GST and the Indian Textile Industry 8 May 2015

Page 2 Taxes to be replaced by GST ► Main Taxes to be replaced are: ► Central taxes ► Central excise duties and ► Service tax along with all relevant cesses and surcharges ► State taxes ► State VAT ► Central sales tax and ► Entry tax Implications of GST for Indian Textile Industry

Page 3 Main advantages of GST ► India-wide common market ► Absence of fiscal barrier (CST/Entry Tax) (Constitutional amendment proposes 1% tax on inter- states supplies) ► Single or limited number of rates ► Production efficiency ► Resource allocation ► No incentive for vertical integration ► Consumption efficiency ► Minimization of classification disputes ► Improved compliance

Page 4 Key effects of GST ► GST ► Reform ► Lower Price of Capital Goods ► Larger Capital ► Stock ► Improved Resource Allocation ► Higher Total Productivity ► Improved Competitiveness ► Higher ► Potential Output Implications of GST for Indian Textile Industry

Page 5 Features of GST in India ► Dual GST: CGST and SGST ► Dual rate structure ► Lower rate: 12 % ► Standard rate: Estimates range from 20-27% for the composite rate ► Exempt category ► Exports zero-rated, imports taxable ► Inter-state sales subject to IGST=(CGST+SGST) Implications of GST for Indian Textile Industry

Page 6 Features of textile industry ► Large unorganized sector ► Large employment potential ► Mix of traditional and modern ► Low tax incidence ► Differentiated segments; composite products ► High export contribution and potential

Page 7 Share of textiles in potential GST tax base

Page 8 Key aspects of current taxation system for textiles ► Usually low/ zero rates of taxes on final products ► Tax is shifted back to production (as opposed to consumption) leading to blocked input taxes and higher cost of production ► Inefficiencies in production ► Exemption of production inputs ► Duty Drawback Scheme ► Exemption by size of operation, giving rise to fragmentation of industry ► Complexities in compliance and administration ► Ad-hoc or piecemeal efforts to apply tax leads to significant opposition from all segments of textiles industry. Any piecemeal tax is complex, creates competitive distortions and is subject to collusion/ harassment by Tax Administration authorities Implications of GST for Indian Textile Industry

Page 9 Key aspects of current taxation system ► Classification disputes ► Fabrics vs garments, e.g. should Sarees be treated as fabrics or as readymade garments ► Lack of Fibre neutrality ► Cotton fibre vs manmade fibre. Cotton fibre treated favorably as compared to man-made fibres ► Effective tax rates vary by degree of integration ► Power looms vs Composite mills. Effective tax rates for composite mills higher than that of power looms discouraging integration of production adversely affecting efficiency Implications of GST for Indian Textile Industry

Page 10 Textile segments Nine broad categories 1. Khadi and handlooms 2. Cotton textiles 3. Woollen textiles 4. Silk textiles 5. Artificial silk and synthetic fibre textiles 6. Jute, hemp, and mesta textiles 7. Carpet weaving 8. Ready-made garments 9. Miscellaneous textile products Implications of GST for Indian Textile Industry

Page 11 Key concerns of textiles industry ► Break in input tax credit chain leads to blocked input taxes ► Complexities and distortions related to Small Business Threshold ► High compliance cost, especially for small units ► Lack of uniformity in Centre and States taxes: e.g., presently Job Workers are treated differentially under CENVAT and State VAT ► Continuing blockage of input taxes under GST – Petroleum products, Electricity, Real estate ► Possibility of some the taxes continuing after GST: e.g. Octroi, Entry tax, Electricity duty Implications of GST for Indian Textile Industry

Page 12 Estimated share of textile segments in tax base Textile Outputs Relative Shares in Estimated GST Tax Base (%) Khadi, cotton textiles (handlooms)1.2 Cotton textiles39.5 Woollen textiles4.3 Silk textiles1.6 Art silk, synthetic fibre textiles18.7 Jute, hemp, mesta textiles0.8 Carpet weaving1.0 Readymade garments16.3 Miscellaneous textile products16.6 Total100.0 Implications of GST for Indian Textile Industry

Page 13 Input structure across the nine textile categories - Shares by types of inputs Structure of Inputs Khadi, cotton textiles (handlooms) Cotton textiles Woollen textiles Silk textiles Art silk, synthetic fibre textiles Jute, hemp, mesta textiles Carpet weaving Readymade garments Miscellaneous textile products Synthetic fibres, resin Textile inputs Non-textile inputs (goods) Non-textile inputs (services) Total Non-textile inputs Non-textile inputs (not shown) Total100.0 Implications of GST for Indian Textile Industry

