The liberalization of
the Central Government’s FDI (‘Foreign Direct Investment’) policy on retail in
September 2012 was widely hoped as a step that would catalyze investment into
the sector. Apart from the high profile IKEA case, results however have not
entirely been on expected lines. Multi brand retail players have sought further
clarity and relaxation of stringent norms before committing significant
financial investment. Approvals for single brand retail trading are coming
through gradually as businesses evaluate their investment strategy.
In our earlier two
issues[1], we have analyzed the factors from a policy
perspective that are influencing corporate investment decisions in the retail
sector. In this third issue of BMR Point of view, we focus on the multiplicity
of indirect taxes and the GST policy framework, which would have a significant
impact on retail investment and operating structures.
Key issues under the
existing law and impact of GST
1. Multiplicity
of taxes and resultant cascading effect of taxes
Presently, the retail
sector in India is subject to multiplicity of indirect taxes. In addition to
customs duty, which is levied on import of goods, the following are the other
key transaction level indirect taxes, levied by the Central Government, which
are relevant on the procurement side:
-
Excise
duty is applicable on goods domestically manufactured in
India.
-
Service
tax is applicable on services received.
-
Research
and Development Cess is levied on import of technology / know-how under a
collaboration arrangement – the applicability of this ‘lesser known’ cess is
laden with ambiguity.
Additionally, the
following transaction level indirect taxes, levied by the State Governments, are
relevant on the procurement side:
-
On every
intra-State sale and purchase of goods, the State Governments levy a Value Added
Tax (‘VAT’). The rates of VAT may vary from State to State.
-
On sales/
purchases involving movement of goods from one State to another (inter-State
sales), there is a levy of Central Sales Tax (‘CST’).
-
Additionally, several
State Governments also levy an entry tax on entry of goods into defined ‘local
areas’ within the State.
-
Finally,
Octroi / Local Body Tax is levied in several parts of the State of Maharashtra –
these are taxes on entry of goods into specified municipal areas.
A primary issue
arising from this multiplicity of taxes is its cascading effect across the
chain. This is because of the limited ability to set-off amounts paid under one
tax against liabilities under other taxes – a consequence of multiple
authorities with different jurisdictions levying multiple taxes on different
aspects of a business. As a basic principle, credit of amounts paid under
Central level taxes is not available against liabilities under State level
taxes, and vice versa.
Typically, in the
retail sector, trading activity attracts an output tax of VAT. Since VAT accrues
to the State Government, the entire host of Central level indirect taxes becomes
a cost in the supply chain and enhances the total indirect tax cost for a retail
chain setting up shop in India. For example, excise duty paid on purchase of
goods cannot be offset against VAT payable on intra-State
sales.
Even for taxes for
which inter se credit / set-off is legally tenable, practical
implementation becomes difficult due to stringent norms for credit availment and
the rigorous approach of ground level tax authorities. Availability of credit
on various inputs and input services is subject to substantiating their direct
nexus with the output services / manufacture of goods, which is often contested
by the tax authorities. Credit of VAT paid on capital goods is typically not
permitted by most States.
A specific mention is
also needed for restrictions on credit of various taxes paid on fuel under
various State and Central laws. This is surprising since fuel (primarily used by
retail sector for captive power generation) is commercially a major input for
all kind of goods or services, including retail. Additionally, it is
economically significant as fuels are typically subject to levy of higher rate
of taxes, both by the Centre as well as most of the States.
Overall, businesses
try to adapt to this myriad of indirect taxes and adopt complex supply chains
and transaction structures that are essentially driven by tax considerations
rather than business imperatives – a clear distortionary impact of taxation.
For every retail chain with operations in multiple States, the outlined factors,
when combined together, lead to higher tax costs eating into profits in the
supply chain. GST is meant to address this inequity.
Impact under
GST
GST is a comprehensive
tax on manufacture, sale and consumption of goods and services at a national
level. GST system in India essentially envisages two taxes – State Level GST and
Central Level GST. In principle, credit of GST paid on the procurement of goods
and services will be available against the respective GST payable on the output
supply of goods or services. Thus, the system envisages continuous flow of
credit across all points in the supply chain without any breakage at any point.
