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GST stocktaking-II: Textile sector wary of new tax regime, but all concerns are not valid

(Editor’s note: A month after the launch of the biggest indirect tax reform undertaken in the country, Firstpost takes a look at how businesses are faring under the new regime. There have been confusion and concerns, much of which have not yet been addressed. This is the second of a four-part series taking stock of the GST’s impact.)

The recently launched Goods and Service Tax (GST) has created outrage and protests in the textiles sector. The textiles and garments sector is one of the largest employment generators in the country. India has around 2 million power looms manufacturing around 20 billon meters of cloth.

The power looms sector accounts for around 60 percent of the total textiles sector. The sector is largely unorganized with many players having hardly 10–20 looms and weaving on an average around 1,000 meters of cloth per loom per month, depending on quality of cloth and loom used to manufacture. Many run their looms on job-work basis and many buy yarn and manufacture cloth. These units are spread across Bhiwandi, Surat, Ichalkaranji, Erode, Bhilwara, to name a few large centres where power looms industry is operating.

Till date this sector has been out of the tax net. The government has in the past tried to impose excise on the power looms sector since 2003. However, after an agitation by the players this was withdrawn. So this sector largely remained out of the tax net, except VAT. Now the sector is being brought into the tax net because of GST.

While it is easy to blame the industry for their inertia and lack of desire to come within the tax net, there are practical complications that need consideration from the government also. At the same time, the aversion in the industry is also because many players don’t wish to come within the tax net and that cannot be ignored.

 GST stocktaking-II: Textile sector wary of new tax regime, but all concerns are not valid

Representational image. Reuters

Till date significant part of this trade was operating in cash. The traders never paid tax of any kind. Now there are concerns on how they can continue their trade in cash. e-way bills and squads inspecting goods and invoices have sent fear across the sector. There are pros and cons about the same. For this we need to understand manufacturing process.

A piece of cloth that we buy in the market goes through various processes and moves in the hands of many intermediaries before we get the final finished piece of cloth. It starts with a textiles manufacturer buying various kinds of yarns. The yarns are sent for intermingling and twisting to get a kind of blended yarn that will be used for weaving. This yarn is then sent for dyeing. After dyeing, the yarn is sent for washing and processing. These yarns are loaded on sticks and beams for warp and weft and then finally it is ready for weaving. Weaving gives us cloth that is called Grey Cotton. This grey cotton is then sent for washing and dyeing and processing. After washing and dyeing we get our finished cloth that is available in the market.

If we observe closely, from yarn to finished cloth there are more than half a dozen processes. Most of these weaving units or power looms don’t have the capabilities to execute all processes in its premises. So they have to send yarn out for intermingling, twisting, dyeing and processing, loading on sticks and beams before weaving. Similarly after weaving they have to send Grey Cotton outside for washing and dyeing and processing and again washing. Add to that all transportation involved in moving material from one place to other and back in the factory.

This means for every material movement in the job-work, they will have to do all the paper work and then also pay GST on labour charges. If the units doing this job-work are unregistered, then the cloth manufacturer (power loom owner) will have to pay GST under the Reverse Charge Mechanism (RCM). Reverse Charge Mechanism is a method of collecting tax wherein the recipient of goods and service pays tax on material and service he buys from unregistered dealers. The government’s intent to impose RCM is to increase tax compliance resulting in higher tax revenues.

The government has not been fully able to collect tax from many unorganized sectors like goods transport and small sector industries (SSIs). According to the government, any exemption on account of backward area benefits or SSI limits is a tax leakage which it is trying to stop. Compliances and tax collections will therefore increase through reverse charge mechanism. This means there will be additional compliance burden on power loom owners. It can be safely assumed that none of the smaller job-work units doing intermingling, twisting, dyeing, etc., will bother to handle all this and the burden of compliance will be on power loom owners.

The bigger reason of fear is that now they may not be able to move their material for job-work at various places. Section 19 of GST Act read with Rule 43A is clear on procedure for sending goods out for job-work and availing input tax credit on the same. But smaller players would find this cumbersome. Can there be a better and easier method to handle this compliance? That needs to be deliberated by the government after a detailed dialogue with the industry.

If we closely analyze the cost structure of power looms, they hardly make any decent margins. On a higher side, a power loom owner cum fabric manufacturer would make not more than 10 percent margin. Out of that he has to pay for power and electricity, labour and wages, and other expenses, leaving a loom owner with extremely low returns. For a businessman operating on such low margins, the cost of compliance that includes hiring an accountant and tax consultant is definitely a pain. This is one reason we are seeing a resistance against GST.

Other contours in GST that has resulted in problems is inverted duty structure and interpretation on where certain fabrics could be placed. This was the issue that created outrage amongst textile manufacturers in Surat and attracted national attention. However, manufacturers were okay with inverted duty structure and loss on account of inability to get full set off of input tax credit. The reason is manufacturers were comfortable in absorbing some losses in order to gain ease in compliance and clarity on how their product would be taxed. The government is now considering reduction of GST on textile job work, which was 18 percent to 5 percent. This is in order to reduce inverted duty structure in textiles sector.

Now comes the bigger issue of black money and tax evasion. Most of the trade in this sector is done in cash. Traders and manufacturers are reluctant about moving their trade to non-cash means. There are two big reasons for this.

The first concern is, how will traders and manufacturers account for stock of unaccounted inventory that they would now sell through non-cash means? This would mean they will have to incur tax on sales income without any deduction for raw material costs. This translates into a huge tax liability for them on income that they have earned over years and decades but never paid tax. Conservative estimates by industry experts pegs the growth in accounted turnover of these players anywhere from 5 times to 10 times or even more due to GST.

The second concern is sharing of information between GST and income tax and how to explain such a massive increase in turnover after GST? The bigger worry amongst traders and manufacturers is of income tax officials issuing notices for reopening of files of previous years in which income was under reported. The government can work on allaying this fear by giving some assurances to trade bodies that cases of previous years’ would not be reopened.

Transition and evolution has always been a challenge for every living being. It is an even bigger challenge when it is about changing the way we do business. Here, government needs to be compassionate and understand valid concerns of the industry and work on smoothening rough edges and removing pain points. This is the only way the government can achieve a mutually beneficial solution in which industry is made to accept and comply with GST while allaying valid concerns to ensure success of the largest tax reform after independence.

Part-III to be published tomorrow: How states need to improve infrastructure. Read Part 1 here  and Part IV here

(The writer is a Chartered Accountant by qualification and a finance and media professional. You can follow him on Twitter on @sumeetnmehta)

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Updated Date: Aug 05, 2017 15:02:13 IST