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SCM Assignment

16 March, 2011

Goods & Service Tax and Its Impact on Indias Telecommunication Sector

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Submitted by: Group 12

TABLE OF CONTENTS
Introduction ............................................................................................................................................................................... 1 Rationale for the New Tax.................................................................................................................................................... 1 Working of GST......................................................................................................................................................................... 3 Impact of GST on Supply Chain Management .............................................................................................................. 4 Indian Telecommunication Industry ............................................................................................................................... 5 SWOT analysis...................................................................................................................................................................... 6 GST - A boon to the Indian Telecom Sector .................................................................................................................. 8 GST A curse to Indian Telecom Sector......................................................................................................................... 8 Hurdles in implementation ................................................................................................................................................. 8 Recommendations................................................................................................................................................................. 11 References ................................................................................................................................................................................ 12

INTRODUCTION
The consumption tax system in India is complicated and multi-layered with levies both at the federal and State levels. A major breakthrough in the sphere of indirect tax reforms in India occurred with the Introduction of the Value Added Tax (VAT) at the Central and the State level. Taxes on goods are levied by the Centre at the manufacturing level through CENVAT, on services through the Finance Act, and on sale of goods via the Central Sales Tax Act. States levy tax on the sale of goods independently, under their own laws. Though some degree of uniformity had been arrived at after the introduction of the Value Added Tax, differences do persist with extreme cases of Tamil Nadu and Uttar Pradesh who are yet to implement the VAT. The next breakthrough in reforms is via Goods & Services Tax (GST) which aims to integrate the overall indirect tax system. The government plans a nationwide goods and services tax, which would streamline its complex and overlapping revenue system, but the same has been delayed twice from the targeted October, 2010 to April 1, 2011 and to April, 2012 as it struggles to iron-out differences with the states (Shukla, A. 2011). In this report, we first discuss the rationale that necessitates the new tax policy followed by the working of GST. The third section deals with the impact of GST on supply chain management. In the fourth section we provide an analysis of the telecom sector in India and impact (pros and cons) of GST on the sector. Finally, we analyse the hurdles in its implementation and conclude based on the overall assessment of the impact of GST on the telecom sector.

RATIONALE FOR THE NEW TAX


Rationale for the new tax has been discussed widely in the literature (Discussion Paper, 2009 & 13th Finance Commission Report, 2009) and on internet. Goods and Services Tax is expected to: Integrate State Economies, promote exports, raise employment & boost overall growth. Create a single unified Indian Market thereby making the economy stronger. Simplify the tax collection process leading to efficient administration. Abolition/Inclusion of other taxes viz. CENVAT, Service Tax, Entertainment tax, luxury tax, Octroi, CST, State level Sales Tax, Entry Tax, Stamp Duty, Telecom License fees,
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Turnover Tax, Electricity consumption or Sale Tax, Goods transportation tax etc. thereby avoiding multiple layers of taxation that exist in India. GST is not an additional tax. The previous tax regime and the GST regime are detailed in Figure 1. Enhance the tax base by employing a tax credit mechanism to collect tax on Value-Added Goods and Services at each stage of sale or purchase in the supply chain. Allow a Set-off of the Tax paid on procurement of goods and services against the tax which is payable on the supply of the same. But the final tax burden of GST would be borne by the Consumer as he is the final link in the supply chain and not at various points in the supply chain. Divide the tax burden equitably between manufacturing and services Remove the cascading effect of the indirect tax regime and bring all goods and services (barring a few exceptions) into a dual GST regime i.e. Central GST and State GST to be levied on the taxable value of the transaction. Bring about a fall in prices in the long term as dealers might think of passing on the benefits of reduced tax burden onto the consumers owing to more efficient collection, increased compliance, smoothened tax process, reduced transaction costs and increased tax-to-GDP ratio.

