By Invitation. Gains guaranteed but will take time

The biggest indirect tax reform in Independent India through the Goods and Services Tax (GST) Bill is now very close to reality, having cleared the most important step in the Rajya Sabha. It would be an opportune time to take a reality check.

The notion of GDP growth of 1.5-2.0 per cent incrementally is misplaced, at least in the short term. To begin with, there could be a postponement of buying manufactured goods (especially discretionary goods), as the proposed GST rate could be lower than that of the current effective rate. Seventeen per cent of GDP contributed by manufacturing would get affected; 60 per cent of GDP is services, which could be taxed at a higher rate of 18 per cent, up from the current effective rate of 15 per cent. As services cannot be advanced, there is no offset to the fall in discretionary purchase of goods. Over the medium term, as GST is adopted, the GDP base would, in fact, increase due to improved productivity as a result of efficiency in the economy and freeing up of capital.

The tax base would increase from the current base of just 20-25 lakh excise and service tax payers because of four factors. First, those companies that have been evading taxes but are in the value chain that has at least one big player would be forced to pay GST in order to enable the latter get input credit. Second, the tax infrastructure driven by technology would increase the vigilance from the tax authorities, making it difficult to be out of the tax net. Third, the entire tax department and its officials would be working as one entity instead of working in silos. Fourth, the process of paying taxes and filing forms would become simple enough, which would enhance compliance.

How are the Indian companies affected?

Though the final rates are not disclosed, there is a recommendation to have four buckets: 1. 2-6 per cent for precious metals; 2. A lower rate of 12 per cent for incentivised goods, clothing and medicines; 3. A demerit rate of 40 per cent for tobacco and beverages and 4. Standard rate of 18 per cent for almost everything else. Alcohol and petroleum products are exempt. The Service tax could be set at 18 per cent. The auto sector currently pays 30-60 per cent of selling price of a vehicle under various taxes. With a standard rate of 18 per cent, the saving due to lower taxes is significant. Even the larger cars that may be taxed at 40 per cent will see tax savings. In segments where competitive intensity is high or capacity utilisation is low, like in the case of two-wheelers, the saving is passed on to the consumer. In segments where industry growth is high and capacity utilisation is high, tax savings may not be passed on to the consumer, leading to higher margins for companies.

The FMCG companies pay excise duty and value added tax in the current scenario, which is greater than the GST standard rate of 18 per cent, leading to tax saving. The oligopoly structure of paint industry helps the companies keep all of the margin expansion due to tax savings. However, a competitive industry like household and personal care may see companies passing on part saving to the consumer.

Logistics companies would benefit by transforming the current set-up into ‘Hub and Spoke’ model. They would replace their short-haul trucks with long-haul ones. The cost of trucks (due to lower GST rate) and cost reduction due to improving efficiency would help them reduce freight costs and increase volume growth. The entertainment sector (exhibition, cable and DTH) could benefit as entertainment tax, which is to the extent of 20-67 per cent, would be subsumed into GST. The state and local-level taxes could be taken as input credit. This would benefit the margins of the companies as the savings may not be passed on due to pricing power.

For some sectors, the existing taxes and cess remain. For instance, the royalty and clean energy cess paid by cement companies on key raw materials would remain. It is neutral for domestic pharma companies as the current tax structure is more or less equal to the incentivised GST rate of 12 per cent.

The road to steady implementation is quite bumpy. But I am optimistic that the implementation of GST is beneficial to corporate earnings and to equity investors!

The writer is Co-Chief Investment Officer, Birla Sun Life Asset Management Company

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