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GST: Captivating Enough For Investors?

GST also brings additional business opportunities to a number of IT companies since every company now need to overhaul its existing IT/ERP system

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The economy is looking at a paradigm shift in the Indian indirect taxation regime with the government’s steady progress towards the roll out of the Goods and Services Tax (GST). The speed at which government is moving and the manner in which industry recommendations have been accepted and incorporated in the revised GST law released on 29 November, is commendable.

What is there for the venture capitalists (‘VC’) who have invested millions of dollars in the Indian startup companies? What do they need to know on GST and its impact on the prominent industries where substantial money has either already been pumped or is in the pipeline? This article aims to highlight few prominent sectors that are of interest to VCs highlighting how GST is likely to impact their margins, working capital needs and overall valuations.

Will GST be a good news for IT companies?
Currently services attract 15 per cent service tax (including cesses). This is likely to increase to 18 cent under GST. As there is always a timing difference between invoicing and payment realization, IT companies shall require additional working capital to manage the statutory dues.

Currently, fungibility of taxes inter se VAT and service tax on procurement of goods is not allowed. GST is going to change this, thus reducing the cost of procurement and consequently positively impacting the bottom line of such businesses.

One of the biggest challenges IT industry faces is classification of software as goods or service, resulting in dual taxation. GST should settle this since the rate of tax and kind of tax charged for both goods and services should be same. Though, the revised GST Law provides enough clarity on customised software that has been deemed as a ‘service’, no clarity with respect to ‘off the shelf software’ exists.

The biggest hit on the bottom line of IT companies shall be the cost of additional compliances, more particularly from increased GST registrations in all the states from where services are performed and filing atleast eighteen times more GST returns annually as compared with the existing scenario. Each IT company having offices in multiple states from where services are provided shall have to be separately GST registered as compared to a single centralised registration under the existing tax regime. This can increase compliances multi-fold.

Intra-company transactions are proposed to be taxed under GST. Any secondment of employees, sharing of common expenses between related companies would be taxed. Though, the receiving entity would be entitled to avail credit of tax charged by the supplying company, this would result in requirement of additional working capital for all such companies.

GST also brings additional business opportunities to a number of IT companies since every company now need to overhaul its existing IT/ERP system. Additionally, the GST Council has also come up with the concept of GST Suvidha Providers (‘GSP’) who will act as mediators between taxpayers and Government. Such mediation shall be routed through development of apps/ websites that will enable Government-2-Business (‘G2B’) interface. A large no. of IT startups are likely to benefit from this initiative.

E-Commerce Industry under the heat!
The E-commerce industry is broadly divided into two segments. One, which is acting as a market place and the other that is selling goods/ services on its own.

All companies supplying goods or services through online portals (apps/ websites etc.) will be looped in the E-Commerce Operator (‘ECO’) Model.

Every ECO shall be responsible for collection of tax at source (‘TCS’) while remitting payment to its business partners. This would drastically increase the documentary & accounting costs and increased compliances for ECOs. The revised draft GST law also provides a provision to make notified ECOs liable to pay GST on all transactions routed through their portal.

The ‘TCS move’ is proposed with an intention to bring vendors under the tax net. Currently, vendors selling goods or services through marketplace platforms don't always end up paying taxes. It will have to be seen whether any increase in price by vendors would impact the price-sensitive market on Indian e-commerce industry.

Substantial compliance burden including filing additional returns will surely add up costs, negatively impacting their bottom line.

Good news for pharma sector?
A major concern for pharma industry is the inverted duty structure that the GST proposes to address positively. GST proposes to grant refund of excess input tax credit in cases where the output taxes are at a lower rate. Till now this is a cost to companies, hence, refund of the same will drastically improve the bottom line of pharma companies.

Majority pharma companies are situated in local excise/tax havens. Under GST, all area based exemptions are likely to go away. However, it is proposed that the benefit will continue to exist in the form of refunds. Even if such a mechanism is introduced, it will be imperative to analyse the following:

- Till when such refund mechanism will be allowed? What thereafter?

- In what time will the refund be credited?

- How to manage cash flow during such period?

With the amendment in the definition of ‘capital goods’ proposed in the revised GST law, there seems to be a big relief for manufacturers including pharma companies engaged in substantial capital expansion. The earlier definition of capital goods that restricted the items basis the chapter headings of the Central Excise Tariff Act, the new definition is much simpler making every item getting capitalised in the books of accounts as a capital assset provided, such asset is used for busines. This will increase the tax credit inflow of companies substantially improving their margins and working capital needs.

Will manufacturing industry take the heat of GST?
Imports by manufacturers currently lengthen their cost sheets as credit of all the duties is not available. Such costs shall no longer exists under GST, thus, acting as a leveraging factor.

Manufacturers are also subject to various statutes like Excise, Service tax and VAT. Such companies are often required to absorb tax cost as the taxes charged by them become cost to their customers. With set off available to customers, there will be no issue in terms of cost being absorbed under GST.

Stock transfers will be taxed under GST. While this can add up to the cash flow needs of manufacturers, it will also open an opportunity to re-work on the supply chain and save a lot of cost on warehousing, compliances, manpower etc.

What do investors need to do?
GST is more a business reform than a tax reform. GST brings with itself opportunities to re-visit the supply chain, analyse if the businesses can be run differently, provides an opportunity to identify vendors that are not worthy of doing business and an opportuity to review the margins.

It is thus imperative that investors and VCs should ensure their investee companies are adequately advised and the management is proactive in their approach to get the impact analysis done for their businesses. Any relaxation at this stage can adversely impact the margins and consequently, their valuations.

Disclaimer: The views expressed in the article above are those of the authors' and do not necessarily represent or reflect the views of this publishing house. Unless otherwise noted, the author is writing in his/her personal capacity. They are not intended and should not be thought to represent official ideas, attitudes, or policies of any agency or institution.

Nimish Goel

Nimish heads the Indirect Tax practice at International Business Advisors. He is a Chartered Accountant and Company Secretary with a rich consulting experience of over 10 years with firms like PricewaterhouseCoopers and Ernst & Young in indirect taxes including Customs, Excise, Service Tax and VAT.

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