GST and its Impact on credit, capital and balance sheet and the way of conducting the jewellery business in future

SANJEEV AGARWAL, Gitanjali
JATIN ARORA, PwC
Rohan Shah, counsel
Jyoti Sharan, SBI
Shivanshu Mehta, MCX
Ranjith Singh, BSE

Intro:
India’s new tax system was the anxiety-inducing subject of the third session of RJIF 2017, titled ‘GST and its impact on credit, capital and balance sheet and the way of conducting the jewellery business in future’. Five experts outlined in practical terms the shape of this looming new reality.

The latest challenge to India’s jewellery industry as a whole is the goods and services tax (GST). Set to come into force nationwide on 1 July, GST is aimed at lowering inter-state trade barriers, boosting tax compliance and encouraging private investment. It will replace a number of central and state indirect taxes, including excise duty, service tax, sales tax and octroi, with what is essentially one tax. But will it comfortably accommodate the complex, traditional world of the jewellery industry?

In this session, five experts spoke on the practical impacts of GST on the jewellery industry, laid out how jewellers at various levels should adjust their practices to comply, and drew attention to the challenges and areas of uncertainty.

Trajectory

“We have been hearing about GST for years,” said Jatin Arora, executive director, PricewaterhouseCoopers India, in his presentation. “Multiple white papers have come into the public domain, multiple discussion drafts, draft versions of the law. But we are still confused.” And it is just two months to the rollout.

“You’re really looking at the Y2K of tax,” said Rohan Shah, counsel, Shah Chambers. “In Delhi, where acronyms are popular, the perception of GST is as a ‘good and simple tax’. Anybody else’s perception of it here is ‘god save the taxpayer’. I think we will reach a stage where it becomes ‘god save me from my tax consultant’.”

He explained the background. After the 2016 agitation against excise, “the central government began to see this industry as non-compliant. The intention is to ensure that, as a business and consuming community, our every transaction is monitored and accounted for. That’s the heart of GST.”

“There are more than 300,000 jewellers in India,” said Sanjeev Agarwal, CEO, Gitanjali Exports, the session’s opening speaker. “In 2006, national and regional players had an 8 per cent market share. Small retailers had 68 per cent. By 2025, 45 per cent of retailers will be national or regional. Large local players will also grow, but their market share will shrink to 20 per cent. The most affected will be small jewellers.” In short, GST will accelerate the twin trends of organisation and consolidation, and woe betide those who fail to adapt.

Shape of GST

Excise is levied on manufacture, VAT on sale. In GST the taxable event is supply. This is a fundamental change. “There will be no differentiation between a manufacturer, retailer, trader, importer,” said Arora. “You are a supplier, either of goods or of services. And ‘supply’ does not require you to receive anything from the other person. If there is a change in the title of the product you are liable to tax.”

GST will be a destination-based tax. This is the second fundamental change. “Taxes will accrue to the state in which the supply ends or finds a consumer,” and not the state of origin.

The GST Council, comprising the Central and state finance ministers, has announced five slab rates, of 0, 5, 12, 18 and 28 per cent, with the highest intended for luxuries and “sin goods” like tobacco. The final “fitment” of goods and services into these slabs is set to take place in May.

“Higher rates are not conducive to stability in this industry,” said Arora. “Jewellery, gems and gold the world over are taxed at extremely low rates,” Shah confirmed. “The moment you have high tax on a high-value item there is migration away from legal transactions.”

For the jewellery sector the GST rate is likely to be 5 per cent, hence 2.5 per cent CGST and 2.5 per cent SGST. This is a significant bump from the prevailing rates, and much steeper than the 1 per cent excise that caused such shock last year.

“VAT is 1 per cent in most states,” said Shah, for context. “Kerala has it at 5 per cent, but also has a composition scheme. Heavy producing and consuming states like Gujarat do not have VAT at all, because the nuances of business make it difficult to administer.”

“Today there is excise duty and on the goods value plus excise duty there is a VAT. So there is a tax on the tax,” said Arora, referring to “cascading”. “In GST the value base will stay fixed, and on that base there will be CGST and SGST.”

Compliance: registration

Today an enterprise has to register separately for excise and VAT in each state of operations, and file two sets of returns accordingly. After 1 July there will be one registration per state, covering CGST, SGST and IGST. Each state will require one set of GST returns. Each state will have its own litigation and auditing mechanism.

