The spread of COVID-19 is one of the biggest crisis faced by the mankind. The emerging situation demands unique responses from the Government in supporting all the stakeholders involved in fighting the pandemic on war footing.
The spread of COVID-19 is one of the biggest crisis faced by the mankind. The emerging situation demands unique responses from the Government in supporting all the stakeholders involved in fighting the pandemic on war footing. For instance, to meet the immediate domestic demand for ‘pandemic care products’ (PPE, ventilators, test kits, masks), the Government exempted such products from basic customs duty and applicable cess for period up to 30.09.2020. In short term, BCD exemption might be detrimental to domestic manufacturing, however the exemption on inputs will help the domestic industry to scale up for the immediate need.
There have been demands for GST exemption on pandemic care products from Public-spirited organisations, individuals and political parties. Owing to customs duty reduction, there was a further demand for exempting these goods from GST. This demand was on the basis that it would lead to reduction in prices of these goods for consumers. However, one must observe that these demands are based on misplaced understanding of GST, a tax based on value addition with deduction in the form of input tax credit for B2B transactions.
The Government’s primary apprehension that an exemption would add to the cost of manufacturing and not lead to substantial price reduction, while at the same time incentivising imports over domestic manufacturing appears to be correct. In this article, the author has attempted to analyse the demand for exemption, experience from the exemption provided to sanitary napkins, competitiveness of domestic manufacturers with that of imports, pitfalls and challenges of such demand.
GST Exemption – How Does It Work?
GST is a value added tax collected on the value added by each supplier. This is done by charging GST on the supply made by a person and allowing deduction for input tax credit paid on procurement of goods and services by the said person. When a product is exempted from GST, it results in simultaneous denial of input tax credit, and a person is no longer entitled to claim input tax credit since he is not discharging any GST on his sale. This can be explained from below:
Cost charged by supplier of goods and services to manufacturer:
GST on final product @ 12% = 80, GST on final product exempt= 80, GST on final product @ 5%= 80
GST on inputs and input services
GST on final product @ 12%= 8 (availed as ITC); GST on final product exempt= 8 (no ITC); GST on final product @ 5%= 8 (availed as ITC)
Cost of production and distribution
GST on final product @ 12%= 80, GST on final product exempt= 88, GST on final product @ 5%= 80
Sale price (after INR 20 margin)
GST on final product @ 12%=100, GST on final product exempt= 108, GST on final product @ 5%= 100
GST on sale price
GST on final product @ 12%= 12, GST on final product exempt= nil, GST on final product @ 5%= 5
Price to customer
GST on final product @ 12%= 112, GST on final product exempt= 108, GST on final product @ 5%= 105
From the above, it can be seen that exemption from GST does not result in reduction in prices to that extent. In fact, while the GST rate was reduced from 12% to Nil, the corresponding price reduction is only approximately 3.5%. This is primarily the result of manufacturer adding to his cost the GST charged by his suppliers which is no longer eligible as input tax credit to him.
Exemption – Not the Perfect Solution
From the above discussion, it can be seen that the GST exemption would result in blocked input tax credit in the hands of manufacturer thereby increasing the cost of manufacturing and distribution. The resulting increase in the cost will overweigh and offset the GST rate reduction benefit. The companies will have additional compliance to maintain separate account of inputs, input services and capital goods used for manufacture of these items or reverse the input tax credit based on formulae prescribed.
Further, granting of exemption would result in distortion in tax structure, wherein import of these goods will become significantly advantageous and cost effective compared to manufacture of these goods in India. The imported goods will be zero rated and will not have any hidden tax cost, whereas the input tax credit will be embedded in the cost of products manufactured domestically, thereby reducing the competitiveness of domestic manufacturers.
Experience From GST Exemption To Sanitary Napkins:
A similar situation had arisen at the time of introduction of GST, when sanitary napkins were placed in the 12% GST rate slab. While there was a significant demand for exempting sanitary napkins from GST, it was clarified vide press release dated 10.07.2017 that most of the raw materials required for manufacture of sanitary napkins attract higher GST rate and granting exemption will result in denial of input tax credit on procurement of these raw materials. This would place domestically manufactured sanitary napkins at a huge disadvantage vis-à-vis imports. The exemption from GST on supply of sanitary napkins in July 2018 resulted in increase in cost for manufacturers. Subsequently, anti-profiteering investigation on various entities conducted by the Director General of Anti-Profiteering
(DGAP) has found that the exemption has resulted in negligible price reduction.
Observations and Way Forward:
As observed in the case of sanitary napkins, a complete exemption does not seem to be a suitable solution for achieving price reduction as the corresponding reduction in prices is not as much as the GST rate reduction from 12% to Nil appears to be. In that event, if the rate of GST on pandemic care products is sought to be reduced, it is suggested that the same should be reduced to 5%, from the current rate of 12% or more. This will help in achieving the objective of reducing prices by straight 7%, while at the same time maintaining the competitive effectiveness of domestic manufacturer’s vis-à-vis import of
goods. It will not only protect the domestic industry but also help us in being self-reliant in times to come. Further, the concerns of accumulation in the hands of manufacturer need to be seriously delved into and a special solution should be drawn to grant full refund of credit accumulation in the hands of manufacturers in such tough times. A possible way to overcome this challenge of credit accumulation could be to expand the scope of refund of tax to tax paid on input services as well as tax paid on capital goods on a pro-rata basis, apart from refund of tax on inputs which is already being granted. This will help in reducing the financial costs on account of fund blockage and administrative cost of refunds.
In times to come, there will be more and more demand for reduction in rate of tax on certain products on a temporary basis. The need of the hour for the Government appears to be devising a fresh mechanism to deal with the challenge of accumulation of credit in achieving indirect price subsidization of the pandemic care products. If the refund mechanism is successfully devised, the Government may even consider an option of zero-rating the products, by not charging any GST on the product and at the same time providing refund of accumulated credit. This will help in addressing the twin challenges of demand for reducing the tax cost of the product while at the same time ensuring that the domestic
industry does not suffer at the cost of imports.
- Asish Philip Abraham, Joint Partner, & Darshan Machchhar, Principal Associate, Lakshmikumaran & Sridharan Attorneys. Views expressed are the authors’ own.