Jul 1, 2016

Will GST result in more Capital requirement for Rail infra sector?

New Delhi: The Rail infra sector in India is fairly unique when it comes to indirect taxes. Depending on the kind of projects, it enjoys many exemptions under the central laws, while most of the states charge the applicable VAT / CST / entry tax on goods procured for the project. Also, most of the taxes that are not otherwise exempt are non-creditable and end up as tax costs in the system. The Model GST law seems to address some of these fundamental issues.

What it means for the contractor

In its current form, GST would appease the contractor due to seamless credit flow and the proposed treatment of works contract as ‘services’. Coupled with subsuming of taxes such as excise, CST, entry tax, etc, GST would bring in the much-needed efficiency for the infrastructure sector on the cost side. At a macro level, it is expected that any impact of increase in GST rates in the hands of EPC contractor should get negated by incremental GST credits in the procurement chain.

The GST regime also seeks to address certain inherent tax risks that EPC contractors presently carry under the existing tax regime. For instance, the entire conundrum of local versus inter-state works contract leading to the debate and dispute as to which state should get the VAT / CST revenues on such supplies should end as it is clear that GST revenues are shared between the central government and the project state. Likewise, the litigation around taxation of in-transit sales model should also abate with both the limbs of the transaction now being taxed, with free flow of credit. Further, it contains clear provisions for inclusion of free of cost supplies received by the EPC contractor in the taxable base for discharging GST, thereby ending any debate on this issue.

May not be such a sweet pill for the project owner

Credit restrictions on goods and services in the “execution of works contract” which result in construction of immovable property continue to exist in the hands of the project owner. For a project owner, the net impact would have to be calculated as net of the overall reduction in project cost on one side and ineligibility of setting-up credits coupled with increased GST rates on the other.

While VAT is applicable, the roads, railways, ports and airports currently enjoy service tax exemptions. The model GST law does not contain the exemption list or the NIL rated schedule. Hence, it is unclear whether the current exemptions would continue under GST.

Renewable energy projects which presently enjoy VAT and entry tax exemptions in some states; and also lower excise duty rates on the key high value equipment may get adversely impacted if the exemption are discontinued under GST which coupled with unavailability of setting up credits, would result in a rise in the project costs resulting in higher capital employed that would, in turn, lead to increase in power tariffs. It is also not clear, if there would be any GST levy on generation and distribution of power, which, in turn, would again have an impact on the power tariff.

FMCG, automobile industries say if GST regime kicks in, rail hubs can take Make in India to a new high

As Railway Budget 2016 promised focus on freight corridors and Railway Board Chairman A K Mittal revealed the strategy to tap sectors like fast-moving consumer goods (FMCG) and automobiles to increase traffic, the success of the ambitious plan hinges on the goods and services (GST) tax regime.

If freight corridors become reality as promised, FMCG sector could cut down expenses and streamline operations.

The inventory-heavy industry, in which logistical efficiency and warehousing play a significant role, will be able to shift towards centralised production at cheaper rates.

Currently, Indian Railways transport only 1,000 million tonnes of FMCG products every year.

While a few majors such as Nestle and milk co-operatives use the railways for supply of raw materials and dispatching finished goods from the factories, a majority of the players depend heavily on road transport.

“We are open to considering railways as the preferred mode of transporting goods, provided that is economically viable,” said Lalit Malik, chief financial officer, Dabur India.

According to top executive of a milk co-operative, while the industry uses railways to ferry milk, for items such as ice creams and foods, it is not viable. “We have a set infrastructure for that. Also, railway freights are higher than the road,” he said.

While most FMCG companies have welcomed the initiative, various state-level taxes are a major hindrance in transporting goods from one part of the country to another by train.

To avoid multiple state-level taxes, most FMCG entities are forced to set up manufacturing units and warehouses near every major market. For example, Coca-Cola India has 57 production units while PepsiCo has 41 units.

According to a Coca-Cola India official, transporting glass bottles through railways could be a game changer since it will help beverage makers reduce the number of bottling units in the long term.

“If GST is implemented, the companies may not need to set up sales depots in every state as is the requirement now,” said Harsh Mariwala, chairman, Marico.

“Typically, primary freight is used by most companies including us to transport raw materials such as palm oil from ports to factories. For secondary freight (using railways) is a challenge since delivery of finished goods in FMCG tends to be door-to-door,” said Sunil Kataria, business head, India & SAARC, Godrej Consumer Products.

“Rail transport can become viable if manufacturing and distribution centres are fewer, so goods can travel large distances resulting in economies of scale.”

Big opportunity in auto transport

Automakers, especially those in the South, are expecting a 10-15 per cent reduction in transportation cost if the planned rail-auto hub in Chennai becomes a reality.

Apart from cost savings, railway is safer and cheaper mode for transporting heavy auto parts or vehicles.

R C Bhargava, Chairman, Maruti Suzuki said “There are advantages in terms of safety to the vehicle. Damages can be avoided. Obviously, it is not an economically unviable proposition.”

Maruti Suzuki has been using rail as a mode to transport vehicles for last few years through dedicated rakes and other wagons.

This is not the first time that the Railway Ministry has made a push to attract automobile companies.

A policy formulated during the UPA regime allowed automobile firms to lease the trains for transporting vehicles with help from logistic companies. The plan, however, wasn’t very successful.

The proposed rail-auto hub will serve Hyundai, Nissan-Renault, Ford, BMW and Daimler which are based near Chennai.

“This will bring significant efficiencies and reduction in logistic costs for many automobile OEMs in and around the Chennai region, including us,” said Sumit Sawhney, chief executive and managing director, Renault India.

Indian Railways uses specially designed wagons to transport vehicles. At present, railways transports only about two-three per cent of new vehicles.

The government is also encouraging vehicle transport by ship. Recently, Hyundai shipped cars from Chennai to Kandla in Gujarat.

Frequent agitations, leading to blocking of highways, freight rate increase, strike by truck drivers and accidents leading to financial loss are some of the inherent risks of transporting vehicles by road.

“The rail auto hub in Chennai would help southern auto OEMs improve their logistical, multi-modal efficiencies significantly. It will encourage transportation of cars through railways, thereby offering greener logistical solutions through decongestion of road traffic,” a Ford India spokesperson said.

Pravin Shah, president and chief executive (automotive), Mahindra & Mahindra said, “This is a very welcome step. These are the enablers for achieving the kind of growth the auto industry is looking for. But we just have to see how quickly these are put into place.”

In Conclusion

Considering the fact that Rail infrastructure is regarded as a measure of development of a nation and GST is a comprehensive tax regime, it is vital that the government takes a benevolent view to further the growth of Rail infrastructure in India and continues the exemptions to such projects under the GST regime, preferably treating them as zero-rated supplies, to avoid any escalation of project costs that in turn would end up requiring even more capital to be deployed, in a sector which is going through a phase of weakening private participation.

 

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