India’s new Goods and Services Tax (GST) will significantly improve the country’s business environment. If GST is implemented effectively, it will have large-scale benefits for multinational companies at all stages of the supply chain, including procurement and sourcing, manufacturing, distribution, and pricing. In this post, I will discuss the implications of GST for multinationals importing into India and for those manufacturing in the country.
Two benefits for companies importing into India:
- Imports as an interstate trade: The GST will streamline the import framework in India as additional customs duties will be consolidated into the GST. Imports will be taxed as interstate trade within the country at the IGST rate. Importers will also be able to claim input tax credit on IGST, reducing costs even further.
- Distribution and inventory management: Under the current system, firms must pay a Central Sales Tax (CST) on interstate sales, which increases costs. To avoid this tax, multinationals open small warehouses in the states where they supply and transfer stock to the warehouses instead (stock transfers are not subject to CST). Under GST, these tax boundaries between states will disappear, and the focus will shift to service times and operational efficiency rather than tax efficiency. This will allow companies to open large, central warehouses to maximize efficiency and reduce costs. Multinationals will also be less dependent on smaller state distributors and will be free to work with more cost-effective larger national distributors.
Four benefits for companies manufacturing in India:
- Lower costs: GST will reduce the cost of goods for firms manufacturing in India. This is because firms will be able to source materials from across borders without paying additional taxes and will also be able to claim tax credit on supplies sourced across state borders.
- Factory locations: Under the current system, factory locations are chosen based on state incentives and tax subsidies. GST will allow companies to decide on factory locations in a tax-neutral environment, based on commercial and productivity factors.
- Clustering and economies of scale: GST will encourage companies to make factory location decisions based on productivity criteria, which will result in consolidation of the manufacturing sector. Natural clusters will thus emerge, allowing multinationals to benefit from economies of scale.
- Distribution networks: Similar to importing firms, manufacturers will also benefit from improved distribution networks and more efficient inventory management systems.
The most important benefit for multinational companies with manufacturing capabilities in India will be a fundamental mindset shift regarding how decisions are made. Tax considerations will be replaced by commercial viability considerations, which will lead to more efficient and profitable business units.
Some general benefits for all multinationals:
- Consolidation: All multinationals will benefit from consolidation of the indirect tax system in India. FSG’s one-stop portal will make filing easier, reduce compliance costs and minimize the cascading effects of multiple taxes.
- Level playing field: GST will also level the playing field between multinationals and local competitors, as a larger share of the informal sector will be subject to the new GST system. As tax avoidance becomes increasingly difficult, local competitors will find it harder to undercut prices, reducing the price differential between local companies and multinationals.
In the long term, if it is implemented efficiently, GST will allow multinationals that are currently importing to consider opening manufacturing units in India. Multinationals with manufacturing capabilities may consider expanding their footprint as a result of lower costs and gains from the economies of scale. Such large-scale changes in operations warrant an evaluation of the GST’s potential impact on companies’ supply chain.
FSG’s insights on preparing for GST
This update is part two of a three-part series on preparing for the transition to GST in India. These posts have been developed carefully based on FSG’s numerous interactions with clients and experts, and will have significant value for senior executives of western multinational companies operating in India. Next week’s update: Concerns surrounding the implementation of GST in India.