Page 14 Current Effective Tax Rates (RNR) - Combined for Centre and States Textile CategoriesRNR (%) Khadi, cotton textiles (handlooms) 4.0 Cotton textiles 7.1 Woollen textiles 9.3 Silk textiles 9.6 Art silk, synthetic fibre textiles 10.2 Jute, hemp, mesta textiles 9.0 Carpet weaving 5.6 Readymade garments* 10.5 Miscellaneous textile products 12.0 All Segments 9.3 Implications of GST for Indian Textile Industry

Page 15 CategoryBase price Base+ Present Taxes Base+GST Increase in price (%) Change in demand (own price relative to all prices effect) (%) Change in demand (income effect (%) Net Change in demand (%) Khadi, cotton textiles (handlooms) %-2.2%0.8%-1.4% Cotton textiles %-1.3%0.8%-0.5% Woolen textiles %-0.7%0.8%0.1% Silk textiles %-0.6%0.8%0.1% Art silk, synthetic fiber textiles %-0.5%0.8%0.3% Jute, hemp, mesta textiles %-0.8%0.8%0.0% Carpet weaving %-1.7%0.8%-1.0% Readymade garments %-0.4%0.8%0.4% Miscellaneous textile products % 0.8%0.7% Total %-0.7%0.8%0.0% Price and Income Effects - N et effect on demand due to a shift to GST from the current system Assumption: GST is levied at a single rate of 12%

Page 16 Key empirical findings ► Overall current RNR lower than the sum of lower CGST and SGST rates (12%); implies additional tax burden ► Blocked input taxes are relatively more for State VAT since output tax rates are zero for most categories compared to Cenvat where Input Cenvat on goods and service tax on service inputs are both rebated ► Category-wise RNR is highest for ready made garments and artificial silk and synthetic fibre textiles Implications of GST for Indian Textile Industry

Page 17 Likely impact of GST ► If applied uniformly, GST is likely to address all concerns of industry ► It will eliminate any blockage of input taxes caused due to break of input tax credit chain ► Provide level playing field to all segments of textile industry ► Shift in tax burden from Production to Consumption (GST is a Consumption Tax) ► Significant simplification in compliance due to GSTN ► VAT rates on textiles in some international jurisdictions ► South Asia: Pakistan (5%), Bangladesh (15%), Sri Lanka (12%) ► Developed nations: Australia (10%), New Zealand (15%), Japan (5%, 8% from 1 April 2014 and 10% from 1 Oct 2015), UK (20%), Germany (19%), France (19.6%) ► China: 13%, 3% for SMEs without input tax credit Implications of GST for Indian Textile Industry

Page 18 Likely impact of GST ► Key concern – Increase in tax burden from 9.3% to possibly 12% which may lead to a reduction in demand ► However overall impact may not be negative ► Greater efficiency in production – may lead to downward movement of prices ► Exports may go up due to true zero rating ► A major reform like GST will lead to higher GDP and higher disposable incomes ► Price and Income elasticity of demand may compensate for each other Implications of GST for Indian Textile Industry

Page 19 Key effects of GST If all textile categories are put at the lower CGST and SGST rates, key effects will be as follows: 1. Transparency effect ► Tax burden will be more transparent since blocked input taxes will be eliminated, all input taxes will be fully rebated 2. Automatic zero-rating of exports ► Some of the present export-subsidy schemes may need to be redesigned or eliminated; thus, exports will be encouraged under GST without the need for explicit subsidy schemes 3. Additional Revenue Effect ► The overall tax incidence on textile products will increase; the additional revenue can be used to redesign subsidy scheme for mitigating adverse impact on lower income groups; a distinction may need to be made between product groups where RNRs are close to the average and products where they are considerably lower Implications of GST for Indian Textile Industry

Page 20 Key effects of GST 4. Present zero-rating of textile outputs in the case of State VAT will go away and taxes paid on capital goods and textile machinery will also be rebated 5. Productivity Enhancing Effects; Improvement in allocative efficiency; modernization of textile sector encouraged 6. Improved Compliance Effect ► With input tax credit at each stage of value added and creation of information chain, there would be automatic improvement in compliance 7. Keeping the same GST rate for all textile segments will facilitate further experimentation in mixing and blending as it can be done without any tax implication 8. Present GST discussions indicate that cascading may continue with respect to petroleum products that serve as inputs; to that extent the burden on artificial silk and synthetic fibres will continue; since much of these products are exported, this disadvantage may continue unless a suitable mechanism is found to rebate input tax on petroleum products Implications of GST for Indian Textile Industry

Page 21 Policy Options under GST ► Key objective for options should be: ► Production efficiency ► Market Neutrality ► Minimize incremental burden on lower-income households ► A uniform and comprehensive GST most conducive for production efficiency and market neutrality ► Minimizing incremental burden on lower-income households is the remaining policy objective that could warrant deviation from a uniform GST

