One year after GST, India’s smaller companies are on the backfoot

On July 1, 2017, India introduced the Goods and Services Tax to replace the patchwork of indirect taxes that existed at the time and to improve tax compliances. As the tax regime completes its first year, Scroll.in reporters interviewed people running a variety of businesses: handicraft-makers in Guwahati, textile manufacturers in Surat and Tirupur, paper-goods dealers in Mumbai, weavers in Banaras, large and small engineering units in Hosur. Most of them were people Scroll.in had spoken to a year ago to understand their hopes and apprehensions about the new tax. This time around, they were asked a different question: what were their experiences with GST like? The sum of their observations provides the answer to a larger pattern: how GST is reshaping India’s manufacturing economy.

From dozens of interviews across the country, it’s clear that GST is working better for larger companies than smaller ones. This has put India’s smaller companies on the backfoot. Some have closed. Even the ones doing well report stable – but not rising – incomes. At the same time, even large sectors such as textiles and auto-components have failed to obtain the tax reductions they have sought.

When GST was launched with a special midnight session of Parliament last year, there was both excitement as well as apprehension. Before GST, businesses in India paid a range of taxes – some to the centre, others to the state government. This arrangement came with its pros and cons. On one hand, it generated revenues for state governments and allowed them a degree of financial autonomy. On the other, it created a welter of taxes that companies struggled to comply with, slowed the movement of goods from one state to another, and given weak supervision, allowed tax evasion.

GST was meant to change all that. All central and state taxes would be replaced with a single, countrywide tax levied on all goods and services. Scroll.in has previously reported on GST’s implications for state autonomy – since state government taxes get subsumed by GST, they become more dependent on central government allocations. What it would mean for companies was no less drastic. Companies would no longer be taxed a percentage of their sales or profits. Instead, tax would be pegged to the value each organisation in a value chain adds to the product.

Take Surat’s textile industry. If Company A, for instance, buys polyester chips from Company B at Rs 100 and sells its yarn at 130, it will pay a tax on that Rs 30. This has big implications. If Company B has not paid its tax, then Company A will have to pay a tax on the entire Rs 130. In this manner, GST introduces a strong incentive for companies to buy only from businesses that have paid their taxes.

India introduced a set of new mechanisms to administer the tax. The GST Council, a forum of state finance ministers chaired by the Union finance minister, was to collectively take decisions about GST. The technology infrastructure was to be managed by the GST Network. Businesses were expected to file returns online, many of them three times a month.

As the tax was introduced, the slabs rapidly emerged as a bone of contention. Some of them were high enough to quadruple a company’s tax obligations. Manufacturing states were worried that they would lose revenues since GST was being collected right till the point of consumption. The IT software was error-prone. Companies struggled with online filing and with the claiming of refunds.

But a year later, with the dust settling down, it is possible to see how GST is subtly changing the topography of Indian business.

Manufacturing cluster, Hosur

A year after the rollout of GST, the manufacturing cluster of Hosur in Tamil Nadu is a study in contrasting moods. LKM Adhi, a former president of Hosur Industries Association, is pleased with the new tax regime for businesses. Apart from a couple of minor niggles like delayed refunds, he said that the Goods and Services Tax’s made life much easier. “The general impression is that the manufacturing sector is doing much better,” he said. “[GST’s] adverse effects have been very minimal.”

But this view is not shared by V Gnanasekaran. Last October, when Scroll.in first met the president of Hosur Small and Tiny Industries Association, he had outlined why GST was hurting him and other members of his association. The biggest issue he flagged was the 28% tax slab on auto-component makers. Not only did this quadruple the tax they had to pay, it also triggered a 20% jump in their working capital needs. These companies had to pay GST at the time of sale but their customers only pay them after a 90-day credit period, as is standard practice in business. As a result, Gnanasekaran said at that time, members were taking loans to avoid defaulting on tax payments.

A year later, that problem remains unresolved. Some members of the association have not paid taxes for months together – and worry their GST licence will be cancelled. In the last year, said K Velmurugan, treasurer of the association, “The number of MSMEs [micro, small and medium enterprises] in Tamil Nadu has fallen by 50,000 [from 2.67 lakh units in 2016-’17 to 2.18 lakh units in 2017-’18], another 20%-30% are sick like my company. At any point, they can die.”

This stark difference in how Adhi, Gnanasekaran and Velmurugan see GST is mostly about scale. Most members of the Hosur Industries Association are large companies like Ashok Leyland, Titan and Venkateshwara Hatcheries. In contrast, Gnanasekaran’s association represents smaller companies, mostly suppliers to the larger companies in the cluster.

