GST – A Bull In China’s Shop

Goods and Service Tax (GST), one the biggest indirect tax reform for which India has waited for more than a decade and most of the Indian corporate as well as global conglomerate, Institutional Investors were curiously waiting to take their bet on Indian economy set off the starting block on July 1, 2017. Incidentally, the ushering of GST era coincided with one of the major border standoff between India and China in Doklam area bordering Bhutan.

The jury, as expected with such tectonic shift in India’s indirect tax structure, is still out on GST and its consequences. It’s still too early to buy into either of the arguments – GST is a panacea or the GST is a pain. The Indian GST aims to achieve the following goals:

1. Curbing the parallel economy,
2. Minimize cascading effect by merging multiple indirect taxes into one tax (leading to reduction in cost of goods and services),
3. Elimination of double taxation of some services which were taxed by multiple government agencies,
4. Increasing tax base (thereby increasing tax revenue for the exchequer),
5. Free flow of goods across nation,
6. Simplification of tax administration,
7. Harmonization of tax rates, tax laws etc.

Mr. Vijay Kelkar, Chairperson, Thirteenth Planning commission, has stated somewhere during October 2009, “India could gain as much as USD 15 billion annually once GST is in place and potential gains in the present value terms could be about half a trillion USD”.

Today I would restrain my article on how GST is going to impact cheap imported Chinese goods in India. Lower labour cost, scale of production, economic efficiencies, lower taxation etc. The list is endless that is cited in public as factors enabling lower cost of imported Chinese goods. However, other than these factors, under-invoicing and virtually lower indirect taxes make them even cheaper compared to Made in India products. Under-invoicing of these products coming down the Dragon’s vast assembly line may tend to lower the effective tax rate upto 70% compared to products manufactured locally or imported by disclosing correct price.

As journey of under-invoiced goods from importer to final consumer involves multiple taxes and multiple authorities, and in the absence of effective information system to track final price of goods sold, it is easier for all participants in Chinese goods to trade without any regulatory check on under-invoicing. Due to lack of information system not only local manufacturer suffers loss because of such anti-competition business environment; the exchequer suffers huge loss of revenue. The same structure can be understood by following example:

Participants of the games are importers, large traders, medium and small traders and retailers. Let’s understand the game with the notional value of goods imported for INR 65 million (USD 1 million).

An importer purchase goods worth INR 65 million (USD 1 million) from China, however he asked counter party at China to raise invoice for the goods at INR 6.5 million (USD 100 thousand). The invoice amount is paid through bank and differential amount is paid through some offshore company in Singapore, Hong Kong, China or elsewhere.

Now, when goods cross into Indian borders, the Custom duty of 50% (for example) needs to be paid on the basis of invoice amount rather than on the actual value of purchased goods. The landing cost of goods in India as per tax authority will be at INR 9.75 milion (USD 150 thousand).

However, actual landing cost of goods will be INR 68.25 million (USD 1.05 million), instead of INR 97.5 million (USD 1.5 million).

Then Importer sells it to a large trader after including his 10% profit margin and sales at INR 75.08 million (USD 1.16 million). However, will invoice at 50% lower than actual at INR 37.54 million (USD 577.5 thousands). Invoice will include local VAT of say 10% i.e. INR 3.75 million (USD 57 thousands). Remaining amount is paid to importer in cash (unaccounted money).

Large trader will sale goods to whole seller sitting in other states after adding his profit margin of say 5% for INR 82.8 million (USD 1.27 million). However the value of invoice will be 30% lower than actual at INR 57.9 million (USD 891.4 thousands). Invoice will include Central sales tax (CST) of 1% i.e. INR 0.6 million (USD 8.9 thousands).

Trader will in turn sell goods to various retailers across country after including his margin of 5% for INR 87.5 million (USD 1.35 million). Now invoice is raised at full amount and there will be levy of VAT if sold in same state or CST if in other state.

So by following above structure, the goods which should cost INR 144.5 million (USD 2.22 million) at the retail level have actually been priced at INR 87.52 million (USD 1.35 million), which is almost 40% cheaper. Exchequer has suffered a loss in the range of INR 34 million (USD 524 thousands) to INR 38 million (USD 584.9 thousands), which is around 70% of total expected revenue.

Impact of GST

As the backbone of GST is strong information system supported by technology, it has replicated Traces model. Income Tax has implemented online tracking of income transaction “Traces” long back. Over the period of time “Traces” has become so efficient, that it captures all the information and as soon as person files its Tax return, it generates list of deviation between income information received from other data source and provided by the person. Similar information system has been installed under GST, whereby, the transaction will be tracked throughout its supply chain and will be red-flagged in case of any deviation or irregularity in data. As there is huge difference in the import price of goods and selling price to retailer, it will be easier for the tax authorities to check revenue leakage and under-invoicing.

So the Modi Government has already triggered a war on cheap Chinese goods that were pricking the Make-In-India initiative. The GST bull has been unleashed in China’s shop.