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Cover Story | September 2017

The Powernomics of GST

<span style="font-weight: bold;">GST has arrived finally! Though passing through initial pangs at present, it is expected to promote 'Ease of Doing Business' in a big way, in due course.</span> <p></p> <p> Finally, Goods and Services Tax (GST) has arrived on July 1, 2017, and the first batch of filing of monthly returns is underway in August 2017. Like any other changeover, GST is also facing its initial pangs. Traders and businesses are facing some difficulties in preparing for and complying with this new regime over June and July 2017. In June, just before launch of GST, the distribution chain - wholesale and retail - were trying to get rid of channel inventory to avoid any potential inconvenience post-transition, even as the government was trying to iron out issues relating to tax rates for some products till the last minute. This has affected the manufacturing sector's performance during the month. In July, when GST came into being, businesses found it difficult to comprehend the process to be followed and its real implications on their business as the input tax credit is a new concept for non-exporters even today.</p> <p>Promoted under the theme, 'One Nation, One Tax and One Market', it has replaced a plethora of indirect taxes at the Centre and in 29 states - at least six-seven taxes each at the Centre and in states each, reducing the complexity of tax administration and compliance. GST took 17 years to become an act of parliament on August 8, 2016 from the time it was visualised as a comprehensive indirect tax tool. </p> <p>The biggest benefit the new tax, which is also called the Super Tax, brings on to the table is to remove plethora of taxes and turning the country into a 'single marketplace', boosting tax compliance in the country and imparting more transparency to business operations. In essence, it encourages firms to join the organised sector and makes input tax credit a wider phenomenon. The new regime is expected to reduce bottlenecks in supply chain and logistics, and improve business efficiencies in due course. </p> <p>For the Indian power sector, which currently enjoys a multitude of tax concessions and exemptions, the advent of GST is going to bring about an unfamiliar change. The industry's ability to adapt itself to the new tax regime will also bring about a shift in the growth trajectory of the sector. </p> <p> Economic impact<br /> The introduction of super tax has had its impact on the economy and growth, if one has to go by June 2017 Index of Industrial Production (IIP) figures. IIP for June came in at -0.1 per cent year-on-year (YoY), down from upwardly revised 2.8 per cent in May. The fall was essentially led by manufacturing, which contracted 0.4 per cent YoY in June from 2.6 per cent YoY growth in May. Meanwhile, electricity generation also slowed during the month. </p> <p>Aditi Nayar, Principal Economist of the leading rating agency ICRA, said in a report, 'Unsurprisingly, the unfavourable base effect, the reduction in inventories ahead of the transition to GST, and slide in growth of non-oil exports culminated in a marginal contraction of 0.1% in the IIP in June 2017, a 48-month low performance.'</p> <p>As expected, inventory paring prior to the GST resulted in a mild contraction in manufacturing output. While mild, the YoY de-growth in June was pervasive, with 15 of the 23 sub-groups of manufacturing and four of the six use-based industries, recording a contraction. Mining growth stood at a low 0.4 per cent in June, dampened by the sharp contraction in coal output.</p> <p>There was a lot of uncertainty surrounding the applicable GST rates through the month of June as the GST Council had not finalised rates for quite a few product categories by then. Additionally, the rates were still in a state of flux and modifications were being made based on feedback received. As a result, the manufacturers of most products did not see any point in going ahead aggressively with production.</p> <p>Power generation segment, though mostly insulated from GST, could not escape from its impact during June. 'The slide in growth of electricity generation to 2.1 per cent in June 2017 from 8.3 per cent in May 2017 is partly attributable to the waning of the favourable base effect. The sequential downturn in June 2017 was led by a contraction in thermal electricity generation, as well as a moderation in the pace of growth of hydro electricity generation,' said Nayar.</p> <p>However, initial data released by the Central Electricity Authority (CEA) indicates an improvement in growth of electricity generation to 3.5 per cent in July 2017 (+1.5% in July 2016), from 0.3% in June 2017 (+8.4% in June 2016), partly on account of a favourable base effect. 