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Introduction to GST Impact of GST Detailed Impact of Removed Tax Barriers on Cross-border Sales Network Re-engineering for GST Our Approach 23 24
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Entertainment Tax etc. In such a scenario it is difficult to evade taxes as that would require collusion from multiple parties. the tax goes into the kitty of the state government where the sale originates. As tax is only on value addition. 23 | GST : Impact on the Supply Chain . Central Sales Tax. networks designed on tax considerations rather than supply chain considerations. MODVAT was further reformed into the CENVAT regime in 2000. State Taxes & Local Taxes. VAT = % Tax Rate * Value Added Exhibit 1 Key Reforms in Indirect Taxation through VAT Disadvantages of Pre-reforms System VAT Reforms Aim at applying as few rates as possible across products and across the supply chain of a product making supply chain decisions simpler. Central Excise Duty. This means that the ultimate burden is borne by & at the point of final consumption. purely on supply chain considerations. the taxes were cascading in nature resulting in several disadvantages which were addressed by the introduction of a Value Added Taxation (VAT) system. Anything bought from outside was taxed with a cascading effect. complex and cascading structure into a largely unified value added system of taxation. The country was first introduced to the VAT system through the introduction of MODVAT in lieu of central excise duties in 1986. This often meant having stocking points in destination states and hence. it is easier to provide end-use benefits. In the pre-reforms era of taxation. Thus. the impact is the same whether value is added within or outside the organisation CST is being removed to allow organisations to design networks. Finally. Value Added = Market Price of Outputs – Market Price of Inputs Therefore. The self policing mechanism of VAT ensures higher compliance as VAT is inter-linked throughout the supply chain or sections of the supply chain. Different tax rates for different products within a category and at different stages of the supply chain created complexity in manufacturing and trading decisions. It is important to note that while Central State Tax (CST) falls under the purview of the central government. etc. Discouraged anciliarisation as there is no tax if inputs are manufactured within the company. Exhibit 2 depicts this in more detail. Some of the examples include: • Central Indirect Taxes: Customs Duty. We could regard the evolution of GST as a gradual transformation of a disbursed. It means that the tax is levied at each stage only on the value added in that stage. • State Indirect Taxes : Sales Tax (Sales VAT). The Government might want to give end-use tax breaks such as on exports. CENVAT and possibly subsume some of the local taxes such as Octroi. disaster relief supplies etc. it was difficult to extend tax benefits or fully extend tax benefits based on end use. Due to the series of input credits in the supply chain. • Local Indirect Taxes : Octroi. was introduced in 2005 and CST was reduced from 4% to 2% during 2007-08. Indirect taxes in India can be classified into 3 categories based on the entities that collect it . the tax authorities are amenable to lower rates. VAT is implemented as consumption based tax. As tracking the tax paid in the supply chain is not easy. There was a lack of a tax chain where the subsequent stages in the supply chain were not inter-linked from a tax perspective. indirect taxes were largely charged at different stages of the goods and services value chain with no regard to taxes paid earlier or later in the chain. State Entry Tax. organisations either incurred the tax incidence or used stocktransfer to avoid cross-border sales and tax. Due to the high rates charged in a cascading manner. As a result. CST became the additional tax burden that companies had to bear on inter-state sales besides the sales tax paid on intra-state sales.Central Taxes. the fundamental indirect tax reform that we have seen in the past 23 years is the shift to VAT. Thus.perspective | Volume 02 a quar terly repor t by Vol u me 0 2 / 2 0 0 9 Introduction to GST GST is the biggest indirect tax reform undertaken in India since independence. This meant that creation of an audit trail and policing of tax compliance was difficult. VAT in lieu of Sales Tax. Central Service Tax etc. GST is slated to be introduced in 2010 which will encompass Sales VAT. In other words. VAT has resulted in higher compliance and a wider tax net. Hence. Thus. evasion of taxes was encouraged. Overall taxes in the entire system were high due to extensive evasion and a relatively smaller tax net.