In Hosur, GST seems to be working better for larger companies than smaller ones. How is it faring elsewhere in the country?

Handicrafts sector, Assam

The rollout of GST was marked by doomsday predictions about Assam’s handicraft trade. Until last year, Assam’s handicrafts industry did not attract any value-added tax. But under GST, raw bamboo and cane are taxed at 5% and finished products at anywhere between 12% and 28%.

Over the year, most of those fears have been allayed. Traders say the worst is behind them. This is mainly because the GST rates on handicraft items were revised in November. Now, bamboo and cane products are taxed at 5%, the same as input tax credit – the deduction companies are allowed based on taxes they have paid while buying inputs to provide goods and services. Besides, the highest rate of tax for cane and bamboo furniture has been brought down to 12%. Only cane furniture which comes pre-fitted with cushions or other value-additions is taxed at a higher rate – 18%.

With that, handicraft makers have seen a revival in sales. Gyanendra Kalita, who manages the Guwahati branch of the Assam government’s flagship chain of handicrafts retail outlets, Pragjyotika Emporium, had told Scroll.in in October that “everything that can go wrong has gone wrong”. Average monthly earnings at his emporium had plummeted from Rs 30 lakhs in June 2017 (the month before the new tax regime was introduced) to less than Rs 12 lakhs in September 2017.

After the revision, business has picked up again. “In April and May, we have done business worth over Rs 30 lakh,” he said. Other traders had similar experiences. “Sales have become pretty much stable,” said Rajeev Poddar, who owns a cane and bamboo furniture business in Assam.

Apart from plummeting sales, traders also had to cope with the effort of filing tax returns three times a month. In October, Poddar, who had been on the verge of laying off some of his employees, had complained the process had been particularly taxing for a small business like his. Now, he affirmed, things have become much smoother. “To be honest we are surprised that a government software works so well,” he said.

E-way bills, which are mandatory for intra-state movement of goods under the GST, have also become relatively easier to generate, he said. Similarly, troubles in receiving input tax credits have dwindled. “We were scared that it would be a recurrent problem, but it’s become much simpler and smoother in the last few months,” said Thakuria.

Despite this, there are still problems. Given the higher tax slab, sales of high-value items like cane and bamboo furniture – one of the more profitable items for the sector – continue to be lacklusture. Naveen Sood, who owns Canecraft and Allied Industries, a company that supplies furniture to the Assam government’s emporium, said there had been a “60% decrease of furniture sales”. There are other grievances too. Kalita complained GST wasn’t being enforced strictly enough – some firms, he says, are dealing only in cash. “There are still places which operate without GST, which means honest players like us lose out on customers,” Kalita said.

Textile sector, Surat and Tirupur

The city of Surat in Gujarat, India’s largest manufacturer of manmade fabrics, hit the headlines last year when traders took to the streets protesting against the advent of GST. Smaller units were unsure if they could stay viable after paying GST, which charged an 18% tax on yarn and a 5% tax on subsequent value addition. They were apprehensive about the paperwork involved and the penalties for non-compliance.

That was not all. As Scroll.in reported, Surat houses two competing value chains for textiles. There is the informal economy value chain where garments move between diverse companies as they climb from one stage of production to the next. Tens of thousands of companies work in this value chain. The second chain is vertically-integrated, where a single company performs all those functions in-house. Approximately 10 companies occupy this space. Smaller companies in the cluster said that under GST, the informal value chain would get taxed at more stages than the vertically-integrated one. Between the low economies of scale of these units plus the GST on traders who take goods from one stage of production to the next, the informal value chain could end up paying as much as 20% more tax than the vertically-integrated companies. In a business with wafer-thin margins, this would move competitive advantage towards larger units.

Larger companies had their own grievances. Manmade fabrics belong to a small set of products (the others are rail locomotives and coaches) for which the government does not refund unutilised input tax credit. As the managing director of the sari-making company had explained in an earlier Scroll.in report on GST’s early impacts on Surat, when he buys yarn worth Rs 1,000, he pays Rs 180 as tax (at 18% GST). Since he should have paid only Rs 40 as tax (at 5% on the value added of Rs 800), he is entitled to a refund of Rs 140. However, when he sells the finished product at Rs 1,800, the company buying it pays 5% as GST, or Rs 90. So, the maximum tax refund he can get is Rs 90. “The government will keep the rest of the money,” he said. “The customer will have to buy a costlier sari, and the industry will take a hit.”

