Macronomics (Unlocked) : How GST Makes Tax Collectors Out Of All Of Us.

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Customer: What soups do you have?
Waiter: There’s clear soup. And there’s GST soup.
Customer: What’s GST soup?
Waiter: It’s not clear.

This is the joke doing the Whatsapp rounds. While it’s still a little fuzzy, our take on GST is that it has the ability to change India dramatically.

What they tell you about GST is that it will change India. What they don’t tell you is that it’ll also change the entire tax collection concept – in specific, it will make tax collectors out of all of us.

This is a long post about the Goods and Services Tax (GST).

But Let’s Explain GST First

Let’s see the situation before GST. There’s a lot of indirect tax (taxes on consumption). Currently taxes don’t offset each other (more about it below), so the effective cost of a tax to a person in the system is much higher.

How did this money get paid to the government? Before GST, the system was in different silos. If you manufactured an item for Rs. 100, you paid Excise duty, of say 14%. This went to the department of central excise. That means you sold it to a dealer for Rs. 114, out of which Rs. 14 was excise.

The dealer has his own costs such as electricity, Telephone and other stuff for which he pays service tax. When he sells the item to an end-user, he has to pay VAT to the state government. GST means all payments go to the same system (GST) and all input taxes (stuff you pay when you buy) is offset against output (stuff you receive from the customer as GST).

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Still Confused? Well, Let’s see how this progresses in the system, before and after GST using a simple example and a table:

The second column is the system before GST. This is a little oversimplied. In reality even the manufacturer has VAT and there is an excise plus VAT component he will charge and the VAT part is offsettable. But we wanted to keep it simple.

The third column above is how the current thinking is: Let’s keep the end-user price the same, charge the higher GST. That increases prices, but profits to the dealer are more than DOUBLE!

But  the fourth column is: if the dealer retains the same profit then even at 28% GST, we see the same taxes and about the same price to the end-user. Only about 1/5th of all items attract 28% GST – the rest are 18% or lower.

The fourth column is the way the government expects us to do business. Reduce our selling price, and maintain the same profits as earlier.

If GST is lower – and in many cases, it is – the profitability of the dealer goes up, and the price to an end-user comes down! (The last column above)

And, in many cases the selling price of the dealer is less than the price he pays to buy the product from the manufacturer. This is counter-intuitive. If I gave you a cheque for Rs. 140, how can I sell for Rs. 130 and still make a profit? The answer: offsets.

Excise is paid by the manufacturer to the central government’s excise department. VAT is paid to the state, by the dealers (and by wholesalers). Service tax is paid by a person to their vendors, who in turn pay it to the service tax department. You can’t pay less VAT because you paid high service tax. No offsets.

GST allows you to offset input taxes. With one tax – even though there are multiple rates – the idea is: if you paid GST on your inputs, you can offset that with GST on your output.

Can I avoid GST while paying for things?

In column one above the cost to a dealer was Rs. 114 plus the services he took etc = Rs. 125.5. He could sell for cash at Rs. 130 and keep Rs. 4.5 as profit, and evade charging VAT.

In the new system, he can still sell in cash. (He can evade GST illegally) His cost is Rs. 128+Rs. 11.8 = Rs. 139.8. To make the same profit he has to charge Rs. 144.3. This is not much of a difference from the “including” GST cost of Rs. 146.6, for the same profit.

Sales in cash will therefore not have the same advantage as today. 

Does this mean no inflation? Will the Government lose?

Of course not. It will take time for companies to realize that they are seeing a much lower cost base. They’ll see it over time, so any inflation may be temporary. Like we said, it’s counter intuitive to charge customers less than the amount you’ve paid, and then to add GST on it. But this will show up, and prices will moderate.

The government will see a big increase in the tax-base, which means more people will have to pay. How? We’ll come to that.

What if people don’t register for GST?

Anyone that has a turnover of less than Rs. 20 lakh doesn’t have to register for GST.

