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India’s Goods and Service Tax

Contents
Introduction .................................................................................................................................................. 2
1. What defines Warehouse Location................................................................................................... 2
2. Current State ...................................................................................... Error! Bookmark not defined.
a. Stock Transfer Sale ....................................................................................................................... 3
b. CST Sale to Distributors................................................................................................................. 3
3. Future State ...................................................................................................................................... 4
a. Complete Elimination of CST Charged on InterstateSale.............................................................. 4
b. Transfer is charged with Provision of Input Credit ...................................................................... 5
4.GST Impact on Warehousing ................................................................................................................. 6
5. Conclusion ............................................................................................................................................. 8

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INTRODUCTION

GST (Goods and Services Tax) is a destination-based tax on consumption of goods and services
with an input credit mechanism across the value chain; that is taxation is onlyon a value added
basis. GST is likely to subsume most indirect taxes (currently levied on both goods and services)
under a single umbrella. Major taxes likely to be subsumed are CENVAT, VAT and service tax.
GST would also mean removal of the existing CST which is payable on inter-state scales, a tax
that is not allowed to be set off against further taxes in the value chain. GST is likely to be
introduced in April 2015 and likely to have a dual structure to be administered both at the Centre
and Statelevel.

What Defines Warehouse Location?

Warehouses are an important part of any supply chain. A strategically placed warehouse not only
improves customer service levels but also reduces the burden on other elements of a supply
chain. In India, apart from other criteria such as customer service levels, freight costs, etc., the
differential state and central taxes levied on sales of goods largely affects the location of a
warehouse. To understand this, we will use a typical supply chain setup as shown below.

Typical Supply Chain

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Current State

Let’s look at two scenarios that show how a consumer goods (CG) manufacturer sells its goods
to a distributor and how that impacts the location of the warehouse in a non-GST environment.
The “input tax credit” at the source and the logistics costs in landed cost component has been
ignored for simplicity.

Scenario A: Stock Transfer Sale


Let’s assume a firm operates a warehouse in another state and does a stock transfer of itsgoods to
the warehouse before actually selling it to the distributor in that state. According to current tax
laws, this transfer carries no central sales tax (CST) since no sale has been realized. In this case,
the value added tax (VAT) is applied only after a sale is made to a distributor using the
warehouse. Also, the VAT paid by the distributor to buy from the warehouse is used as an “input
tax credit” bringing down the “price before tax” of the goods for retailers. A sample calculation
is shown below for understanding.
Current State: Stock Transfer Sale

Scenario B: CST sales to Distributor–


Let’s assume the firm decides to sell its goods directly to the distributor located in another state
without holding a warehouse in that state. In this case, the firm pays CST on this interstate sale.
The rest of the transactions in the supply chain remain the same. Now the calculations look as
shown below.

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Current State: CST Sales to Distributor

In scenario two the final price (`301.6) for the consumer increases in comparison to the final
price (`296.4) paid by consumer in the first scenario. To maintain the same price (MRP) for the
end consumer, the firm has to take a hit on its margins so that the distributor and retailer margins
are preserved. This happens because unlike VAT, CST cannot be claimed as an “input tax
credit.” So, when the distributor adds its own margin to an already high landed cost, the total cost
for the retailer increases. Since the distributor will not like to give the same product at a higher
price to the retailer, the firm has to take a hit on the margin.

The above two scenarios clearly show that distributors will like to buy from a warehouse in the
same state rather than buying directly from the firm in another state. This type of provision in the
current tax structure has forced firms to locate warehouses in all the states where they do
business. Instead of focusing on supply chain efficiency that can be generated from strategically
located warehouses, the firms focus on saving their margins. The above scenarios also show why
most businesses would prefer to source locally and not through interstate purchases.

Future State
With the introduction of GST, the tax barrier on cross-border sales will be removed. The tax
disincentive of cross-border sales due to the presence of CST will be eliminated. There can be
two scenarios by which the government can achieve this task.

