It has been sometime since the Indian Industry has been waiting for the implementation of GST. With Finance Minister’s announcements recently, it seems that this waiting period is nearing its end. An implementation at the beginning of April 2011 now seems a plausible reality, as the Central Government has reached an acceptable middle path with the states.
The new proposed Structure & why it is not optimum
What is being adopted in India is the dual GST structure – where a combination of Central GST & State GST will be levied separately. The manufacturer will have to submit both taxes separately, and he will not get cross-credits for the other. This is less than the optimum scenario of having a unified GST, which reduces complexities in filing tax and keeping track of separate credits. And it does not seem to necessarily reduce the burden of paperwork involved in interstate transfers.
The rates for goods and services too are not unified. It is 20% for all goods, 12% for essential goods and 16% for services. There are some goods like alcohol, tobacco products which are still not part of the GST regime. Again, this leaves some gaps in separately tracking each type of input and value add, and the ‘simple’ tax continues to carry complexities.
However, despite these shortcomings, the new regime offers many benefits which are worth exploring. At the same time, changing into a new regime is not without its challenges - something companies should keep in mind in view of the expected change.
Saving the compound effects of multiple taxes
There are many ways in which the GST or Goods & Services Tax will benefit the Indian Industry. Financially, some of the compounded effects of multiple taxation will be taken away. To take an example, if a good is taxed at an excise of 10% and then levies a tax of 10%, the cost to the customer becomes P*(1.1)*(1.1) = 1.21P, making the tax paid as 21% of P. However, what GST proposes is having the same rate at Center and State, charged at the same base. So if both Center and State are charging tax at 10%, then the manufacturer pays P*0.1 +P*0.1 = 0.2P or 20% as tax.
Tax credit for Service Tax
Another financial benefit would be to get credit for the Service tax. Both CENVAT & VAT which are in practice now, give tax credit to the manufacturer for the tax paid for raw materials (hence a tax is charged only on the value added by the manufacturer). More often than not, there is a Logistics cost involved in getting the input material to a location, and a service tax is also paid on this cost. With the implementation of GST, this logistics cost, or cost of any services, will be considered a value add, and the manufacturer will get tax credit for the service tax paid on it.
No more smaller ‘state’ warehouses
Other than the above direct financial impacts, there is a much greater value hidden in the simplification of taxes, which could have significant impact on the Indian supply chains. The landscape of Indian warehousing could change from various small local go-downs to large central or regional distribution center. The necessity of having a warehouse in each state to avoid CST and paperwork will be eliminated in a GST regime and network decisions would become purely cost & service driven. This is a good time to revisit the supply chain network and identify opportunities for consolidation of warehouses to gain from scale and save costs of double handling.
The larger warehouses can then benefit from technological sophistication by deploying state-of-the-art planning and warehousing systems which are not feasible in smaller, scattered warehouses. At the same time IT costs of having ERPs deployed at many small warehouses can be saved.
A rationalization similar to warehousing can also be done in distribution and transportation routes as tax ceases to become a defining factor. Since the tax rates across states will be uniform, state boundaries will no longer be the parameter for deciding routes. At the same time, with larger warehouses, transportation lot sizes will automatically increase, making way for more efficient bigger trucks.
One of the key benefits expected from the GST implementation is the abolishing of various forms and ‘quotas’ at the state entry points. If this happens, it will save a lot of administrative work and lead times for the logistics companies. The large queues at the State entry points will get dissolved as the need of Sales tax papers and various forms becomes outdated. However, at this stage it is not clear whether these formalities will continue to exist even after GST happens.
A uniform tax structure across states gives companies freedom in terms of both purchasing and selling decisions, which can now be driven by profitability. Companies can sell to other states without investing in a warehouse or losing tax credits for their inputs. Similarly, they can purchase from other states, and still be able to claim tax credits on inputs. This offers a great opportunity to revisit geographic strategies and reassess your potential suppliers.
But there are no benefits without work…
There cannot be much value to unlock from your supply chain simply by being led into a new tax regime, can there? Change of tax regime is a chaotic situation and needs to be handled like a project, like a lot of us learned when VAT was adopted by various states.
ERP System Changes: To begin with, ERP systems need to be reconfigured to calculate taxes only at one stage – not a straightforward task especially for homegrown or Indigenous ERP systems which were built around the Indian tax policies. In addition, companies should build tracking mechanisms to measure tax paid on inputs and services so that appropriate tax credits can be claimed.
Pricing Revision: Firms will have to revisit pricing to decide how much of the tax benefit they should pass on to the consumer. This will involve some estimation of what the competition would do, and also of the potential competition emerging from smaller players breaking out of state boundaries.
Margin structures with distributors and modern trade will have to be reworked to ensure that the profitability is distributed across the value chain.
Revisiting Warehousing & Distribution Strategies: To unlock values from the warehousing and distribution networks as indicated in the previous section, both the warehousing and distribution strategies will need to be re-drawn. This requires a new look at all possible options, understanding their costs, benefits and complexities. It is good to involve some strategy tools at this stage to mathematically optimize the benefits across the different options.
Revisiting Purchasing & Marketing Strategy: Again, as discussed in the previous section – to gain from the larger canvas available companies should revisit their potential suppliers and potential markets taking taxes out of consideration.
A careful project planning can make GST a profit driver, even in its less than optimal form. But if not planned for, it could lead to execution chaos.