Effects of GST on the Working Capital of Businesses

The Goods and Services Tax regime was introduced in the year 2017 across India. By far, it has been the most elaborate tax system introduced by the Indian Government. GST is a unified system of indirect taxation. Previous tax systems of VAT, Service Tax and Excise duty were abolished after GST was introduced.

GST has now been in the country for more than five years and you can see the impact (both positive and negative) it has had on the economy so far. Business entities are the most impacted entities by GST in the economy. Let’s find out how GST impacts the working capital of businesses.

What is Working Capital?

The difference between the current assets and liabilities of an entity is referred to as its working capital. It relates to the liquidity and short-term financial health of any business.

Positive working capital is a situation when the current assets are more than the current liabilities. It shows that the company can fund its ongoing operations and also invest in future growth prospects. On the contrary, negative working capital is not a very favourable circumstance for any entity. This is the reason why working capital is called “oxygen” for any business.

How GST affects the Working Capital of a Business?

Raw Material: GST is levied on the raw material obtained by any manufacturer. When an importer imports raw material from a foreign country, it has to levy a tax of 18%. Before GST, this tax slab use to be 14%. This affects the liquidity of the business since more amount of money has to be paid as tax.

Similarly, the service sector also has to pay a tax of 18%. Earlier this used to be 15%.

It was earlier believed that GST will help businesses make tax savings but unfortunately that hasn’t been the case.

Management of Inventory: Before the GST, businesses had to maintain multiple warehouses in separate states. The reason for the same was to avoid inter-state taxes. This whole process was very burdensome. It was also very expensive as maintenance required a lot of funds. For the entity to move goods to another state, it had to pay different taxes like octroi, CST, and other state-specific taxes. Besides, compliance with different state laws at the same time was another tedious job.

However, with the implementation of GST, things have changed for good. Now, the entities only have to maintain four to five warehouses as per the need of their business and states. Also, upon the movement of goods from one state to another, the tax doesn’t have to be paid every time.

This has led to huge tax savings as no tax has to be paid on the movement of goods from one state to another. It has helped in making savings in the working capital of businesses. The transit time of moving goods has also been reduced. There is no system of tax collection at state borders anymore. The inter-state movement of goods has become much easier now.

Tax Credit: In the system of GST, the tax credit can be claimed by a business only at the time of the sale. However, the tax is levied at the time of the transfer of goods itself. There are a lot of ties when the time difference between the transfer of goods and their sale is quite lengthy. Till the time of sale, the business entities have to wait for the input tax credit. The waiting time for businesses adversely affects the working capital of the businesses as they have to pay the tax which leads to a fall in the working capital. The businesses are sometimes also forced to take a working capital loan.

Inverted Duty: This is a scenario wherein the tax on inputs is higher than the tax on outputs. As a result, unutilized credit is accumulated. This used to exist under the previous provisions of taxes, especially in the pharmacy industry. However, things have changed under the GST regime as it allows for the Inverted Duty Structure.

Businesses can claim unutilized input tax credits which have resulted due to Inverted duty. This has come as a big relief for businesses. Also, the process of refund has been simplified as 90% of the claim is given on a provisional basis and 10% after verification. This way the working capital of the businesses doesn’t get impacted negatively. They can utilize the working capital to meet the daily needs or other financial needs of the business.

Service Sector: Earlier for the service sector, there was one unified act- Service Tax. It applied to the entire service sector of the country. In this, an entity could avail of the service tax credit on its services and use it in any state to set off its service tax liability. This is not the case under GST.

Under the GST regime, the service provider has to register himself in the state in which he wishes to supply his services. The Act limits the setting off of the state GST and central GST of one state with another state. Sometimes, this could lead to a situation where the tax credit is held at a branch of one state. But then the service provider is unable to use it against the branch or tax liabilities of another state.

Such a situation would impact the working capital of the service provider. The business will have to pay cash out of pocket. Such a situation cannot even be handled with the concept of an Input Service Distributor.

Conclusion

GST is still new to the country and businesses are learning to get used to it and make the best use of its clauses. The tax regime has been implemented for the economic growth of the country and will certainly give a positive outcome in the future. Till then, the businesses have to learn to balance their working capital requirements in consonance with the clauses of the GST Act that affect the working capital. Visit Piramal Finance to learn more about GST and its impact on businesses. There are many blogs and articles on the topic that would enlighten you.