The Make in India campaign launched in 2014 signaled the current government’s desire to increase the manufacturing capacity of India, which will diversify and strengthen the Indian economy. Along with the launch of the program several key reforms occurred such as the reduction in foreign investment caps in Indian businesses. Along with the other changes a key reform needed is the Goods and Services Tax (GST).
Presently, India’s manufacturing sector accounts for 16% of its GDP while its services sector accounts for over 50% of its GDP. The remainder comes from agriculture and most people are employed in the agricultural sector. An increase in manufacturing capability will lead to an increase in the productivity of the Indian economy, create stable high wage jobs and improve the agricultural sector by leading to increases in mechanization and automation.
India’s prowess in IT and software development is well known globally but its manufacturing sector lags. One of the challenges India faces is that it does not have enough infrastructure for manufacturing which in turn is dependent on manufacturing, so until the manufacturing capacity and capability increases all the machinery and inputs required for infrastructure development comes from overseas. This creates a situation where there is a restriction on growth in India because of a lack of manufacturing and infrastructure.
Tax impacts the cost and supply chain of manufacturing in India by making it expensive and inefficient to manufacture in India. Consider the following examples and then there is a contrast in India.
A car manufacturer in Germany will complete its final assembly of the item in Munich. The supplies for the car are made across Europe and moved into Germany. The German factor must pay 19% VAT on the inputs it uses including those from outside of Germany. The suppliers can be in many different European Union member states like Austria, Poland and the Czech Republic in each case the German factor will account for the VAT. Even the electricity and water for the factory are subject to 19% VAT. When the car is completed and it is sold either it is subject to 19% VAT or 0% VAT if the car is sold to a unit outside of Germany. In any case, the VAT is fully recoverable for the manufacturing of the car.
A phone is manufactured in China at a factory in Guangdong. The case and screen for the phone also come from Guangdong but the batteries are shipped from Northern China. The Chinese pays its suppliers’ 17% VAT on the inputs used to build the phone. When the phone is completed the factory charges 17% VAT to its distributors and offsets the VAT it paid to suppliers in China.
In contrast, in India there is not a fully integrated indirect tax system and so the factory trying to make something faces problems. First, factories can lack certain inputs and so those could have to be imported which will mean the item will be subject to a Basic Customs Duty and then Countervailing Duty. This could also be the same case in Germany and China but the number of for machinery or other finished items in those countries is far less. If the phone manufacturer or car manufacturer has suppliers in different states then each movement of goods between states is costly and tedious because the movement goods between states is subject to a 2% Sales Tax and not a VAT. Additionally, items have to go through checkpoints to move through states. In China and Germany there are no checkpoints for these items to move through and in Germany the goods can cross multiple countries without being stopped or inspected. The Central Sales Tax becomes a cost which gets built into the goods. Then Central Excise will be levied on the goods at time of manufacture and VAT or Central Sales Tax could then be applied at sale. The multiple taxes are not recoverable and this leads to higher costs. Also, if a business does not choose to collocate its production facilities in a state it can lead to higher costs and longer manufacturing cycles waiting for inputs to arrive.
The GST would change this India example so for the manufacturing plant the tax impact was like China. In this case, the inputs or as they would be called supplies for making the phone or car would be subject to GST. When the product is finished then GST would be charged and the input and output GST are offset against each other. This eliminates the cascading impact of tax described above and GST removes the need for the costly interstate checkpoints so manufacturers can have goods sourced from across India as opposed to in one state.
As noted though the entry price for the GST is the submission of accurate tax information to counter-parties and the government on a continuous basis. Manufacturing companies must ensure their software systems are ready to produce the tax specific data required for GST Compliance. It is likely most manufacturing inputs will be taxed at 18% or 5% but there will be certain supplies which will be taxed at 0%, 12% and 28% and the systems must be prepared for all combinations. Additionally, unlike in China and Germany there will be a requirement to categorize domestic transactions between the different tax regimes. Now the CGST and SGST rates will be 50% of the IGST rate so more rates should be maintained: 0%, 2.5%, 6%, 9% and 14%.
Even after correctly calculating and classifying every transaction, manufacturing companies are submitted data by state or even by plant depending on registration choices to the GSTN for compliance. Similarly, the inputs used for products are downloaded from the GSTN and reconciled to complete the compliance process.
The GST compliance cycle is monthly and the manufacturer must complete its GST returns cycle by the 20th and this is an on-going effort.
When faced with this complex compliance requirement, it could be valuable to utilize an automated GST compliance solution. This automated compliance solution can take GST data directly from a source system and communicate with the GSTN to get counter-party data and create all the returns. A manufacturing company can use a tax engine which can check both sales and purchases to ensure that there is high quality data coming into the compliance system. Finally, if these offerings are SaaS offerings then the manufacturing company can benefit from getting world class technology at the cost of a subscription rather than having to purchase, deploy, and maintain IT hardware.
Contact us to learn more about our integrated GST offerings which can be leveraged today with a variety of manufacturing software systems.
by Anil Kuruvilla.
He is an international Taxation Expert and Chief Content Officer at Adaequare (Parent company of Udyog Software).