GST requires a change in pricing strategies

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The tax savings on sourcing may not offset higher distribution costs. However, in the long run there will be efficiency gains

As we inch towards implementation of the Goods and Services Tax, India Inc continues to grapple with the assessment of the potential impact this mega reform could have on various facets of business.

One of the critical aspects of business likely to be impacted by GST is product pricing. Taxes in India currently constitute a substantial part of the total product/service cost. While pricing is an essential function in all organisations, it assumes greater significance in companies operating in the Business-to-Consumer (B2C) segment.

Companies dealing in consumer products often tend to monitor/control not just their realisation from immediate customers, but also the maximum retail price (MRP) or the retail selling price (RSP), in addition to the margins that the intermediaries in the distribution chain are expected to make.

While fixing the product price and the margins, apart from the taxes forming part of the product cost, the taxes (generally VAT; CST in some cases) payable in the chain by each of the intermediaries (distributors, dealers, retailers) also become a critical factor. Given that GST is likely to completely overhaul the prevailing system of taxation, the entire pricing methodology would need to be revisited. For instance, the intermediaries could henceforth be required to pay dual GST (comprising central and State GST) in lieu of the existing VAT or CST payable on their sales to the customers.

Tax savings?

The cumulative rate of GST on several products is expected to be at least 20 per cent, in contrast to the existing VAT rate of around 12.5 to 15 per cent. This increase in tax incidence may have to be absorbed by one or more of the stakeholders in the distribution chain, that is, the company, the dealers, or the end consumers.

One may argue that GST could lead to significant tax savings to several companies on their sourcing and manufacturing activities, which, in turn, should translate into lower product prices.

However, this may not necessarily be the case. First, the tax savings on sourcing may not always be adequate to offset the incremental GST cost on distribution. The net impact would depend on several aspects, with the current tax rate vis-à-vis the new GST rate for the product in consideration, being an important factor. Second, past experience suggests that many companies may not be generous enough to pass on the entire tax savings arising from GST, to the consumers. A case in point is the perennial grievance of the government that manufacturers of automobiles do not pass on the benefit of excise duty reduction. Companies, on their part, may argue that the tax savings need to be retained to absorb the impact of rising raw material prices and other costs.

Likewise, under GST, many companies may consider retaining at least partly, if not fully, the tax savings on sourcing, which could translate into higher prices to the end customer. This phenomenon has been observed in several other countries at the time of implementation of GST, resulting in steep inflation in the short term.

Other ramifications

There are other aspects associated with GST that could influence pricing. Enhanced enforcement measures through use of technology could compel many of the existing unregistered retailers to get registered under GST. This could add to the tax cost on the margins of such retailers, and hence, impact the product price. Tax treatment of promotional schemes and discounts, would also play a part in firming up the sales and marketing strategy.

From a consumers’ standpoint, over 20 per cent GST on the invoice instead of the current VAT (say, 14 per cent) could be a rude shock. Even if the company were to reduce the base price of the product (translating into a similar or lower overall cost to the consumer), a significantly higher GST on the invoice is likely to outrage consumers.

The government would need to clarify that the enhanced rate reflected on the invoice is due to greater transparency, and not higher tax incidence.

Any incremental savings resulting from taxes or a more efficient supply-chain under GST could give companies added flexibility in terms of increasing the market share through price-reduction, or improving the bottomline.

http://www.thehindubusinessline.com/opinion/gst-requires-a-change-in-pricing-strategies/article7873779.ece

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