With the GST Bill being one of the important laws awaiting approval in the ongoing Parliament monsoon session, Suresh Nair, Partner with the Indirect Tax Practice in Ernst and Young, focuses on the possible impact of the Bill on pharma entities
“This bill has gone through the Standing Committee for two and a half years, dozens and dozens of meetings of empowered committees…Only then has a consensus happened…I beseech you rise above party considerations,” Arun Jaitley, Union Finance Minister of India in the Parliament
This passionate statement emphasises the NDA Government’s commitment to ensure that the Constitutional Amendment Bill (‘CAB’ or ‘Bill’) finds favour with the Opposition in the Parliament and consequently paves way for the implementation of the Goods and Services Tax (‘GST’) law in India from April 1, 2016.
The proposed new law cannot be implemented in India unless the Constitution of India empowers both the Central and State Governments to levy GST on supply of goods and services. While the Bill has been passed by the Lok Sabha, the hurdle of clearing Rajya Sabha continues and getting the consent of Congress could be critical in this journey. The Rajya Sabha Select Committee headed by BJP MP Bhupendra Yadav has submitted its report on July 21, 2015 detailing clause-wise recommendations on changes, if any, to the CAB. The Union Cabinet has moved quickly to accept certain amendments to the CAB with an eye to garner support from all parties/states for the CAB. Needless to reiterate, that enactment of this Bill will pave way for introduction of this much awaited tax reform in India.
With the possibility of GST implementation inching its way to a definite finality, Corporate India is gearing up to understand the possible impact of GST on its India operations.
GST Constitutional amendment bill and its impact
India will have a dual GST i.e. both centre and states would levy GST on a common base (CGST and SGST). Integrated-GST (IGST) will be levied on inter-state supplies as well as on import of goods and services.
The CAB has proposed to subsume the following taxes/ levies at the central level
► Additional customs duty commonly known as countervailing duty, special additional duty of customs, service tax, central excise duty, additional excise duties, excise duty under the medicinal and toilet preparations (Excise Duties) Act, 1955 and central surcharges and cesses relating to supply of goods and services.
Similarly the following taxes / levies are proposed to be subsumed at the state level:
► State VAT/Sales tax, entertainment tax (other than the tax levied by the local bodies), CST, entry tax, purchase tax, luxury tax, taxes on lottery, betting and gambling and state cesses and surcharge relating to supply of goods and services.
The bill has also proposed a GST Council with participation from centre and states alike. This council will play a key role in recommending the GST tax rates and approach towards exempting goods and services from the said levy, model GST law, principles of levy, threshold, preferential treatment to specific states etc and resolve disputes arising therefrom.
The most contentious issue is the proposal to levy additional tax of upto one per cent on interstate movement of goods which would not be creditable to the buyer / recipient of goods in the destination state. This is clearly a departure from the consumption-based non cascading concept of GST levy. Introducing the additional tax which is non creditable starkly highlights the compromise made to get the opposing states on board. The Rajya Sabha Select panel, in its report last week has suggested that this additional tax by originating states should be on inter-state sales only and not on inter-company stock transfer. The cabinet has, however, suggested that the mechanics of this levy of upto one per cent tax should be finalised while framing the rules thereby leaving it open for interpretation as of now.
Pharma industry – tax impacts
Notified life saving drugs / APIs used in manufacture of life saving drugs presently benefit by way of non-levy of excise duty to the extent covered under specific notifications under the central excise law. Given that the central excise duty would be subsumed under the proposed GST law, it would be relevant to ensure that the life saving drugs enjoy tax free status under GST. This would enable exemption from IGST on import of said goods also eg medical devices which enjoy exemption from CVD/SAD on import would be keen to hold on to the said beneficial treatment under GST.
From a pharma industry perspective, GST rate on formulations as compared to the GST rate on Active Pharmaceutical Ingredients (API) should be a key watch out area. In case the present deviation in central excise duty rate of pharma formulations vis-à-vis the duty rate of API is not addressed, the issue of accumulation of GST credit could continue even in the GST regime. The industry would be hoping for a favourable solution to this concern.
