A taxing situation
India tax regime would promise benefits to business, including changing how companies distribute goods.
By Eric Johnson
India's taxman may soon have a huge bearing on how companies in the world's second most populous country structure their distribution networks.
That's because the country could, as soon as April, implement a new tax regime that will likely prompt companies to reduce the number of warehouses from which they distribute.
As part of a two-decade-long push to open the country's economy and simplify its tax system, India's finance ministry is pressing for a national goods and services tax, or GST, to replace the current value-added tax/state sales tax regime.
The move, economists say, would:
' Lower overall tax burdens on companies.
' Induce non-payers to start paying more consistently.
' Reduce the number of layers of levies owed on products made and transported in the country.
From a logistics standpoint, the change could have a profound effect. It could lead companies to start distributing from regional warehouses that cover multiple states, rather than the current environment in which warehouses tend to be located in each state where a company distributes.
On Dec. 15, a commission of India's finance ministry recommended a 12 percent flat GST ' with 5 percent to go to the national government and 7 percent to go to states.
It's not so simple to compare that with the current tax rate, simply because every state has its own rates and systems. But one thing is clear: the current system wholly dissuades companies from distributing across state borders because levies are then assessed in both states.
'If you subsume everything, 12 percent seems a viable rate,' D.K. Srivastava, director of the Madras School of Economics and a previous member of the national finance commission, told the Indian business newspaper Mint in mid-December.
The national government has had trouble convincing some states to do away with the current system ' in which the central government, states and municipalities all are able to levy their own duties on goods and services.
From the viewpoint of manufacturers, shippers and logistics companies, that tangle of duties creates complexity, never mind higher costs. The GST is not only expected to lower overall duties on raw and finished materials, it's also expected to provide a simpler platform for companies to pay taxes.
A single GST, replacing the web of national value-added taxes and local levies, will drive companies to find more practical solutions for inbound and outbound distribution throughout the country.
Currently, a company wanting to distribute to every state in India has to locate distribution facilities in every state, or face crippling interstate duties. The GST will lead to an environment where companies can locate regional distribution centers or warehouses in cities that make the most sense for their business outside of tax issues.
As an example, the capital, New Delhi, is an administrative area much like Washington, D.C. New Delhi, like Washington, also borders two states (Uttar Pradesh and Haryana).
Under current tax rules, it makes more sense for a company to operate distribution facilities in Haryana, Uttar Pradesh and within New Delhi, despite the fact that a drive between the three places can take less than one hour.
Under GST, a company could combine those facilities into one regional center without facing the implications of cross-state levies. Theoretically, it could even distribute from one facility to areas beyond Delhi and the two bordering states.
Though the move to GST sounds like a winning proposition, there could be some losers ' most notably companies looking to import into India and tap into its growing consumption market. The new regime would ostensibly make Indian-made goods more competitive as a product manufactured in the southern state of Karnataka would be taxed the same whether it was distributed to Karnataka's capital (Bangalore) or several hundred miles north to Delhi.
Imports currently receive favorable duty treatment compared to domestically made goods.
However, exports stand to benefit greatly, as the same principles would apply to India-based manufacturers moving their goods to Indian ports. Currently, a product to be shipped abroad out of Nhava Sheva, the country's biggest container port, would be best served by being distributed out of Maharashtra (the state that's home to Nhava Sheva). Under GST, that product could be distributed from a regional warehouse in another state where labor and real estate prices might be much cheaper than in Maharashtra.
That leads to another concern of states ' lost revenue from facilities moving to states with more attractive costs. The government is trying to assuage those fears by creating a $7 billion fund, to be generated over the first five years after GST comes into effect, that would compensate states that would lose revenue due to the changeover in tax regimes.
Amit Dhingra, India country manager for the global 3PL Menlo Worldwide, told American Shipper the government will operate a clearinghouse of tax revenue and redistribute the funds between states as prescribed by whatever formula is eventually approved. That means that states wouldn't have to deal with the transfer of tax revenue between each other for products moving from a regional distribution center in one state to a consumption market in another.
'Everybody understands the benefits of the GST,' he said, adding that it will usher in an era of 'borderless travel' within the country. 'The states are just concerned about the redirection of taxes.'
Delays Expected. Those concerns could very well delay the implementation date of the GST until beyond April, despite the government's attempts to fast track the policy. Like many things in India, patience is needed.
| Chan |
Yet Desmond Chan, regional manager for South Asia at Menlo, said customers want to be prepared no matter when the GST comes into effect. In India Menlo's primary business is the handling of spare parts for the automotive industry.
'They're not stopping just because it might be delayed,' he said. 'We know it's a big change, and we know it will be delayed beyond April. But it's just a matter of time. Companies are looking at this, and even if it comes in two years, they want to know how to restructure a post-GST model. They say, 'I need a plan.' '
Chan said key questions revolve around how to structure supply chains under the new regime. Should warehouses be concentrated into regional centers rather than state-by-state facilities? Where are suppliers located? Where are end customers to be found? What does it mean in terms of tax and fuel surcharges?
But the recurring theme is cutting back on inventory.
