Exporters need to prepare for GST
[Source: www.thehindubusinessline.com; Author: Ajay Srivastava]
GST will usher in a new regulatory regime for India’s exports. For the manufactured product exporters, the most significant impact would be the increased requirement and blockage of working capital.
For manufacturing a product, a firm buys locally or imports raw material and machinery. The current export schemes allow firms to buy these without payment of applicable duties through ab-initio exemption or subsequent refund of duties.
The proposed GST system mandates that all duties must be paid at the time of a transaction while refund for these can be obtained after exports. This means the exporter will have to arrange money for the inputs, manufacturing and payment of duties and taxes.
The current system of export schemes has evolved over the decades. For example, the Advance Authorisation Scheme that allows duty-free sourcing of raw material is in existence since the 1970s. The Export Promotion Capital Goods (EPCG) scheme that allows duty-free sourcing of machinery was introduced in early 1990s.
Both schemes have been used extensively by engineering, electronics, automobile, chemical, petrochemical and pharmaceutical sectors to build an export base. The Special Economic Zones (SEZ) scheme, though introduced in 2005, was already in existence in some form since the mid-1960s.
Most of India’s 130,000 exporters who currently use these schemes must comprehend the post-GST impact of the changes. We do it through the example of Jaya, a medium-sized garment exporter from Coimbatore. Jaya just got an export order from a buyer in Germany for supply of 10,000 linen shirts at $100 each. We will have a look at the current export options available to Jaya and how these will change post GST. Jaya will need to buy linen fabric and manufacture shirts from it. She can either import or buy it locally. Her manager tells that the total customs duty would be 24 per cent of the import value of the linen.
Jaya can use the Advance Authorisation Scheme for import of the required quantity of linen from Italy. Currently, she need not pay any duty on imports. However, post-GST, while she will get an exemption from payment of only basic customs duty (7 per cent), she has to pay Integrated GST which (let’s assume) will be around 18 per cent of the import value.
She can get the refund of this duty only after exports and realisation of money. Considering a value addition of 15 per cent and cost of capital at 12 per cent, Jaya’s working capital equal to 15.65 per cent of export value will be blocked for six to 12 months.
Post GST, Jaya cannot use the two regularly used variants of Advance Authorisation. One, currently she can buy linen from a domestic manufacturer who will supply without payment of duty. Post GST, the domestic manufacturer cannot supply without charging duties.
Two, currently, Jaya can buy linen from domestic market paying full duty, manufacture the shirts and export. She can subsequently use the authorisation to import linen without payment of duty. Post GST, this option will not be available.
Jaya needs to buy textile machinery for making quality garments. She currently imports duty-free using the EPCG scheme. In return, she has to undertake to export garments six times the value of the duty saved amount in six years. Alternatively, if she buys machine from an indigenous manufacturer, she will have to export 25 per cent less compared to what she would have had to had she imported the machine. This way EPCG scheme nudges exporters to use indigenous machines. Post GST, imports under EPCG will become expensive.
She will have to pay IGST which may be around 18 per cent of the import value. This money may be blocked up to six years, the time allowed under EPCG scheme to complete exports. For an import value of ₹100, if Jaya takes a loan at 12 per cent for paying IGST of ₹18, she may have to return about ₹35.5 after six years.
This high additional cost will affect the viability of many enterprises. Worse, since capital goods do not get consumed in the process, it may be difficult to link specific capital goods imports with the specific exports and in that case no GST refund may be a likely scenario.
Another option currently available to Jaya is buying duty paid linen from the domestic market and using the drawback scheme for obtaining refunds of duties paid. Currently, the drawback scheme largely refunds the basic custom duty and other central duties paid on buying inputs. However, post GST, the schemes will refund basic custom duty only. The other central duties will be refunded through the GST mechanism on a case-to-case basis.
SEZs, EOUs, deemed exports
Currently, the SEZ developer and units can import their requirements duty-free. Also, the supplies made by the domestic units to SEZs are considered exports and hence are free from payment of taxes and duties. Not anymore. The model GST law defines exports as taking goods and services out of India to a place outside India.
And India is defined to include the Exclusive Economic Zones lying at 200 nautical miles beyond territorial waters. Since SEZs are within Indian territory, these would be reduced to the status of a normal domestic firm. This means, no duty or tax exemptions on imports or exports would be admissible. Imports into SEZ will attract IGST while supplies to SEZs will attract CSGT and SGST or IGST. With average value addition at SEZ already less than 10 per cent, the new law may make many SEZs unviable.
The GST will also affect the supplies defined as deemed exports. Currently, the supplies to projects under International Competitive biddings (ICB), mega power plants and World Bank funded projects are exempted from central taxes. This has been done to enhance competitiveness of Indian firms participating in global tenders or large scale bids. Post GST, these supplies, currently termed as deemed exports will become taxable where no refund would be available.
GST will block working capital
The provision of no exemption and only refund will lead to blockage of about ₹1,85,500 crore annually for the manufactured goods exporters.
This figure considers export value of $200 billion, an average 30 per cent value addition over the inputs and cost of capital at 12 per cent. Capital at 12 per cent in India is way too high compared to 0-1 per cent in most developed countries.
And secondly, most SMEs can’t get capital even at 12 per cent. The more sophisticated a product, higher is the need for external sourcing of inputs, leading to higher requirement and blockage of working capital.
Resolving working capital issue
The working capital blockage issue can be resolved without compromising the integrity of the GST model. Allow firms to pay tax on transactions leading to exports through e-currency. This would be of the nature of an IOU where a firm would agree to set off its IOUs with the actual payment within an year or at the time of the completion of exports, whichever is earlier.
A firm can be allowed to use IOUs equal to the value past year’s export performance. This solution keeps the current GST framework of making payment first, refund later, intact.