'The sequential uptick in July 2017 was led by a rebound in thermal electricity generation to a growth of 4.2 per cent (-1.6% in June 2017), even as the pace of growth of hydro electricity generation moderated sharply to 2.2 per cent from 11.2 per cent in June 2017,' ICRA said in a recent report.</p> <p>The pace of contraction of output of Coal India Limited (CIL) narrowed considerably to 0.3 per cent in July 2017 from 7.2 per cent in June 2017, which would boost the performance of mining sector in July, Nayar said. </p> <p>The big question is, whether IIP dip into negative territory is a trend shift or just a blip? There is a general consensus among economists and stock brokerages that the negative trend in IIP will reverse once the traders start restocking of inventories in the coming months. ICRA said, 'Notwithstanding the favourable base effect and the rebuilding of inventories post-GST, we expect IIP growth to trail the 5.2 per cent rise recorded in July 2016.' </p> <p>Early indicators for IIP growth in future is coming from rising automobile production, growth in power generation, narrowing contraction coal production in July. Citing monthly sales figures coming from FMCG and auto sectors in July, Angel Broking said in a report, 'That means, once the impact of GST wears away, the IIP should get back into positive territory. What is a matter of concern is the consistent downward trend of the IIP.'</p> <p> <span style="font-weight: bold;">Tax Impact</span><br /> In the power sector, GST implementation is set to be positive for thermal segment, while it will be marginally negative for wind and solar segments. The overall impact of GST, including for balance of plant (BoP) equipment and GST on service component is estimated to increase the capital cost for new projects by about 4 per cent, assuming 30 per cent imported components. The thermal segment will gain on operational front from lowering of tax on domestic coal under GST regime from 11-12 per cent to 5 per cent, while the solar segment will see their capital costs rise by 6 per cent due to GST on solar PV, and impacting the generation cost by 11-12 paise per unit. The cost of wind generator and components is expected to go up by 4 per cent, while that of boilers, turbine and generator components used in thermal are expected to go up by about 2 per cent, according to ICRA. However, EPC contractors in general are the most affected, with a GST bill of 28 per cent.</p> <p>Tough GST has helped ease domestic coal prices, imported coal will continue to attract basic customs duty (BCD). 'It is estimated that power producers who use domestic coal will get a relief in variable cost of generation by about 3-4 paise per kWh/unit. However for power producers who use imported coal, the variable cost of generation would increase by 7 paise per unit,' says Sabyasachi Majumdar, Senior Vice President and Group Head, ICRA.</p> <p>For domestic equipment vendors mainly wind operated electricity generator, its components and parts thereof, including rotor and wind turbine controller suppliers, GST would be applicable at 5 per cent (previously 3-4%). In addition to GST, BCD on imported equipment would continue. The impact would vary depending on VAT rate applicable in various states and mix of imported equipment.</p> <p>With 5 per cent GST rate on solar PV modules, the impact on capital cost for new solar power PV based projects is estimated to be limited at about 6 per cent, which would, thus, translate into an increase in levelised cost of generation by 11-12 paise per unit for such projects, says Majumdar. </p> <p>As such, many recent bidders who have bid for solar power at very competitive rates might have to factor in these additional costs, based on the stage of their execution. 'Given the fact that the competitively bid-based tariffs have significantly come down in the solar power segment over the last 4-5 month period, timely approval by regulators for pass-through of any higher cost incidence due to change in taxation, which is permitted under change in law, remains crucial from developers' perspective,' Majumdar pointed out.</p> <p> <span style="font-weight: bold;">Business impact</span><br /> Despite the government taking several initiatives to educate the industry, small and medium enterprises (SMEs), traders etc., confusion reigns supreme on finer points of information on the super tax. 