GST 2.0: Reductions vs Retail Reality: Impact of Rate Cuts on Unregistered Sellers

GST 2.0 – Reductions vs Retail Reality: Margin Squeeze and Market Shifts: The Unseen Impact of Rate Cuts on Unregistered Sellers

The Goods and Services Tax (GST) regime, while designed to create a unified tax structure, inadvertently creates significant competitive disadvantages for unregistered retailers when GST rates are reduced on existing stock. This analysis demonstrates how GST rate reductions from 18% to 5% and 12% to 5% fundamentally alter market dynamics, forcing unregistered retailers to either accept substantial margin erosion or lose market competitiveness entirely.

The Core Problem: Input Tax Credit Asymmetry

Understanding the GST Framework Disparity

One of the fundamental features of GST is the seamless flow of input tax credit (ITC) across the supply chain. However, this benefit is exclusively available to registered suppliers, creating a structural disadvantage for unregistered retailers who:

• Cannot claim ITCon their purchases of inputs, raw materials, or services
• Bear the full burdenof GST paid on inputs without any offset mechanism
• Face embedded tax coststhat become part of their cost structure
• Experience cascading tax effectson final pricing, reducing competitiveness in formal market transactions

This asymmetry becomes particularly pronounced during GST rate reductions on products where retailers hold existing inventory purchased at higher tax rates.

Scenario Analysis: GST Rate Reduction Impact

GST rate reductions, while benefiting registered retailers who can leverage input tax credit, create a significant competitive disadvantage for unregistered ones. Unregistered retailers, burdened with embedded taxes on their existing stock, are forced to either accept severe margin erosion—up to a 23% to 47% loss—or lose market share (customer shift).

Scenario 1: GST Reduction from 18% to 5%

Items Reduced from 18% to 5% – Personal Care and FMCG Essentials

The GST 2.0 reforms have significantly impacted personal care and hygiene staples, with soaps, shampoos, toothpastes, and detergents shifting from 18% to 5%. This category represents some of the most frequently purchased FMCG items by households across all income segments.

Key Items in 18% to 5% Category:

• Personal Care Products: Soaps, toothbrushes, hair oil, shampoos, toothpastes
• Hygiene Products: Detergents and cleaning agents
• Food Items: Instant noodles, chocolates, instant coffee, namkeen (savory snacks)
• Household Essentials: Basic toiletries and daily-use consumer products

GST 2.0 Impact : Initial Position Analysis

Both registered and unregistered retailers purchase stock at similar base costs:

• Item Cost: ₹100
• GST at 18%: ₹18
• Total Purchase Price: ₹118

The reduction of GST from 18% to 5% highlights a key challenge — unregistered retailers cannot claim Input Tax Credit (ITC) on stock purchased at the earlier higher tax rate. As a result, they are unable to offer competitive prices compared to registered sellers, who can fully pass on the benefit of lower GST to consumers.

Unregistered retailers suffer a steep 47% margin erosion, as they must slash profits to match registered sellers’ GST-adjusted prices, making them structurally uncompetitive.

The justification with calculations is presented in the table below.

Scenario 2: GST Reduction from 12% to 5%

The changes, effective September 22, will cover milkshakes, butter, ghee, jams, cheese, frozen products, ice-creams, pickles, coconut water and tomato puree, which have moved to the 5% tax bracket from 12% earlier.

Key Items in 12% to 5% Category:

• Dairy Products: Butter, ghee, cheese, milkshakes, packaged paneer
• Processed Foods: Packaged food items, basic household products
• Beverages: Coconut water, packaged juices
• Preserved Foods: Jams, pickles, tomato puree
• Frozen Items: Ice-creams and other frozen food products
• Ready-to-Eat Products: Various packaged food items and instant mixes

Comparative Impact Analysis – Registered Vs Un-registered

Initial Stock Position:

• Item Cost: ₹100
• GST at 12%: ₹12
• Total Purchase Price: ₹112

With GST reduced from 12% to 5%, registered retailers continue to enjoy a clear cost advantage through ITC, enabling them to keep prices attractive for consumers. Unregistered retailers, however, face a squeeze on profitability, as they are compelled to cut margins to stay competitive — reducing their margin from 22.32% to 17.18%, which directly undermines their sustainability.

