India Inc Has Work To Do On GST; Some May Have To Tweak Business Models

India Inc, which has been vociferously asking for a unified goods and services tax (GST), should be taking a hard look at its own business models now that it seems like the tax is closer to legislative success than ever before. The Modi government seems confident that it now has the Rajya Sabha numbers to pass the constitutional amendment, and with almost all states barring Tamil Nadu now willing to go along, the state-level laws too could get passed by the end of this financial year, making the GST operational by 1 April 2017.

This means the ball will soon be in India Inc’s court. The assumption so far is that GST will be a great benefit for everybody, but individual businesses have to do a lot of homework to arrive at the same conclusion. Or make changes to benefit from it.

Consider the important ramifications:

First, the most important impact may be on companies that are vertically integrated; many companies integrated themselves from end to end – from inputs to final product - because the old tax system was multi-point, with inputs sometimes being taxed more or less than the final product. By bringing all operations under one roof, only one tax - on the final product – was leviable.

But under GST, the tax rate is the same whether you produce the input in-house or purchase it from someone outside. You get a deduction on the GST paid by your vendor, and so it does not matter whether you produce your components and inputs in-house or buy them from a vendor. If a vendor is more efficient than you, you should outsource production to improve your margins.

A company like Reliance, which is vertically integrated from oil and gas exploration and production to refining to petrochemicals to plastics and retailing, will have to consider whether producing everything under one company is sensible or a complication. This could be true for cement companies or steel companies too.

Second, manufacturing companies will also have to get their suppliers to pay taxes. This means their vendor sourcing norms will change depending on who is willing to formally start paying GST and who isn’t. When there was no GST, companies could source from the cheapest vendor. Now you need to balance cheapness and tax setoffs. If your vendor hasn’t paid taxes or is exempt, his product now needs to be cheaper roughly equal to the amount of tax payable by other vendors. The supply chains will have to undergo a shakeup for big manufacturers. This is because the main attraction of GST is that it is a self-collecting tax: to gain from GST, you have to ensure all your vendors have paid taxes too.

Third, GST has major cost and pricing implications for services companies. This is because unlike manufacturing companies, which use many inputs, services companies have fewer input costs to set off against the GST they themselves have to pay. Consider your telephone bill. The service tax feeds right through to higher prices for users as telephone companies have very little variable costs to set off taxes against. Ditto for your insurance policies, or consultants, or the security services hired by your office or building. The GST will add to your costs, and this may require rationalisation of services purchased. Services companies have to be ready for a minimum of 18 percent as the initial starting GST. And let’s not forget the cesses that come on top of all taxes.

The first year or two will also see a lot of confusion, as the excise department gears up to make new rules and regulations on how GST is to be administered. Also, don’t be surprised if your GST is the subject of state and central wrangling, or even multi-state tussles over who collects the tax, and whom the money will be passed on to.

GST may be good for India Inc, but it will need to do a lot of hard work before it can reap the benefits. GST may or may not come on 1 April 2017, but the time to start looking at your business model is now.