'They are really interested in pooling inventory rather than putting inventory in each state,' Chan said.
Dhingra said Menlo's customers are also looking at how changing their distribution network would impact their own end customers. For instance, an advantage of having a warehouse in each state is that transit times tend to be low since there's a finite distance from storage to store. Even in the largest states, markets can typically be reached in a few hours.
The key for Menlo's customers will be to transition to a regional network of distribution centers that doesn't impact transit times. That's why several cities in central India ' notably Nagpur, in western Maharashtra ' are being eyed as distribution hubs.
'Nagpur should emerge as a hub,' Dhingra said. 'On average, it's 48 hours by road to virtually any part of the country.'
He said Chennai and Mumbai would also grow as hubs, given their proximity to India's two biggest seaports. Chennai is particularly key as an automotive hub.
Dhingra added that one issue to watch is municipal taxes. It's possible that the GST won't prevent cities, like Mumbai, from levying its own taxes on goods.
'It's not clear if these will be rolled into GST,' he said.
But as Chan pointed out, those are the concerns of Menlo's customers' customers. Menlo's direct customers are focused on saving inventory costs, never mind all the attendant costs of operating more facilities than are strictly necessary.
'Pooling inventory together is the most important aspect, especially with the shorter life cycle of products,' he said. 'Companies do not want all this inventory tied up in extra facilities.'
Menlo is conducting optimization analyses for its customers in India with the goal of determining whether a switch to a regional network would save them money. Preliminary estimates, Chan said, are that 30 percent to 50 percent of costs could potentially be saved, though he cautioned that more concrete estimates would be available in a couple months.
The switch to GST may change how India thinks about inventory. Chan said companies are currently driven by market demand ' essentially ensuring that they don't run out of stock ' rather than by minimizing supply chain costs.
'Inventory costs represent about 60 percent of supply chain costs,' he said. 'By pooling inventory, you will save supply chain costs as well as distribution costs.'
Aside from reduced inventory, there are also the costs associated with operating facilities that may be superfluous.
'Having so much warehousing infrastructure ' setting up and managing these facilities ' drives up costs,' Dhingra said. 'It takes a lot of coordination to manage the service providers associated with each separate warehouse. Fewer warehouses mean fewer service providers to manage.'
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| Amit Dhingra India country manager, Menlo Worldwide |
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| 'Everybody understands the benefits of the GST. The states are just concerned about the redirection of taxes.' | |
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Tax experts in India say the impending switch will be hugely attractive to businesses.
'GST is needed because the tax system is the real cause of the problem,' Rajeev Dimri, an indirect tax partner at BMR Advisors-Taxand, said in a report by International Tax Review in November. 'Duties can be charged by both the state and the central government.'
In the same report, Prashant Deshpande, an indirect tax partner at Deloitte in India, said reduced complexity is sorely needed.
'There are currently multiple taxes, different tax authorities, different rates and different legislation for indirect taxes in India,' he said.
In the Indian magazine DNA, columnist R. Jagannathan wrote in July that the new regime will also make companies think about how they structure their business within India. He said it may make more sense under GST to strip out subsidiaries and let them operate independently rather than under a national or global umbrella.
'Take a company like Reliance, which is vertically integrated from oil prospecting to refining to retailing to petrochemicals to plastics and textiles,' he wrote. 'When there were so many state and central taxes, it made sense to house all these diverse businesses under one roof. Reason: you pay taxes only twice, once when you buy the raw material, and another when the final product leaves your showroom or factory. There are no taxes in between.
'Once GST kicks in, the implication for business is simple: there will be no difference between taxation at one level of production and another. You can completely break up every stage of production into a separate company and there would be practically no impact on the total taxes you pay.'
Another example came with textiles.
'If you are a textile company buying cotton at one end, and then spinning and weaving it, and then transporting it to a showroom for final sale, you can have separate companies (or entities) running each part of the business and the taxes you pay will be the same if you ran all of them under one roof,' he wrote. 'Nothing wrong in doing it all under one roof, but what if you are earning higher margins in retailing, and losing it in spinning? You can then focus on the part that you are best at. If you have a very competitive retail business, you can dump your textile factory and source material from the cheapest places. You become more competitive.'
The GST is actually a natural progression from the heavy-handed tax regime that existed for decades after India's independence in 1947 to the current value-added tax system, or VAT. Individual states charge their own VAT levels but companies are also subjected to national government's concurrent central sales tax. That tax has gradually been lowered, from 4 percent in 2008 to 2 percent in 2009 and a promised zero percent in 2010.
In 2008, American Shipper wrote about how the change from sales tax to VAT was not progressing as smoothly as it could ('A VAT of confusion,'). The report said that despite the VAT regime's intent to do much of what the GST promises, layers of levies and complexity still kept companies from optimizing their distribution networks.
Since GST is supposed to replace the central sales tax and VAT, it will be interesting to see if GST succeeds where VAT
didn't.
'Ultimately, it's about how do we simplify the flow of products,' Chan said. 'How do we cut unwanted costs. It's pretty common to look at this outside of India. It's not that common in India.'
(A link to the government's proposal to change to GST is available here.)