8/25/2017 GST Impact on Supply Chain & Distribution

GST Impact on Supply Chain & Distribution

GST has a far-reaching impact on the business of any organisation. It not only alters the way
taxation of goods and services takes place, the concept of intra state and inter-state supplies, to
the method of taxation, system of allowance of ITC, quantum of ITC and to its accounting and
filing of returns. Thus, every area of business will require a relook under the GST environment.

The impact of GST on supply chain and distribution is discussed hereunder:

Supply chain

Supply chain includes sourcing and its logistics. Sourcing includes procuring /manufacturing;
goods and services. Both could be out of imports, inter-state, local / domestic purchases, stock
transfer / inter branch etc.

Tax burden

The cost of tax is inbuilt in pricing of any goods or services. Typically, in the product cost includes;
taxes like the CST, Central Excise Duty, Cess, Service Tax, etc. paid on inputs. Similarly, in case of
services; the taxes paid on inputs required to provide services, other input services are also
embedded in cost of service. Of course, to the extent of the allowance of input tax credit and / or
cenvat credit under the respective legislation reduce the incidence or the burden of taxation on
input. Thus, to the extent of the taxes which are not eligible either as input tax credit / Cenvat or
abatement(s) results into cascading of tax.

Base price and the change therein

Under the GST, the main objective is to do away with cascading of tax by providing seemless
transfer of input tax credit to all levels of distribution of goods and services. Therefore, the base
price on which the taxation would apply would undergo change necessitating the reworking of
pricing with both supply / vendor as also customer / client.

A simple example will make this regard will be helpful.

Pre-GST Post-GST
Base Price 87.5 Base Price 87.5
Excise 12.5
100
VAT @ 13.5% 13.5 GST @ 28% 24.5
113.5 112

It can be seen that the base price on which the excise duty was levied would become the base
price on which the levy of GST would arise. This is because the entire element of the duty/tax is
now eligible for input tax credit leaving no burden of tax on onward distribution. Base price has to
change because, excise duty, cess, service tax etc. levied / charged by his vendors is now
available as ITC.

Please note, the incidence of tax and base price Pre-GST and Post-GST mentioned hereinabove
is illustrative figures and is worked out to understand the conceptual change.

The change in the pricing with the vendor would also require that the price charged by the
supplier to this customer / client would also reworked. For example; where a builder and
developer has awarded a contract to a contractor for providing and fixing aluminium glass
windows during the pre-GST period, the builder would demand for reworking of the contract price
considering the GST now to be levied. In this case, the contractor will have to calculate the
incidence of tax which was factored into by him as cost (which was not available then as ITC
and/or CENVAT credit) in the pre-GST period and compare it with the ITC now available in GST on
such inputs of goods and services. This will give idea of reduction and/or increase in the tax due
to introduction of GST. Obviously, before working out the incidence of tax in the transaction, the
contractor will have to also demand the reduction in incidence of tax which the vendor would have
factored in his pricing for supplies made to him/the contractor. Thus, the GST would require both
the customer and supplier and its vendor to re-examine the indirect tax structure and base value
on which such taxes to be levied.
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Obviously, this involves internal computation and workings; both, by vendor and supplier and also
by vendors of the vendor and so on. True, this chain reaction would require some time to settle
out and in the transition there could be some cases where some partners in the supply chain may
get benefited or impacted adversely. Surely, as GST settles down, the economics of demand
supply and resultant impact on pricing will force the constituents of supply chain to rework out
pricing / cost and offer their goods and services.

Government incentive schemes

During the pre-GST period there were some schemes floated either by Central Government under
Central Excise Laws or some State under the respective laws to promote and / or for dispersal of
industry into lesser developed area of economy. Thus, we have some schemes under the Central
Excise for promotion of industry in Sikkim, Jammu, Baddi and other areas. Similarly, some
schemes do continue under the VAT Acts of States in respect to some pockets of our country.
These schemes essentially provide that the units set up in these areas have tax advantage
[beside other incentives] to enable them to offer goods and / or services at concessional rate.
Thus, buyer of goods / services from such units has lower incident of input tax. Under the GST
Act these schemes are not continued. However, being part of the Government promise [and not to
be charged with promissory estoppel], the Central and State Government has to compensate
these unit with appropriate measure including cash refund by the respective Government. Surely,
this would also impact the base price of the goods / services procured from such units.

