As India Inc gets ready to change to the Good & Services Tax (GST) from July 1, many companies are anticipating an increase in working capital requirements due to the lack of an immediate set-off for the input tax credit and the replacement of quarterly tax payments with monthly ones.
“From a cash flow perspective, it (the transition) will be expensive, working capital needs will increase,” says Sunil Sayal, CFO, Region, India, of the data networking and telecom equipment company, Nokia Siemens Network. “Earlier, excise duty would be deferred to the time the product moves to a third party,” he says.
The same thought was echoed by Mahesh Majithia, CFO of machine manufacturing and engineering company, KHS Machinery. He anticipates an increase of 5% in their working capital requirement, and thinks that most other sectors will also suffer an increase of 5-10% in working capital.
The reason for this rise in working capital is that now companies have to submit the taxes immediately in terms of input tax credit. “Under GST, we will have monthly filing of returns and payment of taxes, which were earlier being made quarterly. Working capital needs will obviously go up,” says Majithia.
According to India Ratings and Research (Ind-Ra), the transition to GST will disrupt the working capital cycle of businesses in the initial phase and thus easy liquidity in the system is essential for two to four months. Based on a sample set of 11,000 corporates, the agency estimated that “the input credit lock up for this sample could be around INR 1 trillion of which about INR500 billion could be blocked for about two months which may result in higher short term working capital requirement for businesses in the near term.”
The biggest impact is likely to be on exporters as there is a chance of credit getting locked for a longer period of time. Such firms did not pay any customs duty on import of goods in the earlier regime. Under GST, however, they will have to pay tax Integrated GST (IGST) on import of raw material.
“The government has promised to make 90% of the refund within 10 days, but we still have to see how effectively it will be implemented,” says Pratik Jain, Partner and National Leader – Indirect Tax at PwC India. Jain therefore reckons working capital stress for companies other than exporters will be minor.
For some companies who have seen an upward movement of tax rates under the new regime obviously, the capital requirements have seen a jump.
For instance, Vivek Gupta, CFO and Company Secretary, JBM Auto Ltd explains that earlier auto component companies were charged excise duty, octroi, central sales tax and the total tax incidence came to 14.5% to 17%. Now it will come out to 28%, so there is an increase in 9% (taking an example of Haryana).
Any additional expenditure that you incur you should be able to offset it against the profit that you make. So it is important for CFOs to realise the additional working capital needs and costs.Pratik Jain, Partner and National Leader – Indirect Tax at PwC India
The working capital cycle is generally for the period of 30 days for passenger vehicles and 90 days for commercial vehicle/farm equipment. Higher incidence of tax increases the interest costs too. Gupta anticipates an average 2-3% impact on the working capital due to higher interest, but expects some of this hike to be offset by the fact that central sales tax is getting subsumed in GST. His parting shot, therefore, is “Maybe, the impact will not be on profitability but the cash flow will get impacted.”
In case of services, the hit is clear—an increase from 15% to the 18% under GST. Since GST is an interplay of several factors, various finance heads that ETCFO spoke to seem to be in wait-and-watch mode. Many believe that mechanism of refund and input tax credit system has to be understood properly at the operating level. “It doesn’t seem like a strategic challenge,” says the CFO of a pharma company. He too believes that there is “no big challenge on profitability, but only on cash flows.”
Ind-Ra’s study suggests that around 85% of the blocked input credit will be with companies with greater than Rs 500 crore revenues. Ind-Ra believes larger companies whose credit profiles are relatively stronger will tide over the short term working capital disruption relatively easily as compared to the ones which have weaker credit profiles.
There is a silver lining too. An increase in working capital cost is something to keep in mind while coping with the anti-profiteering clause, advices PwC’s Jain. He adds, “Logically any additional expenditure that you incur you should be able to offset it against the profit that you make. So it is important for CFOs to realise the additional working capital needs and costs.”
Ashvin Parekh, Managing Partner at Ashvin Parekh Advisory Services LLP comes in with the final word. He believes that if the total tax collected under GST exceeds the tax collections in the previous regime, then there will be a clear increase in working capital requirements. That, however, only time will tell. In the meantime, Parekh very sagely advices, “neither the state nor any industry should suffer or benefit alone.”