GST: Uniting a Fragmented India into One Market

After 7 years of deliberation and a monumental 7-hour debate, the Rajya Sabha finally cleared a constitutional amendment that possibly spells the most important economic reform since the Liberalization and Privatization reforms of 1991. The Goods and Services Tax (GST) Bill, passed by the Rajya Sabha on August 3 and the Lok Sabha on August 8, is being hailed as the biggest tax reform since Independence. The implementation of the GST, planned for commencing in the next financial year (beginning April 1, 2017), now depends on the ratification by a majority of the Indian states within a month.

The Current Tax Scenario

Presently, companies pay taxes at different stages of production as well as being taxed separately by different government authorities. The two key problems with the current tax system can be understood by the points below:

Causes double taxation

Unlike services, goods need to be manufactured before they are consumed. The manufacturer is required to pay an indirect tax to the Central Government when the goods leave the factory. The goods then reach the retail store, where they are bought by consumers. Here is where the State Government steps in and levies the value added tax (VAT) on consumption. So, the goods are taxed both at the factory gate as well as on purchase by the final consumer.

Complicates tax norms across states

Different states have the power to levy different tax structures within their borders. The states treat goods coming from another state as an import and levy a tax on them. Let’s say a company has a factory in Gujarat, but uses a component or material from Uttar Pradesh to manufacture the final product. The company would need to bear the cost of the tax paid by the provider of the component or material to the UP state government. When the final product is ready, the company would be taxed at the factory gate by the Central Government. When the goods are bought by the consumer, tax would need to be paid to the Gujarat government. If, however, the goods are sold in another state, let’s say Delhi, the Gujarat government would treat it as an export and levy the central sales tax (CST).


The Tax Revolution Called GST
The Goods and Services Tax (GST) is the system by which a single tax would be levied on the supply of goods and services. All Central and State level taxes on all goods and services would be subsumed within an integrated system of taxation. Thus, there would be an indirect tax levied uniformly across the country.

The GST is a complete overhaul of the current tax system, impacting the tax structure, incidence, computation and payment as well as compliance, credit utilization, and reporting.

The GST would replace all indirect taxes. Being a consumption-based tax system, the GST would reduce the cascading effect of tax (or double taxation) by levying taxes only where the consumption takes place.

The current tax system creates borders within borders, creating obstacles in supply chains within the country. The implementation of the GST would streamline India’s fragmented tax system and unite all states into a singular market.

The GST is also expected to make the tax base more comprehensive and the compliance burden less complex and less time consuming.

Who Will Benefit from GST
According to a research note published by Morgan Stanley, four sectors that would benefit from the implementation of GST are:
• Consumption (consumer goods and services)
• Logistics companies
• Manufacturers of house building materials
• Industrial manufacturing

The GST will benefit traders who supply raw materials or components to factories across the company. Distributors with a network across various states and manufacturers with facilities in many states would also benefit immensely from the new tax regime.
Implications for the SME Sector
While the GST is expected to have a far-reaching impact across most businesses, small and medium enterprises would particularly benefit from the new tax regime.

Eliminates the Cascading Impact of Taxes
Under the current tax regime, large enterprises were managing their infrastructure to reduce the burden of double taxation and CST. On the contrary, SMEs typically lack the infrastructure resources and have been bearing the burden of taxes that accompany interstate sales. This increases the cost of the goods being offered by SMEs, leaving them less price competitive compared to large enterprises.

The GST neutralizes these impacts by uniting all states into a single market and by eliminating the cascading impact of input taxes.

Eases Documentation
SMEs that are directly catering to customers and those that have e-commerce models would particularly benefit due to the ease of cross-border transactions. Each state requires a different set of documentation for businesses to conduct transactions, which create obstacles for businesses. This resulted in the need for dedicated resources to manage clearances which further added to the cost. The hassle involved can be entirely avoided with the implementation of GST. An e-commerce company or one that provides goods directly to consumers can now benefit from a smoother supply chain and logistics network across the country.

Simplification of Tax Filing
All taxes can be filed and paid online. While existing taxpayers would not have to register afresh under GST, new companies will have a simple application form that can be filled and submitted online for registration.

Less Incentive for Tax Defaults
With the elimination of the currently huge central excise tariff, the simplification of tax filing and payments as well as the removal of different documentation needs by various states, there would be less incentive for tax frauds.

Although it has several advantages, GST has a drawback too. The threshold limit for tax exemption has been reduced from Rs.150 lakhs to Rs.25 lakhs, which would impact small businesses that were so far shielded from compliance requirements. This lowering of the tax exemption not only has a cost impact but a significant working capital implication as well.

Impacting India’s Business Climate
With the GST making it easier to conduct business and allowing the free movement of goods across the country, many SMEs would look to expanding to different states. SMEs will no longer be hindered by geographical restrictions and can optimize the opportunities to scale at a geometric rate without artificial hurdles.

As mentioned earlier, the manufacturing sector will benefit from GST. However, there might be flux in the near future, as all the participants in the supply chain must be incorporated to pay taxes. If a supply chain participant isn’t registered, the benefits of GST will not be transferred down the chain. The flux is expected to be temporal in nature as gradually, GST will be advantageous in streamlining payment of taxes across the supply chain and eventually adding to the country’s GDP.

The service sector might experience a hit, though, due to increased taxation. This sector will need to find a response mechanism to handle the slight inflation in taxes without impacting service delivery or customer satisfaction. Services, being intangible in nature, become hard to evaluate from a consumption perspective and any increase in cost might negatively impact the perception of value by the end consumer. That being said, this might be a minor blip in the longstanding effects that GST has on Services. Early resistance from end customers notwithstanding, the unification of taxes will eradicate ambiguity in taxation, which eventually benefits the consumer.

The post has been originally authored by Gaurav Hinduja, Co-founder, Capital Float.