Q3-2017

Welcome to the quarterly newsletter of SeaLink Capital Partners.
 
Albert Einstein once said, “The hardest thing in the world to understand is the income tax.”  And he wasn’t even referring to the byzantine tax structure in Indian commerce when he said that. 
 
It may have taken a while, but lawmakers in India have collectively agreed with Einstein.  On July 1st, India will implement the most significant tax reform in its history and begin the transition from an economy where a myriad central, state and municipal taxes (e.g., local body taxes, excise, value-add, sales tax, service tax, luxury tax) levied on businesses, which created cascading taxation, supply chain inefficiencies and provided opportunities for evasion, will be subsumed under a Goods and Services Tax (GST). 
 
Many countries in the world have a single unified GST system i.e. a single tax applicable throughout the country. Some, like Brazil and Canada, have a dual GST system whereby GST is levied by both the federal and state or provincial governments.  In India, a dual GST system has been adopted whereby a Central Goods and Services Tax (CGST) and a State Goods and Services Tax (SGST) will be levied on the taxable value of every transaction of supply of goods and services.
 
There are several benefits of GST including reducing corruption and leakages; increasing tax compliance; eliminating the cascading taxation on goods and services and simplifying the overall structure and bringing uniformity in tax rules across the country.
 
How will GST work?
 
Under the current indirect tax structure, a product’s interim value is taxed at each step in the value chain, thereby increasing the price of the item and creating a cascading situation wherein tax is applied on tax that has already been paid, since there were multiple taxes levied (customs duty, excise, sales tax, value added tax, service tax, etc.), and not all taxes were available for an “input tax credit”. Sounds a bit like double jeopardy in taxes, doesn’t it?
 
Under GST, credit for tax paid in previous stages of the value chain is applied, thereby eliminating the cascading effect. 
 
However, the onus of ensuring tax compliance shifts to each participant in the supply chain.  A retailer can only benefit from a tax credit if the wholesaler has been compliant with his own taxes.  If the wholesaler attempts to evade taxes or does not complete the requisite documentation, the retailer will not be able to claim the tax credit, and will eventually find an alternate wholesaler.  The expectation is that tax compliance will become a necessary step for conducting business thereby increasing the overall tax net and tax revenues.
 
Increased efficiency is another benefit of GST.  Due to differences in state tax rates, goods transport vehicles in India lose 60 percent of transit time to roadblocks, tolls, and other stoppages, leading to higher logistics costs and possibly even wastage of goods. While truck drivers may still need to stop to have their goods checked, GST will cut the idle time in half, according to a 2014 World Bank report.  Intermediaries who benefited significantly, and informally, at state borders where a bevy of additional levies were charged before providing entry clearance to trucks, will have to find alternate sources of employment. Manufacturers and wholesalers will also be able to optimize supply chain efficiencies as the choice of state for manufacture and distribution will no longer be governed by different value added tax rates.
 
A Parliament session is scheduled for midnight on June 30th where the President, current and past Prime Ministers, Members of Parliament, state Chief Ministers, central and state Finance Ministers will collectively and formally roll out the much awaited GST structure. 
 
With a forecasted increase in tax revenues, the spending potential of the government will increase, providing further impetus to GDP growth.  For the fiscal year ended March 2017, India’s GDP grew at 7.1%.  Experts believe that GST will push that growth rate to over 8%.
 
There will be tiered tax structure for good and services with rates of 5%, 12%, 18% and 28%; with the lower slabs for essential items and the highest for luxury and tobacco products.  Not all products will get cheaper with GST; some will end up costing more.  Daily food items (e.g., milk, fruits, vegetables), which effectively constitute half of the consumer inflation basket, will have no, or minimal, tax imposed on them.  Education and health services will also continue to be exempt.
 
It may take a couple of quarters for things to stabilize
 
Change, as we all know, is never easy.  When that change involves a shift in the way business is conducted for a US$2 trillion economy with 8 million goods and services providers it is a gargantuan task.  As with any reform of this order of magnitude, there is some anxiety about the impact on business in the first few weeks post rollout.  Several companies of varying sizes are still rushing to update their ERP and other back-end systems for the new compliance requirements and tax tiers and trying to ensure alignment across their supply chain.
 
Compliance filing for businesses that operate in multiple states is going to be more onerous. Limited Internet connectivity has also caused delays for vendors that need to complete their GST registration.  There are hiccups anticipated before manufacturers, suppliers, distributors, retailers, and consumers all become accustomed to the new normal, and some believe it may take up to two-quarters for the system to stabilize.  The hope though is that GST will bring in long term gain with sustained growth for the nation.  At a time when many markets globally are carving out new economic boundaries, a unifying reform such as GST is being viewed rather positively for increasing the ease of conducting business.