Goods and Services Tax (GST) in India

1. Goods and Services Tax
Indirect Taxation – A Perspective
India has historically had the world’s most complex regime of Indirect Taxation. Taxes have been
levied at various levels:
 Central – Excise, Central Sales Tax
 State – Sales Tax, Entry Tax
 Town/Municipality – Octroi
To compound the problem, each State and Town interpreted taxes in its own way. For example, Sales
Tax may have been levied at first point or last point with percentages varying from 5% to 20%. Octroi
may be ad valorem or on weight for different commodities.
Over the years a series of reforms by Government and responses from FMCG companies have
characterised the landscape. A brief summary leading up to the current situation is presented below:
 The first action by the Government was aimed at consumer protection. The introduction of a
maximum retail price with local taxes extra was a welcome step that paved the way to further
reform. This was followed later by an MRP that included all taxes. FMCG companies with
nationally distributed brands had to compute a weighted average of their sales state wise so
that they could fix an MRP that took all possibilities into account and optimised their margins.
Overall the introduction of an MRP has been a very important step and in many ways India is
ahead of developed countries in this matter.
 The evolution of Excise has also been interesting. In its original form Excise is a tax on
manufacture and is levied on the ex-factory price. However, the Government offered tax
concessions to small scale manufacturers so that they did not have to pay Excise. This led to
some interesting developments. The first response by FMCG companies was to start sourcing
products from 3rd party manufacturers so that Excise could be levied at the price at which the
goods were purchased by them. This move eventually led to the development of companies
focused on contract manufacturing which is an important element in the FMCG Supply Chain
today. Secondly, many FMCG companies started sourcing goods from multiple small scale
manufacturers who were below the exemption level for Excise applicability. These
developments led to the Government changing the applicability of Excise onto MRP albeit
with allowed abatements. At present the excise tax regime is neutral to whether the goods are
produced in house or through contract manufacturers whether the manufacturers are small
scale companies or not.
 An important development was the establishment of zero excise zones in the hill states. This
has led to wide scale establishment of manufacturing facilities especially in HP, Uttarakhand
and to a lesser extent in J&K. There is some development in the North East as well. On a
pure cost basis without taking taxation into account it may be argued that these units are less
cost effective due to additional logistics costs. A major logistics industry has also come up to
support these units. For example Zirakpur near Chandigarh has a high concentration of
Mother Godowns and C&FA’s catering to goods flowing down from Baddi and Parwanoo. The
tax concessions have now been withdrawn and are not applicable to new units. We will have
to see how whether companies will find these facilities viable when full excise will be levied.
 Central Sales Tax which used to be levied on all interstate sales at 4% is a major contributor
to the evolution of the logistics structure as it exists in India today. Virtually all FMCG
companies had to set up Company owned Depots and later C&FA agents in major states to
avoid paying CST. The only exceptions may have been the North East States and perhaps
J&K or HP. There is an additional cost of running these C&FA’s but that is lesser than the
CST levied. Government has now brought down the CST to 2%. However the structure of the
CFA system has not altered much as yet.
 Some uniformity has been achieved after the introduction of Value Added Tax (VAT).
However differences still exist.
To sum up, the evolution of Indirect Taxation in India has been a long process. Progressive reforms
have had a beneficial impact on both the consumer and FMCG companies. Concessions offered by
the hill states have led to industrialisation of these areas and has had a significant impact on GDP
growth and poverty alleviation. However there is still some way to go and the introduction of a
standard Goods and Services tax is a much needed initiative. As will be seen from the graphic below,
the contribution of Indirect Taxes to total Taxation is the highest in India.

2. % Share of Indirect Tax in Total Tax - 2007
80
70 Source NCAER
60
50
40
30
20
10
0
Goods and Services Tax
International Experience
From its earliest introduction in Europe close to 50 years ago, GST has been introduced in more than
140 countries in some form as of now. There are many alternative models in use. For example,
Singapore and New Zealand have basically one tax rate. Indonesia has 5 basic rates and various
categories of exemptions. In China, GST is applicable only to goods. In most cases the introduction of
GST has resulted in a positive impact on the economy due to the simplification of the tax regime and
the avoidance of cascading. GST rates vary from 5% to 20% across countries.1
Country Wise GST rates
25
20
Source: NCAER
15
10
5
0
1
Gagan Seksaria, Principal Tuscan Ventures

