Get Ready For Some Taxing Times

“What is the tangible benefit that the introduction of GST [Goods and Services Tax] is going to bring to the table?” an SME owner popped the question at an interactive session held by FICCI-KPMG in Mumbai recently. Sachin Menon, FICCI co-chair GST task force, and head, indirect tax, of KPMG, replied rather succinctly, “At times, you would have wondered how some businessman or trader you know could buy an expensive vehicle? That’s going to change because a lot of folks thriving in the cash economy will now be a part of the formal economy. There is no escaping that.” While the jury is still out on whether that will indeed be the case, the motley crowd had just about everyone from management executives to traders to SME owners, who were more keen to know whether the transition to the new regime would indeed be as smooth as envisaged and whether the payoffs would be worth the pain. With less than a month on hand, the biggest tax reform change since Independence will not just change the way India Inc runs its business but will also cast the tax net wider by bringing under its ambit the country’s entire universe of 55 million micro, small and medium enterprises (MSME), which contribute around 8% to the GDP.
Here’s a quick look at what’s good, bad and ugly for SMEs in the new dispensation.

A new order: Hitherto, manufacturers with a gross turnover under Rs.1.5 crore were outside of the excise duty ambit, but under the Goods and Services Tax, any entity that supplies goods and services and whose turnover exceeds Rs.20 lakh will need a GST registration. However, if a sub Rs.20-lakh turnover entity ends up dealing with a business whose revenue exceeds the limit, the micro SME may still have to register voluntarily to pass on the benefit of input credit to his buyer. In other words, every single SME unit will now end up being part of the formal economy. Sanjay Mahendru, from the 1992 batch of the Indian Revenue Service and now commissioner of customs, central excise and service tax, believes the change is radical, “For the first time you are going to see the creation of an integrated supply chain instead of a fragmented one, thanks to the inclusive nature of GST.” Santosh Dalvi, partner, KPMG, believes this will prove to be a big kicker to the economy. “One of the major benefits of GST is that it provides an equal footing to large enterprises as well as MSMEs and gives better competitiveness to these enterprises. It will also eventually increase the competitiveness of Indian goods and services in the international market,” feels Dalvi. While the outcome may be desirable, the task of bringing the entire MSME universe into the GST ambit seems to be a rather herculean one. Tejas Goenka, executive director of Tally Solutions, whose ERP software is popular among small enterprises, mentions that most small enterprises have yet to come up to speed to ensure that compliance happens in time. Every entity in the GST chain has to ensure that returns are filed on the 10th, 15th and 20th of every month, besides an annual return. In short, while the multitude of taxes is paving way for a common four-tier tax rate structure (5%, 12%, 18%, and 28%), the complexity of operations is not. But Mahendru believes that while there will be teething problems, the gains in store for SMEs will far outweigh the troubles of compliance.

Smooth start: Don’t read too much into this one, except for the fact that any new business being set up under GST would need a centralised registration. Previously, one had to submit excise, value added tax (VAT) and service tax returns separately every month, now an entity would need to maintain just one book for GST. A simplified tax now replaces the combination of central sales tax (CST), VAT and entry tax for any inter-state purchase. But the hitch is that small and even large enterprises will need multiple registrations in whichever state that they supply goods or services. The main reason for dual GST is to account for the share of state governments, that is, SGST (State Goods and Service Tax) and the share of IGST (Integrated Goods and Service Tax). “Since GST is a destination-based tax, and one needs to account for the taxes paid, registering separately in all such states where you do business is a must,” explains Mahendru.

Easy money: Sounds like an oxymoron, doesn’t it? Nevertheless, at first glance, SMEs in a GST era can look forward to better access to credit as digital invoicing and data analytics will ensure a verifiable trail of transactions in the supply chain, thus, bringing more credibility into their businesses. Based on this information, SME owners can now look forward to flow-based lending as against collateral or asset-based lending from banks and non-banking finance companies. “They will become more bankable by being part of the formal supply chain and that negates the perceived high cost of compliance,” points out Mahendru. Currently, for a fee, the centre and Sidbi-owned Credit Guarantee Fund Trust for Micro and Small Enterprises provides guarantee of up to 85% of a sanctioned loan to an SME.

Less ambiguity: With the GST Council comprising central and state finance ministers fixing the rates for over 1,200 items, with some essential items either under the lower tax category or completely exempt, there is far more clarity on how states will treat such commodities. Take the instance of sweets. S Satish, executive director, RSM Astute Consulting, says, “Earlier, mithai (Indian sweets) would be treated differently from confectionery by one state, whereas the same product would be clubbed as part confectionery in some other state. But now that’s no longer the case as standardisation of products and categories with uniform rates offer much more clarity.”

Leeway on expenses: Unlike the current restrictive rules on input tax credit, GST has widened the input tax credit ambit to include any input or services used or intended to be used in the course of or for “furtherance of business”. Under the current CST rules governing inter-state sales, input credit is not offered to a buyer, resulting in a higher cost for the buyer. Satya Pramod, CFO at Tally Solutions, mentions that for, as an example, service tax paid by a trader on advertising services for business purposes is not allowed as credit, and instead treated as an expense. But the same will be now allowed under the concept of “furtherance of business”, thus potentially reducing a SME’s cost of operation, and, in turn, offering the possibility of better net margins. But the catch is that SMEs will need to avail the goods or services from a registered entity to account for the tax paid on the overhead.

