Reverse charge squeezes out small firms

The new indirect tax regime is having an effect akin to setting a cat among pigeons for micro and small businesses across the country. This is largely due to a provision for collecting and paying tax on behalf of unregistered vendors and suppliers, under what is termed the reverse charge mechanism (RCM).

A concept borrowed from the service tax, the RCM also now applies to supply of goods. However, higher compliance cost, including a larger working capital requirement, is causing a shake-out in the procurement chain of businesses. The smaller ones, operating largely in the unorganised space, are losing. Consider: Large companies in the fast-moving consumer goods (FMCG) space have started pruning their vendor list for sourcing products and services, weeding out small suppliers which are yet to register under the goods and services tax (GST). The remaining ones — barely 10 per cent of their vendor universe — have been put on notice;

In the textile hub of Tirupur in Tamil Nadu, many companies are discouraging supplies from household units, managed by family members on a part-time basis;

Larger textile and leather-making units in Tamil Nadu are looking at starting of job work activities in-house, as against the usual practice of outsourcing these to micro and small units. The trigger is the 18 per cent tax on job work that larger units will now have to bear under the RCM when they source from these units.

Textile & leather clusters In Tirupur, roll-out of the new indirect tax regime over the past two weeks has resulted in transactions coming down by 25-30 per cent. The impact is more visible on the large number of household units.

Around 25 per cent of units in Tirupur or 50,000-odd households work as suppliers for large companies, says Raja M Shanmugham, president of the Tirupur Exporters’ Association (TEA). Registering under the GST would also be tough for many of these micro units, as they might not have all the documents or wherewithal to complete the procedure, say local entities.

So, many large companies which have been giving job work to these units are looking at setting up their own units for such activity. Shanmugham says job work attracts 18 per cent GST, compared to the five per cent tax for processes up to compacting. “Activities like embroidery and stitching are in the 18 per cent slab, a great anomaly,” he says. The TEA has requested the central government to look into this issue. The suppliers who source from unregistered small units note that they also have to foot the tax upfront. Whereas, they will get the money from the buyer only after three to four months.

The owner of one large unit says he has taken a list of his suppliers and asked all those not registered under GST to get this done or face the risk of their contracts getting cancelled. Currently, 90 per cent of large- and medium-sized units in Tirupur have complied with the GST registration requirements.

The situation is similar for small units in the leather industry. In Vellore district in Tamil Nadu alone, there are around 200 such units, focusing on job work for the footwear industry. Faced with heat from suppliers to get GST-registered, most of these say they might find it difficult to sustain over a period of three to four months. Many of the micro units have a single owner-cum-employee and are not able to fully comprehend the tax filing mechanism. Chemical clusters In the chemical clusters of Gujarat, in and around Ahmedabad, Vadodara and Surat, most of the entities have already migrated to organised procurement. Rupen Patel, proprietor of a small-scale textile unit in the walled city area of Ahmedabad, says RCM was a big deterrent for his unit to continue procurement of chemicals for processing from the unorganised players.

He began negotiations in June for procurement for processing from organised entities. “We had to stall our procurement and production for at least a fortnight before we made the transition,” says Patel. This has, of course, had an impact on the margins, due to renegotiations with new suppliers. Even so, it was important for availing of input tax credits, he says.

Most small chemical units in Vadodara are aware of the composite levy scheme under the GST. “We are a very small unit, with limited manpower. It is taking us some time to set things in order,” says the owner of one of these. He plans to opt for the scheme by the end of the month. FMCG Most large fast-moving consumer goods (FMCG) companies have sent out circulars on a strict note to their vendor partners, to get GST-registered. So, the issue of dealing with unregistered vendors is lower here. Conversations with multiple companies and stakeholders reveal the larger players have been able to prune their vendor universe, drastically bringing down their dependence on unregistered ones.

“The problem for us comes with those people who are outside our vendor system,” says Sunil Kataria, business head, India and Saarc, at Godrej Consumer. He is referring to the wholesale channel that remains largely unorganised, accounting for 35-40 per cent of an FMCG company’s sales. Companies are now working with these through their distributors, to convince them on switching to a GST regime.

At a broader level, says Sumit Malhotra, managing director, Bajaj Corp, companies are also trying to reduce their dependence on the wholesale channel, pushing their own distributors to reach retailers directly.

“Demonetisation was a wake-up call for companies to reduce their dependence on wholesale, since this channel tends to be cash-led,” says Malhotra. “This effort will now gather steam after the GST.”