Demystifying challenges in embracing Goods and Service Tax in India – Part III

In the Part I of this series Demystifying challenges in embracing Goods and Service Tax in India we have seen about the Training of the Teams and Registration Numbers and in Part II have seen about the Contract Renegotiation, Change in Business Process and Impact on Costing of Products and Services  and in this we will review the impact on working capital management, IT Systems & future expansions. ……………..Happy Reading

6. Working Capital Management

Working capital is the lifeline of any business. Working capital is required for day-to-day operations for meeting cash expenses, for payment to vendors, for payment of salaries, etc. Working capital is financed by the banks based on the current asset ratio, the Gross Current Assets of the company and other current liabilities (i.e. excluding CC limits, term loans etc.

Impact on working capital will be increased due to the following reasons

a) Increase in tax rates

b) Removal of exemptions

c) Change in input tax credit mechanism

d) Service Tax to be levied by states also

a) Increase in tax rates

In GST the number of taxes are being reduced, this is a welcome gesture as the complexity and tax administration is minimized but the flip side is there will be an increase in the tax rates. Under current tax regulations. today when goods are procured from neighboring states only CST is being paid at the rate of 2% or 1% based on the exemptions availed by the seller. In GST CST is being replaced with IGST which is a sum of CGST plus IGST and the total of these two expected to be around 18% and even more in the case of sin goods. The taxes rate will be increased from 14.5% (12.5% Excise duties plus 2% CST) to 18%, this means an increase in tax rate of about 25% (18%-14.5% / 14.5%).

This has an immediate impact on the cash outflows as the supplier has to be paid normally within 30 days if goods are procured on credit basis and if in on cash basis the impact will be even more. In most of the organizations about 20% to 30% of the goods are procured from other states, in some case it may be more also. Keeping in view of this, the organizations have to plan accordingly.

b) Removal of exemptions

The basic objective of GST is the rationalization of goods and services taxes which means that goods and services will be taxed in the same manner and a lesser number of exemptions. Currently, under central excise there are around 300+ items which are taxed at lower rates and going forward under GST, these exemptions will be removed that means the cost of these products will go up along with additional cash outflow.

Today for overall balanced economic development in various locations excise exemptions are granted to promote the industry. Under GST, these exemptions will no longer be applicable for new units and also for the existing units  will be supported till the sunset clause. We need to wait for the actual bill to see who the same will be handled. In the case of the exemptions are removed asking the existing units to levy GST during supply and apply for the refund, the organization will have to pay additional funds.

c) Change in input tax credit mechanism

In the current taxation, the credit of Excise and VAT is available on the receipt of goods based on the invoice. The credit availed on receipt of goods in case of Central Excise and VAT and on receipt of Invoice for Service Tax helps the business to adjust with the output tax liability to be paid during the month end. This will help in the cash flows as there is no need for additional cash to be spent and it is taken on the accrual basis i.e supplier payment is not a criteria for availing the input tax credit.

Under GST the input tax credit is available only when the supplier pays the taxes. This input credit will be validated for the buyer based in the GST2 based on the GSTR1 filed by the seller. This means that credit cannot be taken immediately on receipt of goods or service invoice. The seller may remit the taxes in the immediate month or subsequent months, the longer the seller delays the tax payment the longer period the buyer has to wait to avail the credit. This process means the cash out flow for payment of taxes will be more i.e increased in working capital limits. In case if the buyer avails the credit without linking to supplier payment in GSTR 2, if the seller does not pay the taxes, the same will be reversed with penalty i.e additional outflow. The  Government has proposed this approach to reduce the revenue leakage.

d) Service Tax to be levied by states

Currently under the existing constitutional provisions service tax is being levied by the center government but under GST states are also entitled to levy service tax. This means additional taxes to be paid on the service being procured like security charges, finance charges, courier charges etc.

Under the current tax regulations, the service tax is charged at 14.5% including Swach Bharath Cess of 0.5% with effective from 15th Nov, 2015. Under GST the tax rate is proposed to be around 18% as per the recommendations of the chief economic adviser. The service tax will be increased by around 25% ( (18%-14.5)  / 14.5%).

Under today’s conditions service tax is be paid on all services, this means additional outflow of funds i.e impact on working capital. Companies have to plan accordingly to meet the cash flows.

The working capital requirements are going to be increased to an extent of 5% to 10% minimum based on the size of the operations and nature of the business. In some cases, it may even go up to 20% also. An increase in the  working capital means, an increase in finance costs, which means increase in overhead and ultimate increase in the cost of production. In today’s competitive market the business have to take a call to pass on the increased costs or absorb the same. Absorbing the same means decreases in bottom-line or increase in selling price means decreases in the top line.

While evaluating the purchase proposals, care should be taken on the genuineness of the seller also going forward apart from the price, quality of supplies, timely delivery.

7. IT Systems

Nowadays, most companies are using various accounting packages or enterprise resource planning software’s of various vendors. All these packages are designed specific to Indian requirements as taxes are applicable on the movement of goods, unlike in other countries, on invoicing.

For GST to be rolled out, the one hundred and twenty-second constitutional amendment bill has to be passed in both the houses of Parliament and then ratified by at least 50% of the States in their Assemblies. Once this process is done or during this process, the government is planning to introduce the actual GST Bill. The last two sessions of the parliament were washed out for whatever be the reasons. We need to wait and watch for the budget session scheduled form 23rd of February 2016.

