Implications of Goods and Services Tax for Indian Textile Sector

CMA (Dr.) S. K. Gupta

Goods and Services tax (GST) constitutes the last mile of a long journey of reforms of indirect taxes in India. GST will replace a number of central and state taxes. The important taxes that may be subsumed in GST are cenvat and service tax at the central level and state VAT/sales tax, central sales tax, and entry tax at the state level along with a number of additional or special duties and cesses and surcharges. The final design of the GST and the related constitutional amendment are yet to be finalized. However, the impact of GST on the textile sector is expected to be quite significant.

Current Domestic Indirect Tax Structure

The main central indirect taxes are central excise duties or cenvat and service tax. Since textiles are goods, the relevance of service tax is only with respect to service inputs into textile outputs. The main state taxes are sales tax/State VAT,tax on inter-state sales (also called the central sales tax) and entry tax. These pertain to textiles outputs as well as non-service textile inputs.

• In spite of reforms, the current domestic indirect tax regime suffers from various inefficiencies.
• Several problems continue with each segment of the system of taxation of goods and services as summarized below:
• In the case of Cenvat, the issues relating to definition of manufacturing and methodology of valuation remain causing difficulties in implementation of the tax.
• The problem of multiple rates remains although the tax rate structure is simpler than what it used to be. This leads to various classification disputes.
• In the case of service taxation, problems relate to distinguishing between a good and a service. The distinction between the two is often blurred.
• Exclusion of services from the tax base of the states potentially erodes their tax buoyancy in a growing economy that is service-sector centric.
• Cascading has not been fully eliminated as there is cross cascading between State VAT, Cenvat, and the service tax.
• The Central sales tax continues to cause artificial interstate tax borders. It constrains achieving the objective of a destination based system of taxation of goods and services.

The main difficulties faced by the textile sector in the current domestic indirect tax regime may be summarized as below:

• Classification disputes Fabrics vs. garments, e.g. should sarees be treated as fabrics or as ready made garments
• Fibre neutrality :Cotton fibre vs. man made fibres. Cotton fibre treated favorably as compared to Man made fibres
• Effective tax rates vary by degree of integration : Power looms vs. Composite mills. Effective tax rates for composite mills are higher than that of power looms discouraging integration of production adversely affecting efficiency.
• There are many gaps within the current arrangement. The State VAT applies to primary producers, manufacturers and distributors and retailers. However, it excludes the service sector. The CENVAT and the service tax are levied on manufacturers and service providers respectively but the primary producers, distributors, are excluded from their scope.
• In the current tax structure, the excluded sectors cannot take credit of the tax charged to them on inputs by their suppliers. The input tax on these services gets added to the cost of the product supplied by them, leading to tax cascading.

Design of GST: Basic Features

GST will be a concurrent GST where the central and state governments will share a common tax base consisting of
the value added of goods and services in the production and sale of goods and services.

The significant features of GST are likely to be as follows :

• The GST will have two components: one levied by the Centre (CGST) and the other levied by the States (SGST).
• The CGST and SGST would be applicable to supply of all goods and services made for a consideration except for the exempted goods and services, goods which are outside the purview of GST and the transactions which are below the prescribed threshold limits.
• The CGST and SGST are to be paid to the accounts of the Centre and the States separately. Taxes paid against the CGST and SGST will get input tax credit (ITC) within the CGST and SGST chains respectively but cross utilization of ITC between CGST and SGST would not be allowed.
• The administration of the CGST will be with the centre and that of SGST with the states
• The following Central Taxes are likely to be subsumed under the GST:(i) central Excise Duty, (ii) Additional Excise Duties, (iii) Excise Duty levied under the Medicinal and Toiletries Preparation Act, (iv) Service Tax, (v) Additional Customs Duty,commonly known as Countervailing Duty (CVD), (vi) Special Additional Duty of Customs (SAD), (vii) Surcharges, and (viii) Cesses.
• The following State taxes and levies should be, to begin with, subsumed under GST: (i) VAT / sales tax, (ii) entertainment tax (unless it is levied by the local bodies, (iii)luxury tax, (iv) taxes on lottery, betting and gambling, (v) State cesses and surcharges in so far as they relate to supply of goods and services, and (vi) entry tax not in lieu of Octroi.

Under GST, exports will be fully and automatically zero-rated. This will cover all domestic taxation of inputs used for products that are exported.