By September, the disaggregated value chain was getting hurt. Its customers had begun buying from Surat’s larger companies, which had sales offices in other states. A black market emerged, supplying finished garments to customers outside Surat, driven largely by local transporters who muscled into the turf of traders. At the same time, both traders and manufacturers struggled to comply with GST’s filing requirements.

Take RDI Tex, a small manufacturer in Surat’s Pandesara estate. His margins were too small to allow him to comply with the new requirements. “Companies have to file three GST returns every month,” said manager Pavan Daga. “But we cannot afford to have a full-time person for tax compliance. That will be another Rs 5,000-Rs 6,000 a month.” At the same time, bigger companies buying from RDI Tex were in the tax net. If they buy from larger suppliers that have paid GST, their tax burden goes down. As a result, they were telling Daga that they would deduct tax at the official slab of 5% and pay him. “Only they do not ask for a 5% deduction but a 7% deduction,” he said. Between this and falling orders from traders, his profitability was dropping.

By October, only some of these concerns had been allayed. Companies welcomed the GST Council’s decision allowing units with a turnover up to Rs 1.5 crore to file returns every quarter instead of every month but noted that they would still need to pay taxes monthly. Other problems stayed unresolved. Smaller units continued to slip back into the informal market, working only in cash. Midsize companies began to shut down.

How are things now? According to Mahendra Kajiwala, a member of the South Gujarat Chamber of Commerce and Industry, the integrated value chain is doing well but the disaggregated one is in recession. Business for weaving units, he said, is down by 30%-40%. It is the same story for the traders and processing units. Daily production has fallen, as Business Standard reported, from 40 million metres to 25 million metres. In the town’s markets where traders sit, shop rentals have fallen. Manufacturers and traders are leaving the trade, leasing their premises to other companies.

It’s a similar tale from Tirupur in Tamil Nadu. The town has both export units and domestic manufacturers. Both are struggling – and for different reasons. One problem for exporters is the delay in getting refunds. Said TR Vijaya Kumar, general secretary of the Tirupur Exporters Association, “GSTN is working well but the software is taking time and also making mistakes.” The system, he said, did not work in the initial months of GST and refunds piled up. It worked fine in January and February, but stopped working from March. That glitch was fixed by June but since then more errors have cropped up. In all, exports have fallen. Tirupur’s domestic manufacturers are in trouble too: as many as 15%-20% of them have closed in the last year. There has been a slowdown in demand, probably due to the combined effect of demonetisation, GST and a cash crunch.

Sari trade, Varanasi

In September, Rajan Behal of the Banarasi Vastra Udyog Sangh, an association of traders in Varanasi, predicted that business would not recover from the new tax. A wholesaler, his sales to retailers took a hit when GST was imposed on a product that had not been taxed before. Initially, he struggled to file three returns every month and there were glitches in the IT system for filing returns. Payments made to his GST account would be reversed. Though those kinks have been ironed out, his business is still 30% down.

At any given point, he said, over 20% of his capital is “locked up due to GST” instead of being invested back into the business. Before GST, the Banarasi sari trade ran on udhaar or credit. Weavers borrowed material from raw material suppliers; wholesalers borrowed finished saris from weavers; retailers borrowed from wholesalers. Once the goods were sold, everyone in the supply chain was paid. Now retailers get four months to pay wholesalers like Behal even though he must pay 5% GST on finished saris every month. “So over four-five months, 20%-25% of my capital is in GST,” he said.

Besides, retailers are buying fewer saris from wholesalers because returning unsold stock entails complicated paperwork, a hassle both parties want to avoid. “If they ordered 100 pieces before, they will order 50 now because they are worried about not being able to sell all of them,” said Behal. This, in turn, has meant wholesalers place smaller or fewer orders with weavers.

Consequently, the weaver colony of Jaitpura-Chhora in Varanasi is left with just a fraction of the work it had before GST. “Business is still very low, between 25% to 35%,” said master weaver Abdul Hasan who runs HAR Fabrics, a GST-registered sari-manufacturing unit, at Jaitpura-Chhora. “The wholesalers are not taking our product.” For him, the GST return filing process is still not glitch-free. “Sometimes service does not work or there is some other problem but we are fined for being late with payments,” he said.