Since IT plays a critical role in today’s business, ERP’s or the accounting software’s should be changed to meet the new tax requirements in the following areas

a) Provision to capture the new registration number for GST – GSTIN

b) Infrastructure to enable input tax credit only on supplier payment

c) New reporting requirement

d) Revising of the current transaction processing

a) Provision to capture the new registration number for GST – GSTIN

In the current systems, the tax registration numbers are captured at the manufacturing plant level in case of ECC, Service Tax at national level, ISD in case of the client’s business requirements, VAT at state level and for CST again at state level. In GST, the GSTIN is at state level and the same registration number is applicable for all taxes. The existing registration numbers have to be end-dated and provision for the new one has to be provided by the accounting software / enterprise resource planning software vendors.

This information is available based on the business process document on Registrations issued by the Joint Committee.

b) Infrastructure to enable input tax credit only on supplier payment

In the current tax regulations, input tax credit is available on receipt of goods and the same is being supported by the accounting software’s or enterprise resource planning vendors. Under GST the same is being shifted to payment of taxes by the supplier, to track that the existing mechanism will be very cumbersome as the user is expected to query for each and every receipt and update the receipt accordingly.

As it is confirmed, the accounting software / enterprise resource planning software vendors can come out with a design where the user can query based on supplier or invoice number and update the same accordingly.

Apart from this, there is also change in the credit utilization i.e offset against each tax. Changes can be made in the accounting software / enterprise resource planning software vendors so these will save time for them to develop when the actual details are available.

c) New reporting requirements

Under the current tax regulations the business houses have to file around 400 + returns / declarations / annexures by whatever name we call it if they have presence across India. This means the business houses need to have dedicated team of indirect tax professionals to file them on monthly / quarterly or yearly basis. These returns or reports are different for central and states and differ from state to state.

This complexity is being done away in GST and the business houses have to file four to five returns for both the central and state reporting.

The reports to be filed under GST are

GSTR -1: to be filed on monthly basis, uploading transaction wise details for B2B transactions and for B2C with different conditions. It has to be filed by 10th of the subsequent month

GSTR -2: to be filed by the buyer and it will auto populate the credit for the invoice for which supplier has paid the taxes and buyer can also upload adjustment documents like credit memos, debit memos etc.

GSTR – 3: to be filed by the buyer and it will show summary of the purchase, sales, tax paid, adjustments if any etc

GSTR – 4:  quarterly return to be paid by dealers who have opted for compounding scheme under GST

GSTR – 5; return to be filed by non-resident tax payers

GSTR – 6; monthly return to be filed by input service distributor

GSTR – 7: to be filed by tax deductor

GSRT – 8; annual return to be filed by the sellers with for the year showing the sales, purchases, services details, tax break up for input tax, output tax, etc

All the above returns have to he developed and tested by the accounting software / enterprise resource planning software vendors.

d) Revising of the current transaction processing

In the current accounting software or the enterprise resource planning software’s the purchase and sales transactions update the Excise records like RG 1, RG23 A Part I/ II, RG 23 Part C Part I / II etc and with roll out of GST all these registers should not be updated. To stop updating the relevant changes for the software must be done.

To make all these changes the accounting software or the enterprise resource   planning software’s have an option to release a new release or a solution with the changes.

8. Future Expansions

In India, most of the decisions related to setting up of new manufacturing facilities is based on tax exemptions provided by the State Governments or based on the geography or economically backwardness of the area, etc. Taxes play an important role as the governments may give Sales Tax exemption, i.e. exemption from sales tax for a certain period or deferment, i.e. Sales Tax will be collected from the buyer but will be deposited to the tax authorities after a period of time. The deferment of Sales Tax helps in cash flows for the company in the initial years. Apart from this, there are exemptions related to land registration fees, stamp duty, etc.

The tax exemptions have helped in India for States like Himachal Pradesh and Uttarakhand. But going forward in GST, these exemptions do not have any meaning as the taxes will be based on the destination principle as against the origin principle.

The latest constitutional amendment bill has laid down very clearly that the exemptions are to be decided by the GST council and some of the States are clearly stated in the bill for attaining balanced growth. Based on the recommendations of the GST council, the exemptions to the States will be granted.

The current exemptions will be applicable till the sunset clause and there will not be any change. The current exemptions for Excise may undergo some change as the destination State will not get any tax if goods are shipped from an exempted locations. We will come to know the exact process when the actual GST bill is made available to the public.

The future decisions for setting up of industries will no longer be based on tax exemption but on factors related to the nearest point for supply of raw materials or place of consumption. If the industry is close to the place of supply of raw materials, the transportation costs will be minimal; or if it is near the place of consumption too, the transportation costs will be less and the cost advantage will be passed on to the customers.

This approach will bring a paradigm shift in the decision-making process of setting up of industries. This method also leads to development of all geographic areas as there is no skewed benefit of taxation.

Even though GST is dubbed to be mother of all indirect tax reforms in India, there quite a few challenges in rolling out GST as well as corporate’s adopting GST. To have a smooth transition, a detailed action plan has to be prepared and executed in a timely and meticulously to be an early adopter and reap the benefits of the at the earliest.

Any views or opinions represented above are personal and belong solely to the author and do not represent those of people, institutions or organizations that the owner may or may not be associated with in professional or personal capacity, unless explicitly stated. Any views or opinions are not intended to malign any religion, ethnic group, club, organization, company, or individual.

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