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GST Impact: Discontinuing incentives could hit domestic manufacturing

February 16, 2017

Mobile handset manufacturing in India has gained fresh momentum in the past two years with a number of original equipment manufacturers and third-party contract manufacturers setting up manufacturing plants  in the country. The number of mobile handset manufacturing facilities increased to 40 in August 2016 from just three in 2014. The government’s Make in India initiative and the differential duty structure for the handset industry have played a vital role in seeding mobile handset manufacturing in the country and offsetting local disabilities.

However, the roll-out of the goods and services tax (GST) is likely to negatively impact the incentives, especially the duty differential, available to mobile handset manufacturers under the current regime. This will also negatively impact the government’s Phased Manufacturing Programme, which seeks to domestically manufacture 1.2 billion mobile handsets worth Rs 15 trillion by 2025-26.

It is expected that smartphone adoption in India will reach around 688 million by 2020, compared to 238 million in 2015. Further, the overall mobile handset market in the country is likely to grow at a compound annual growth rate of 23 per cent over the next four to five years. Continuation of incentives under the GST regime will be key to meeting the increasing demand through domestic production. There is also a need to provide more incentives in order to increase the contribution of local value addition and move to full-fledged manufacturing, with greater investment in design and research, and focus on sourcing more components locally.

Current duty structure in India

During 2014-15, the government introduced a duty differential structure for mobile handsets, wherein the rate of excise duty was fixed at 1 per cent, subject to the condition of non-availment of central value added tax (CENVAT) credit on the inputs and capital goods used in the manufacture of goods, thereby incentivising local manufacturing of mobile handsets. Subsequently, in the year 2015-16, the differential was enhanced to 11.5 per cent by raising the countervailing duty (CVD) to 12.5 per cent.

Further, in order to broaden the mobile components manufacturing ecosystem in a phased manner, the government introduced the Phased Manufacturing Programme. Under this, a differential structure has been created on three components of mobile handsets – chargers, batteries and headsets – wherein the rate of excise duty has been fixed at 2 per cent (instead of 12.5 per cent), subject to certain conditions including non-availment of CENVAT credit on the inputs and capital goods used in the manufacture of such goods. The current structure has resulted in a differential of 8-10 per cent in sale price between imports of mobile handsets and manufacture of mobile handsets in the country.

Besides this, the government provides several benefits to companies engaged in the manufacture of consumer electronics under the modified special incentive package scheme. These include a capital expenditure subsidy of 25 per cent in non-special economic zones (SEZs) and 20 per cent in SEZs; reimbursement of CVD/ excise duty on capital equipment for non-SEZ units and production subsidy at 10 per cent of the production turnover (ex-factory) to select high-tech units such as semiconductors and memory chips.

Proposed GST structure and its impact on handset manufacturing

The basic intent of GST is to avoid a cascading tax effect in the supply chain with seamless credit flow, which, in turn, would make products cheaper and increase the country’s global competence. With this intent, it is expected that GST would be introduced with minimum tax exemptions. However, this would take away the benefits currently available to domestic handset manufacturers.

As per the government’s model GST law, integrated GST (IGST) on the import of goods will be levied in accordance with the customs provisions. Credit of IGST will be available at the time of further supply in India, unlike the present regime where the import duty paid is a cost for the importing trader. This will increase the importer’s pool of creditable taxes, which are otherwise a cost.

The unlocking of these benefits for importers under the GST regime will remove the differential of 8-10 per cent enjoyed by domestic manufacturers under the current regime.

Assuming that mobile handsets are classified under the 18 per cent rate slab, an importer’s upfront cash flows may increase by 4-5 per cent (computed as a per cent of the sales price to the distributor/retailer) due to an increase in the rate of duty to 18 per cent. On the other hand, domestic manufacturers would be required to pay duties on the import of parts, components and accessories for manufacturing, as compared to zero duty under the current regime. This withdrawal of exemptions would increase the upfront cash flow of domestic manufacturers by 11-14 per cent.

The proposed GST regime would facilitate seamless credit across the supply chain under a common tax base. Considering that importers will now be eligible for credits of GST paid on the import of mobile handsets, they will be able to unlock far more non-creditable taxes as compared to domestic manufacturers. The difference can be as high as 10-11 per cent.

Suggestions for incentivising domestic manufacturing under GST

In view of the above discussion, it can be seen that importers and local manufacturers would be at par under the proposed GST regime as the duty differential of 8-10 per cent under the current regime may go down to zero. Importers may also benefit in other ways under the proposed GST regime, as credit flows would increase and the impact on cash flows would be lower as compared to that on local manufacturers.

In order to promote local manufacturing and build a complete handset manufacturing ecosystem, there is therefore a need to continue providing benefits to domestic manufacturers under the GST regime. The government has frequently mentioned that any incentives under the GST regime would be in the form of a refund or subsidy.

Given the provisions under the revised model GST law, a separate mechanism for incentivising mobile handset manufacturers can be recommended, wherein manufacturers can be granted relief/exemption by way of a refund/rebate, consistent with the currently available incentives. Further, the government may provide similar benefits to component manufacturers.

Incentives may be granted by way of a refund at the time of outward supplies by manufacturers to distributors. A suggestion to compute the incentive to manufacturers is as follows:

Incentive amount = Net GST payable by the manufacturer = GST paid on output supply - GST paid on the import of goods and services

Further, the actual incentive amount can be enhanced with a multiplier to grant a benefit that is at least equivalent to the incentive available under the current regime (8-10 per cent) and higher incentives can be granted where the local value addition is more.

The government may further consider deferring the payment of customs duty (equivalent to the GST rate) on the import of goods and services till the time the goods are further supplied to customers, as payment of customs duty at the time of import would result in an upfront outflow for manufacturers. This would further incentivise local manufacturers by eliminating the impact on working capital, as is the case under the current regime. It would also encourage exports because GST would not be applicable on outward supplies and this GST deferment would therefore ensure that exporters are not required to undergo the refund process.

A similar scheme can be extended to component manufacturers, which would encourage more investment in India and give a boost to the entire manufacturing ecosystem. Once the ecosystem is created, the prices of parts and components may also become more competitive, which, in turn, will reduce the cost of mobile handsets and make Indian handset manufacturers more competitive globally. s

Based on the paper “Incentivising Domestic Handset Manufacturing in  India under the GST regime”, by EY and the Broadband India Forum

 
 

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