'There have been a few instances in which some of our members faced specific issues due to a lack of knowledge on the process of registration, applicability of HSN Codes, implications of reverse charge, raising of correct invoices, claiming of input tax credit etc.,' says Rakesh Zutshi, President, Electric Lamp and Components Manufacturers Association of India (ELCOMA) and MD, Halonix Technologies Pvt. Ltd. </p> <p>The industries that were enjoying some subsidies and exemptions in some states were the worst affected segments. As part of promoting energy efficiency, several states had kept lighting and other high efficiency products under zero value added tax (VAT) earlier. With the advent of GST those sops have gone as GST is a pan India tax system. </p> <p>Still, as compliance to GST calls for procuring computers and software it involves a certain amount of capital investment, albeit it being a onetime investment across the spectrum of indirect tax payers. While exuding the hope that these issues also would get settled in a span of a month or two, Zutshi says, GST did not bring in much change in cost of compliance as it did not affect business functionality, except for requirement of more knowledge about the procedural compliance.</p> <p>Though many in the industry have tried to prepare themselves for the tax in advance, some ELCOMA members have faced minor obstacles like slowdown of GST portals, difficulty of finding out the suitable HSN code etc. Many industries have reported expansion in their working capital cycles post-GST.</p> <p>But, one has to wait to know if there was any impact of GST on turnover/sales of different tax payers. 'However, at the first glance, we do not see any significant impact on the margins of ELCOMA members,' said Zutshi.</p> <p> <span style="font-weight: bold;">Taxing twists</span><br /> The whole power sector is expected to suffer because of exclusion of the industry from GST. </p> <p>Power generators will not have to pay any output tax, though they have to pay GST on their inputs. Thus, they will not be able to claim any input credit. This could result in higher production costs. However, doscoms are unlikely to be affected by GST directly, for they operate only as market intermediaries by purchasing power at wholesale rates for selling to end consumers. </p> <p> Engineering, procurement, construction (EPC) contractors who are involved in building infrastructure for generation of electricity, boost energy efficiency and shore up renewable power, are also affected by exclusion from GST. It is not clear how transmission and distribution (T&amp;D) of electricity will be treated under GST, being in the negative list of services, as per the Finance Act of 1994. Some of the distribution vendors are not included in the GST regime, which will affect their businesses too. The same is the case with discoms or distribution franchises (which are trying to bring in efficiencies in the system), they will not be able to set off their input taxes against their bills, resulting in lower profitability to an extent. </p> <p>The whole industry, including solar and wind are also expected to suffer losses due to 'exclusion' clause. Besides, the solar industry is staring at an ambiguity over taxes based on 'end-user' classification, and how to prove the ultimate use of a product. Coal users are also grappling with problem in calculating total cost of coal, whether to include cost of logistics or not. Clarity on this aspect will help consumers like power, steel, cement and coal users in planning their costs and incomes. However, CIL is expected to reap a big amount of input tax credit, say analysts.</p> <p> <span style="font-weight: bold;">The way forward</span><br /> Implementation of GST, which makes the country a single marketplace, was long overdue. Besides bringing in transparency to businesses and efficiency in tax administration, it is expected to improve supply chain and logistics efficiency across the country. </p> <p>However, it is a challenging task, if one were to go by global experience as well. <span style="font-weight: bold;">NITI Aayog Member Bibek Debroy</span> recently said that only six to seven countries in the world are implementing 'proper' GST and that among them, except Canada all other countries are unitary in nature, means the central government takes all decisions. Even Canada is not a match in terms of administrative complexity of India.</p> <p>The system that brings in some kind order in the process of transaction tracking and tax liability is a must in any civil society, to bring in a balanced risk-reward ratio. Otherwise the tax system will end up promoting abnormal profits for a few through illicit means, and that too bereft of tax accountability. </p> <p>Foreign companies seeking to invest in India for a pie in the vast Indian market used to dread the earlier complex tax system. Now, they can heave a sigh of relief, with GST in place.