The goods and service tax (GST) is finally slated to be rolled out on July 1, 2017. And the journey so far has been anything, but easy. The fact that the proposed date of implementation for the tax has been shifted several times (from April, 2010 to April,2013 to April 2016 to now finally to July 2017) is a testament enough to the problems involved in getting all stakeholders – the central and state governments – on board.

Admittedly, there is a considerable degree of agreement among market participants that GST is indeed one of the greatest economic reforms we have seen in the recent history.
However, with now less than two days to go for its implementation, some serious transitional issues have come to the fore as the country prepares itself for the mammoth transition, which we think have been downplayed and, are, therefore, worth flagging.

1. The much touted deflationary impact of the new tax regime

While Prima facie, the fitment of 1,211 goods and 568 services under the four-tier rate structure appears to be deflationary with 60 per cent of goods and 91 per cent of services to be taxed at 12 per cent/18 per cent and less than 50 per cent of the CPI basket likely to be impacted by GST, we believe the effect on prices might not be that straight forward.
Admittedly, a four-tier rate structure for India is likely to cushion inflation risks unlike most other economies, which had a single point of taxation and witnessed a temporary spurt in inflation post the GST implementation.

However, even with this, we suspect the possibility of incomplete pass-through of tax savings by firms in the initial months of implementation, which could in turn affect the price dynamics. Moreover, even a part of the price adjustments could actually come with a substantial lag as businesses juggle with various transitional issues.

2. Short-term implementation hiccups for businesses are understated

While the benefits like uniformity of tax rates across the country and removal of cascading effect would definitely be long-term positive for the India Inc, several clauses in the new law and the fact that the entire indirect taxation regime would undergo such a massive shift imply that businesses would have to undergo a painful transition before they start reaping benefits over a longer term.

First, the treatment of closing inventory on the date of transitioning to GST (with only partial credit for the excise duty already paid for businesses that cannot produce duty paying documents) is likely to disrupt companies’ cash flow cycles during the initial phase of GST transition.

In addition, clauses like payment of tax on the date of receipt of advance against a future delivery of goods & services and tax on inter-company stock transfers would increase working capital requirements. This would also impact the logistics and supply chain of certain firms which operate warehouses across different states.

3. The sin of being small

With just two days to go for the GST roll out, the transition, in our view, will be much more painful for the SME sector (which contributes around 50 per cent of the industrial output and 42 per cent of India’s total export). Specifically, SME manufacturers, who are presently exempted (if annual taxable turnover is up to Rs 1.5 crore) from paying excise duty, would be liable to pay full rate of GST as the exemption limit has been lowered to Rs 20 lakh.

Not only will this bring their products up for stiff competition with those of industry leaders in terms of tax costs involved, but also would result in additional working capital requirement since they may be required to discharge the GST liability pending realisation of the invoice.

Moreover, with regard to the requirement of higher working capital requirements under the new regime (as mentioned above), it is worth noting that larger companies with stronger credit profiles are still likely to tide over the short-term working capital disruption relatively easily as compared to the smaller ones, which have weaker credit profiles and suffers frequent unevenness of cash flow.

At the same time the changeover to digital book keeping and additional compliance in terms of registration requirements and filing of returns (a minimum of 37 returns per year) would mean, more investment in equipment and tax consultants for SMEs, especially given the fact that a lot of such units operate in cash.

On balance, we argue that while GST is definitely a long-term positive change for the Indian economy, its impact on both the economy and on businesses in the short term remains a mixed bag of pluses and minuses.

It is, therefore, safe to assume that economic activity in general might see some swings especially in the second and third quarter of FY18 before the companies start to get comfortable with new rules and procedures.

(Opinion piece by Abhik Barua, Chief Economist, HDFC Bank)

Source: The Economic Times