This will reduce the scope of duty drawback scheme considerably as all input taxes paid in regard to domestic indirect taxes, namely, central excise duties, service tax, state sales tax, inter-state sales tax, and entry tax will be rebated. The money that will be released from duty drawback scheme could then be used for supporting the sector.

With the abolition of the inter-state sales tax (central sales tax) and entry tax, the Indian market will become a genuine all-India market without fiscal barriers. Textile industry, where considerable movement of both inputs and outputs takes place, will be one of the main beneficiaries.

A Goods and Service Tax Council (GST Council) will be constituted which will decide on the following issues:

• Taxes, cesses and surcharges levied by the centre, the states and the local bodies that are to be subsumed in GST;
• The goods and services that may be exempted from GST;
• The threshold limit of turnover below which goods and services may be exempted from GST;
• The rates including floor rates and bands for GST;
• Any special rate or rates for a specified period to raise additional revenue during any natural calamity or disaster;
• Special provisions with respect to the States of Arunachal Pradesh, Assam, Jammu and Kashmir, Manipur, Meghalaya, Mizoram, Nagaland, Sikkim and Tripura;
• Any other matter relating to the GST as the Council may decide.

The GST Council is to be guided by the need for a harmonized structure of the goods and services tax and for the development of a harmonized national market for goods and services.

Under GST, the core functions relating to the dealer-administration interface such as registration, returns, payments, and refunds will be centralized.

This will lead to significant simplification of compliance as it virtually eliminates interface between taxpayers and tax administration for compliance related activities. The role of state governments will be largely limited to audit and assessment.

Likely General Effects of GST:

• Implementation of a comprehensive GST is expected to provide gains to India’s GDP somewhere in the range of 0.9 to 1.7 percent.
• The real returns to factors of production will go up: returns to land will go up between 0.42 to 0.82 percent; wage rate gains will be in the range of 0.68 to 1.33 percent; returns to capital would increase in the range of 0.37 to 0.82 percent.
• The overall price level would go down;
• The efficiency of energy resource use will improve;
• The manufacturing sectors including textiles and ready made garments would benefit from economies of scale;

Implications of GST for the Textile Industry

The textile industry is characterized by large inter-state movements both in respect of inputs and finished products. It also draws inputs from many other sectors consisting of both goods and services including dyes and chemicals, petroleum products and transport services. There is a large inter-face between organized and unorganized sectors. Given the inter-state and inter-industry movement of goods and services and interdependence of organized and unorganized sectors in the textile industry, the GST will have significant effects on the growth and productivity of the textile sector.

Taxation of textile sector is opaque and non-neutral across its various segments. Many textile outputs are either exempt under the central and state tax regimes or are subjected to relatively low tax rates. Most of the indirect taxes fall on inputs, both goods and services, and therefore remain hidden. On the whole, the textile sector is lightly taxed and extensively subsidized. Textile exports are supported through payments of un-rebated taxes (duty drawback) on textile inputs and other subsidies.

Taxation of the textile sector will be significantly recast with the implementation of the Goods and Services tax (GST). The GST is expected to replace a number of existing central and state taxes.India has a number of schemes for rebating or subsidizing textile exporters

The main implications of GST compared to the present domestic indirect tax regime in the context of Textiles can be divided into two parts: (a) main and immediate effect, which may be adverse in nature and (b) other longer term positive effects.

Main Effect: Rate-Revenue Effect

Since the CGST and SGST rates are likely to be higher than the corresponding textile sector RNRs; the textile prices would go up. This will adversely affect demand for textile products. Our estimates based on time series on private final consumption expenditure on clothing shows that demand elasticity with respect to implicit price deflat or of clothing relative to implicit price deflator of all goods is low (about 0.3). Therefore the magnitude of effect will be low. This will be further mitigated because estimates

indicate that GST will have an overall positive income effect. Demand for clothing is also income elastic and the magnitude of estimated income-elasticity is somewhat higher at 0.5.Furthermore, since the demand elasticity is less than one, the fall in quantity demanded will be less than the increase in prices due to the rate increase resulting in higher revenues.

Other Positive Effects

Some of the longer term positive effects would be as follows.