Compliance bug: There is no ease of filing returns though. At present, an entity has to file VAT or excise returns once in three months but now a GST-registered business will be required to file three returns every month – GSTR-1, GSTR-2 and GSTR-3 – comprising details of all purchases, sales, and the final tax liability after setting off the input tax credit. What queers the pitch is that the GST suvidha providers have not got enough time to test the software for each data set, for example, the sales or purchase register of a firm. The service provider needs to upload the dummy data on the GST network to check if data is being correctly captured. “The government hasn’t provided for enough time to do a trial and error check of the Application Program Interfaces (APIs) as it will ensure a glitch-free kickoff for SMEs,” mentions Goenka of Tally. More importantly, lot of SMEs are still to upgrade their IT systems to incorporate the changes, meaning the process of invoice matching, which is crucial to avail of input tax credit can be severely hampered. 

Transitional blues: To make the transition smooth, the GST rules allow a business to carry forward eligible tax credits availed under the existing indirect law provisions into the new regime. However, to avail of the benefit, the entity needs to ensure that proper records of all receipts and invoices are maintained. But units operating under the sub Rs.1.5 crore excise duty limit are in a fix. “If I am a VAT-registered dealer who deals in excisable goods, but since I am not excise-registered [because of the exemption limit] I may have not necessarily retained the excise invoice. If I don’t have that data I am not in a position to claim the credit. The government is still to clarify its stance on the same. Unless that doesn’t happen and gets incorporated into the IT system, SMEs will find the transition a loss-making affair,” points out Goenka. Satish of RSM Astute Consulting, points out that according to the draft transition law, depending on the relevant tax slab, companies can get credit of up to 40% to 60% of their central GST liability against excise duty paid on stocks lying with traders or retailers when GST gets implemented. “The government is clear in its stance. But the jury is still out on who will bear the loss,” he adds.

Cash flow squeeze: Come July 1, stock transfers made by an entity among its own branches or units will be  taxable. With GST due on the date of the transfer but credit available only when the stock is liquidated by the receiving branch, cash flows of smaller enterprises could be impacted. Currently, if a company ships a good from Mumbai to a store in Delhi, 2% excise sales tax is paid on the MRP and sales tax is incurred only at the time of sale. Post GST, for a transfer to any place outside a state, the company still has to pay GST and take one-time credit. Putting it in perspective, Ganesh Babu, chief financial officer, House of Anita Dongre, which clocked a turnover of over Rs.400 crore in FY16, explains, “I would have paid GST in advance but that benefit only kicks in when the sale happens. I will still have a one-time working capital requirement. Even for a company of my size, it means an additional working capital of Rs.20 crore. So, the reality is that one-time working capital requirement is not going away.” Yet another issue that will impact an enterprise’s cash flow is that under GST, on receipt of advance against supply of goods or service at a later date, tax needs to be paid on the date of receipt of advance. Goenka of Tally feels the taxability of stock transfers under GST will have an impact on cash flow. “The tax is paid on the date of stock transfer, but the input tax credit is used when stock is liquidated by the receiving branch. Hence, under GST, for businesses engaged in stock transfers, especially for pharma and FMCG, the need of additional working capital arises due to tax instances,” he explains. Similarly, today, an entity can set off service tax credit availed on input services against a service tax liability without any restriction across states. But in GST, since registrations are state-wise, one cannot offset CGST credits against SGST liability and only use it for CGST and IGST. This is expected to put additional pressure on a SME’s cash flow. Dalvi of KPMG, though, observes some positives as well. For example, the change in the mechanism to avail credit on tax paid on procurement of capital goods from 50% to 100% in the year of purchase is expected to result in better working capital management.

Rating trap: Just like a credit rating, the government too plans to have a GST compliance rating for registered users. While the move is a welcome step, the fact that some SMEs may not be able to pay the tax in time could adversely impact their business. Goenka of Tally points out: “What if there is a promising auction or offer for materials which offers a SME higher profitability? They have to readjust their cash cycles for a few weeks to take advantage of it.” Hence, a delay in meeting the obligation will make the supplier vulnerable to buyers and a poor rating will eventually accentuate the crisis for the enterprise. “It can potentially drive almost every small business to eventual closure.” What’s more, even refunds to a taxpayer will be determined on the basis of the ratings. A SME or any entity with the highest rating of 10 will be entitled to complete refund immediately, while a lower rating will result in commensurately lower percentage of refund amount being settled.

Way-ward: The introduction of electronic challan (E-way bill) for shipping goods over Rs.50,000 is seen as another spoiler as the same consignment at different legs of its journey could end up needing an updated e-way bill given its limited time validity. For distances less than 100 km, the validity of an e-way bill is a day and for a distance of over 1,000 km, it’s 15 days. It means that a new challan needs to be issued every time a truck fails to meet the time limit. What’s painful is that the whole process is multi-layered, involving not just the transporter but also the supplier and recipient. For a bigger company, it would not be an issue but for a resource-constrained SME that would entail a substantial waste of productive hours. Importantly, it defeats the grand idea of “one nation, one market” as the e-way bills will make shipping of goods across the country a cumbersome and expensive affair.