EIC Research Series: Opening doors to India
By: Yuwanee Ouinong
India is a country that brings to mind diversity and complexity in virtually all aspects. Its variety of culture, ways of living between social groups and large population size of over a billion has been key feature attracting the focus of investors all over the world. Yet doing business in India is no easy task. Trivial regulations and inconsistencies between states are only part of the problem that has led India’s to rank 130th in ease of doing business out of 190 countries. Until now, the current government under leadership of Prime Minister Narendra Modi is pursuing an ambitious economic reform in multiple areas. One of the top priorities is the biggest tax reform since the country’s independence in 1947. The new tax system called Goods and Services Tax (GST) is now rolling out across India.
Removing the complex tax system.
India, which is a large country, is administered under a decentralized system composing of one central government and 29 states. Each state would have their own administration and were previously allowed to levy different tax rates. As a result, India had among the most complex tax system in the world, of which has been deterring foreign investors from India.
Key obstacles for doing business arose from the old tax system are as follows.
1. Understanding the tax system is too time consuming. Those doing business have difficulty in assessing cost or profit in each state. Furthermore, as some states require border inspection and entry tax collection, careful planning in terms distribution and tax calculations is therefore essential. In fact, trading between states in India can be just as difficult as trading with 29 different countries.
2. Inspection is difficult due to having multiple tax collecting agencies. The central government’s tax agencies work separately with their state counterparts, therefore making it troublesome to examine redundancy of tax collection or recording of tax credits. Generally, manufacturers that have already paid tax on a purchase for raw materials should be able to subtract the amount off tax amount required on sale of final product, known as tax credit. However, given that the tax collection data are not consolidated between agencies, it would be difficult to determine whether a manufacturer have appropriately paid for their tax on raw materials.
3. Huge incentive to bribe officers. Officer discretion is needed in certain tax assessment procedures due to lack standard tax rate enforcement. Furthermore, under the old system officers need to manually examine documents as the system is not yet online.
4. State-border trades have high cost in both terms of money and time. A World Bank report showed that for up to 60% of the time used in transporting goods within India, the truck is not moving at all. This is because trucks need to spend time at state-border checkpoints for tax assessment. Given such, businesses also have trouble approximating time of delivery.
5. Problems in exports and manufacturing, as manufacturers need to divert their shipments to avoid state-border checkpoint. For instance, an exporter in Tirupur, Tamil Nadu state would rather choose to transport its goods to a port within the same state than sending goods to a nearer port in Kerala state just to avoid crossing the border between Tamil Nadu and Kerala. Exporters in India have higher transportation cost than international standard by up to 2-3 folds. Moreover, in certain cases it is cheaper to import raw materials from overseas than buying them from another state. Such has led many firms in India to avoid using local material in their production.
Source: EIC analysis based on data from World bank, Apparel Resources, and Google maps.
The new, unified tax regime
GST (Goods and Services Tax) is a system that will unify tax rate on goods and services within the country. The system is a change from the previous that allowed each state set their own tax rate. The new system would replace approximately 15 categories of indirect tax such as central sale tax, entry tax, Octori, VAT, Excise tax, etc. Each product will be imposed the same rate throughout the country. Furthermore, tax procedures will be required to conduct online in order to avoid contact between tax payers and government officers. For intra-state trading, tax on goods or services will be collected by between the state government (State GST: SGST) and central government (Central GST: CGST) equally. Therefore, assessment procedures is expected to be strictly complied on both governments. For inter-state trading, the tax, called integrated GST (IGST), will be levied solely by central government.
Source: EIC analysis based on data from thegstindia.com
EIC believes the most obvious gain from the transition towards the GST system is lower logistic cost and removing cascading tax effects. The GST system will transform India into a unified common market by eliminating various taxes in different states and allowing manufacturers to get full tax credits for input. Such would significantly lower tax burden and cost of production in India, and in turn raising consumption. The GST system will also improve ease doing of business, promote transparency and efficiency in tax collection, and quicken transportation of goods. The World Bank estimated that logistics cost in India could fall by 30-40% if transportation time is cut by half. Spillover benefits into other sectors include promotion of export and import sector, of which in the whole the government of India expects the GST to boost GDP by another 2%.
Source EIC analysis
Allowing to claim input tax credit credits will encourage more businesses to register for the new tax system. This is because businesses will be able to claim input tax credits only if they purchase from suppliers that are registered under the GST system. Therefore, producers will be less likely to buy inputs from unregistered suppliers. Moreover, unregistered producers who do not get tax credit will carry higher cost of inputs and thus have lower price competitiveness. Given such incentive to register, the government believes greater number registered businesses should be able to compensate for certain tax revenue that will be loss under the reform.
Although India’s GST is not actually ‘one nation, one tax, one rate’ as the government once said, the reform is a great step forward for India. The GST system consists of 4 tax rates, which are 5%, 12%, 18% and 28%. Commodities likes rice, grain or milk, however will be exempt from tax under the new system. Meanwhile, the highest tax rate of 28% will be imposed on luxury items such as air conditioner and movie tickets. Nevertheless, products such as petroleum and alcoholic drinks that are significant income source to the government will be excluded from the GST system. The general view is that a single tax rate would be difficult to impose as the same product as its necessity may vary depending on the group of people. Enforcing the same tax rate on each product throughout the country is already considered a significant achievement for the Indian economy.
It’s time for Thai investors to find opportunities in India.
Thai investors should turn their attention towards India as they are already steps behind foreign investors. Since the government under Modi’s administration began in 2014, firms all over the world saw the potential for growth and have since rushed for opportunities. The value of foreign investments has since been increasing at average rate 28%YOY with major investments coming from Singapore, Japan and the U.S.. On the contrary only 20 Thai companies1 currently have investments in India. Total investment value of Thai firms in India at the end of 2016 stood at USD 906 million, or only equates to 7.8% of the total investment of Thai firms in CLMV even though India has a population size 8 times greater than CLMV.
Thai businesses that have potential to benefit from this tax reform are businesses related to logistics and consumer goods.
1. Logistic businesses will have an obvious gain from this reform. Although currently several global logistics firms have already entered the Indian market, the majority of the market share is still accounted by local logistics companies1. The complexity of India’s tax system has been an important hurdle for foreign firms, leading local businesses to have the advantage. This tax reform will be key to unlocking the logistic sector in India. A summary of expected changes to the Indian market and significant opportunities for Thai investors are as follows.
Source: EIC analysis
2. Consumer products business such as processed food, drinks, soap, shampoo, clothes and household products have immense growth potential given the size of consumer population in India. This business also stands to benefit clearly from this tax reform. The key impacts on this business group are as follows.
Undeniably, India will become a key driver of global growth in the decades to come. Business involved with logistics and consumer products are mere examples of businesses that can profit from this tax reform in India. Thus, other business groups should also keep close watch for opportunities in India. It is now the time Thai investors need to build a better understanding of this market so to not miss timely opportunities for investment.
1 Data from the Royal Thai Embassy, New Delhi, Republic of India
2 Mitra S. (2008), Logistics Industry: Global and Indian Perspectives.
3 Data from the India Brand Equity Foundation (IBEF)
4 Data from Thai-India Business Information Center, Royal Thai Embassy, New Delhi, Republic of India and Prachachat.