But there is this complication. Let’s say I’m your customer, and I’m registered with GST, you are not. When I buy something worth Rs. 10 lakh from you, the conversation goes like this:

Me: I’ll pay you Rs. 10 lakh plus 18% GST

You: I’m not registered with GST, pay me Rs. 10 lakh only

Me: Wait, if you’re not, then I have to pay “Reverse Charge” of (say) 18% to the government.

You: Okay, that’s not a problem, you can claim it back when you sell.

Me: How? I sell to my customer at Rs. 15 lakh plus 18% GST. That’s 2.7 lakh of GST I collect. I can’t offset it now?

You: Yeah, you have to file returns in a complex way. First you tell the government that you need to pay the reverse charge for me, of Rs. 1.8 lakh. Then you say you’ve collected Rs. 2.7 lakh from the customer.  They will do the math and tell you that all this will eventually be offset and you only have to pay Rs. 2.7 lakh in total, nothing more. That’s what you’ve collected from the customer.

Me: Okay I love it, no problem. But I’ve paid GST on this item, don’t you get hurt?

You: Oh goodness. You’re right. Now I can’t offset MY input GST on stuff I buy because I don’t have registration! I could have registered, charged you GST, and offset my input costs. Now I can’t!

Me: Yes, but that’s not my problem. Are you registered or not?

You: Hang on. I don’t care about this 20 lakh lower limit, let me just register.

Over time, most business-to-business companies will need to register.

It’s not that simple, because GST requires some form filling etc. But over time people will realize, if they are doing business with other businesses, that it is simply more efficient to register with GST. If your competitor is registered and able to offset input GST (on goods or services) then his profit is higher for the same price.

Reverse charge has existed in many forms in Service Tax, though the scope was limited. Now it’s been made all-encompassing. The problem was usually that that offsets weren’t cross-tax, so many people stayed unregistered with Service tax or such. There was also a lot of under reporting. But now, since every single invoice will need to be registered with the GST system, you will see more people looking to comply.

Effectively, many more small businesses will get registered for GST.  The process sounds complex, but within a few months, you will find that GST filing will become a small-ticket business, with services being provided for 100s of rupees, rather than the many thousands being charged now.

The expanded tax base now allows the government to be able to view invoice level sales. Meaning, you can find out accurately how much turnover a company has made by looking at its customers’ and suppliers’ GST filings. This may sound like a privacy nightmare (it is) but it will change a lot of things for the better – more compliance for one.

Note: kirana businesses (or “business to consumer”) may not need to register, as their customers don’t really want GST credit. They might see smaller profits (since they pay GST but can’t offset it) but many MRP sellers won’t even see that change.

Massive Change in Credit

In a few years, the change in credit opportunities will be huge. Today, small vendors can’t get organized credit because they prefer cash. But with GST, they’ll be filing returns and banks will be able to use their (and their customers’) GST statements to analyze how “real” a business is – and provide credit faster. This is huge, because 70% of businesses don’t get access to organized credit today.

Making Tax Collectors out of all of us

How does GST filing work? If I buy from you, something worth Rs. 10 lakh, and you charge me Rs. 1.8 lakh as GST, then I need to file this.

Also, I’ve sold the product onward for Rs. 15 lakh, and collected Rs. 2.7 lakh as GST. What happens?

First, on the 10th of the next month, I will state that I have received Rs. 2.7 lakh as GST from my customer. (Note: I’m not paying anything yet.)

You, on the 10th of the next month, will also state that YOU received Rs. 1.8 lakh as GST from me. You’ll put my GST number in that filing. You don’t pay anything either.

On the 15th, I will log in to the GST portal and see that you have filed Rs. 1.8 lakh as GST against my name. I’m super happy. Because the system now offset the two, and says pay Rs. 0.9 lakh as NET GST to the government. I have till the 20th to pay and file the final return saying all is well.

This is great. But what if you don’t file by the 10th about my paying you Rs. 1.8 lakh? I will be super unhappy.