• GST is likely to have a fibre-neutral rate structure unless differentiation is introduced by explicit choice (Fibre Neutrality Effect);
• Textile outputs will be taxed if domestically consumed and input taxes paid will be rebated making the tax-regime transparent (Transparency Effect);
• Exports will be zero-rated and all input taxes paid will be rebated by the tax authorities making duty drawback kind of schemes redundant (Export Zero rating Effect);

• Fiscal barriers to inter-state movement of textile inputs and outputs like the CST and the entry tax will be eliminated (Common Market Effect);
• Taxes on capital and machinery will be fully rebated (Investment Promoting Effect); and
• For the industry, compliance costs will be lower (Compliance Promoting Effect).

Segment wise effects will be different depending on the specific Revenue Neutral Rates (RNRs). Given the segment­wise textile specific RNRs and the GST rates, those textile sectors where the RNR is lower than the GST rates, there will be an additional tax burden. For those textile segments, where the RNR is more than the GST rate,there will be a lower tax incidence compared to the present situation. Except for two segments, namely silk textiles and artificial silk and synthetic fibre textiles,all other segments have a low effective rate of tax and in all probability GST rates will be higher than the segment specific RNRs.

An important issue particularly in the context of textiles would be to determine the threshold. There will be a uniform threshold for CGST and SGST. It is likely to be much lower than the current SSI threshold of Rs. 1.5 cr under CENVAT and higher than the most common State VAT threshold of Rs.10 lakhs. Present discussions indicate that the threshold is likely to be around Rs. 25 lakh. The threshold could be lower for hilly States.

A low small business threshold is likely to discourage power loom owners from fragmenting their units to stay under the small business threshold. To facilitate integration of small power loom units into the GST, the Ministry of Textiles in cooperation with Ministry of Finance and respective State governments could consider providing shared tax compliance services to such units in prominent clusters to minimize compliance costs.

With the abolition of the inter-state sales tax (central sales tax) and entry tax,the Indian market will become a genuine

where considerable movement of both inputs and outputs takes place, will be one of the main beneficiaries.

Some of the outstanding issues in the implementation of GST that will have significant implications for the textile sector relate to whether there will be:

• Single/dual control of dealers by Central and State governments;
• Single/Multiple tax rates; and
• Degree of cross-matching of data – invoice level matching vs. dealer level Matching

Fibre-neutrality Effect

Depending on how the GST is structured, it is likely to treat all fibres in the same way whether cotton based or based on man-made fibres. There will thus be adjustments within the textile sector even if the overall textile sector demand does not get affected by the transition to GST rate, as discussed below.

The Handloom industry: The uniform GST rate is likely to be significantly higher than the current effective tax rate of the Handloom industry. While demand for high value ­addh and loom products with low price elasticity can be expected to remain largely unaffected, low value-add hand loom products with higher price elasticity may witness a fall in demand. Therefore, producers of low value-add handloom products can be expected to upgrade to the powerloom sector, resulting in increased productivity, quality and returns on investment. This can be classified as a process efficiency effect.

The cotton textile industry presently has a lower effective tax rate as compared tothe synthetic textile industry. The uniform GST rate is therefore likely to lead tohigher increase in prices of cotton textiles as compared to synthetic textiles. As a result, cotton textile manufacturers can be expected to increase blending ofsynthetic fibres with cotton fibres. This can be classified as the fibre-neutrality effect.

Policy Options for Textiles under GST

The overall impact of GST on the textile industry and consumers will depend on how the available policy options are exercised in implementing GST in relation to textiles. The main policy options, which may be considered for specific segments or all segments of textiles, are as follows:

• Zero rating
• Exemption
• Lower rate of tax
• Standard rate of tax with appropriate subsidies

Zero rating other than for exports is not recommended although it is possible if all input taxes are refunded. It should be recognized that zero rating will not cover producers below threshold levels. On the other hand, it may lead to rush for registration with the central and state governments to claim the refunds. It may also open up an avenue for claims that may be fraudulent. To ensure that exports remain truly zero rated, the Duty Drawback rates could be revised to account for input taxes which remain uncredited.

Exemption The second option is exemption for selected segments. Exemption does not mean no incidence of tax since it results in blocked input taxes. It may result in higher tax incidence due to blocked input taxes and tax cascading. The tax impact of exemption becomes dependent on the nature of supply chain. For example, vertical integration may reduce the magnitude of block input taxes. This option is also not recommended asit distorts resource allocation choices. It shifts tax burden from consumption to production and leads to complexities in the administration of tax.