Most importantly, the focal point of taxation under GST is consumption – it’s
the ultimate point of consumption where the tax cost
sticks.
As a further step
towards ensuring that the incidence of the tax falls on the consumption of
commodities without any distortionary or cascading effect and the revenue
accrues to the State where the final consumer is located, we expect there should
be no distinction between raw materials and capital goods in allowing input tax
credit in the GST regime. We also expect that fuels should be subjected only to
GST (both Central and State) with the benefit of input credit like any other
intermediate good[2].
2. Tax on
packing and labeling activities
The present tax regime
in India deems packing and labeling activities for a specified category of goods
to be a manufacturing activity and therefore, subject to levy of excise duty.
Retail sector which inevitably requires packing, labeling, re-labeling, etc at
some level, lays exposed to this levy along with the requirement to undertake
various attendant compliances. This issue has been a subject matter of debate in
the e-commerce segment and it’s only a matter of time that the issue becomes
live in other scenarios. For example, where a retail chain procures toothpastes
and toothbrushes separately in bulk from manufacturers (who would have paid
excise duty on such clearance) and initiates a campaign in their stores where a
toothpaste and toothbrush are sold together at a discounted price and for this
purpose, loosely put together in some sort of a package. Potential levy of taxes
on such processes creates challenges for the retail sector under the present
indirect tax regime.
Impact under
GST
Here too, GST is
expected to usher in a solution. GST would be structured on the destination
principle. As a result, the tax base will shift to consumption. Under GST
regime, tax would be levied on goods or services at the ‘point of supply’ rather
than for undertaking a ‘process’ (like packing / re-packing etc) in relation to
supply of goods. Thus, GST would be applicable only on transactions of supply of
goods (and services) in the retail value chain rather than on the processes of
packing or labeling that may occur at multiple levels. Overall, no additional
taxable event is foreseen under GST for similar packing / labeling activities
undertaken by retail chains.
3. Double
taxation on property management services
Property management
services including contracts for housekeeping, engineering, maintenance of
facilities, form a major input cost for retail outlets. Under the current
indirect tax regime, some confusion exists regarding the levy (VAT and/or
service tax) as well as taxable base for levy for such contracts.
This stems from the
fact that such contracts, while composite in nature, involve relatively lower
value of material supply component and a higher focus on the service element.
Service tax authorities seek to charge service tax on entire value of such
contracts without giving the benefit of abatements available for ‘works
contract’ services. On the other hand, VAT authorities demand VAT on value of
goods involved in the execution of such contracts. On account of practical
difficulties in substantiating the actual value of materials and services
involved for such contracts, application of deemed deduction / abatement schemes
often leads to levy of VAT and service tax much higher than actuals.
Impact under
GST
Such levy of dual
taxes on almost the same taxable base is expected to be mitigated under the GST
regime where tax is proposed to be levied on ‘supply’. It is likely that the
difference between goods and services for tax purposes would get dissolved under
the GST regime and double taxation issues relating to property management
contracts may be avoided.
4. Retail price
linked valuation issues
While the proposed GST
regime may prove to be a panacea for few major indirect tax issues experienced
by retail chains, however, certain issues may still remain such as the valuation
for tax purposes of packaged goods (procured in bulk) which are taxed on Maximum
Retail Price (‘MRP’) basis. Typically, MRP valuation is not attracted is not
case of procurements by institutional/ industrial buyers. Only where the
pre-packaged goods are procured under the tag of ‘intended for retail sale’, MRP
based valuation usually applies.
Impact under
GST
The applicability or
otherwise of MRP based valuation in different scenarios is an extensively
litigated aspect under customs/ excise laws in India and may continue to
challenge under the GST regime as well, unless the Government discontinues MRP
based valuation post GST. Similarly, valuation related disputes may continue to
arise vis a vis various forms of gift vouchers, discount coupons and other
promotional schemes under the GST regime as well.
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