GST and Working Capital Management (Positive & Negative Impact)

GST and Working Capital Management: Goods and Service Tax (GST) has replaced all indirect taxes levied on goods and services by the Government, both Central and States. GST is one of the biggest Tax Reforms in India since its independence. One of the Key benefits of GST is removal of the cascading tax effect.

GST and Working capital:

Working Capital means operating liquidity available to company for running the Operations. Effective management of Working Capital is very essential to maintain smooth running of a business. No business can run successfully without an adequate amount of Working Capital. Needless to say that, Working Capital is the blood and oxygen of a business. Businesses should focus on periodical assessment of the Working Capital needs. The GST implementation makes this even more imperative. Tax rates of the business will change depending on various factors such as nature of the business & locations. Not just this, rules and timelines for availing a line of credit will also be revamped under the GST regime. It will impact cash flow and new sources of Working Capital finances will be required to be looked for. This is very much important especially in the case of SME with low financial reserves.

Let us see that How GST can impact the Working Capital

GST – Positive impact on Working Capital :

i) Input Tax Credit : Pre GST era, Input Tax Credit was available only on inputs which was used for or linked to the taxable output. If tax was paid for overheads of a business, then it was not eligible for credit. E.g. Expenses incurred on product promotion and taxes paid on the same were not entitled to get input tax credit. It is an additional burden on the Working Capital w. Whereas, Post GST era, the Input tax credit has a very broad scope and includes input of services that may be either used or intended for use during the course of or in furtherance of a business. The input tax credit can, therefore, be availed on inputs related to the services. Continue with the same example, input tax credit is available on taxes paid on product promotion. In other words, Working Capital positively impacted the extent of taxes paid on overheads, unlike as a burden on working capital erstwhile. However, for effective management of working capital, businesses are required to procure their goods and services only from the registered dealers to get full Input Tax Credit.

ii) Supply Chain: Under previous tax regimes, a lot of time and efforts were required for movement of goods from one State to another, which resulted into increase in the cost of material on account of local taxes, entry levies and octroi etc. It mainly affected companies that have multiple presence across states (warehouses, offices, factoriesetc.). Ultimately this led to additional burden on the cost of doing business across states. With GST, this movement towards goods across the states has been simplified and has become more cost effective. It helps not only to improve the cash flow but also margins. India’slogistics sector would gain the most from the GST as the cost would fall by almost 20%.

iii) CST: Pre GST era, CST was applicable on inter State sale of goods @ 2% and no tax creditwas available on the interstate purchases. It was burden on the cost and increased cash out flow. Post GST era, abolished CST and reduced cost of purchases by 2%, has led to +ve impact on cash flow and business margins as well.

iv) Elimination of Multiplicity of Taxes and their cascading effects: One of the Key benefits from GST is removal of the cascading tax effect. In simple words, it is removal of Tax on Tax.

Below example shows the net saving from cascading tax effect.

Pre GST Post GST
Rs. Rs.
Sale Price 10,000 10,000
Excise Duty @12.5 % 1,250 0
Sub Total 11,250 10,000
VAT @ 5.5% 618.75 0
CGST @ 9% 900
SGST @ 9% 900
Total 11,868.75 11,800
Cascading effect 68.75

Cascading effect while calculating VAT (an indirect tax) is levied not only on the product value but also on the Excise Duty (as an indirect tax).

Main advantage from nullifying cascading effect is saving in the Cash flows, positive impact on working capital and lower burden on net landed price to the ultimate customer.

GST – Negative impact on Working Capital :

i) Stock Transfer: Pre GST Era, Stock transfer are not eligible to be taxed under VAT upon furnishing of Form F and excise duty payable on the cost of production plus 10%. While, Post GST Era, Transfers are included in supplies under the GST. Stock transfers are taxable under the GST. -Ve impact on Working Capital of a business is due to the tax paid on stock transfers and input tax credit may be used effectively upon such stock being liquidated by the branch.

ii) Non Compliance: The input tax credit levels will depend on whether your suppliers comply with taxation and financial norms. This will make it imperative for your suppliers to declare their outward supplies along with their tax payment. Purchaser will also be held accountable, if supplier fails to furnish valid returns. This adversely affects the cash flow in the event of Supplier’s non-compliance. The purchaser will reverse their input credit tax claims and also require to pay interest.

iii) Export: Major challenge before exporter is the blocking of significant amount of Working Capital due to the widen gap between the date of export and the time required to get refund on taxes paid on inputs. Sometimes, refund gets delayed due to strict compliance procedure and it affects the business negatively.

Conclusion:

Management of Working Capital is a critical task that all businesses have to take care.Working Capital helps to stem the needs that arise from daily operational activities of a business and is required by small and large businesses, irrespective of their size. Working Capital helps in enhancing the role of a business, especially in the case of SME. Under the GST regime, the Working Capital of a business shall be impacted greatly and businesses must ensure compliance in order to have a smooth flow of operations. Businesses should avail of full benefits associated with claiming input tax credit on business overheads and not losing out on such credit.

All these aspects shall help in mitigating any risks that may arise on usage of Working Capital. Because of tax, higher working capital may be required by businesses and it’s difficult to function on lesser working capital for SME. The burden and impact on Working Capital may be reduced by examining movement of goods to branches and planned effectively cross branch transfers. Thus, a business is required to do a complete impact analysis of all the various locations from which it operates.