</p> <p>Despite some initial hiccups, once GST gets stabilised, it will bring in a lot of advantages to indirect tax payers, tax administrators and ultimately to consumers. However, addressing the governance issues in general and ensuring efficient implementation of government various programmes as is being sought by citizens for decades, has to become a reality too along with the new super tax system. </p> <p>Otherwise, the resources raised with a lot of effort will only go down the drain as it had been happening over the years.</p> <p>Come what may, the Centre has to honour its promise that it has made for building consensus among states for joining the new tax regime, stating that the states will be compensated for the monetary sacrifices they have to make the initial years of GST implementation by joining the regime. </p> <p>Overall, let's hope for the best from GST for its stakeholders in the months and years to come. <br /> </p> <p> <span style="font-weight: bold;">Salient features</span><br /> GST is a destination-based tax that replaces the earlier Central taxes and duties such as excise duty, service tax, Counter Veiling Duty (CVD), Special Additional Duty of Customs (SAD), central charges and cesses, and local state taxes, i.e. Value Added Tax (VAT), Central Sales Tax (CST), octroi, entry tax, purchase tax, luxury tax, state cesses and surcharges and entertainment tax (other than the tax levied by the local bodies).</p> <p>It is a dual levy classified as the Central GST and State/Union territory GST. Moreover, inter-state supplies would attract an Integrated GST (IGST), which is the sum total of CGST and SGST/UTGST.</p> <p>Petroleum products, alcohol for human consumption, tobacco and electricity have been kept outside the purview of GST for the time being.</p> <p>'The GST is expected to simplify and rationalise the current indirect tax regime, eliminate tax cascading and put the Indian economy on high-growth trajectory. The GST levy may potentially impact both manufacturing and services sector for the entire value chain of operations, viz procurement, manufacturing, distribution, warehousing, sales, and pricing,' says Adarsh Jain, Chairman, Economics &amp; Taxation Committee, Indian Electrical and Electronics Manufacturers Association (IEEMA) and Senior General Manager, Finance/Commercial, KEI Industries Limited.</p> <p> <span style="font-weight: bold;">GST Impact - Snapshot</span><br /> Goods and Services Tax (GST) has arrives on July 1, 2017, the first batch of filing of monthly returns begins in August.<br /> Removes plethora of taxes at the Centre and in 29 states and turns the country into a 'single marketplace'<br /> It encourages firms to join the organised sector &amp; makes input tax credit a wider phenomenon<br /> Impact on the economy: Index of Industrial Production (IIP) for June came in at -0.1% YoY.<br /> Growth of electricity generation falls to 2.1% in June 2017 from 8.3% in May 2017.<br /> Capital cost for new thermal projects to go up by about 4%, assuming 30% imported components.<br /> Cost of domestic coal based generators to get a relief of 3-4 paise per kWh/unit.<br /> Cost of imported coal based generators to go up by 7 paise per unit.<br /> Solar segment capital costs to rise by 6%. <br /> The cost of wind generator &amp; components is expected to go up by 4%.<br /> Cost of boilers, turbine &amp; generation components used in thermal expected to go up by 2%.<br /> Industry, small and medium enterprises (SMEs), traders etc., are still in confusion about the procedures and processes.<br /> Exclusion from GST to keep off power sector players from input tax credit many a time, affecting the whole supply chain. </p> <p> <span style="font-weight: bold;">GST on Works Contract in India</span><br /> <span style="font-weight: bold;">Works Contract in Pre-GST Regime</span><br /> Works Contracts involves supply of goods as well as supply of services. It consists of different kinds of tax levies i.e. VAT &amp; Service tax as per the Pre-GST Laws. Earlier, the supply of goods is taxable in the form of VAT and the service is taxable under service tax. Under the Pre-GST regime, different states had different Valuation method for VAT &amp; Service tax such as Actual valuation, Standard valuation &amp; Composition. Also like to mention that Works Contract was a much disputed matter in earlier Taxation in VAT as well as service tax in regard to the complex valuation rules. </p> <p> <span style="font-weight: bold;">Actual Valuation Method: </span>VAT was charged on the basis of actual material value and Service tax was charged on actual services value. There were different VAT rates under different states.