Questions remain about GST's impact on the infrastructure sector, given the new tax regime's numerous nuances, says Krrishan Singhania, Managing Partner, Singhania & Company.
All states will implement GST by July 2017. The Constitution Amendment Bill for Goods and Services Tax has been approved by the President of India post its approval in Parliament (Rajya Sabha on 3 August 2016 and Lok Sabha on 8 August 2016) and ratification by more than 50 per cent of state legislatures.
The government is committed to replace all indirect taxes levied on goods and services by the Centre and the base will be far reaching, as for all intents and purposes, all merchandise and ventures will be assessable, with least exclusions. GST will be a change for the Indian economy by creating a pan-Indian market and decreasing the falling impact of duty on the cost of products and ventures. It will affect the expense structure, impose occurrence, charge calculation, assess instalment, consistence and credit usage, prompting a total redesign of the current aberrant duty framework. GST will have a broad effect on every part of various business operations in the nation, like estimating of items and administrations, store network improvement, income tax, bookkeeping, and expense consistence frameworks.
Benefits of GST
GST has been envisaged as an efficient tax system, neutral in its application and attractive in its impact. The advantages of GST are:
Wider tax base, necessary for lowering tax rates and eliminating classification disputes;
Elimination of multiplicity of taxes and their cascading effects;
Rationalisation of tax structure and simplification of compliance procedures;
Harmonisation of Central and state tax administrations, which would reduce duplication and compliance costs;
Automation of compliance procedures to reduce errors and increase efficiency.
The GST structure would follow the destination concept. Accordingly, imports would be subject to GST, while exports would be zero-rated. In the case of inter-state transactions within India, state tax would apply in the state of destination as opposed to that of origin.
Current scenario in the infrastructure domain
The Indian infrastructure sector largely encompasses power, roads, ports, railways and mining. Although these sub-sectors are often referred to in the same breath when speaking of infrastructure, the indirect tax landscape is varied and unique for each of them.
Goods and services for infrastructure projects enjoy a large number of concessions and exemptions under Central and state laws, since the sector is of national importance. Yet, the multiplicity of taxes and general construct of contracts give the infrastructure sector a heightened degree of complexity from the perspective of indirect taxes.
What does GST mean for the infrastructure sector?
The proposed Revenue Neutral Rate (RNR) of about 27 per cent has sent the industry into a spin, making it imperative that the tax structure of the infrastructure supply chain is carefully thought out under GST. Given that the underlying premise of a goods and services tax is widening the tax base while minimising exemptions as said by the finance minister, the key issue for the sector is the continuity of current concessions and exemptions under GST and its plausible impact on credit chains and costing. This aspect needs to be resolved through active engagement between stakeholders and the government.
For example, at present, there are no indirect taxes on the output of the power sector, except electricity duty levied by states. As a result, all input taxes (such as capital expenditure on setting up power plants and duties and taxes on coal) are a cost to power companies. If power is kept out of the ambit of GST and there is no concessional GST on the input side (like the 2 per cent CST and service tax of 15 per cent), the 27 per cent GST paid on procurements will significantly increase the cost for this sector. There are similar skews in other sub-sectors. In the mining sector, VAT is generally applicable, whereas excise duty is not levied on most products arising out of mining.
For roads, VAT is generally applicable on goods used for construction, whereas service tax is exempt on the actual construction of roads. Furthermore, in the railways and ports sector, construction, erection and commissioning services are exempt from service tax. On the contrary, rail travel services are partially taxable and port services are fully taxable. Thus, it would be critical to see as to how each of these sectors is handled under GST.
Fortunately, an end to the works contract debate is imminent, as each such transaction would attract GST (comprising CGST and SGST), effectively negating the need to separately value work contracts for the purposes of service tax and VAT using various alternative mechanisms such as abatement and composition. This would avoid the current overlap of taxes in a few cases.
Because of the extent of civil work in infrastructure projects, it would be interesting to see the extent to which input credits are liberalised, since such credits pertaining to civil works are usually not available currently under both CENVAT and state VAT.
Overall, there are many unanswered questions about the impact of GST on the infrastructure sector, given its numerous nuances and its position in terms of structure and exemptions. The overall sentiment on GST in the economy is positive to increased tax compliance and will attract more foreign direct investment across sectors due to tax transparency and ease of doing business. Increase in foreign direct investment in the economy would lead to development in infrastructure in the long run.