Entertainment Tax Luxury Tax Entry Tax & Octroi Central Sales Tax VAT Sate Levies

GST

Central GST, Subsumes


Cental Excise Tax Customs duty Addl. Custom & Excise duties Service tax Central Sales tax Surcharge & Cess

State GST, Subsumes


VAT Entry tax Entertainment tax Luxury Tax Tax on Lottery Surcharge & Cess

FIGURE 1: THE TAX REGIME AFTER VAT (LEFT) AND AFTER GST (RIGHT) 2|Page

WORKING OF GST
A comparison between the tax regime after VAT and the tax regime after GST is shown in Figure 1. The proposed GST is an indirect tax on goods and services with comprehensive and continuous chain of set-off benefits from the producers point and service providers point up to the retailers level. It is essentially a tax only on value addition at each stage, and a supplier at each stage is permitted to set-off, through a tax credit mechanism, the GST paid on the purchase of goods and services as available for set-off on the GST to be paid on the supply of goods and services. The final consumer will thus bear only the GST charged by the last dealer in the supply chain, with set-off benefits at all the previous stages. The illustration shown below indicates, in terms of a hypothetical example with a manufacturer, one wholesaler and one retailer, how GST will work. Let us suppose that GST rate is 10%, with the manufacturer making value addition of Rs.30 on his purchases worth Rs.100 of input of goods and services used in the manufacturing process. The manufacturer will then pay net GST of Rs. 3 after setting-off Rs. 10 as GST paid on his inputs (i.e. Input Tax Credit) from gross GST of Rs. 13. The manufacturer sells the goods to the wholesaler. When the wholesaler sells the same goods after making value addition of (say), Rs. 20, he pays net GST of only Rs. 2, after setting-off of Input Tax Credit of Rs. 13 from the gross GST of Rs. 15 to the manufacturer. Similarly, when a retailer sells the same goods after a value addition of (say) Rs. 10, he pays net GST of only Re.1, after setting-off Rs.15 from his gross GST of Rs. 16 paid to wholesaler. Thus, the manufacturer, wholesaler and retailer have to pay only Rs. 6 (= Rs. 3+Rs. 2+Re. 1) as GST on the value addition along the entire value chain from the producer to the retailer, after settingoff GST paid at the earlier stages. The overall burden of GST on the goods is thus much less. This is shown in the table below. The same illustration will hold in the case of final service provider as well. Stage of Supply Chain Manufacturer Wholesaler Retailer Purchase Value of Input 100 130 150 Value Addition 30 20 10 Value at which supply of goods or service is made to next stage 130 150 160 GST Rate 10% 10% 10% GST Input Net on Tax GST Output Credit 13 15 16 10 13 15 3 2 1

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IMPACT OF GST ON SUPPLY CHAIN MANAGEMENT


Supply chains are impacted by 3 major forces: Forces intrinsic to the organization, Market specific forces and Fiscal forces of which fiscal consideration is the key determinant in India (Madhvan, S., 2010). The existing indirect tax regime has several characteristics which negatively impact supply chains. These ranges from irrecoverable taxes such as the Central Sales Tax (CST), complex documentation of inter State movement of goods, entry barriers at State borders resulting in long transportation times and imposition of local levies such as entry taxes and Octroi upon physical entry of goods into designated areas. The increased cost due to taxes force businesses to make decisions based on tax exemptions rather than operational efficiency. GST endeavours to foster a single market in India through a seamless and uniform application of the CGST and the SGST on all taxable supplies, throughout the supply chain. GST moves away from origin based taxation to a destination based consumption tax i.e. all taxes will be based on where consumption of a good or a service takes place. Also, the taxable supplies under the GST will extend to all inter State movement of goods, including on branch or consignment transfers not resulting in a sale of goods. This has major implications for supply chains, particularly on classic hub and spoke arrangements of centralised manufacturing and disaggregated distribution. These changes pose challenges for companies as to how they might engineer their supply chains so as to be GST efficient. It is probably fair to suggest that the longer the supply chain, the more the tax points in the GST scheme of things and hence increased compliance costs. This will lead to compressed supply chains for GST efficiency while ensuring that the business objectives in and around supply chains are also met. The dual GST consequently affords companies significant opportunities for realignment of procurement, manufacturing and distribution/sales patterns and to engineer their supply chains on purely economic rather than fiscal considerations. GST will also help in reducing inventory costs and cash flow benefits. Currently, the CENVAT is included in their inventory costs, which has to be financed by them. Under the new structure, the GST paid on inventory would be fully recoverable immediately as input tax credit, reducing the inventory financing costs. Further, the dealers/retailers would be collecting GST from their customers as they make sales, but would be required to remit it to the government only at the end of the month or the quarter, when they file their returns. This extra cash float would allow them to achieve scale and invest in making their operations more efficient.
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INDIAN TELECOMMUNICATION INDUSTRY