</p> <p><span style="font-weight: bold;">Standard Deduction Valuation Method:</span> In most of the states standard deduction of 15-30% available on all the Contract Price for charging VAT. VAT was chargeable on approx. 70-85% value of Contract. In addition, Service tax was chargeable on 40% Contract value in case of new Works and 70% Contract value in case of repair Contracts.</p> <p>So on an all, a tax payer had to pay tax on more than 100% value of Contract creating extra burden of tax or you can say double taxation on Works Contract under VAT &amp; Service Tax.</p> <p>Also in the Pre-GST regime Contractor is not eligible for Input credit of Excise Duty payable on Input like Cement, Steel or any other input material.</p> <p>Under GST, all such issues are being undertaken with much simpler straightforward calculation by treating it as a service, taxable at single flat tax rate of 18%. </p> <p> <span style="font-weight: bold;">Works Contract in GST</span><br /> Definition of Works Contract as per sec 2(119) Central Goods &amp; Service Tax Act, 2017: Works Contract means a Contract for building, construction, fabrication, completion, erection, installation, fitting out, improvement, modification, repair, maintenance, renovation, alteration or commissioning of any immovable property wherein transfer of property in goods (whether as goods or in some other form) is involved in the execution of such Contract. </p> <p>Meaning of Immovable Property: Under GST, immovable property is not defined. But as per Wikipedia and general understanding immovable property is defined as an immovable object, an item of property that cannot be moved without destroying or altering it or a property that is fixed to the earth, such as land or a house.</p> <p> Immovable property includes premises, property rights (for example, inheritable building right), houses, land and associated goods, and chattels if they are located on, or below, or have a fixed address.</p> <p>Works Contract is a mixture of supply of goods &amp; services. Thus it is a composite supply of goods &amp; services.</p> <p><span style="font-weight: bold;">What is not Works Contract</span>: a)If a Works for building, construction, fabrication, completion, erection, installation, fitting out, improvement, modification, repair, maintenance, renovation, alteration or commissioning results in <span style="font-weight: bold;">movable property, </span>then it is not a Works Contract as per GST law. For example, AMC Contract of Photocopier Machine where supply of material (toner &amp; Ink) &amp; labour is included in this Contract which tantamount to Contract for movable property &amp; thus does not fall under definition of Works Contract under GST.</p> <p>b)The Contract that is merely for supply of goods is not a Works Contract. Like supply of material only for construction is pure supply of goods which attracts provision of supply of goods.</p> <p>c)The Contract that is merely for supply of labour is also not Works Contract which attract provision of supply of service. Therefore, Architect who only provides design for construction is not Works Contract or only labour Contract for construction of civil structure without any material.</p> <p><span style="font-weight: bold;">Treatment of Works Contract as Service:</span> As per Schedule II clause 6(a) of Central Goods &amp; Service Act Composite supplies under Works Contract as defined in clause (119) of Section 2 shall be treated as a supply of services.</p> <p>GST Law has classified many types of transactions which involved both supply of goods as well as services or either of them i.e. either supply of goods or of services. Thus even when there is transfer of property in goods during execution of any Works Contract, such Contract shall be classified as supply of services and the entire value shall be taxed accordingly and no more bifurcation of such Contract is required in future.</p> <p>Thus GST has removed the confusion regarding the tax treatment. This treatment of Works Contract as service and not as supply of goods has brought in much needed clarification to the Works Contracts. </p> <p>Place of supply in case of Works Contract: As per Section 12(3)(a) of Integrated GST Law, Place of supply of services directly in relation to an immovable property, including services provided by architects, interior decorators, surveyors, engineers and other related experts or estate agents, any service provided by way of grant of rights to use immovable property or for carrying out or co-ordination of construction work, <span style="font-weight: bold;">shall be the location at which the immovable property or boat or vessel is located or intended to be located.