Impact on various sectors
Taxability of Free of Cost (FOC) supplies by project owners to contractors appears to be liable to GST. Thereafter, the contractor may need to include value of such free supplies in the value of his services, thereby increasing the tax incidence, especially in scenarios where the project owner is not eligible to take credit or where the contractor avails any exemption. Else, the FOC supplies would create a cash flow issue.
Flying will become expensive, as service tax will be replaced by GST. Service tax on fares currently ranges between 6 and 9 per cent (depending on the class of travel). With GST, the rate will surpass 15 per cent, if not 18 per cent, effectively doubling the tax rate.
The current regime does not impose any tax on aircraft, aircraft engines and other assorted parts except a 10 per cent service tax on the finance for leasing and import of aircraft. Once GST is implemented, the import of aircraft would be subject to the Integrated Goods and Services Tax (IGST), leading to acute liquidity crunch for the sector.
The aviation ministry is estimating a loss of Rs 5,000 crore annually and Rs 800 crore by the airlines if GST is levied on the leasing, supply and import of aircraft and associated parts.
GST is expected to inflate electricity costs by 8 per cent as the government has kept electricity out of the ambit of the regime.
Power producing companies, both renewable and non-renewable, would have to pay GST for their inputs such as fuel and machinery, but will not be able to get these taxes refunded, given that their output electricity is exempt.
This higher cost of producing electricity will be passed on to consumers under the change of law clause in power purchase agreements. Developers selling electricity in the spot market or on a non-PPA basis would have to factor in the higher cost.
Works contracts and EPC Positive
GST seeks to provide much-needed clarity on works contracts, and therefore on EPC business line. Works contracts are proposed to be taxed as services.
This means the GST rate and provisions like place of supply rules as applicable on services will apply to works contracts.
The major gain from this treatment is that the tax would be now charged on the actual contractual base. Also, local versus interstate works contracts, that at present lead to innumerable disputes, should be eliminated.
GST will eliminate multiple levies. It will also allow deeper penetration of digital services. GST along with positive policy changes in India like Digital India would lead to development and exponential growth in this sector.
Increased requirement of working capital
GST on import of services used as input for services that are exported would lead to locking of funds in working capital.
The provisions mandating tax collected at source for transactions on third party e-commerce can potentially render such an e-commerce market place financially unviable.
Software Technology Park
IT service exporters under the STP scheme presently burdened with recurring service tax refund claims could well see an increase in the number as well as quantum of such refund claims under GST. IT companies can have several delivery centres and offices working together to service a single contract. With GST, companies might require each centre to generate a separate invoice to every contracting party. Duty on manufactured goods is going to go up from existing 14-15 per cent to 18 per cent, which means the cost of electronics and mobile phones will rise.
Companies will increase savings in logistics and distribution costs as the need for multiple sales depots will be eliminated. FMCG companies pay nearly 24-25 per cent including excise duty, VAT and entry tax. GST at 17-19 per cent could yield significant reduction in taxes which would improve the bottom line of the companies and in turn increase profits. Warehouse rationalisation and reduction of overall tax rates is expected to generate savings which could cumulatively range between 200-300 bps.
The singular tax rate would facilitate free flow of goods and services in the country and this would mean faster turnaround time and improved efficiency.
The most visible impact of GST would be on the warehousing strategy of FMCG companies. Distribution costs vary from 2 to 7 per cent of turnover for FMCG companies. Currently FMCG companies establish warehouses in each state (with the tax consideration to avoid CST on interstate sales) and do stock transfers to them. Subsequently goods are sold to distributors locally. The decision on warehousing is based on tax consideration rather than market proximity or transport considerations.
Under GST, as local and interstate supply would be tax neutral with India emerging as a single, large common market, location of warehouses needs to be reconsidered. Savings to the tune of 1.5 per cent of sales is expected as a result of warehouse rearrangement. A level playing field would be created in favour of small start-ups in the business of delivery of organic products for e.g., khadi, oils and perfumes.
Supply chain structure
GST will lead to re-evaluation of procurement and distribution arrangements. However, applicability of tax at all points of the supply chain is likely to require adjustments to profit margins, especially for distributors and retailers.
Increased cash flow
Tax refunds on goods purchased for resale implies a significant reduction in the inventory cost of distribution. Distributors are also expected to experience cash flow from collection of GST in their sales, before remitting it to the government at the end of the tax filing period. If the recommended 40 per cent "sin/demerit" GST for aerated beverages and tobacco products is levied, then prices may increase by over 20 per cent. Many food companies may see increase in effective tax as many companies enjoy concessional rate of excise.