The Indian telecommunications industry is one of the fastest growing in the world. The industry has witnessed consistent growth during the last year on the back of rollout of newer circles by operators, successful auction of third-generation (3G) and broadband wireless access (BWA) spectrum, network rollout in semi-rural areas and increased focus on the value added services (VAS) market. A brief highlight of the telecom market as on Jan 11 is shown in Table 1. It can be seen that the wireless market has been growing at a rapid pace of ~2.5% per month. However the tele-density is still very low in the rural area signifying that the industry will continue to have growth opportunities. As per the report by Ernst & Young, the number of subscribers is estimated to reach 1 Billion by 2014.
TABLE 1: HIGHLIGHTS OF TELECOM MARKET AS ON JAN 11. (TRAI, PRESS RELEASE NO. 13/2011)

Particulars Total Subscribers % Total Monthly growth Urban Subscribers % Urban Monthly Growth Rural Subscribers % Rural Monthly Growth Tele-density Urban Tele-density Rural Tele-density

Wireless Wireline 771.18 2.52% 512.26 2.19% 258.93 3.20% 64.74 143.36 31.05 34.94 -0.41% 26.13 -0.30% 8.82 -0.75% 2.93 7.31 1.06

Total 806.13 2.39% 538.38 2.06% 267.74 3.07% 67.67 150.67 32.11

The Indian telecom industry can be primarily divided into basic, cellular and internet services. It also has relatively segments such as radio paging services, very small aperture terminals (VSATs), public mobile radio trunked services (PMRTS) and global mobile personal communications by satellite (GMPCS). The wireless segment in India is much larger (94.6% market share) than the wire line segment and is growing steadily due to the convenience and utility it offers. In fact, the subscriber base of the wire line segment is decreasing due to its limited usage. Rural markets are expected to be the next key growth drivers for the Indian telecom sector, given rural Indias growing population and disposable income. Average revenue per user (ARPU) has been declining because of price wars but is compensated by increase in MOU (minutes of usage) and increase in number of subscribers.

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MNP (Mobile number portability) has been the most significant change in the industry recently. This has taken the competition to the next level and gives a wide choice to the customers. This will change the whole business and service providers will have to maintain their service level at its best both to maintain and attract new customers. SWOT ANALYSIS SWOT analysis of the Indian telecom industry is presented below.

Strengths
High Customer potential - Low rural tele-density and broadband reach High Growth rate High FDI limit range 74-100% High Return on Investment - Easier to create economies of scale Lower CAPEX in long run because of high area density

Weakness
Poor telecom infrastructure - large number of call drops Late technology adopters - Among the last countries to lget access to 3G technology Most competitive market - 10 to 12 service providers in most parts Initial investment outlay is huge

SWOT IndianTelecom Industry


Opportunity
3G & 4G Telecom services Quality Service - Maintain and attract new customers with MNP Boost for Telecom manufacturing companies Telecom Equipment exports - Expected growth rate of 26% Horizontal integration of services

Threats
Telecommnunication policies - Launch of 4G in 2-3 years will make 3G obselete Declining ARPU - Price wars will lead to survival of the fittest Government partiality - Allowing 3G option in PSU (BSNL, MTNL) before auctioning in the market

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GST - A BOON TO THE INDIAN TELECOM SECTOR

GST A CURSE TO INDIAN TELECOM SECTOR

HURDLES IN IMPLEMENTATION
The telecom sector is a multifarious industry with three major components; 1. Telecom service providers 2. Passive infrastructure providers (i.e. the tower companies) 3. Equipment and mobile handset manufacturers. While the First Discussion Paper on GST outlines the broad contours of the proposed GST model, it has not delineated the tax treatment for specific sectors of the economy. Hence, there is still a lack of clarity as to how Telecom sector will be taxed, given its peculiarities and challenges. 1. Affordability of Services The total incidence of regulatory charges and indirect taxes presently borne by the telecom sector ranges from 22 per cent to 32 per cent in value terms. The proposed GST would subsume a majority of the federal and State indirect taxes such as excise duty, service tax, VAT, entry tax etc. However, there is no proposal at all to include the regulatory levies such as license fees or spectrum fees in the GST. These are at high levels and are expected to remain so, in the near future. The telecom sector acts as a facilitator to many other activities. With the next level of growth expected from the rural areas, it is looked upon as a facilitator in their growth. Hence, it is essential that the rate of GST on telecom services and on mobile phones is maintained at an appropriate level to ensure affordability of services. This is the first and key point. This calls for a detailed analysis of the entire supply chain of the telecom industry to identify the points which can be taxed and ensure ease of identification of ownership, tax collection and verification.

