG, by and large tax burden would reduce. The biggest relief would be in Soap and Hair oil segment.

Some other aspects of GST which will add to competitiveness and ease of doing business of manufacturing sector are as follow:

Correct Valuation of goods

  • Currently, various pre-packaged products for retail consumption are subject to excise duty not on the ex-factory transaction value but on a specified percentage of the maximum retail price (MRP) printed on the package.
  • The MRP based value (which is usually between 30%-35% of the MRP) is in most cases, much higher than the ex-factory transaction value leading to a higher excise duty liability than would otherwise be the case.
  • This increased excise duty itself, results in a higher MRP, ultimately leading to a higher cost burden for the consumers.
  • Under the GST regime, GST is payable by the manufacturer at the transaction value, and is creditable for all subsequent resellers up to the final consumer. Accordingly, the unnecessary tax burden of the MRP regime will no longer be
  • relevant.

Reduction of cascading taxes

  • Under the present indirect tax regime, Central taxes cannot be set-off against State taxes and vice versa.
  • This often leads to a situation where manufacturers are unable to set off excess credit of central or state levies.
  • Further, central sales tax paid on inter-state procurements is also not creditable and are costs for the company.
  • Another issue 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 GST, 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.

Formalisation of Manufacturing

  • Input credit is proposed to be allowed only if the details declared by a taxpayer matches with the details declared by vendors in their returns.
  • This will incentivize vendors supplying to manufacturing firms to move from informal to formal sector, because if they are in informal sector and do not furnish bill to their customers i.e. manufacturing units then these units will route supplies from those vendors which provide bills.
  • Reduction of classification disputes
  • Currently, due to varying rates of excise duty and VAT on different products, as well as several exemptions provided under excise and VAT legislations, classification disputes are a regular cause for litigation under both central excise and VAT, especially for the
  • manufacturing sector.
  • It is expected that the inception of GST which is based on the principles of a simplified rate structure and minimization of exemptions will significantly reduce disputes regarding classification of products.

Supply chain restructuring based on economic factors

  • Current supply and distribution models are structured to optimize indirect tax impact 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).
  • For 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 location advantages vis-a-vis key customers.

Impact on services

  • Services sector accounts for 60% of GDP (2013-14) and contribute to 70% of overall yearly GDP growth since 2011-12.
  • A adverse impact of new tax regime may sub-due overall growth of Indian economy on the other hand gains from new tax regime shall boost overall growth.

The assessment of Risks, Opportunities and challenges are as follow:

Risks

  • The government has unveiled a four-tier GST rate structure for the sector - 5 percent, 12 percent, 18 per cent and 28 per cent.
  • The bulk of the services will, however, be taxed at 18 per cent.
  • The sector is currently taxed at 15 per cent, so the GST regime will likely increase tax incidence for this sector.
  • Economic principles tell us final output sold might show slow growth due to increased prices.
  • This may be a bad news given that services sector is not doing well because exported oriented part of services like business process and IT industries are showing decelerated growth due to protectionist stance in Advance economies including USA.
  • But, services sector also include Public administration and defence which might see tremendous growth on account of increase in tax revenue, enhancement of tax base and ease in tax compliance.

Opportunity

  • Under GST input credit would be available for goods purchases as well as services which enter the production as services like transportation services.
  • This treatment of service inputs shall have atleast two distinct effects.
  • First, as producers could get tax credit for service input it will automatically reduce prices of goods.
  • Secondly, outsourcing of services will increase, as input tax credit will be available for services many services in the production process which are produced by producer themselves will now be outsourced to third party.
  • These third parties will provide services at a cheaper cost as compared to in-house production by producer due to economies of scale and division of labour.
  • Thus, price of final products shall reduce because of cheap service inputs.

Challenges

  • A four-tier tax slab and differential rate between the goods and services sectors may distort/influence business by providing arbitrage practice.
  • For example, if a car is taxed at 10 per cent and leasing rates are at 18 per cent, we may have a situation where car sales could be replaced by car leasing.
  • In the area of composite services, a contract may be specially designed to avail the lower rates on services. Therefore, there are implications in the area of dispute management.

On Taxation system

  • Both the CENVAT and the State VAT have certain incompleteness. The incompleteness in CENVAT is that it has yet not been extended to include chain of value addition in the distributive trade below the stage of production.
  • It has also not included several Central taxes, such as Additional Excise Duties, Additional Customs Duty, Surcharges etc. in the overall framework of CENVAT, and thus kept the benefits of comprehensive input tax and service tax set-off out of the reach of manufacturers/dealers.
  • The introduction of GST will not only include comprehensively more indirect Central taxes and integrate goods and services taxes for set-off relief, but also capture certain value addition in the distributive trade.
  • Similarly, in the present State-level VAT scheme, CENVAT load on the goods has not yet been removed and the cascading effect of that part of tax burden has remained unrelieved.
  • Moreover, there are several taxes in the States, such as, Luxury Tax, Entertainment Tax, etc. which have still not been subsumed in the VAT.
  • Further, there has also not been any integration of VAT on goods with tax on services at the State level with removal of cascading effect of service tax.
  • In addition, although the burden of Central Sales Tax (CST) on inter-State movement of goods has been lessened with reduction of CST rate from 4% to 2%, this burden has also not been fully phased out.
  • With the introduction of GST at the State level, the additional burden of CENVAT and services tax would be comprehensively removed, and a continuous chain of set-off from the original producer's point and service provider's point upto the retailer's level would be established which would eliminate the burden of all cascading effects, including the burden of CENVAT and service tax.
  • This is the essence of GST. Also, major Central and State taxes will get subsumed into GST which will reduce the multiplicity of taxes, and thus bring down the compliance cost. With GST, the burden of CST will also be phased out.

On common consumers

  • With the introduction of GST, all the cascading effects of CENVAT and service tax will be more comprehensively removed with a continuous chain of set-off from the producer's point to the retailer's point than what was possible under the prevailing CENVAT and VAT regime.
  • Certain major Central and State taxes will also be subsumed in GST and CST will be phased out. Other things remaining the same, the burden of tax on goods would, in general, fall under GST and that would benefit the consumers.

Conclusion

  • GST will not increase the tax burden drastically, and in many cases total tax burden will decline due to removal of cascading effect replacement of gamut of tax systems by one tax systems.
  • The biggest gain shall be from increase in competitiveness and ease of doing business which GST brings with it. The overall impact is expected to be positive on economy thereby increasing the overall economic growth.
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