Lower rate of tax The next option is to subject the textile segments to the lower rate of tax, which may be possible in a dual rate regime. This is an advisable option if the government chooses to have a lower GST rate along with a standard rate.It is also suggested that all textile fabric categories (e.g., khadi, cotton, synthetic, and ready-made garments) should be in the same category to avoid classification disputes and maintain fibre neutrality. However, the scope of lower tax rate needs to be determined. There will be issues if inputs aretaxable at higher rate and outputs are taxable at the lower rate. It gives rise to issues relating to refunds and requires monitoring of refunds.

Standard rate of tax with appropriate subsidies. Another option is to apply the standard rate of tax with appropriate subsidies. If the country goes for a single rate regime, this option may be recommended in preference to zero-rating and exemption even if there is a net positive effect on prices. However, the price effect of GST will depend on the actual level of the standard GST rate.

A GST regime with a standard rate results in a clean tax system. It achieves production efficiency, which is the key concern as opposed to the regressivity of the tax system. Itcan be accompanied by an appropriate subsidy regime to support weakest segments ofthe textile industry. In the case of textiles, additional resources will be released to finance such subsidies as many of the existing support schemes will not be required once zero-rating of exports becomes integral to the tax system as under GST

GST: Government and Industry Preparations

Both the government (textile ministry and state textile departments) and textileindustry should prepare for the transition to GST. Adequate preparation for the implementation of GST, not only by the central and state governments, but also by the industry, that is producers, wholesalers and retailers is a prerequisite for the success of GST in India. Dealing with the input tax rebate system in central excise, service tax, and sales tax has prepared the ground somewhat but much needs to be done when input tax rebate chain has to run full circuit in CGST chain, SGST chain, and IGST.

The key aspects of preparation for GST will involve the following:

• Industry/dealers will have to register with Common Tax Portal. A PAN based ID should be considered. They will be identified with a GSTN number. They will deal with the central government’s Indirect tax authority which will also be the IGST authority, Finance Departments of State Governments, designated banks, and other dealers registered with Common tax portal, which will work as a clearing house. Throughout the country, the same registration number will operate for all participants in the chain of transactions.
• Each dealer or industry will have to develop its own GST IT interface. The entire record-keeping can become automated through the development of suitable GST software which should have the relevant return forms for declarations. A consolidated return in the approved format will have to be prepared for the agreed time cycle, showing claimed rebates, assessed tax, recipient tax authority, and net tax paid to the credit of the centre under CGST/IGST and states in the designated banks.
• Returns: The states as well as the centre would require taxpayers to file periodic returns to assess whether the taxpayers have computed, collected, and deposited their taxes correctly. ITC credit will also be verified on the basis of the returns filed and revenues reconciled against challan data from banks.

Periodicity of filing returns – monthly, bi-monthly, quarterly

Basis of settling accounts – payment, invoice, or hybrid

• Clarity needed in design of returns to show: Whether supplies are exempt

Whether supply is of a good or service, sale of land or asset

Whether supplies are zero-rated

• Whether the supply involves inter-state transaction, and if so, clear identification oforigin and destination state.Under GST, inter-state trade will be leviable to Integrated Goods and Services Tax(IGST). Under IGST, the tax paid bythe selling dealer in the exporting state will be available as ITC to the purchasing dealerin the importing state. This requires verification of ITC claims and transfer of funds from one state to another. Further, in an interstate business to consumer transaction, tax collected in one state has to be transferred to another state as finalized by the business processes. Thus, periodic inter-state settlement is required.Invoice level detail will be necessary for the reconciliation of tax deposits, and the end-to-end reconciliation of ITC. A dealer will need to distinguish between the supply channel, where input tax credits are to be claimed and sale channel where tax has to be paid.

(Author can be reached at sunilkumar@clcindia.com) 

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We would like to thank CMA Harshad Deshpande, who is also the Chief Editor of WIRC Bulletin, ICAI, for his effort to make the content on GST available to larger section of people and for dissemination of knowledge on the topic , which is of prime importance  not only for the taxpayers but also for common man of the Country.

Article been published with permission from CMA Harshad Deshpande given on behalf of Western India Regional Council of India of The Institute of Cost Accountants of India.

Source- WIRC Bulletin Diwali Special Edition on GST

HSN Code under GST