GST: why profit may become collateral in war on profiteering
The new anti-profiteering rules imply that all savings must be passed on, including the benefit earned from input tax credit
Since the time the first set of goods and services tax (GST) rates were announced, the S&P BSE Fast Moving Consumer Goods (FMCG) Index is up by 8.6%. Some of that is due to the broad market rising by 2.8% in this period and the monsoon’s onset has brought cheer too.
The FMCG sector is expected to benefit in the long term from a more efficient business structure. Even in the near term, moderation in tax rates on some goods was positive for the industry, but the government’s anti-profiteering rules may be a dampener.
A Credit Suisse note said the rules do not augur well for FMCG companies, according to a report on Moneycontrol.com. This is especially true for Colgate-Palmolive (India) Ltd, whose share has gained by 12.7% since 18 May, as margins on toothpaste were expected to increase due to lower tax outgo under GST. That view may no longer hold good.
The new anti-profiteering rules imply that all savings must be passed on, including the benefit earned from input tax credit. What does this mean? At present, if a company was selling a product for Rs100 and it included indirect tax of Rs30, the net realization was Rs70. Under GST, if the tax comes to Rs30 and input tax credit is Rs10 then the net tax payable is Rs20. The government wants the new price of the product at Rs90 (Rs70 plus tax Rs20), implying a 10% reduction from the earlier price. Even a retention of Rs5 as savings will fall foul of this law, as it stands.
Now, companies never said they will retain all tax savings. For instance, a Hindustan Unilever Ltd investor presentation mentions that GST on soaps, toothpaste and detergent is lower than the current level. But the management said it intended to use savings in one category to offset increases elsewhere. That is, at the company level it would pass on net benefits due to GST.
The current anti-profiteering rules don’t offer that flexibility, simply saying any tax reduction in supply of goods and services must be passed on by a commensurate reduction in prices. More clarity will emerge when the National Anti-Profiteering Authority determines the methodology and procedure for taking up cases, said the finance head of an FMCG company who did not want to be identified. He said the spirit of the rules indicates that tax benefits have to be passed on and the government’s intention is to take on profiteering and not profit, which is essential for a business.
Also, anybody can file a complaint but will have to show evidence that tax savings have not been passed on. This requirement will ensure a system of checks and balances, according to the official quoted above. However, that information may be available with the government or competitors.
The National Anti-Profiteering Authority’s tenure is for two years, which Abneesh Roy, analyst and vice-president at Edelweiss Securities Ltd, believes is too long and one year should have sufficed. Being a competitive market, the need for this sort of a mechanism was also not strong, at least for the FMCG sector, he said. Companies cannot afford a situation where their products are not priced competitively.
The anti-profiteering clauses can be a dampener in the near term. While any immediate benefit to margins from GST seems unlikely, there is a risk of rivals filing cases and companies getting stuck in litigation. Investors should move their sights beyond a near-term boost to margins from tax savings, to the longer run when the structural benefits of GST should set in.
Editor's Picks »
- Fund managers slashing allocations to equities in emerging markets, shows BAML survey
- ICICI Lombard tightens grip on profitability in a lean growth quarter
- TCNS Clothing IPO: Valuations capture the upsides adequately
- Nightmare of Indian Accounting Standard 115 comes to haunt firms in the real estate sector
- What is driving the optimism in stocks of paint companies?