Distribution

Distribution of goods and services will surely also have its share of impact on pricing. When we
discussed the impact on supply chain it also means the impact on the distribution of the earlier
vendor.

MRP and fixation of MRP

Many cases, the manufacturer and/or brand owner decides and controls the product pricing in the
distribution channel from the entire manufacturing till the retailer and consumer. The maximum
retail price (MRP) is worked out considering basket of taxes like different types of taxes customs
duty additional and special customs duty, cess, excise duty, surcharge and other cess, octroi and
entry tax, VAT, CST, service tax and other indirect taxes.

Therefore, before fixing the MRP of goods /services; the brand owner normally would factor the
total burden of taxes which the consumer bears / transferred to bear as price of the goods /
services. Moreover, in case where MRP of goods / services is to remain same across State , an
additional exercise is done to find out average burden of taxes factoring different percentages of
the State and local levies. Thus, the exercise of fixation of MRP is a function of lot many different
types of taxes and incidences and finally the burden of the same on the customer / client. Since,
in the GST regime, these constituents indirect taxes in the MRP are to go total change, the
entire exercise to fix MRP would require a to be done afresh. Once again, the prices offered by the
vendors in the entire distribution channel as also suppliers of the goods and services from
manufacturing till distribution including transportation, storage etc will have to renegotiate and
there base price for taxation in the respective cases be re-fixed. These by itself is an exercise!

Margins in distributive channel

It is observed that the percentage margin in the distribution channel i.e. percentage of earning by
the wholesaler, distributor, stockist, and retailer is required to be re-fixed since the very base
price on which this percentage of margin was worked out would change. E.g. where the unit price
on which the landed cost, say, in the hands of distributor is considered and the percentage of
margin is worked out for the distributor, if the unit price is reduced downwards [before levy of tax
as the tax component is always a pass through] the percentage worked out on this lower landed
cost would result into lesser margin in rupee terms. Therefore, in order to make distributor earn
the same margin in rupee terms, the percentage of the landed cost may require upward revision.

Distribution design Tax efficiency

In pre-GST period, several times the distribution model was designed to ensure efficient tax
management i.e. to minimise the incidence of tax in the distribution. Accordingly, some cases,
consignment agent were appointed or CNF agent were appointed or at times, goods were stock
transferred to branches for onward sales. The customer may demand local VAT invoice to claim
the ITC. The transaction / contract may be negotiated with separate terms for supply of goods
and the services. The contracts were worded to suit claim of sale in the course of import,
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onshore and offshore provision of services etc. It seems there is total change in the way the GST
intra state and inter-state transaction with the mechanism of ITC in place, the entire distribution
model may require to be revisited and again find the balance in tax efficiency in the distribution
channel.

Decentralised billing v. centralised billing

Typically, for a service company providing services from different locations across the county, may
also require revisiting the decision of centralised billing vis-a-vis billing from branches or service
point. Surely, this will also require factoring the preference of the clients for an IGST vis-a-vis
SGST and CGST invoices.

In case of common services, the GST mechanism provides for one or more place of business(es)
as ISD. This mechanism will facilitate transfer of input credit to the other places of business
outside the state of the credit in respect of input services. Thus, the accounting and transfer of
such credit require to monitor and efficiently work to avoid blockage of credit, if any.

Rate contract

The rate contract for institutional supplies e.g. supply of medicine at Government Hospital, price
contract with CSD etc. will require to be renegotiated.

