Implementation of the goods and services tax (GST) bill is a now one more step closer to reality, as the government unveiled the taxation rates / slabs for a host of products and services last week.
Here is how leading research houses and brokerages have interpreted the announcements and their impact on the economy, corporates, real estate segment and the equity markets.
We believe that while corporates would pass on the direct benefits of GST (like a lower tax rate), they would aim to retain partly (if not fully) the indirect benefits from the saving in logistics costs, streamlining of business processes and the seamless flow of input credits.
While GST laws include anti-profiteering measures (which say that the benefits of the reduction in the tax rate and input credit shall be passed on by a commensurate reduction in prices and the government may appoint an authority/empower an existing authority to monitor profiteering), we believe such measures are difficult to implement and would be a retrograde step, similar to price controls, if implemented in haste.
First, it would be difficult to assess the commensurate price cuts (due to difficulties in the estimation of the benefits of GST). Second, the government may not have sufficient bandwidth to check / monitor the pricing/profitability of the entire gamut of tax-paying entities. In our view, pricing / profitability would be driven more by industry dynamics, rivalry and competitive intensity than by government directives on price cuts.
Rates indicate a clear bias towards lower taxes on daily consumption and products used by lower-income classes. Food, personal care, luxury items and building material items get taxed at higher-than-expected rates. Volume growth expectations across categories should be moderated given low scope of “branded becoming affordable” and unorganised now having a wider tax gap to manage.
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Organised players will have to make a choice of margins or volumes since. Against expectations, we are negatively surprised for FMCG, building materials and light electricals, whilst for most others rates were in line with expectations (and closer to earlier rates).
In the short term, GDP growth is unlikely to receive a booster as the adoption of a brand new indirect tax structure will entail a meaningful disruption. From a Government finances perspective, Central Government finances will be adversely affected in FY18 as it will have to pay compensation to supplier-state.
KOTAK INSTITUTIONAL RESEARCH
It would be interesting to see how the government handles the vexatious issue of tax on gold and jewellery since (1) the industry vehemently opposes any changes to the taxation structure and (2) gold imports have surged of late.
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In our view, the government should separate the two ‘roles’ of gold between savings and consumption and tax the ‘roles’ separately to achieve its objectives of (1) higher disclosures on purchase and sale of gold and (2) higher household financial savings. Accordingly it can: (1) exempt ‘paper’ gold (gold bonds) completely from tax as is the case for other financial savings products (other than any GST on transaction fees), (2) tax bullion at a rate of 5% to discourage savings in the form of physical gold and (3) tax jewellery overall at 12% GST or making charges (service) separately at 18% GST.
INDIA RATINGS AND RESEARCH
The transition to GST will disrupt the working capital cycle of businesses in the initial phase and thus easy liquidity in the system is essential for two to four months. In order to minimise the magnitude of such disruption at the earliest, and to absorb the sudden changes in requirement of short term finance, easy system liquidity is necessary.
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Ind-Ra studied a sample set of 11,000 corporates and estimates that the input credit lock up for this sample could be around Rs 1 trillion of which about Rs 500 billion could be blocked for about two months which may result in higher short-term working capital requirement for businesses in the near-term.
Even if businesses are able to achieve this seemingly mammoth task and the amounts are credited to the electronic ledger on a provisional basis, it will be subject to variations in the near term as there could be litigations on eligibility and availability under the existing laws and under the GST regime which may lead to disruption of working capital for businesses. The impact on individual companies could however vary widely and Ind-Ra’s study suggests that around 85% of the blocked input credit will be with companies with greater than Rs 5 billion revenues.
The impact of GST has been a mixed bag for the Capital Goods and the Consumer sector. While the Capital Goods sector would benefit from a lower tax rate on contracts there would be higher tax incidence on cables and transformers.
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A few segments in the consumer sector would see higher effective taxes and need to take price hikes to offset cost pressures from increased taxes. Key changes/ surprises versus expectations were for a) Fans which were expected to come in the 18% bracket but have been bought at 28% (currently at 24%) and need price hikes. B)Air conditioners which have been put in the 28% bracket and would need 2-3% hikes, c) Transformer put in the 28% GST rate vs. the current 18% implies price hikes need to be taken d) Cables which were earlier in the 18% bracket taken to 28%, e) Work contract which is in the 15-20% range (depending on the VAT rate) taken to 12% is a positive for the construction sector (L&T, BHEL)
GST rate for under-construction development assets is 12% on property value (including land). Based on our analysis, we expect developers in states with composite VAT (Maharashtra, Haryana) to be negatively impacted as transaction rates increase from 5- 6% to 12% marginally offset by higher inpout credit.
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For states with non composite VAT (Karnataka, Tamil Nadu, Andhra Pradesh), the transaction value changes marginally from 10- 11% to 12% under new regime. With input cost credits available, we could see developers in these regions to witness improvement in margins in case no price revision takes place (subject to anti-profiteering clause).
For affordable housing segment, only labour cost has been given exemption from GST. We await more details on the offset available and introduction of land abatement before implementation of GST.
CRISIL Research believes that industry stabilisation, under the new tax regime, will take a couple of quarters. However, the benefits of GST on business practices and company strategies will be seen only in the medium term (1-3 years). The extent of business efficiency is estimated to be higher in goods as compared to services.
At present, supply chains across major manufacturing industries are strategised based on tax arbitrage aspect. Seamless tax treatment under GST will eliminate the need of multiple warehouses across states. Furthermore, companies will modify their supply chains based on the assessment of tax saving, inventory carrying cost and response time to meet market demand.