The goods and services tax (GST) is slated for rollout in less than two months and voices are coming forward on the possible negative impact on small manufacturers. We have heard these stories earlier – when the country did away with quantitative restrictions on imports in 2001 and when it opened up sectors reserved for production by small-scale industries.
Each time, the risk of decimation of small enterprises was vociferously raised – but then quietly buried when the sector remained resilient and, in fact, grew faster than the overall manufacturing sector. The fears regarding GST impact on small enterprises are likely to be similarly misplaced.
India’s micro, small and medium enterprises (MSME) account for 6% of GDP, one third of manufacturing output and 45% of exports. They number some 51 million enterprises and employ more than 111 million people. Any shock to the sector would have a ripple impact on the entire economy.
The GST is a landmark reform measure almost two decades in the making. The most significant indirect tax reform in the country post independence, it is a destination-based tax that would subsume numerous other indirect taxes imposed by the central and state governments. These include excise duty, service tax, octroi, local state taxes, central sales tax and others, so that the earlier system of tax-on-tax would be eliminated.
With the entire country governed by a common tax rate, India will become a single, unified market. Apart from simplification of taxes, the GST will add efficiency to the system as it is expected to be location-agnostic and reduce logistics costs.
Notably, the GST is to be implemented through an online system, the GST Network (GSTN). Prepared to handle some 3.5 billion transactions every month, the automated system will match invoices and ensure input tax credit. Businesses are supposed to register on the network and interface with the system up to 37 times a year for tax return filing.
Although the overall benefits to the economy from the introduction of the GST are expected to be positive, there are several concerns being expressed about whether small enterprises will have the resources to deal with what could be a somewhat complex system. Would MSMEs have access to computers, software and online connectivity required for regular filing of returns? Would proprietors be able to manage the invoices and input tax credits? What if a supplier was unable to file their tax return on time?
The GST Council has set a threshold of Rs 20 lakh turnover for exemption from filing of returns (Rs 10 lakh for businesses in the northeast and hill states). Earlier, this limit was Rs 10 lakh for excise payment. This in itself would mean that most small enterprises would not be included in the tax net.
Further, the council has offered the option of composition levy for businesses upto Rs 50 lakh turnover, at the rate of 2.5% of total revenue for manufacturing firms and 1% for others (except suppliers of food and drinks). While firms with turnover of between Rs 20 lakh and Rs 50 lakh would require GST registration, they would have to only pay tax once every quarter at the prescribed rate.
It is expected that the GST will bring more enterprises into the formal system. Currently, as per the MSME ministry, just about 1.6 million of almost 20 million enterprises are registered. It will also infuse discipline to operations and reduce tax incidence, so that small firms become more competitive, efficient and productive.
With a stringent process of online invoice matching, there is high incentive for enterprises to avail of the benefits of input tax credit and step within the formal tax fold. Much as the self-help groups in the micro-credit sector have leveraged peer pressure to ensure repayment of micro loans, purchasers would be keen that their suppliers file tax returns on time, so that they themselves can receive the tax benefit.
For example, a firm selling a bicycle part for Rs 200 would pay Rs 20 as tax. The buyer of the part would add value of Rs 100 and sell her product for Rs 300+Rs 30 as tax and receive back as input tax credit Rs 20 paid by her vendor. If the vendor does not pay her Rs 20 of tax, the purchaser would be liable for the entire amount of Rs 30. This is a powerful incentive to ensure that all nodes of the supply chain pay tax and pay it on time, and could expand the tax base.
Firms which currently avoid declaring their entire turnover and prefer to transact in cash outside of the tax net would find it now more difficult to operate in this manner. Coupled with the increasing prevalence of digital transactions and greater tracking of the movement of goods through the GSTN, their businesses would be subject to greater scrutiny from tax officials.
Parts of the underground economy, estimated at around a quarter of India’s GDP, may thus be forced to emerge from the shadows. According to the Economic Survey 2015-16, about 15.5% of net national income excluding taxes was reported to the tax departments and nearly 85% of the economy is outside the tax net. Lethargic firms above the threshold turnover should quickly pull up their sleeves and consider complying with the new regulations.
Critics have pointed to the fact that small enterprises often face disruptions such as illness or unforeseen events due to which they may not be able to file returns within the stipulated period. This would not only put this firm at risk of losing business, but also impact the purchaser, possibly another small enterprise that may not have sufficient working capital to absorb the loss of input tax credit. Such risks would have to be tackled by proprietors, with perhaps alternate workers to file returns.
Another risk that has been pointed out comes from the rating of vendors by buyers. The GST system permits buyers to rate their suppliers in payment of taxes, so that those who consistently do not pay on time may lose business. However, the rating imposes a strong discipline and ensures compliance, making the whole supply chain function smoothly and efficiently.
A third factor relates to the frequency of tax interface and its online application. Enterprises must file returns three times every month plus one annual return, in different forms. Finance ministry officials have taken pains to reassure taxpayers that these involve mostly a single detailed filing, followed by a matching exercise for purchases and sales from both players in the transaction.
A key concern is that despite extending the time limit for GST registration, the majority of eligible firms in the services sector are not yet enrolled, indicating the challenges in outreach.
Enterprises above the threshold limits that wish to remain in legitimate business will face an adjustment and transition period and must set in place the required fundamentals of software and registration in time. A trial run for a few months may be in order, when penalties do not apply and enterprises have time to deal with the changes without pressure.
Ultimately, the proof of the GST pudding will lie in the efficiency of its implementation. Government officials, tax consultants and industry associations are working hard towards awareness, but initial glitches are very likely, especially since some of the rules and tax rates have not yet been finalised. Once the adjustment period is managed, all enterprises and the overall economy will benefit greatly from the GST, and only inefficient firms may find themselves in trouble.