Printers and paper products, Mumbai

Last October, businessmen in Mumbai’s printing and paper products sector had a litany of complaints about GST. At the top of the list: GST had reduced cash flow for small businesses, leading to a considerable slowdown in the industry. Some paper product manufacturers claimed their business had shrunk to 30% of what it used to be. A year into the new tax regime, their stories have not changed much. In the back lanes of Mumbai’s Fort area, paper and printing businesses are still struggling with smaller client lists and shrinking turnovers, even as the other teething problems of GST implementation have smoothened out.

“Business has been terrible after GST – our turnover is down by 50%,” said Somnath Bhattacharya, the co-owner of Sanjana Prints, an offset printing enterprise in Fort. One of the reasons for this downturn, said Bhattacharya, is the shortage of working capital. “We are forced to pay GST by the 20th of every month, or we face a fine of Rs 100 a day. But there is no such deadline or fine for our clients,” said Bhattacharya. “Clients often take two or three months to make payments, so we have to pay the GST from our own pockets and face a cash crunch.”

With a general dearth of cash flow in the supply-chain of the paper printing industry, Bhattacharya’s client list has also grown smaller in the past year. “At the same time, we now have the added expense of hiring a chartered accountant, which we did not need earlier,” he said. “We have had to let go of many of our labourers in the process.”

Jehangir Ansari, who runs an envelope-making company, attributes the slowdown to two main factors. First, the end product has become more expensive. “A pack of envelopes that I used to sell for Rs 100 now costs Rs 118. So naturally fewer clients want to buy from me,” said Ansari, whose turnover has reduced from Rs 18 lakh in 2016 to Rs 8 lakh this year. Second, he says, is the disadvantage of being a very small business in the age of GST. “I don’t need to have a GST number because my business is not worth Rs 20 lakh. But now clients only want to deal with those who can give them GST numbers [so they can gain credits], so we lose out to the bigger companies,” he said. “Small dhandhas like mine are really suffering because of GST.”

The silver lining is that the process of filing monthly tax returns under GST seems to have become relatively easier. For instance, when Scroll.in spoke to Fort’s paper industry owners in October last year, many had expressed confusion about which GST code to apply to which kind of paper product, since pamphlets, envelopes, cardboard files and other products were all being taxed differently. If a company paid excess GST on any given month, the refund took a long time. Finally, there was the problem of mismatched invoices: clients sometimes rejected damaged goods a month or two after the payment of GST, causing a mismatch between the invoices submitted by the seller and the buyer.

“These issues have sorted themselves out now, over the past one year,” said Saurabh Patel, the owner of Safety Pack, a company that manufactures cardboard files. The impact of the industry-wide downturn is that some companies have been forced to either shut shop or reduce the scope of their business. “At least three paper companies have shut down on this street itself, and many labourers are returning to their villages,” said Ansari.

One such company is Urvesh Kapasi’s Deep Impac, a printing and binding company that used to have a main branch in Grant Road and a second branch in Fort. “But then business began to shrink quite a lot in the past year, and it got harder to pay the rent and worker wages for two places,” said Kapasi. “So I decided to shut down my Fort unit some months ago.”

The big picture

Put it all together and the final picture is odd.

While some of the procedural glitches have been ironed out, others remain. Software code, as exporters like Tirupur’s Vijaya Kumar maintain, continues to have a greater role in dictating outcomes than decisions by the GST Council.

There is also opacity. Some things about the GST were puzzling from the very start. An instance here is the decision to deny refunds on unutilised input tax credits to manmade fabrics. There is also the decision to tax auto component makers at 28% but the larger companies they supply to at 18%. Both decisions are bleeding these industries.

As is evident in Hosur and Surat, GST is working better for larger companies than smaller ones. There is the obvious advantage larger companies enjoy in terms of ensuring compliance to GST, be it in their ability to employ good accountants or absorb delays in refunds. But a second reason has to do with access to the GST Council. In Hosur, auto-component makers are struggling principally because of the 28% tax. However, unlike the handicrafts makers of Guwahati, they have not been able to get this changed despite multiple efforts to do so at both the state and central level. This raises questions about how the GST Council functions. How do grievances come to the GST Council’s notice? How does it act on those?

Larger companies – and their associations – have far easier access to the centre. As Velmurugan, the treasurer of the Hosur small industries association said, “There is no single association for MSMEs in the country. We can speak but not lobby.” Despite this, at its October meeting, the GST Council cut tax on Gujarat’s khakra snack and also on handicrafts in Assam. But auto-components and textiles did not get the relief they wanted. Textiles and auto-components are large employers in the country. Politicians ought to have an interest in keeping them viable.

Year Two will be vital.