Page 22 Policy options ► Zero rating ► Exemption ► Lower rate of tax ► Standard rate of tax with appropriate subsidies Implications of GST for Indian Textile Industry

Page 23 Policy options - Pros and Cons ► Zero rating ► Zero rating is possible only if all Input taxes are refunded ► Most jurisdictions find it difficult to administer and monitor input tax refunds ► Zero-rating in India proposed to be limited to exports ► Exemption ► Most distorting option ► Results in higher tax incidence due to blocked input taxes and tax cascading ► Shifts tax burden from Consumption to Production ► Exemption to fabrics leads to pressure from industry for exemption from production inputs as well. This leads to complex administration of tax Implications of GST for Indian Textile Industry

Page 24 Policy options - Pros and Cons ► Lower rate of tax ► Advisable only if government chooses to have a lower GST rate ► Lower rate should be extended to all fabrics and personal wear items to avoid classification disputes and market distortions ► However, difficult choices to be made: ► Fabrics Vs Apparel for personal wear ► Home textiles ► Technical textiles ► If inputs are taxable at higher rate and outputs are taxable at lower rate, refund and monitoring of refunds issues will arise ► Standard rate of tax with appropriate subsidies ► Clean tax system ► Achieves production efficiency, which is the key concern as opposed to the regressivity of the tax system ► Can be accompanied by an appropriate subsidy regime to support weakest segments of the textile industry Implications of GST for Indian Textile Industry

Page 25 Infirmities of the current Constitution Amendment Bill (CAB) relating to GST ► Imposition of a 1% tax on all inter-state supplies including branch/ stock transfers. Given the significant inter-state movement of textile inputs and outputs, this tax is likely to lead to significant tax cascading ► Treatment of various sectors ► Alcohol for human consumption has been excluded from GST. Will attract only state levies such as the State Excise Duty and Sales tax/ VAT ► Petroleum products such as Crude oil, Petrol, Diesel, Aviation Turbine Fuel (ATF) and Natural gas kept out of the GST for the time being, till such time the GST Council may decide. These products may be included in the GST base in the future ► Tobacco has been included in the GST. However, the Centre retains the power to levy an additional excise duty on tobacco ► Electricity is included in the GST. However, it may remain exempt under the GST and continue to attract the Electricity duty levied by the States. Possibilities of blockage of input taxes ► Under the CAB the scope of GST is limited to goods and services. While Goods mean “articles, materials and things”, Services has been defined as “anything other than goods”. It is not clear if these definitions will allow the government to levy GST on Real property. If excluded, it will give rise to significant cascading and lead to disputes about what constitutes Real property

Page 26 Duty drawback ► The duty drawback scheme, aims at promoting exports by seeking to rebate duty or tax chargeable on any imported/excisable goods and input services used in the manufacture of export goods ► The duties and tax neutralized under the scheme are ► Customs and Union Excise Duties in respect of inputs ► Service Tax in respect of input services ► Two kinds of duty drawback are available currently: ► All Industry Rate (AIR): It is a generic rate applicable to a specific industry fixed as a percentage of FOB price of export product after extensive discussions with all relevant stakeholders including exporters ► Brand Rate: It is the rate at which the incidence of Customs, Central Excise duties and Service Tax is compensated by paying the amount actually incurred by the export product. It is allowed in cases where the export product does not have any AIR of Duty Drawback or the same neutralizes less than 4/5th of the duties paid on materials used in the manufacture of export goods ► Under the GST exports will be zero-rated and all input taxes paid will be rebated by the tax authorities making duty drawback kind of schemes redundant (Export Zero-rating Effect) ► The World Trade Organization (WTO) discourages export subsidies. Under the GST when exports will be automatically zero-rated, the duty drawback scheme would be perceived as an export subsidy, and may therefore be withdrawn

Page 27 Supplementary Slides

Page 28 Fractile Class Basic Food Processed Food Fuel and light Clothing & bedding Medical Other expenditure Total 0-P P 5 -P P 10 -P P 20 -P P 30 -P P 40 -P P 50 -P P 60 -P P 70 -P P 80 -P P 90 -P >P All Pattern of expenditure on essential items in Urban India - Share of Monthly per capita expenditure Implications of GST for Indian Textile Industry

Page 29 Fractile class Basic Food Processed Food Fuel and light Clothing & bedding Medical Other expenditure Total 0-P P 5 -P P 10 -P P 20 -P P 30 -P P 40 -P P 50 -P P 60 -P P 70 -P P 80 -P P 90 -P >P All Pattern of expenditure on essential items in Rural India - Share of Monthly per capita expenditure Implications of GST for Indian Textile Industry

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