betting.State GST and Central GST.perspective | Volume 02 a quar terly repor t by Vo l u m e 0 2 / 2 0 0 9 Exhibit 2 Evolution of Key Indirect Tax Reforms GST Introduction GST 2nd Level Reforms CST Reduction CENVAT Introductory Reforms Sales VAT MODVAT Impact of GST on the Supply Chain We have all seen and are aware of the impact that VAT has had on the supply chain so far. additional customs duty (Countervailing Duty CVD). Octroi. the firms would be encouraged to minimise pre-GST inventory which has less input credits • As the GST implementation date approaches closer. taxes on lotteries. the tax rates may also get changed for many products • Unless the GST rates go up for its products. gambling and purchase tax as the main components. allied levies and service tax as the key taxes. » State GST would comprise of VAT/Sales tax.3% service tax charged by logistics companies can be largely offset against the Central GST liability • Post GST. suppliers and customers Extended Central GST Chain Affected Inventory Subsuming Octroi & Entry Tax Organisations will be encouraged to locate warehouses and hubs in entry tax and Octroi zones and stock more inventory there Organisations will be encouraged to locate warehouses and hubs in entry tax and Octroi zones and stock more inventory there Organisations can and should design their networks purely on supply chain considerations and not tax considerations GST : Impact on the Supply Chain | 24 . Entry tax. service tax on logistics services consumed during distribution and retail are not off-settable against CENVAT • Extended Central GST chain will allow the offset in post manufacturing This will boost outsourcing in supply chains networks and provide greater impetus to 3PL’s • This will lower the cost of logistics outsourcing as the 10. companies would no longer be required to have a warehouse in every state just to facilitate stock transfers and avoid CST Organisations need to study GST’s final mechanisms and plan inventory transition very carefully for themselves. inventory will carry Central GST and new GST rates credit. » Central GST would incorporate Central excise duties. one could expect uncertainty and panic regarding pre-GST inventory as was seen during VAT introduction • Octroi and entry tax are not in line with the spirit of GST although in some cases entry taxes are VATable • Once these taxes are paid reverse flow of goods becomes difficult . surcharges. hence companies prefer postponed and uni-directional flow of goods across entry tax and Octroi borders • There are two possible scenarios through which tax barriers would be removed: » Scenario 1: CST rates would reduce to zero with no carry-over of input credit across states » Scenario 2: Stock-transfers are disallowed/taxed and inter-state sales are taxed with carry-over allowed • In both cases. • Octroi and Entry tax are expected to be disbanded but the likelihood of the contrary cannot be ruled out. inventory will also carry Central GST & inter-state GST input credit. • The tax disincentive of cross-border sales and supplies which is currently there because of CST will hopefully go. Central GST chain may extend right upto the last transaction at the retail level. Exhibit 3 GST Characteristic Impact of GST on the Supply Chain Impact on Supply Chain Implication • At present. State cesses and surcharges on goods and services. There are 4 key characteristics of the GST regime that will impact the supply chain further:• It is expected that we will have a dual GST structure . • Inventory during transition will be impacted as post GST.
4 129.2 135.9 150.9 150.5 5.6 144.2 12.0 Final Price 129.9 Margin 24.3 0. Exhibit 4 Table1: Current .perspective | Volume 02 a quar terly repor t by Vol u me 0 2 / 2 0 0 9 While the implication of the first three characteristics is straightforward.5 13.2 VAT 0% 12% 12% 12% CST 0% 4% 4% 4% Commercial Impact of GST (All figures except VAT and CST are in US$/unit) Tax 5.2 135. Exhibit 4 shows an illustrative example that proves this point.2 130.2 135.2 Margin 21.2% CST Sale Stock Transfer Sale Source Depot Distributor Retail Landed Cost 100.2 Net Tax 2.2 129.0 129.2 VAT 4% 4% 4% CST Tax 5.4 129.2 135.9 Margin 24.2 Price Before Tax 124.0 124.8 Source: Technopak analysis Final Price 12.2 5. the impact of removed tax barriers on network design needs to be understood in much greater detail.2 130. the implication remains the same.3 7.5 13.8 Net Tax 5.8 6. For the sake of simplicity.2 130.7 Table3: GST-Zero CST Sale Stock Transfer Sale Source Depot Distributor Retail Landed Cost 100.9 150.0 124.0 Table2: Current .2 5.0 5.0 Price Before Tax 121. Detailed Impact of Removed Tax Barriers on Cross-border Sales Previously we mentioned that whether CST is reduced to zero or cross-border sales are taxed with offset allowed.6 Input VAT Credit 5.2 Price Before Tax 124.5 Input VAT Credit 5.8 Net Tax 5.9 Margin 24.2 135.0 5.0 0.8 Final Price 12.0 0. we are ignoring logistics costs in the landed-cost component and also ignoring any input credit available at the ‘source’ location.8 124.6 VAT 0% 4% 4% CST 2% 0% 0% Tax 2.0 5.6 Input VAT Credit 5.0 25 | GST : Impact on the Supply Chain .2 6.4 5.2 Price Before Tax 124.Stock Trasfer Sale Stock Transfer Sale Source Depot Distributor Retail Landed Cost 100.2 124.2 0.0 5.4 5.5 13.2 6.5 5.6 144.2 5.5 5.2 6.2 VAT 0% 4% 4% CST 0% 0% 0% Tax 5.2 130.9 Final Price 124.2 135.Inter State Sale Taxed with Offset Allowed Stock Transfer Sale Source Depot Distributor Retail Landed Cost 100.8 Table4: GST .0 124.0 0.2 135.9.8 Net Tax 5.3 0.6 Input VAT Credit 5.6 144.