2. Double Taxation

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Taxability of SIM cards is a classic illustration of this problem. A transaction is either a supply of goods or the provision of services (or possibly a bundled supply of goods and services) and hence cannot be subject to the levy of both the sales tax and the service tax. With the advent of the GST, a key expectation would be the resolution of this endemic problem. The idea is to ensure that the GST applies equally, at the same uniform rate, on taxable supplies of both goods and services. However, should the tax rate vary across goods and services, and possibly across categories of goods themselves, the problem is not resolved and the task would be then to ensure that the GST rules clearly categorize telecom services as constituting a taxable supply of services, say, in order that the problem is resolved. 3. Categorisation The third challenge, resulting from the dual GST that is under consideration, is the determination of the time and place of supply of telecommunication services, in order for the appropriate CGST and, more importantly, the SGST to be charged on such supplies, bearing in mind that the intended GST will be destination based. Typically, telecom services are supplied by operators located centrally, to the subscribers located all across the country. As a result, it is possible that more than one State Government may proceed to charge SGST on such services, in the absence of clear rules. For instance, if a subscriber based in Maharashtra avails roaming services while travelling from say Mumbai to Bangalore, both the Maharashtra and Karnataka Governments can potentially charge the SGST; Maharashtra by virtue of the location of the subscriber in its State and Karnataka by virtue of the actual consumption of telecommunication services within. To avoid such a situation, it is imperative that the GST code incorporate clear supply of services rules, identifying the appropriate State for levy of the SGST or formulating guiding principles to resolve such issues. At present, multiple levies and charges are paid by the telecom companies to the Centre as well as to the various State governments. Though the levies charged by the state might be lower, they have significant compliant costs associated with them. This slows down the roll out of services. 4. Mobile Phone Affordability Yet another key imperative for the sector is taxation of another important supply chain component - mobile phones. Clearly, these have been instrumental in enhancing communications across all strata of society and hence a key facilitator of economic growth. Recognising this, several countries have provided for concessional rates on such phones. For example, in Sri Lanka, while the standard VAT rate is 12 per cent, the supply of mobile handsets is exempt from the levy. Given the importance of the telecom sector for Indias economic growth, especially in the rural sector, it is critical that policy makers seriously consider these implications in the GST scheme of things.

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5. Changes in Supply Chain models Recently, there has been a trend in the industry, where the tower services, which constitute the backbone of the network, are being outsourced to specialist providers such as GTL Infra, Viom, etc. The tax laws need to be framed to identify and accommodate such developments in the supply chain model.

Recent Examples: 1. Applicability of Service tax on services provided to customers in J&K. Currently, there is a lot of confusion on applicability of service tax on services provided to customers in J&K. There could be situations where: a. Services are provided from J&K and consumed within J&K - service tax not applicable, b. Service provided from J&K but consumed outside J&K - service tax applicable c. Services provided from outside J&K but consumed within J&K - Not clear In the first case it is clear that the service tax is not applicable as service tax is applicable in whole of India except for the state of J&K. In the second case, as the services have been provided to customers outside J&K & consumed also outside the state of J&K, service tax becomes applicable; however, there appears to be no administrative mechanism to collect the same in J&K. Taking a cue from the arguments taken in the second case i.e., the service tax is a destination base tax, ideally the service tax should not be applicable but divergent views and clarifications issued by CBEC / service tax authorities have created a lot of confusion in the mind of the tax payers & the assessing authorities, which needs to be cleared. COAI(Cellular Operators association of India) had approached the government to clarify the doubts by issuing an appropriate circular that the service tax is a destination based tax and the intent of law is very clear i.e., to keep all the services provided to customers in the state of J&K out of the purview of service tax.