Because if you don’t file it, I don’t get the 1.8 lakh offset, and the government will demand my full GST of 2.7 lakh as a payment.

So I will call you up and tell you to file.

If you refuse, I will hold up all future payments. In all likelihood I won’t even pay you until you file the GST. So you will file, and I will hound you until you do.

In effect that means the government will collect the Rs. 1.8 lakh from you. And only 0.9 lakh from me. And I better file in time, or my customer will hound me.

The income tax department didn’t have to do anything. We worked it out between ourselves.

Effectively, the government has make all of us a tax collector.

That’s the interesting thing about GST, or any law – public policing. While this may cause issues in the first six months, we are going to see big changes to the tax efficiency going forward.

Wasn’t this the case always? Well, no. In service tax, you only have to declare your input service tax as a whole, and not at an invoice level. So you consolidate the number, but you don’t have to really say where you offset the service tax from (enforcement at smaller levels is weak, though the big guys face constant audits). Also, there’s no easy way for the government to know if the person you pay service tax to (your supplier) has filed for that service tax or not.

With the GST, this changes. As you become a tax collector, you also become a tax reporter, reporting all your suppliers’ income. And that of your customers.

The Negatives: Input credit refunds, change in payment periods

Let’s say you’re registered on GST. If I buy something from you, and you don’t report the GST collected by the 10th, I have a problem. So, while I can hound you, I will instead change my payment metrics. Instead of paying you the GST on your invoice, I will pay you the GST only when you report the GST collected. This will change or complicate payment cycles for short-credit-period industries, or where payment is in advance, such as cash and carry systems.

Second, look at the fabric industry. Fabric has a GST of 5%. Synthetic yarn has a GST of 18%. A yarn processor into fabric (think of powerlooms) will hurt. They will buy the yarn at 18% GST, but have only 5% GST on output fabric to collect. They can’t claim a refund on the extra GST on the input. Many Gujarat and Coimbatore based small scale units do just that, and this therefore increases the price of the fabric they sell back.

So it makes much more sense if you are an integrated unit (that is, you make your own yarn and produce fabric from it), than to be an outsourcer. However, we hope these discrepancies will be sorted over time.

The Change: GST will slowly skew the game

While many people say the game will move to the big players, we think differently. India is mostly unorganized and consists of small vendors. If registering for GST is the only way they can make money, they will register for GST. And there will be a lot of small accountants that will help them register.

The small guys have a HUGE advantage. They never took advantage of input offsets earlier. When they see the input offsets coming up, they will compete, cut prices and sell more. The cost of compliance will reduce only due to volume.

People that only take cash will need to have a supply chain that only takes cash – otherwise they will find themselves having costs they cannot offset. For instance, you will pay GST on an electricity bill, a phone bill, on a motorbike or such; a cash business has to take the GST paid on it as a cost. A registered business can offset it with tax collected.

Small business is the key to India’s growth. Not farming. Not infrastructure. The small business succeeds despite the system.

In the longer term, if tax compliance increases, tax rates can be reduced somewhat. A rate of 20% might be more acceptable in a few years . Secondly, as people get in the system, they get access to much cheaper credit through banks.

But there are negatives. The first year will be miserable. Capacity to file returns isn’t coming overnight. People will have to learn, adapt and grow. Till such time, we will find that prices are either too high (because GST education isn’t clear) or that compliance costs are too high. This will take a while to adjust. Companies will report falling revenues, or lowered investments until the system realigns.

The short term is not the long term. By making tax-collectors out of us, by ensuring that even small businesses get into the system and by retaining strong input tax offsets, the GST might actually change the financial game substantially. Let’s hope that after the first filing (in September 2017) we don’t see them botch it up.

2 COMMENTS

  1. Deepak

    Very well put in simple language
    However, in the early part you meant column 4 instead of 3

    Our business people are smart and will adapt wherever they see a gain
    I too am hoping we do not go back to the inspector raj

    Best
    Vipul

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