However.24 16 . • Table 3: If CST rates were to become zero then the firm can do cross-border sale (at 0% rate) directly to the distributor without any loss of margin to itself. we see that when tax barriers on cross-border sales are removed whether through the route shown in Table 3 or 4. The specific business realities of the company will also have a great bearing on the actual number of warehouses required.24 18 .50 per unit and incurs local VAT only when it sells in State B to its distributor through its depot. the size and number of hubs could get affected. With fewer warehouses. The distributor charges a margin of US$ 0. close and re-locate. GST : Impact on the Supply Chain | 26 . It thus gets a margin of US$ 0. The supply chain can then be designed not on tax considerations but purely on logistics cost and customer service considerations.14 per unit and charges the final price by adjusting the input credit (which is available since the sale from depot was intra-state). without going through a stock transfer at the depot.28 22 . the distributor or the retailer and yet charge the same MRP to the consumer. The calculations are based on the premise that the US$/unit retailer margin. Exhibit 5 Approximate Number of Warehouses Needed in the GST Scenario Delivery Lead Time for 80% Urban Customers Annual Turnover (US$ Mn ) < 600 600 .1500 24 Hrs 24 . In this case. Exhibit 5 provides an approximate guide on the number of warehouses for a distribution company dealing in fast moving goods can have in a GST scenario. distributor margin and MRP are maintained at the same level. the firm incurs US$ 0. then also the margins and MRP remain intact for everyone. • The move towards fewer warehouses would require many warehouses to combine. Price to Retailer = (Distributor Landed Cost + Distributor Margin – Distributor Input Credit) * (1 + VAT Rate). • The linkages between factories-hubs-warehouses-customers for various products will get re-aligned. the average size of the warehouse will go up. a key feature of post GST supply chain > 1500 20 . • Hubs are not directly impacted by CST considerations.perspective | Volume 02 a quar terly repor t by Vo l u m e 0 2 / 2 0 0 9 • Table 1: Suppose a firm currently does a stock transfer from State A to State B. • Table 2: In today’s 2% CST scenario.08/unit loss in margin if it were to do a crossborder sale to the distributor.13/unit after accounting for input credit at retail level as well as retailers’ US$ 0. before selling in State B to avoid paying CST. due to larger throughputs. it becomes unnecessary to have a depot in the destination state. fewer & larger warehouses may make it feasible to route plant production directly to warehouses rather than through hubs.26 48 Hrs 20 . Similarly the MRP comes out to US$ 3. The re-organised network will in fact be significantly different. • Required capacity of many warehouses will undergo changes. • Table 4: If CST is abolished and inter-state sales or stock transfers are taxed with input credit allowed at the destination. Thus. Network Re-engineering for GST We have already established that an optimum network design post GST would be different from an optimum network design in today’s taxation scenario. Thus. This means simpler and leaner networks which could incur lower costs of operation as explained below.22 Hence.28 /unit margin.20 networks would be fewer warehouses or distribution Source: Technopak analysis centres than before.
or a warehouse “on the way” in State A itself. it would appear that some of these savings would be offset by the increased cost of freight. the source is in State A (left) and the customer is in State B (right). Due to CST barriers. this might not necessarily always be true as the network linkages of source-warehouse-customer could actually get shorter by removal of inter-state sale barriers. In Case I. the benefits outweigh the disadvantages. With fewer intermediate stocking points (warehouses) between sources and customers. The inverse root law states that:Safety Inventory a 1/sqrt (Number of Stocking Points) Exhibit 6 Pros & Cons of Network Re-engineering for GST Pros Cons Reduced fixed warehousing costs Reduced inventor y (inverse square root law) Simplified planning and reduced warehouse and C&FA management Higher lead times to customers Possibly higher freight cost especially secondary freight This means that the safety stock requirement would also go down. Prima-facie. Besides providing a simpler and more manageable network. after the introduction of GST. Exhibit 7 explains this in greater detail. Fewer warehouses would mean a straight saving on warehousing costs. Technopak estimates between 5% to 10% net savings in logistics + inventory carrying costs of an organisation through this exercise.perspective | Volume 02 a quar terly repor t by Vol u me 0 2 / 2 0 0 9 Exhibit 6 lists all the pros and cons of doing a network re-engineering exercise for GST. In Case 2. However. the customer can only be served from a warehouse in State B but by back-tracking in the direction of the source. Clearly. The freight distance saving translates directly into freight cost saving. the average freight legs should get longer. the network linkage is re-defined and the back-tracking is saved substantially by serving the customer directly from the factory. Exhibit 7 Freight Savings Due to GST Case 1: CST at 2% 1000 kms State Boader Old Warehouse Plant Customer 1 Illustrative freight distance (and hence cost) saving of 400 kms for customers1 Customer 2 Case 2: GST 1000 kms State Boader Old Warehouse 500 kms Plant New Warehouse 200 kms Customer 1 Customer 1 27 | GST : Impact on the Supply Chain .