2. Simplification of taxability of telecommunication services for its effective distribution Telecommunication industry offers business opportunity for millions of persons (known as distributors) across India. Telecom operators give certain amount of commissions; allow trade margins etc. to its distributors for doing business with them. Currently, the provisions of Service tax provides for:

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Individual registrations, charging, collection and payment of service tax by all these distributors. It is administratively very difficult to ensure collection & payment of service tax by all these distributors on monthly basis. Also a very high percentage of these business persons are small time business units who don't even cross the annual threshold limit of Rs. 10 Lacs to get themselves registered under the Service tax provisions. The telecom operators pay the service tax to the Government on the maximum service charge which includes all trade margins offered to the distribution channel resulting into payment of service tax on the entire telecom service offerings. Thus, there is no revenue loss to the Government. COAI had suggested that appropriate changes should be made in the Finance Act, 1994 to allow the telecom industry to discharge service tax liability on distribution margins. Similar relief has been granted to the insurance industry which also involves a huge distribution force whereby the onus to discharge service tax on distributor/associate margins has been put on the insurance companies. The relief sought is similar to the one provided to millions of insurance agents & the applicability of service tax on their income under the Insurance Auxiliary Service and will not have any revenue implication.

RECOMMENDATIONS
1. Benchmarking with countries where GST is successfully implemented: Canada has successfully implemented a version of a dual GST (HST) model. There are well defined parameters to determine the place of supply of telecom services. These can be considered for adaptation to India as well. The EU, as the bastion of the GST, could also be studied for identifying best practices with regard to taxation of telecom services and, in particular, the taxation of prepaid cards/vouchers, interconnect services, roaming services, free supplies of telecom services, bundled supplies of mobile phones with the purchase of new telecom connections and so on. The telecom markets of UK /Europe are very advanced in scope and scale, leading to constantly evolving GST laws to cope with the technological advances in the sector. India could potentially evolve a sophisticated GST regime for the telecom sector if these laws were to be analysed for potential adoption. This is not withstanding that the EU itself is overhauling its GST laws through the introduction of the VAT Package and the like.

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2. Providing Incentives: The various levies and charges should be included in a single tax. The fall in the revenue should be compensated by the larger subscriber base, more revenues from the increased usage of services and lower costs and better implementation due to simpler tax regime. The Centre can also provide incentives to the States, such as sharing a portion of its revenues to compensate for their losses. The simpler process will also provide an impetus to competitive forces within the industry. This should help to achieve the goal of increased penetration.

REFERENCES
Shukla, A. (2011). Manufacturing sector reforms and GST rollout to top Ficci's agenda. New Delhi. http://businesstoday.intoday.in/bt/story/manufacturing-sector-reforms-and-gstrollout-to-top-ficcis-agenda/1/13695.html Empowered Committee of State Finance Ministers, (2009) First Discussion Paper on Goods and Services Tax in India,. New Delhi 13th Finance Commission, (2009). Report of the Task Force on Goods & Services Tax Poddar S., Ahmad E., (2009) Working paper on GST Reforms and Intergovernmental Considerations in India. Working Paper No.1/2009-DEA Madhvan, S., (2010) Dual GST will impact supply chains. New Delhi. http://www.businessstandard.com/india/news/dual-gst-will-impact-supply-chains/378018/ Seksaria, G., (2009) India after GST. http://www.maritimegateway.com/mgw/index.php? option=com_content&view=article&id=46:india-after-gst&catid=51:article&Itemid=126 TRAI, (2011), Highlights of the telecom subscription data. Press Release No. 13/2011 E & Y, (2010) Telecommunications http://www.ibef.org/download/Telecommunications_ 270111.pdf http://www.business-standard.com/india/news/gst-treatmenttelecommunicationsector/399600/ Jacob, J., Jain, R., (2010) Telecom Taxation: An Assessment. Indian Institute of Management, Ahmedabad. http://gstindia.com/ - Accessed on 13 March, 2011 http://www.financialexpress.com/ on 13 March, 2011 12 | P a g e

http://www.cainindia.org/news/ on 15 March, 2011 http://www.coai.in/ on 15 March, 2011

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