Posted On Friday, Sep 09, 2016
My first encounter with the madness of indirect tax computation in India was as a student in the final year of my Bachelors of Commerce degree. The subject of Taxation was divided into Direct and Indirect taxes. Typical questions on indirect taxation would involve goods being manufactured in one state, transported via a second state and eventually sold in the third state. Complications to this standard setup would involve goods sometimes moving back and forth between the same states. The examiner would want to know which all taxes will be applicable and to which states would these taxes be payable. There was excise, VAT, Central Sales Tax, Octroi and a host of other taxes to be calculated. While trying to follow the flow of goods and calculate the eventual tax liability, my only thought was, “Why can’t all this be made simpler?”
It’s been around 15 years since my Bachelors of Commerce exam and India still follows this convoluted and cumbersome process of calculating indirect taxes. The passing of the constitution amendment in the Rajya Sabha, enabling the Goods and Services Tax (GST), brings us one step closer to a much simpler tax structure. If and when the GST is adopted, apart from CFOs who have to deal with the chaotic tax calculations, I expect future generation of taxation students to have an easier time.
So what are the big implications of India adopting the GST? Firstly, the incidence of taxes on corporate India, especially the manufacturing sector, is expected to reduce without impacting government tax collection. In fact, government tax collection might actually improve. How does this magic happen? An ex-colleague of mine during my days at Edelweiss had done extensive research in understanding the implications of GST. He explained to me, ‘the real target of GST is the black economy; right now they enjoy a price advantage over the organised sector by not paying taxes, once the GST is in place, it will be very difficult for them to conceal their final sales as they would have a tax credit against their account on purchase of inputs’. In simple terms, it’s a bit like how TDS is deducted by banks against interest income, making the interest impossible to hide for the tax payer. Hence, if the eventual rate of GST is lower than the current tax incidence for any company, the indirect tax liability for that company should reduce. At the same time, since manufacturers who were previously part of the black economy are now forced to pay taxes, government finances should remain unaffected. But this is still conjecture. While tax lost due to a lower effective tax rate can be quantified, the gain due to former tax non-payers who will now come under the tax net is extremely tough to calculate.
What about services? Well, for them it could just be plain bad news. The GST rate now bandied about of ~18% is higher than the current service tax rate of ~15%. Moreover, the destination-based rule of taxation (i.e. taxes would be owed to the state that consumes the final product) could actually increase administration costs for service companies. Take for instance the Asset Management Industry, service tax collected as a part of the expense ratio would now be allocated on the basis of the location of the investor. Tracking investor locations more closely and calculating taxes due to various states would further increase administration and compliance costs. Similar implications can be expected for other financial services sectors like Banks, Insurance etc.
Will corporate profits zoom after GST? There are too many unknowns at the moment to make a fair assessment. First and foremost, the GST rate itself is unknown. The state governments are already clamouring for a higher rate than 18% to negate possible revenue loss. A higher rate if imposed would mean very few companies will actually benefit from lower incidence of taxation. Secondly, since the potential savings accrue to the entire sector, it becomes extremely difficult for a company to retain the benefit in case its competitor decides to pass it on to the consumer. In fact, it is fair to assume that in a fiercely competitive sector, most of the benefits may eventually be passed on to the customers. Corporate profitability may remain unmoved despite lower tax incidence.
The passing of the constitutional amendment in the Rajya Sabha and an assent from the President of India conveys a strong positive signal that despite being a diverse and vibrant democracy, at crucial times, national interest has superseded party politics.
At Quantum, the passing of the GST bill doesn’t affect us much; we continue to do what we have always done. We regularly track companies and try to forecast their long-term earnings in an attempt to buy outstanding stocks at a discount to their intrinsic values. We believe that India remains a great long-term structural story, and the introduction of the GST is a good step in the right direction.
For more information, click here to read the FAQs on GST published by the Ministry of Finance, Government of India.
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