Arora spoke in depth about compliance. “As a single-state entity, taking all supplies in-state, you will register in that one state,” he said. “You will file a single return for all your supplies, and pay taxes in-state. Taxes will accrue to the destination state, but you do not pay in that state.”

Compliance: returns

When you supply a product, you will file an outward supply return on the GST Network portal. Your outward supply return will become your customer’s inward supply return. Your vendor’s outward supply return will be your inward supply return. (GSTN is a private limited company with 49 per cent government participation, set up to build and run the IT infrastructure that will underpin GST.)

The data will auto-populate on GSTN’s network. When the supplier files his outward supply return with details about you as the buyer, the data will auto-populate your GSTN account. “You will have to match this inward supply data with the supplies actually done by your vendor,” said Arora, so that “your credit eligibility is captured.”

The vendor will have to file his outward supply return by the 10th of the following month, and you your inward supply return by the 15th. Similarly, you will have to file your outward supply return by the 10th. Your outward supply return must include any advance payments from your customers, which will be taxable.

Data from your two returns will auto-populate the final return for the month, due probably on the 20th. In this third return you will check and correct your numbers for imports, exports and reverse-charge liabilities. You will not be able to file this consolidated return until you have paid the taxes.

So, even though it means 36 returns per state per year, the GST is going to make life simpler for you.

Compliance: inputs and invoicing

“Under GST,” said Arora, “almost everything you purchase for further use in your business will be treated as an input and credited. The government is looking at introducing a reverse charge mechanism. If you as a business receive certain specified categories of input services, you will be able to self-compute the tax on the amount you pay the vendor, pay it to the government and take it as an input tax credit.”

The mechanism will apply also to certain specified goods. The final “fitment” of different goods and services in the five rate brackets is to be hammered out in May.

“Those who set up a new business, showroom or unit will have contractors doing the work,” Arora said. “You will be liable to withhold tax on the payments you make for their services.”

If you as a registered MSME purchase goods from an unregistered MSME, than you have to raise an invoice. “This is linked with the reverse charge mechanism. Therefore, it will matter how many unregistered MSMEs you deal with,” said Arora. “You may want to convince your vendors to start compliance on their own so that you can get proper credits and do less compliance.”

Unresolved questions

To reduce their burden of compliance, smaller, single-state enterprises can consider the composition scheme under GST. It is limited to Rs50 lakh annual turnover. “We should urge the government to increase this to Rs2.5–5cr,” said Arora. “In this scheme you will pay a lower rate of tax (1–3 per cent) but not be eligible for input credits.”

During the actual transition, however, “What happens to your goods lying in the warehouse, or at the retail level, on 1 July when GST comes into force?” he asked. “What happens to the taxes already paid, and the credits?”

It goes without saying that you will need to reconfigure or “patch” your IT systems and enterprise resource planning (ERP) tools. “How you raise purchase orders, book inventory, compute taxes, raise invoices, your management information system (MIS) and report capturing, all will change,” said Arora.

Credit flow

“What is going to be the credit flow?” under GST, asked Rohan Shah. “Every input must result in a tax payment. The vendor records a tax payment, you as a purchaser record what you have paid, and the reconciliation of the two completes the circle of credit.

This is the flow today: “You have a principal manufacturer, brand owner, retailer. You go to jobbers depending on how complex the piece of jewellery is — maybe three jobbers, maybe 11. The finished goods come back to you and you sell them directly, remove for sale on an approval basis to a wholesaler, or stock-transfer to another outlet you have,” Shah summarised.

He added a caveat for the future under GST. “For export goods the government says, pay tax first and then on proof of export take a refund. Everybody knows that the refund actually costs. Also, I should be confident that the government can afford to pay. Between December and March, if the government hasn’t earned enough money, I will not get my refund. So this is not an exemption, as under Rule 5 or Rule 19 currently.”

“Today, on imports we pay the basic custom duty, which is in the range of 10 per cent,” said Arora. “Some products are subject to CVD [countervailing duty]. Now the CVD and customs duty will be replaced by the IGST, which will be fully creditable for output liabilities. So it’s not going to be a fixed cost.

What’s more, said Shah, “If you don’t raise an invoice you’re not taxable, but within six months you have to generate an invoice whether or not the goods are sold. If anybody makes a mistake while entering details, the tax payment occurs but the credit doesn’t.”

Ideally, any excess tax payment in a unified system should be creditable towards any other tax due. However, the GST setup is designed to ringfence the Centre’s revenue. Consider the following description, as laid out by Shah.

