How streamlined GST credits may help Indian manufacturers stay agile amid global disruption

By Bipin SapraThis New Year ushered an exciting set of events on the public policy front in India, with India signing/agreeing FTAs with the EU and the US and the annual Budget unfolding with a host of new policies and promises, even as these developments coincided with heightened geopolitical volatility, disrupted global supply chains, and persistent geoeconomic headwinds. In a tough negotiating climate with strong geopolitical developments, the FTAs have ushered in a sense of relief for exporters with the promise of greater market access and lower tariffs. At the same time, ongoing global uncertainties continue to impact trade flows, logistics costs, and investment decisions, and the Indian market is set for more aggressive competition as tariff barriers are lowered and the competitiveness of Indian goods gets tested. Accumulated GST credits are locked capital at a time when manufacturers need liquidity and agility.As India opens its markets through FTAs, domestic cost structures, especially those linked to GST credit accumulation, become even more critical to ensure a level playing field.GST has been one of the biggest economic reforms of this century and continues to evolve into an efficient indirect tax structure for the country. The recent rate rationalization dubbed as GST 2.0 has brought in major changes of reducing the four-rate structure of GST to effectively a two-rate structure of 5% and 18%, doing away with the rates of 12% and 28%. It is expected that this will boost demand in the country leading to growth and competitiveness.Globally, in most mature VAT jurisdictions a single standard rate is the applicable rate on most goods and services with little deviation and minimal exemptions. The Indian GST structure now consists of most services and capital goods at 18%, while most finished goods of essential nature and being used by common households at 5%. Given the substantial difference in the rates, inversion of duties is a given and accumulation of credit is an expected by-product. The accumulation of credit leads to a reduction in ability to recover credit input in the supply chain along with an interest cost on account of cash flow disruption, which leads to an increase in the effective rate of GST. Depending on the business model, this increase in effective GST rate can vary from 2-5% of the overall cost or even more, bringing the domestically manufactured essential goods nearer to an 8% rate. The impact of this inversion also means that any new capital investment for the goods being manufactured in India and taxed at 5% GST, will lead to the capital cost being higher by 18%, the GST rate on the capital asset being purchased. This happens since there is no leeway for the credit of the capital goods purchased being utilized on account of existing accumulated input credits due to an already existing inverted duty structure. Accordingly, the capital cost of any manufacturing investment goes up and hence, the cost of the product being manufactured will be higher in India. A similar product when imported does not have such an inbuilt cost of credit accumulation over and above the IGST levied at the time of import. This puts the Indian manufactured product at a disadvantage as compared to those manufactured in other countries. Accordingly, this issue needs a resolution for continued investment inflow and the success of Make in India.As the appetite for any big reforms will return once the results on GST 2.0 are evident, short-term measures to solve inverted duty structure will revolve around providing a refund of the accumulated credit.The current law also provides refund of accumulated credit in case of inverted duty structure, however the eligibility of the same is limited to the inversion happening on account of rates of input goods being higher than the rates on finished goods and services. If eligible, the refund itself is limited to the accumulation of credit on account of GST paid on input goods only. This leaves out a major part of the accumulated credits even for most eligible companies. The solution lies in including GST paid on the input services and capital goods for inverted duty refunds, the total refund on capital goods may be linked to depreciation in a year. The eligibility of such refunds should also not differentiate between goods and services while evaluating the rate of inputs being higher than the rate of output supply.The accumulated credit in a company is blocked capital and freeing it will reduce cost and also increase competitiveness and investment. These accumulated credits if refunded should not be looked at as a revenue outflow of the government since the government is spending an equivalent amount to boost the manufacturing of these goods in India. Since refund of these accumulated credits improves competitiveness of the products in Indian and global markets, the GST council needs to build in the solution of refund of all accumulated credits at the end of the year, if accumulation is sustained over at least two years.The rationalization of credit mechanism and providing for refund of accumulated credit is a must for the goods to genuinely be able to compete in the global markets. Measuring these changes on short term revenue losses will only harm the companies and while imports will give as much of revenue, allowing refund of the accumulated ITC to the industry will accelerate the ‘Make in India’ story.(The author, Bipin Sapra is Tax Partner, EY India. Views are personal)