Sales promotion items and gifts: Distribution of sales promotion items and gifts is typically done
by the brand owner through the branch network. These items are either transferred to
distributors who are in turn required to give it to customers or to targeted persons. Since the
inter-state stock transfer from distinct person is considered as supply, such stock transfer would
also attract IGST. Such IGST on inputs with the respective branch would be disallowed when these
goods are distributed as free. At times, the C&F agent or distributors are required to incur certain
expenses say local advertisement, hiring for man power for conducting marketing survey,
purchase of gifts for special customers, holding event for marketing etc. These expenses are then
reimbursed to the C&F agent or the distributor by the company. The arrangement will have to be
re-worked out to ensure smooth flow of ITC in respect of GST paid on inputs of goods or services
being reimbursed by the company.

Discount schemes

To promote goods and services, various types of discount schemes are floated. These schemes
are either given in the monetary terms i.e. by issuing credit note for discounts or are issued in
quantity as free quantity. Under the GST, the debit note and credit note for pre-agreed
discounts offered are to be uploaded and acknowledged by both the supplier and recipient. Thus,
it is a two-way traffic on GST network.

The quantity given free invite disallowance of Input tax credit. Such schemes be reengineered and
the invoicing be made in the manner to provide for rupee discount in the invoice and/or credit
note equivalent to quantity offered as free. Care should be taken that the scheme floated also be
rewarded to demonstrate it as extra discount.

Transition Stock with MRP

In the transition, the goods in the distributive channel carries the MRP label based on the earlier
incidence of tax which was factored and price fixed between the distributive channel accordingly.
In the GST era, as discussed, the incidence of tax on the amended base price would change.
Therefore, it is likely that even after considering transition benefits as per section 140(3) on the
stocks held by the distributive channel, there could be some loss of margin the trade partners
may suffer. Obviously, considering the business policy of the company the brand owner may have
to compensate the trade partners in such cases.

MRP Re-labelling Stickering Legal Metrology Act

The fixation of label of MRP is governed by the provisions of Legal Metrology Act. Refixation of
pricing or relabeling is strictly governed by this Act. Thus, if MRP is to be amended appropriate
permission and procedure as provided therein needs to be observed. Wide Trade Notice dt. 4-7-
2017, Ministry of Consumer Affairs, Govt. of India, under the Legal Metrology [Packaged
Commodities] Rules, 2011, the Government has allowed the refixation of price by affixing stickers
by the manufacturer or importer only. Thus, if the manufacturer or the importer holds this stock
as on 30-6-2017, such stocks can be relabelled as per the Act. Mind you, this relaxation is not

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applicable to the stock held by the partners in the distribution channels. Thus, relabelling by the
distributors, stockists and retailers is not permissible.

Godown Need to obtain registration

In the GST era, business will have to take decision in case of import and distribution of goods
where goods are to be stored at the port for some period where activities like grading packaging
etc. are carried out at this location and traded from there. At times, the goods are simply stored
for some time before its sale. If the goods are stored in public warehouse one may examine the
need or otherwise of the registration at this location.

Issue of P.O. by H.O.

It is common observation that the head office negotiates the prices with the vendors and issues
purchase order for requiring the vendor to dispatch goods to factory/ branch from other States.
Under the GST Act, these transactions are similar to bill to ship to type of a transaction. This will
require internal billing between the head office and the factory / branch and the purchase invoice
from the vendor in the name of head office. This by itself would require relooking at the system of
issuing purchase order in the organisation.

Cash-flow and working capital impact

Since the adjustment of SGST CGST of one state is not permissible against the liability under the
SGST/CGST from another State, care will have to be taken to monitor accumulation of credit in
the state and try and examine opportunity to utilise these credits efficiently by an organisation.
This could have substantial impact on cash flow of company and need for working capital.

Since inter-state stock transfer of goods will invite IGST liability, one will have to examine the
time lag of the liability of IGST and its utilization by the receiving branch. The longer time lag will
involve higher working capital needs.

To end

The introduction of GST has brought about the shift in the way the business is conducted. As
discussed, one of the objectives of the introduction of GST is to bring transparency and level
playing field amongst businesses across the states. It is expected that the business would take
decision based on business exigency and not to work out tax efficiency. The supply chain, the
distribution will get re-modelled accordingly. We hope the GST ushers in much desired
transparency and efficiency in the businesses.

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