Mumbai: Implementation of the goods and services tax (GST) may change car-buying behaviour, prompting auto firms to revisit a significant part of their business, including product strategy. It is also likely to lower the prices of spare parts by doing away with multiple taxation.

Currently, depending on their length and engine size, passenger vehicles are taxed at four different excise rates in addition to value-added tax and cess.

The effective tax rate on small cars works out to 24.2%. For sedans with engines up to 1,500cc, the tax works out to be 36.2% and those with larger engines are taxed at 39.05%. On premium sports utility vehicles (SUVs) and luxury cars, the tax rate works out to be 42.5%.

The suggested tax structure under the model GST law is different and proposes a dual duty structure—18% for non-luxury cars and 40% for luxury cars.

If this is accepted, compact cars (including hatchbacks and compact sedans) will be cheaper by 30,000-35,000. And the price of sedans may fall by nearly 1 lakh, said Rajeev Singh, partner and head of the automotive practice at KPMG in India.

That means the fourth quarter of fiscal 2016-17 may see a slowdown in passenger vehicle sales as buyers will tend to postpone purchases, anticipating a price reduction in the first quarter of 2017-18, he said.

If the government goes with a dual slab—of say 18% and 24% for cars in the mass segment—the excise duty gap that exists today between the hatchback/compact sedan and a full-size sedan is likely to come down to 6% from the current 12%. This will also narrow the price difference between the two segments.

As a result, in a departure from the current trend, buyers may no longer see merit in buying a hatchback/compact sedan and instead, owing to the reduced price gap, may prefer a full-size sedan, said Singh. “This is one big shift that GST can bring from the consumer behaviour perspective," he added.

At present, seven in 10 models sold in India are either a hatchback or a sub-four metre sedan. The new tax regime may change that forever, prompting companies to rework product strategy.

So far, the planning has been skewed in favour of the sub-four metre sedans, a concept that owes its origin to the current excise duty structure that favours such cars. It’s a concept that is unique to the Indian market.

Clearly, car makers including Toyota Kirloskar Motor India Ltd, Volkswagen India Pvt. Ltd and Honda Cars Ltd, which have a premium positioning in the market, will benefit from the unified tax structure.

“We do expect to see a mad scramble among buyers for cars above four metres once the GST is implemented as the price difference comes down, allowing one to buy what they always wanted," said Shekar Viswanathan, vice-chairman at Toyota Kirloskar Motor, saying the current tax structure impinges on the buyer’s choice.

“It shouldn’t be dictatorial and one should be able to buy what one desires. While it’s desirable to have a rate which is low, the choice of car should be incentivized based on the emission levels not on car dimension," he said.

Not everyone agrees though.

“GST is not about impacting market dynamics, it is about unifying the market, widening the base and generating efficiencies throughout the value chain. Regarding small cars, they will continue to remain significant to Indian manufacturing in line with Make in India," a spokesperson for Maruti Suzuki India Ltd said in an email response.

“GST will bring uniformity, clarity, enhance transparency and initiate a structural change," said Rakesh Srivastava, senior vice-president at Hyundai Motor India Ltd. Srivastava refused to comment on the likely GST rate and its impact on the buying behaviour.

Irrespective of the GST rate and whether a single or dual structure comes into play, the sub-four metre sedan will lose its sheen, said Singh.

GST may also accelerate demand for compact SUVs.

KPMG estimates demand for such vehicles, expanding at a brisk pace, to gain further momentum. By 2021, the segment is set to outgrow the small car market in value terms, according to KPMG estimates.

Under the current tax structure, the average price point of a small car is 4 lakh, while the average price of a compact SUV is 8-8.5 lakh. “The average price of compact SUVs is expected to come down to 7-7.5 lakh, but it will still be higher than the average price point of a compact car. So, that’s the reason, even if it reaches 50% the size of the compact car market, by value, it will be the largest segment," explained Singh.

Among other things, the crucial tax reform may also alter the way spare parts for automobiles are procured and priced. It may mark the end of high margins that dealers currently enjoy.

“More than anything else, the GST will impact the way spare parts are priced and sold," said Mahantesh Sabarad, deputy of head of equity (research) at SBICap Securities Ltd. It is also set to halve the warranty cost for car companies. It is currently 1-2% of the cost of a vehicle.

A change in the choice of manufacturing locations is likely if state subsidies such as tax holidays, offered as incentives to auto makers, dry up.

“If the states are earning less, they can’t give more," said Singh.

This will change the projections that companies had made earlier. On the specific issue of subsidies that companies are enjoying, the Maruti Suzuki spokesperson said, “Modalities need to be discussed with respective state governments."

Others are more optimistic.

“In all likelihood, the benefits extended will not be withdrawn," said Ravi Sud, chief financial officer at two-wheeler market leader Hero MotoCorp Ltd.

A 10-year tax holiday for Hero’s Haridwar plant in Uttarakhand will end in March 2017. Its recently set-up facility in Neemrana (Rajasthan) and an upcoming one in Gujarat are eligible for tax refunds, he said.

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