Economy/Strategy: GST: Godot has arrived - Kotak

GST: Godot has arrived. The most significant tax reform for India will likely have its fair share of glitches post implementation. Agility on part of businesses and governments will be needed to navigate through the initial phases of uncertainty. The economy stands to gain over the long term as efficiency gains and higher government revenues translate into higher growth potential. Job creation will remain a concern as the unorganized sector shifts towards the organized sector.

Neutral to negative impact as uncertainty-led risks high in the short term

The short-term impact of GST could be neutral to negative for the broader economy. Production processes will likely take some time to align with the new framework as firms adjust to the input tax credit system and get a handle on the working capital requirements too. Micro and small enterprises could see costs increase due to higher compliance and a shift towards the organized sector. We would be cautious on economic growth for next one to two quarters. The GST rate structure will be neutral to marginally disinflationary for CPI inflation. We estimate CPI inflation to be lower by around 20 bps on an average due to GST rates.

Positive implications likely in the medium to long term

The economic benefits in the medium to long term would be from two major factors: (1) efficiency gains from a simpler tax system, more productive business operations, and creation of a one nation market for production and consumption, and (2) higher government revenues due to expansion of the tax base as compliance increases and unorganized segment shifts to the organized segment. However, we note that unorganized sector employs a majority of the labor force. With the unorganized sector shifting to the organized sector, a significant labor absorption capacity that currently exists may get eroded. This can compound the already chronic problem of job creation in India. Given India's economic structure and GST framework, drawing quantitative conclusions from other countries' experiences would be unfounded.

Post-implementation challenges: proof of the pudding is in the eating

Challenges will be more evident after the implementation, but it is important to recognize a few issues which may crop up. The primary concern will be glitches in seamless tax credit which can have a negative effect on the working capital requirements of the firms. Further, the industry could have concerns on the limited number of GST Service Providers (GSPs) presently approved and the reliability of the linkage between the firms and Application Service Providers (ASPs) in terms of security and network. Some concerns will also be on the ability of micro and small retailers to be able to submit online returns which the GST regime mandates to be done on a monthly, quarterly and annual basis.

Companies' challenges: short-term hitches will be the focus for now

Summarizes the key changes and our understanding of the issues and challenges of the sectors. Most challenges now revolve around compliance, infrastructure, and logistics of the GST system which would essentially demand an on-the-go course correction, if any. Over the next few quarters as the dust settles on short-term glitches, the business will move to resolve the more structural issues of reforming business models and gaining efficiency.

GST: In Summary

The Goods and Services Tax (GST) is a destination-based indirect tax that will subsume all current indirect taxes being levied—both by center and the states—except basic customs duties and a few state and local taxes. The new taxation system under GST is aimed at making a simplified indirect taxation regime which has pan-India uniformity thereby removing inefficiencies arising from taxing the same good multiple times at different rates across each state. The GST aims to remove the cascading effect of various central and state levies. Alcohol for human consumption and electricity are outside the purview of GST while levy on petroleum products (crude, diesel, petrol, natural gas, and ATF) will be recommended by the GST Council at a later data.

GST Council: Apex body for decision making

GST council is the top constitutional authority for GST, which is created to mirror the federal structure of the country, with the Union Finance Minister as the Chairperson, a minister from a state government as the Vice-Chairperson and all state finance ministers and the Union Minister of State (Finance) as members. The States have 2/3 weightage while the center has 1/3 weightage. Any decision needs support of at least 75% of the council with a quorum of 50%. It is the prime decision making body for GST with the power to make recommendations on rules and laws, rates, exemptions and thresholds, etc.

Rate structure: Dual control and multiple rates

The current GST rate structure is a combination of both central and state government having a share in the tax collections. There are three types of taxes—Central GST and State GST for intra-state transactions and IGST (Integrated GST) for inter-state transactions.

The GST Council has decided the tax rates while trying to keep the rates closer to present effective rates for most commodities and services. Tax rates in GST will be kept under four specific slabs—5%, 12%, 18% and 28%—while certain basic goods and important services are exempt from GST. Luxury and sin goods, as identified, will attract additional cess over the peak rate of 28%. Precious and semi-precious stones and precious metals would attract a GST rate of 3% while rough diamond would have a GST rate of 0.25%.The cess will be used to compensate states for any revenue loss incurred due to GST implementation for five years after implementation. The loss is to be calculated with FY2016 as the base year and an annual growth of 14% over the period of compensation. Summarizes the relevant tax base growth rate over the last few years across various states.

Existing area-based exemption from certain states or central excise exemptions will be converted to reimbursement based scheme. Under GST, these central and state governments will have to tax the entities and exemptions related refunds will have to be given out from the budgets. This will lead to some increase in working capital for companies enjoying these benefits. However, such future benefits cannot be implemented under the GST structure though if state governments want to offer them they have to do so through the budgets rather than through tax breaks.

GST will apply to businesses having a turnover exceeding Rs2 mn (Rs1 mn for special category states). In effect it would be a relief for certain traders and service providers which had a threshold of Rs0.5 mn in most states' VAT and Rs1 mn for service tax. However, for manufacturing units this would be a reduction in the threshold limit as they enjoyed central excise duty exemption till Rs15 mn of turnover. As decided by the GST Council, states would have administrative control over 90% of tax payers having a turnover below Rs15 mn and center would have administrative control over the remaining 10%. Taxpayers above this threshold would be divided equally between central and state tax administrations.

Benefits: one uniform market, increasing efficiencies, and expanding tax base

The GST will likely create a more efficient taxation system. It aims to make the tax-base broader by making the entire chain of value-addition responsible for ensuring payment of GST by entities preceding them in the chain. By way of trying to achieve a seamless flow of tax credit, working capital requirement of entities in a chain get affected if the vendors/partners in a chain are not compliant.

Tax avoidance is expected to be significantly difficult as under the GST system, a 'successor' entity in the GST chain will not be able to claim (offset) the taxes paid by it on procurement of goods and services from a 'predecessor' entity in the chain against goods and services sold by it (take a credit of taxes on inputs, in other words) in turn unless the 'predecessor' entity has made the payment in the first place.

As a result, tax revenues should see a significant increase as (1) either there is a successful migration from unorganized to organized sector or (2) market share gain of larger units in the manufacturing sector from the multitudes of smaller players. As the share of unorganized players in several sectors is quite large, there can be a meaningful increase of tax revenues as and when they become part of the formal economy.

Given the rate structure, there should be minimal impact on retail prices. In fact, if GST is implemented seamlessly and tax benefits are passed on to the consumers, it could be marginally disinflationary (CPI inflation could be lower by around 20 bps). The GST framework incorporates an "anti-profiteering" clause which the authorities will use judiciously to keep any unscrupulous price activity post GST implementation. The GST Council has finalized the rules related to anti-profiteering and has recommended a five-member National Anti-Profiteering Authority as well as a standing committee and state-level screening committees to enable smooth functioning of the Authority.

Source : Equity Bulls

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