• Improved Assortment: Often SKUs needed by customers are not available at the warehouse meant to serve them although they may be idling at another warehouse. With stock aggregated at fewer warehouses. This is especially true for slow moving items. the planning and assortment availability improves for slow moving SKUs. service to customers could be maintained or even improved in a network re-engineering exercise. especially organised retailers • Increasing scarcity of skilled labour and real estate requiring vertical and mechanised warehouses Impact on Service Level The key fallout of GST aligned networks is fewer warehouses but this also has two implications on customer service: • Longer Lead-times to Customers: This would not be an issue as long as the network redesign exercise puts a minimum lead time/distance constraint while serving customers in the new network. Technopak estimates that for most organisations. variable warehousing and taxes (VAT / CST / Excise) • Understand existing service levels and logistics constraints • List the external business environment factors affecting network design and performance • Identify candidate locations for warehouses & hubs based on Technopak’s understanding of the Indian logistics sector • Design a Mixed Integer Linear Program (MILP) model based on a firm’s internal and external business environment translating into appropriate variables. freight. size & location of hubs & warehouses • Network linkages between various supply chain entities • Optimal transport modes and mix Inputs Model Design & Creation Output GST : Impact on the Supply Chain | 28 . modernisation of key warehouses is strongly recommended on account of: • Large sizes. Thus. fixed warehousing. Thus. 6-8 locations will have mega warehouses with complex operations in the near future. Our Approach A scientific tool-based redesigning of the distribution network would be helpful in delivering optimal logistics and inventory carrying costs without compromising on service levels to customers. Exhibit 8 Network Re-engineering Approach • Collate demand pattern and existing supply chain costs of manufacturing. The key here is to undertake a professional scientific exercise as opposed to manual experience based methods that many firms have used for designing their legacy networks.perspective | Volume 02 a quar terly repor t by Vo l u m e 0 2 / 2 0 0 9 Impact on Warehousing New or enlarged warehouses will have to be designed/re-designed. constraints & assumptions • Pre-processing of input data to improve model performance and ensure accuracy of results • Scenario building & sensitivity analysis • Number. high throughputs and more complex operations • Increasing level and variety of service required by customers. Exhibit 8 illustrates this scientific tool-based approach in greater detail. handling.
1 Year Distribution Setup Design •Network modelling based on MILP Programming •Minimise cost subject to service level & other constraints Change Management Planning •CST transition planning •Vendors •Employees. Exhibit 9 Our Methodology for GST Solutions Impact Analysis •Audit of current setup •Future scenario impact Model Warehouse Engineering • Design & layout • Modernisation Implementation • New network rollout • Change management 2 Weeks 4 Weeks 6 Weeks 2 Weeks 6 Months . Principal Consultant I sachin.rajpal@technopak. Some of the other benefits are: • Robust design to support growth over next 3-5 years • Optimal realisation of back-haulage and direct despatch opportunities • Savings from optimisation of legacy network • Transport mode optimisation in the re-designed networks • Evaluation and factoring of opportunities arising from GST and entry tax rationalisations • Improved service levels to all or key customers • Optimal network flow paths for goods.com Sachin Jagtap.email@example.com 29 | GST : Impact on the Supply Chain . We deliver an end-to-end solution which includes the first four design stages as well as implementation hand-holding. Vice President I anil. systems & processes Benefits Beyond Zero GST A network re-engineering exercise with us has many more benefits than just the ones arising from the GST opportunity.perspective | Volume 02 a quar terly repor t by Vol u me 0 2 / 2 0 0 9 Exhibit 9 depicts our methodology that helps organisations meet the GST deadline in the most optimal state. hub-spoke connections and feeder depot concepts Authors Anil Rajpal.
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