“If you sell from one state to another it’s IGST. If you sell within a state you pay SGST and CGST, and CGST + SGST = IGST. When you pay IGST on behalf of your supplier, you can use that credit towards IGST and it’s fungible, you can use it to pay CGST or SGST. If what is paid is a CGST, however, you can only use it to pay IGST or CGST. And if you pay an SGST you can use it towards an SGST or an IGST, which effectively means the CGST cannot be used to pay SGST, and vice versa.”

Concerns: working capital

Your working capital is going to be impacted by GST.

“Today you purchase the gold or goods for your business at a 2 per cent tax rate. Tomorrow you will pay 5 per cent GST, upfront,” said Jatin Arora. “If you are a retailer, you realise the value from the customer immediately. What if you are a manufacturer or trader? If you purchase something today and pay on the input side, you take a credit but you’re not utilising it, so it’s in your books. Then you have conversion time, supply chain, warehousing and inventory holding period. Even stock transfer is subject to IGST.”

Ecommerce marketplace operators, like Amazon and Flipkart, will be required to collect 1 per cent tax at source on all sales made through their platforms. “So if you supply your finished goods to customers through the ecommerce route,” said Arora, “the platform operator will hold 1 per cent from the net payments to you.” Until the operator files its return and you get the credit, this will remain as a 1 per cent cost for you. “This will add to your working gap requirements.”

Other GST compliance questions, too, will concern ecommerce players. Arora had examples: “Where is the order coming from? Where am I sending the goods from? Where are my warehouses? I’m raising my invoice on a person, so how will taxation apply?”

“If you had a credit on goods of 90 days,” said Shah, “please be aware that the tax of your supplier has to be paid in 30 days. So tax payments are in 30 days even if on the sale price you get 60 days more.” (For services you can take three months.)

Concerns: job work

Job work is integral to the jewellery sector. “Job workers’ supplies that you release will count as inputs, and no tax will be payable if you bring them back within one year,” said Arora. “But if you want to remove the manufactured product directly, this has to be subject to tax. Who will pay the tax, the job workers or you? The government would say the accounting responsibility is yours.”

In the current system no karigar pays tax, because the principal manufacturer pays excise. In GST, however, said Shah, “a karigar is not a contributor towards manufacture; he is a service-provider. Any karigar who goes over the Rs20 lakh threshold of turnover will pay tax himself.”

Shah was a member of the high-level committee appointed for discussions with the government on excise last year. He said, “We are debating with the government whether Rs20 lakh should be his mazdoori or include the value of his goods. If the latter, he is out of the bracket within a few days.”

His point was difficulty of compliance. “The moment your karigar has to pay, at the very least he has to be on a computer. You both need to speak the same language on each transaction. He needs to log it, you need to log it, that circle needs to be complete for you to get your credit.”

Karigars may not be familiar with computers and the upload process. Therefore, in the short term, “You are likely to lose a lot of money,” said Shah. “Your whole ecosystem must be compliant before you say you are compliant.”

There is yet another concern about accounting for job work. “If job work charges are the value-adds, and if one karigar charges RsX and another charges RsY, this is also going to be very hard to explain,” said Shah. You could well be challenged, “Why is this labour charge separate? Why does this design cost lakhs of rupees, and that one only Rs3,000?”

His recommendation? “You need to pre-prepare your whole basis of pricing. If you can’t get consistency, get answers as to why one is different from the other.”

There is one positive. “In the high-level committee,” said Shah, “we learned how powerful and national is the network of karigars. The government must realise that it is a votebank. Their number is a strength.”

Concerns: anti-profiteering

“The government says any benefit you derive from a reduction in tax or an increase in input credits should be passed to your customers in terms of prices,” said Arora. “This is to limit consumer price inflation as a result of the transition to GST.”

“Anti-profiteering concerns are relevant if your tax rates fall,” Shah pointed out. “Our argument would be that the effective tax rate is 2 per cent, if you make it 5 per cent where is the question of profiteering?” Even so, the government is set to scrutinise your pricing before and after GST comes into force.

Concerns: traditional practices

What happens to remaking? “If a customer brings old jewellery to remake,” observed Shah, “effectively they get back a new piece of jewellery. That is taxable. How do you account for it?” There is no such thing as a standardised valuation for old jewellery.