See the Table Below:

The Cascading Effect: Beyond Immediate Competition

Cascading Tax & Market Impact

1. Cascading Burden: Without ITC, taxes on inputs inflate costs, and customers end up paying tax on tax.

2. Price Disadvantage: Registered sellers can fully pass GST benefits, while unregistered retailers remain stuck with inflated costs.

3. Stock Devaluation: Any GST rate cut erodes the value of unregistered retailers’ existing inventory.

4. Margin Squeeze: To stay competitive, unregistered sellers are forced to compress margins, undermining profitability.

5. Market Share Risk: Over time, these distortions shift demand towards registered retailers, squeezing out unregistered players.

Customer Behavior Impact

Consumers naturally gravitate toward lower prices, creating a preference shift toward registered retailers who can:

• Offer immediate price reductions
• Maintain competitive margins
• Provide better value propositions

This behavioral shift accelerates market share transfer from unregistered to registered retailers.

The Input Tax Credit Challenge: Systemic Disadvantage

Embedded Cost Structure

Unregistered retailers face a fundamental structural disadvantage through:

Input Cost Burden:

• Full GST payment on all business inputs
• No mechanism for tax recovery
• Embedded costs in every transaction
• Cumulative tax effect across the supply chain

Competitive Positioning:

• Higher baseline costs compared to registered competitors
• Limited pricing flexibility during market changes
• Reduced ability to respond to policy-driven rate changes
• Structural inability to offer competitive pricing in formal tenders

Strategic Implications: The GST framework effectively creates a two-tier market structure where registered and unregistered retailers operate under fundamentally different cost structures. This disparity becomes most apparent during policy-driven rate changes, forcing unregistered retailers to either accept margin erosion or exit competitive segments.

The data suggests that the GST system, while achieving its objective of creating a unified tax structure, also serves as a powerful tool for economic formalization by making unregistered status increasingly unviable in competitive markets.

The Margin Pressures & Passing Dilemma: Will Consumers Truly Gain & See Immediate Price Relief?

With the revised GST compliance guidelines of The Department of Consumer Affairs; Weights and Measures Unit (Sept 18, 2025), manufacturers are allowed to sell old stock with unchanged MRPs and use old packaging till March 2026, only notifying wholesalers and retailers of price changes.

While this eases compliance for industry, unregistered retailers face a major hurdle — they cannot revise MRPs downward without incurring extra costs, nor can they fully pass GST benefits.

This creates price rigidity, margin pressure, and weak competitiveness, making it difficult for them to match registered players in the transition period.

The government, meanwhile, is driving consumer awareness campaigns, industry advisories, and strict monitoring of non-compliance to ensure GST benefits are transparently passed on.

During this transition, most unregistered retailers are unlikely to pass on GST benefits to consumers due to existing higher-cost stock, logistical hurdles of re-labeling, weak enforcement, and margin pressure.

Government actions, awareness campaigns, and monitoring mechanisms are unlikely to be fully effective for small retailers like Kirana shops, neighborhood general stores, mom-and-pop outlets, and small unregistered local wholesalers, as the Government machinery cannot practically reach, detect, or ensure compliance—particularly for FMCG and fast-moving consumer goods.

Conclusion

The analysis clearly demonstrates that GST rate reductions, while beneficial for the overall economy and registered businesses, create significant competitive disadvantages for unregistered retailers. The fundamental issue lies in the asymmetric access to Input Tax Credit, which creates structural cost disadvantages that become pronounced during rate reductions.

Key Findings:

1. GST rate reduction from 18% to 5% can force unregistered retailers to accept up to 47% margin reduction to remain competitive

2. Even smaller rate reductions (12% to 5%) result in significant margin erosion of 23%

3. The Input Tax Credit unavailability creates embedded costs that cannot be recovered

4. Market dynamics increasingly favor registered retailers, accelerating formalization

During this transition, most retailers are unlikely to pass on GST benefits to consumers, as existing higher-cost stock, logistical hurdles of re-labeling, and weak enforcement make price reductions impractical.