3. GST in India
In its simplest form GST is a single comprehensive tax levied on Goods and Services at every stage
of the supply chain from manufacture or provision of service to consumption. At each transaction point
(sale or provision of service) the seller or service provider will claim the input credit of tax which he
has paid while purchasing the goods or service. This will avoid the incidence of cascading or ‘tax on
tax’
However, the pristine form described above will not be applicable in India due to the Federal nature of
the country. The plan is to introduce a dual GST structure with a Central GST and a State GST. Both
CGST and SGST will be charged by the manufacturer or service provider in the first transaction. Most
state and local taxes will be subsumed within the new regime. The combined value of the two GSTs is
being deliberated as of now but may be in the range of 14 – 20%. Thereafter, the split between CGST
and SGST will have to be agreed between the centre and the States. There are several important
legal and constitutional hurdles for implementation which are outside the scope of this paper.
However, the following issues are pertinent:
 Input tax credit may be claimed at each stage of sale or provision of service. However, tax
credit is not transferable between CGST and SGST
 The threshold annual turnover for SGST will be relatively low for both Goods and Services
while the figures for CGST will be considerably higher
 Rates for GST may be lower for essential commodities, standard for most other materials with
a special rate for precious metals. Services may have a standard rate for both CGST and
SGST
Impact of GST on the FMCG Industry
Manufacturers in India have to bear the brunt of a plethora of taxes as follows:
 Imported raw and packaging materials are subject to a complex regime of customs duty,
CVD, Cess and other levies. The multiplier for landed cost to CIF is as high as 33% 2 for
finished goods even though the base customs duty is 10%. Many of the levies cannot be set
off and downstream taxation is applicable on the duties as well.
 Excise duty would then be levied on manufacture.
 Central Sales Tax may be applicable if interstate sales are being done.
 VAT would be applicable on sales within a state. Entry tax may also apply for some states.
 Local taxes and levies such as Octroi would be applied in some towns within some states
such as Maharashtra.
 Service Tax would be levied on transport.
In addition, legal compliance, book keeping and litigation further add to the administrative and cost
burden. A lot of the advantages that India has as a low cost manufacturing base get nullified due to
the taxation structure. The introduction of a unified system of GST will simplify the whole regime to a
very great extent. It is yet to be seen whether there will be actual reduction in the overall tax amount
(depending on the rates that are finalised by Government) but administration and management will
certainly be simplified. Cascading of tax will also be eliminated to a large extent.
Factory Locations
Many FMCG Companies including HUL, Dabur, Colgate, Bajaj Corp and most of the other majors
have established manufacturing facilities at HP or Uttrakhand. Locations such as Baddi and
Parwanoo in HP and Haridwar and Dehradun in Uttarakhand have become veritable hubs for the
FMCG industry. A host of ancillary and support industries especially in packaging and selected raw
materials have also come up in the same locations. This growth has largely been based on two
exemptions – Excise as well an abatement of Income Tax. However, both these are coming to an
end. New units will no longer have excise exemption and existing ones will run their course. There
could be profound changes in factory locations as these exemptions come to an end. There is
additional logistics cost involved with having factories located in remote areas. Without the
exemptions FMCG companies are likely to move manufacturing closer to markets and sources of
supply.
2
YFactor Analysis

4. Distribution Structure
Over the years FMCG companies have responded to the tax regime by developing a chain of C&FA
agents in each state. Goods are transferred to the C&FA without a title transfer (sale) thereby
avoiding the incidence of Central Sales Tax. However it is also true that stock movement to smaller
distributors is difficult from long distances. For instance if we consider a large state like UP, most
FMCG companies would need to establish 3 C&FA’s to cover the state effectively especially if they
Factory - Baddi
Mother
Typical FMCG Distribution Godown -
Zirakpur
C&FA -
C&FA - Lucknow C&FA - Varanasi
Ghaziabad
Distributors in Distributors in Distributors in
West UP Central UP East UP
are covering smaller markets. Typically, the locations may be at Ghaziabad, Lucknow and Varanasi. It
is a moot point whether after the introduction of CST, FMCG companies would find it suitable to
reduce or relocate their C&FA’s in the state of UP. YFactor’s view is that while there will be changes
in the logistics structure based on the implementation of GST which are discussed below, the
changes will also need to be driven by a change in the structure of FMCG distributors. As long as
distributors continue to operate at town level, servicing requirements may make it imperative to
continue with distributed warehousing.
 It is possible that the numbers of C&FA’s may come down to some extent. For example if
interstate servicing of distributors does not attract tax, a C&FA at Ghaziabad could service
both Delhi and Uttarakhand in addition to West UP.
 Total warehouse space may also come down as companies would be able to use their
warehouses more efficiently.
 Larger warehouses would make investments into automation, racking systems and ERP
systems more practical and cost effective. At a rough estimate, these investments become
practical for warehouses larger than 30,000 sq ft. Transportation will also become more
efficient and cost effective with the use of larger vehicles for stock replenishment.
 Inventory, transit stocks, stockouts would all come down.
YFactor’s recommendation is that all FMCG companies should undertake a comprehensive review of
their Manufacturing and Logistics Strategy in anticipation of the introduction of GST. As discussed
earlier, factory locations may need to be reviewed. The Cost/Benefit of C&FA locations will similarly
come up for discussion. Based on market priorities and servicing requirements it is unlikely that there
will be a ‘one size fits all’ solution for all companies.