What about the relationship between supplier and recipient? “In our industry I transfer to myself, I transfer to a cousin, I transfer to my sister, I transfer to my aunt,” said Shah. “The moment you sell to a related entity, that is not a genuine price.”

But what will replace it? “If you don’t have an actual sale price, you then have surrogate value, which means the price of a comparable good. In jewellery the artistry, design, making skills all vary. How will you find a comparable good?”

Shah recommended that “instead of selling to a related entity, now sell to an arm’s-length entity. If you must sell to a related entity, get your pricing right, otherwise you will face a lot of scrutiny.”

And what happens to discounting under GST? “How will you justify a diminishing value when the goods remain the same?,” Shah pointed out. “Be very careful. Your discount policy must be pre-stated, clear and uniform. The government is not going to accept ad hoc discounting.”

Opportunities: finance

The pressure on working capital under GST had been flagged as a concern. In his presentation, Jyoti Sharan, general manager–Mid Corporate Group, State Bank of India, Mumbai, offered reassurance regarding access to finance.

“When we fund your working capital, we take into account the existing tax, a transportation cost, and the basic price of the materiel that you are buying,” he said. “If there is any additional cash outflow on account of GST, that will be taken care of by the lenders.”

“Two things will improve your ability to get finance,” confirmed Shah. “One, the extent and valuation of your inventory will be far superior. Second, the value of your receivables will have a greater integrity. Events for which you need to be funded can be predictable, and the quality of data will improve over time.”

“Those of you who are presently non-corporate may like to be corporate going forward,” Sharan recommended, “because there will be no distinction in compliance level. Once you are in an automated system, the information flow starts. That is a big comfort to any financing bank. I feel the credit flow to the sector will go up.”

Opportunities: hedging and listing

Entering the organised economy would offer even small jewellers valuable opportunities, such as access to commodity exchanges. Listed companies are already required by the Securities and Exchange Board of India (SEBI) to undertake risk profiling and risk management.

“Month-on-month over the past year, bullion has seen a volatility of 15 per cent on average for gold and 22 per cent for silver,” said Shivanshu Mehta, head–bullion, Multi Commodity Exchange of India (MCX), in his presentation. “Exchanges are a platform for the transfer of risk from the physical industry, which wants to avoid gold price fluctuations while maintaining its markup, to the speculators, who take on that risk.”

He gave two examples, with solution. “You have given a fixed price for an order, and don’t have the metal. Or you have a priced inventory but you don’t have an order. In either case you utilise the commodities exchange platform by doing a long hedge or an offset hedge. The advantage, apart from the efficient use of capital, is that you block only a certain margin. Companies that have a solid hedging mechanism enjoy better valuation. You protect your profit margins and you protect your inventory from a fall in prices.”

MCX, said Mehta, can help hedge against fluctuations in bullion prices and currency rates, and even changes in the customs duty.

Ranjith Singh, assistant general manager, Bombay Stock Exchange (BSE), was well positioned as the speaker after Mehta. He laid out the opportunity as well as the criteria for listing on the BSE, whether main board or SME board — criteria including IPO size, company size and track record, assets, profitability, balance sheets, post-paid capital, dematerialised shares, website, and so on.

With the multi-front push towards transparency and accountability, of which GST is the major engine, there is little doubt that a number of jewellery players will be exploring this option in the near future.

Clarity and trust

GST offers the prospect of a smoother and freer economy for India — at the cost, for each and every enterprise, of being transparent to the government. The impact of so radical a tax reform on this diverse and deeply traditional industry is not wholly predictable.

And yet, warned Shah, there is little clarity on the details. “The tax collector knows as little as you, the taxpayer. The only people licking their lips are lawyers.”

Having the government’s hands so greatly strengthened in its dealings with any enterprise is a particular risk. The high-level committee on excise, said Shah, was “very concerned that seizure, search, confiscation of goods on the road, going to a karigar’s premises, all this would not happen, and that even if my shop was raided my goods would be given back to me immediately.” Various provisions were agreed to protect against overly aggressive excise tax collectors. Those changes are not available in GST.

“If we have conveyed a sense of fear,” said Shah, “trust us, you should be scared. Having said that, change is inevitable, and we have a terrific chance to embrace it. There will be GST software, there will be government support. This industry can talk to the government as it has done so many times in the past and get to something we can live with.”

The responsibility goes both ways. “You, as the government for five years, give us five years. Don’t ask endless questions, don’t make our lives miserable. Once we are in the system our businesses are innovative enough, we are compliant, we can adapt well.”