GST will help create a single unified market across India and allow free movement and supply of goods in every part of the country. It will also eliminate the cascading effect of taxes on customers which will bring efficiency in product costs. There would be reduction in brick and mortar and increase in the e-commerce space over the coming years. This sector has still got great untapped potential. There has been a great increase in digital penetration, which would also benefit this sector.
The tax collection at source (TCS) guidelines in the GST regime will increase administration and documentation workload for e-commerce firms and push up costs.
Freebies and discounts
Freebies or discounts will have to be explicitly mentioned in the invoice to arrive at transaction value on which GST is applicable. Any post-sale discount will attract GST.
E-commerce companies store goods from sellers at their warehouses and supply to end-users upon receiving orders. Under GST, both e-commerce companies and sellers would have to simultaneously register these warehouses as principal and additional place of business, respectively. This would be challenging as these facilities don't have dealer-wise physical segregation or designated areas within the warehouse.
Both e-commerce players and sellers will have to upload invoice details of supplies in their respective returns and the GST system will match them. Unless reconciled, this will be added to the liability of the seller.
Handset prices are likely to come down or even out across states. Manufacturers are also likely to pass on to consumers cost benefits they will get from consolidating their warehouses and efficiently managing inventory. For handset makers, GST will bring in ease of doing business as they may no longer need to set up state-specific entities and transfer stocks to them and invest heavily into logistics of creating warehouses in each state across the country.
Call charges and data rates will go up if tax rate in the GST regime exceeds 15 per cent. Tower firms won't be able to set off their input duty liabilities if petro-products continue to stay outside the GST framework.
On-road price of vehicles could drop by 8 per cent, as per a report by Motilal Oswal Securities. Lower prices can be construed as an indirect stimulus to boost volumes.
Demand for commercial vehicles may be hit in the medium term. GST will subsume local taxes, reduce time at check-posts, and ease logistical hurdles. With fleet productivity increasing, operators may not feel the need to expand mid-term.
DTH, film producers and multiplex players are levied service tax as well as entertainment tax, GST will bring a major change and uniformity in businesses. Taxes could go down by 2-4 per cent. Multiplex chains will save on revenues as there will be a more uniform tax, unlike current high rate of entertainment tax levied by different states.
Higher rate of Imports Materials and machinery imported from abroad will have a higher incidence of IGST levied on them, increasing the cost of imports.
Continuity of the area-based indirect tax benefits under the GST regime is critical as this may also indirectly impact the cost of medicines and ultimate price to be paid by the patients.
Reconciliation of inward and outward supplies
A mismatch between the details of outward supplies and the inward supplies, not rectified by the vendor in the month of communication, shall make the recipient liable to pay the differential GST along with applicable interest.
Taxability of Free Supplies
Stock transfer of promotion materials/free samples shall be subject to GST. Subsequent supply of promotion materials to stockists/end-customers will also attract GST.
Place of Supply of Services
Pharmaceutical companies provide/receive services from multiple locations. It may not be possible to determine such location, making place of supply unclear to determine whether the supply is an intra-state or inter-state supply.
Pharma companies have huge capital requirements. Thus, planning and blocking of working capital is required to be done with implementation of GST.
Insurance policies - life, health and motor - will begin to cost more from April 2017 as taxes will go up by up to 300 basis points.
The effective rate of tax for cement companies is now 25 per cent. If GST rates are fixed at 18-20 per cent then the overall tax incidence will be lower. GST is expected to lead to savings in transportation cost, which currently comprises up to 20-25 per cent of total revenue. One common market will bring down the number of depots in the country. UltraTech, one of the largest cement companies in India, states that its depots will come down to 100 from 550 at present.
Gearing up for the change
The scale and term of infrastructure projects make it imperative that the draft GST legislation is put in the public domain at the earliest, so that transitional challenges are minimised and the people are well aware of the regulations - and the authorities are adequately trained. Ongoing long-term contracts at the time of introduction of GST may or may not have clauses dealing with changes in taxes and laws. Project awarders and executioners must safeguard themselves appropriately in this regard. The infrastructure sector is as much of a game changer as GST, from the perspective of the Indian economy. The government should consider this fact carefully before coming out with the final legislation.
Ashwin Vasista & Anish Shetty, Associates, Singhania & Company also contributed to this article.