Scenario A: Complete Elimination of CST Charged on Interstate Sales


In this case a firm can sell directly to the distributor in another state without paying the CST. The
calculations shown below verify that this would not lead to any loss of margin for the firm and

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distributors and retailers can enjoy their share of margins without increasing the final price of
goods.
Future State: Eliminate CST Charged on Interstate Sales

Scenario B: Elimination of CST But Interstate Sale or Transfer Is Charged with Provision
of Input Credit
Let’s assume that CST is abolished and interstate sale is taxed with input credit allowed on the
subsequent sale. Even in this case the margins for companies, distributors and retailers are
maintained without affecting the final price for the consumer. This is depicted in the calculations
below

Future State: Eliminate CST but Charge Interstate Sale or Transfer

The scenarios below clearly show that with the advent of GST, having a warehouse in every state
where a firm does business will no longer remain a necessity. The supply chain can be designed
purely on logistics costs and customer service considerations and not on tax considerations. The
firms can now have fewer and more strategically placed warehouses. The supply chain network
can be made leaner and smarter so that the operational costs are minimized and efficiency is
improved. With the provision of the input tax credit, each tax point in the supply chain will be
required to record, maintain and file tax transactions happening at that point. It is probably fair to
suggest that the longer the supply chain, the more the tax points in the GST scheme of things and

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hence increased compliance costs. The challenge and the opportunity is thus to compress supply
chains for GST efficiency while ensuring that the business objectives in and around supply
chains are also met.

GST Impact on Warehousing


In today’s context, a firm spends large sums of money in managing different warehouses to
overcome the fiscal regime. The presence of these duplicate entities in the supply chain has
added to the additional cost of administration, utility services and technology required to manage
these entities. The effect on cost of goods sold (COGS) is further pronounced due to productivity
inefficiencies creeping into the system with the presence of many smaller stocking points. The
logistics and inventory carrying cost of goods are very high as firms carry more inventories to
fulfill demand and are handcuffed in selling products across states. The tax regime has also
proved detrimental to the development of 3PL and 4PL providers in India, adding to the logistics
woes of the country. India has one of the highest logistics cost as a ratio of GDP (see Figure 2)
compared to other countries of the world. Also, transportation, inventory and warehousing
contributes up to the 70% of the total spend on logistics in India. All of these costs are in some
way impacted by a differential tax regime which promotes smaller and multiple stocking points.

Cross Country Logistics Cost Comparison

From a technology perspective, the implementation of ERP at multiple warehouses is a costly


affair, so most small to medium businesses in India have stayed away from technology imple-
mentations that can result in long-term profits. This has resulted in the proliferation of myriad
technology implementations in warehouses and increased technology spends by firms. The non-

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standardized modus operandi in these warehouses also hampers the ability to bring efficiency in
people-related processes. There are many more such inefficiencies that Indian firms are living
with due to the differential tax regime. In a GST frame of things, logistics costs and not tax
considerations will play an important role in determining the location of a warehouse. Firms will
move towards fewer and more strategically located warehouses and this will entail combining
the existing capacities of warehouses or creating new capacities. As simple as it sounds, the firm
has to prepare for various impacts and challenges that this may bring. First of all, fewer and
larger warehouses may make it feasible to route plant production directly to warehouses rather
than through hubs. Thus, the size and number of hubs could be affected. While consolidating the
warehouses, the optimum path for moving current inventory to the newly located warehouses has
to be worked out to reduce the cost of manufactured goods movement. An increase in inventory
movement cost may impact the price of goods directly. Once the firm decides to move to fewer
warehouses, the overall COGS will come down. At current price levels, this will entail more
profits for the firm, and passing on this benefit to consumers will positively affect the demand
for products.

With increasing demand for products and services, the demand planning and management at
newly constructed or consolidated warehouses will have to be reevaluated. Even if the demand
planning is perfected, the logistics costs associated with delivery of goods will change. Firms
have tolook for new optimization techniques which can help them keep the current service levels
and save on logistics costs. To maintain the current lead time with fewer warehouses, the firm
has to redesign the network by factoring in various parameters that affect lead time. GST will
foster growth of 3PL and 4PL providers, and firms will have to consider their services while
designing the distribution networks of the future. Fewer and larger warehouses may even
encourage adoption of cross docking that can alter the way products are handled in the
warehouse. Advent of GST may even change the customer perception about a firm’s products.
As the footprint (in terms of warehousing) required for operating in the Indian market will
shrink, more foreign companies will enter the market to do business. The competition among
foreign and national players will intensify, resulting in an upsurge in customers’ demand for high
quality.

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Conclusion
A common tax structure for goods and services in India is necessary for improving supply chain
efficiencies and rationalizing business objectives. The only question that needs to be answered is
when this will become a reality. Whenever it happens, it will come with a set of challenges that if
addressed at the right time can take businesses to new heights.