</span></p> <p>e.g. If a Contractor based on Delhi provided a work Contract service at Noida (U.P) then, he can raise the bill from Delhi charging IGST to Noida customer.( subject to Definition of location of the supplier of services as per Section 2(71): <br /> a)where a supply is made from a place of business for which the registration has been obtained, the location of such place of business.<br /> b)where a supply is made from a place other than the place of business for which registration has been obtained (a fixed establishment elsewhere), the location of such fixed establishment.<br /> c)where a supply is made from more than one establishment, whether the place of business or fixed establishment, the location of the establishment most directly concerned with the provisions of the supply; and<br /> d)in absence of such places, the location of the usual place of residence of the supplier. <br /> <br /> <span style="font-weight: bold;">Definition of 'Fixed establishment' as per Section 2(50):</span> Fixed establishment means a place (other than the registered place of business) which is characterized by a sufficient degree of permanence and suitable structure in terms of human and technical resources to supply services, or to receive and use services for its own needs.</p> <p>With reference to above example Delhi Contractor if having a permanent establishment at Noida (U.P), the location of supplier will be treated in Noida (U.P) Works Contractor had to get registered in Noida. Contractor will raise bill from Noida (U.P) Charging CGST+ SGST to Noida customer.</p> <p>But if no proper site office has been established then no registration is required in Noida (U.P). Contractor will raise bill from Delhi to Noida (U.P) charging IGST.</p> <p> <span style="font-weight: bold;">Invoicing:</span> As per Section 31(5) of CGST Act for Time of Invoice under continuous supply of services will be as follows:</p> <p>a)where the due date of payment is ascertainable from the Contract, the invoice shall be issued on or before the due date of payment<br /> b) where the due date of payment is not ascertainable from the Contract, the invoice shall be issued before or at the time when the supplier of service receives the payment<br /> c) Where the payment is linked to the completion of an event, the invoice shall be issued on or before the date of completion of that event.</p> <p><span style="font-weight: bold;">Definition of Continuous Supply of Service: </span>'continuous supply of services' means a supply of services which is provided, or agreed to be provided, continuously or on recurrent basis, under a Contract, for a period exceeding three months with periodic payment obligations and includes supply of such services as the Government may, subject to such conditions, as it may, by notification, specify.<br /> For e.g. If Terms of payment under a Works Contract is as under- For Supply Portion of Contract: 50% on supply, 30% on erection, and 20% on hand over.<br /> For Erection Portion: 90% on erection, 10% on hand over.<br /> Now, the Contractor needs to raise a bill of 50% of supply amount only, on supply of material as per above rules mentioning the SAC code 9954.<br /> Input tax credit for Works Contract: Contractor is eligible to take input credit of GST paid on his inputs i.e. all purchases like cement, steel or others &amp; input services of any nature like sub-Contractor services will be available to the Contractors.</p> <p> Transitions - Treatment of long term construction / Works Contracts<br /> Section 142(10) of the Central Goods and Service Tax Act, 2017 provides that the goods and/or services supplied on or after the appointed day (i.e. 1st July 2017) in pursuance of a Contract entered into prior to the appointed day shall be liable to tax under the provisions of this Act.</p> <p> <span style="font-weight: bold;">Conclusion</span><br /> So, to charge GST under Works Contract you need to check whether the Works amounts to an immovable property or not. If the work does not amount to an immovable property then you need to apply Mixed/Composite supply rules under GST. The GST rules related to Works Contract resolved all the problems regarding taxation in pre GST regime. </p> <p> <span style="font-weight: bold;">Author: Adarsh Jain, Chairman, Economics &amp; Taxation Committee, Indian Electrical and Electronics Manufacturers Association (IEEMA) and Senior General Manager, Finance/Commercial, KEI Industries Limited.</span></p> <p><span style="font-weight: bold;">-BS Srinivasalu Reddy </span></p>
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