The treatment of current accumulated credit (due to the inverted duty structure) while transitioning into GST, is another watch out area for the pharma manufacturing companies given the high stakes involved therein. A beneficial win win resolution is amongst the key ask of the industry.
Loan licensee operations is a widely accepted prevalent model under the present Indian indirect tax law where supplies made to a loan licensee is not subject to VAT. If pharma formulations are cleared by the job worker to the loan licensee, then the manufacturing activity is subject to central excise duty based on MRP minus abatement. It would be in the interest of the pharma industry to have clarity on the tax treatment for such supplies to and from loan licensee under the GST regime and ensure that the levy of additional tax is not imposed on job work related transactions.
Also, as per the current model, there is no service tax on the processing charges paid to the loan licensee as the process per se amounts to ‘manufacture’. With this concept no more applicable, the need to specifically zero rate the levy of GST on such processing services should also be examined.
It is a known fact that many pharma companies have set up units in states (such as HP, Jammu and Kashmir, Sikkim etc), wherein the central and state governments have offered exemptions/incentive schemes with respect to excise and VAT taxes. These schemes are either by way of upfront exemption or by way of refund of taxes paid subject to conditions.
While the GST Council would recommend the continuity or otherwise of existing benefits in tax beneficial zones/fiscal incentives/state level incentives etc, it would be imperative for the pharma industry to examine the benefit of continuing with the said exemption under GST and the impact on their business planning in case the said benefits are discontinued going forward. There would be cases where expiry stock is to be returned back destruction purposes. Further, there could be movement of pharma formulations for relabelling to meet the DPCO requirements. From an operational perspective, it would be beneficial to ensure that such supply of goods is not subject to levy of GST and the additional tax.
Pharma industry – other impact areas
GST would be a tax triggered business transformation and hence the transition to the GST regime should involve not only the indirect tax team but would require focussed participation of a cross functional team of the companies from IT, supply chain, procurement, accounts, HR etc.
The impact of IGST on stock transfers could open up the need for pharma companies to examine to the requirement to redesign supply chain network – to study the optimal number of warehouses, locations and linkages. Inventory management norms presently followed by the companies would also need to be re-evaluated in light of the proposed changes. It may be interesting to revisit the benefits of in house manufacturing vs outsourcing by way of contract manufacturing model.
Similarly, a re-look at the sourcing pattern could be mandated to evaluate the potential impact on pricing due to possibility of higher tax for imports in post-GST scenario and the proposed levy of additional tax on inter-state movement. Efficient planning on transition to GST could provide competitive advantages in terms of pricing of the goods and overall strategy of the companies.
Apart from the above, key accounting impact due to the proposed law could involve change in chart of accounts, need to modify SOPs, study transitional impact and impact on financial ratios and working capital of the companies.
One critical aspect would be the impact from an IT systems perspective. A need to effect changes to organisation structure mapping in IT systems to facilitate transition to GST would be required. Also, mapping of various regions/locations and various tax registration numbers including changes to vendors and customer master (e.g., tax registration details) would be integral part of the GST implementation exercise. The change would also require addition/modifications to chart of accounts and tax determination rules, tax masters, for the various purchasing and sales transactions of the companies.
Creating awareness with key stakeholders such as suppliers, distributors and internal stakeholders would be the need of the hour so that they are kept informed of the plan and progress on the GST implementation initiative of the company.
Needles to reiterate, industry needs to ensure timely readiness for the GST. Delay in the implementation could have potential reputational, business and compliance risk. Hence senior management oversight to ensure timely completion of tasks for implementation of GST would be a defining part of in-house strategy.
The road ahead
The passage of CAB in the monsoon session would be very crucial to the government’s intent to implement GST by April 1, 2016. The need to have GSTN operative by this date would also be of paramount importance to the go live of GST in India. Industry should also closely follow the recommendations of the Committee of Dual Control, Threshold and Exemptions in GST Regime, Committee of Revenue Neutral rate for SGST & GST and Place of Supply Rules and the Committee to draft model GST law for India. This would provide insights on the design and mechanics of the proposed GST.
Until them, lets continue with ‘Crystal Ball’ gazing ….May be, even Nostradamus would have failed in this endeavour to get it right!!!
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