5. Logistics Industry
It is a matter of concern that India’s spend on primary logistics is very high (Rs 2.7 Trillion in 2008-09
equivalent to 8.2% of GDP vs 5-6% for developed countries3) due to several built in inefficiencies.
There are several issues with specific reference to the FMCG Industry:
 Most, if not all movement of raw material, packaging and finished goods across the country is
by road. Rail transport has virtually ceased to service this sector. Air transport is obviously
expensive and is resorted to only in a crisis situation. Waterways, including coastal and
riverine movement are also not used by the FMCG Industry.
 Road transport in turn has its own issues. Poor physical infrastructure, badly maintained
vehicles, checkpoints and entry barriers at all state borders make transit a long drawn out
process. It can take upto 2-3 weeks for goods to reach from a factory in Baddi to East or
South India whereas the same distance would be covered in 2-3 days in a developed market.
Stock in transit is a significant element in the overall inventory carried by FMCG companies.
 In most towns, ‘transport markets’ serve to direct trucks for picking up goods from factories or
C&FA’s on a roster system in return for a small fee. Transport unions have sprung up in many
places to ensure that truckers get a fair rate for their work. However, since these are largely
unorganised, FMCG companies tend to find ‘work around’ solutions. In Baddi and Parwanoo
for example the rates from the trucking union are high compared with similar rates from
Zirakpur in Punjab. This has effectively reduced the usage of trucks from Baddi to a shuttle
service to Zirakpur where most companies have located their mother godowns.
 The slow growth in establishment of professional trucking fleets is a matter of concern. Most
companies being highly cost conscious tend to trade off future efficiency for current cost. This
effectively reduces the usage of professionally managed fleets.
 A similar situation prevails in warehouse management. As discussed earlier, smaller
warehouses tend to be less efficient. With the advent of GST there is likely to be some
consolidation at the company level. Hopefully, there will also be a greater role for professional
3rd Party Logistics Professionals who can bring about much needed consolidation and
expertise into this segment.
Benefits from GST Implementation4
NCAER estimates that the benefits from implementation of GST would be:
 An increase of GDP between 0.9 – 1.7% corresponding to absolute values of GDP increase
over 2008-09 GDP levels between Rs 42,789 Crore and Rs 83,899 Crore, respectively. The
equivalent dollar value increment is estimated to be between $9.5 Bn and $18.6 Bn.
 The additional gain in GDP, originating from the GST reform, would be earned during all
years in future over and above the growth in GDP which would have been achieved
otherwise. The present value of total gain in GDP has been computed as between Rs. 1,469
thousand Crores and Rs 2,881 thousand Crores. The corresponding dollar values are $325
billion and $637 billion.
 Gains in exports are expected to vary between 3.2 and 6.3 per cent with corresponding
absolute value range as Rs. 24,669 crore and Rs. 48,661 crore. The comparable dollar value
increment is estimated to be between $5,427 million and $10,704 million, respectively.
Imports are expected to gain somewhere between 2.4 and 4.7 per cent with corresponding
absolute values ranging between Rs. 31,173 crore and Rs. 61,501 crore. The comparable
dollar value increment is estimated to be between $6.9 Bn and $13.6 Bn, respectively.
 GST would lead to efficient allocation of factors of production. The overall price level would
go down. It is expected that the real returns to the factors of production would go up. Our
results show gains in real returns to land ranging between 0.42 and 0.82 per cent. Wage rate
gains vary between 0.68 and 1.33 per cent. The real returns to capital would gain somewhere
between 0.37 and 0.74 per cent.
 The efficiency of energy resource use improves in the new equilibrium. The introduction of
GST would thus be environment friendly.
3
Source CRISIL
4
The section has been taken from NCAER’s report on GST

6.  Based on NCAER computations, the revenue neutral GST rate across goods and services is
expected to be positioned somewhere in the range of 6.2 per cent and 9.4 per cent,
depending on various scenarios of sectoral exemptions.
As per NCAER, “implementation of a comprehensive GST in India is expected to lead to efficient
allocation of factors of production thus leading to gains in GDP and exports. This would translate into
enhanced economic welfare and returns to the factors of production, viz. land, labour and capital.”
FMCG companies should anticipate the change and institute a comprehensive review of their Supply
Chain and Logistics systems to capitalise on the anticipated benefits.