JUNE 17, 2016

By Neeladri Chakrabarti, Corporate Lead, Indirect Tax, CMC Limited

MANUFACTURING industries in India have re-focused from large scale operations for quite some time and have instead consolidated their bases around managing core competencies, marketing, and business development for their finished products. The broad manufacturing has been outsourced by most of these industries to small scale factories and medium scale industry under various references like sub-contracting, labor processing or what is most commonly known as "job work".

The process of "job work" [Notfn. 214/86-CE refers] is designed to un-complicate production in large industries (the principal manufacturer) and focus the use of specific skillsets from job workers. Typically, the large industry may supply the raw material/semi-finished goods, tools etc. to the job worker who then fashions the finished product by applying his own processes. The finished goods are usually sold directly to the market from the job worker's premises and duty is paid at the factory gate, by the job worker, on the final selling price of the principal manufacturer Ujagar Prints - 2002-TIOL-03-SC-CX-LB. In case, the goods are sent to a depot and then sold, then the depot selling price (minus cost of transport from depot to delivery point) is adopted for payment of duty. Typically, the job worker takes credit of input taxes paid on his procurement of consumables, transferables and other inputs to offset his output tax liability. Service tax is applicable if the job work process does not amount to manufacture (intermediate processing).

In most job work cases, the property in the goods remains with the principal manufacturer and there is no levy of sales tax etc. on the re-transfer of goods to the principal manufacturer after conclusion of the process. [Any good consumed/transfer of property during the process by the job worker may have a separate sales tax liability (either separate or composite liability) in the hands of the job worker]. As a result, today there are thousands of job workers in the country who are unregistered for the various applicable taxes, as the case may be, because either they do not have a tax liability or their liability is below the threshold limit or because the dominant nature of their work renders them ineligible to one tax over another.

The unified fabric of the proposed GST proposes to tax goods and services based on their supply. This means any transaction of goods or services will be effectively brought to tax unless specifically excluded. With the introduction of the concept of ‘supply', sans any requirement of transfer of title, even supplies of goods to job workers or where there is no consideration paid for supply (transfer to material from principal manufacturer to job worker) would attract GST.

This raises a considerable conundrum in the tax net. The supply of goods from the principal to the job worker would be ideally on payment of IGST (interstate) or on SGST and CGST (intrastate). This would lead to all job workers necessarily having to get themselves registered under the tax laws as the tax will be payable on supply on principle. However, the proposed 1% additional tax, if it survives, may not be applicable as that is required to be paid only on payment of consideration on interstate sales. This entire process of registration will introduce a wave of small taxpayers into the system already stressing the developing nascent system.

What would be the major advantages of registration? Credit of tax charged will be used to offset the tax on supply and value addition. Credits would become more seamless as the distinction between consumables, transferred goods, materials and capital goods credit etc. would get removed. Issues of forms and other compliance hurdles are expected to be removed and the pricing issues adopted will be the final price to customer or the final sale price at depots.

And the major disadvantages? Cash flow / Working Capital will rise for both the principal manufacturer and job worker. Valuation of capital goods will be a major sore point and valuation certificates may need to be provided. Also, there would be an imbalance between the tax paid on capital goods by the manufacturer and the credit available to job worker to offset such tax. Since supply of goods from principal to job worker will be without consideration, there may be valuation issues on such supply where intrinsic value may have to be adopted. Training of many small scale factory workers to handle tax systems would be a major hurdle as many people employed in this sector would not be versatile with IT infrastructure. There could be implications in the reporting of revenue, as transactions not in the nature of sales could be adopted for the purpose of tax, resulting in inflated numbers.

Every new transition comes with its bag of challenges and the proposed GST law is no stranger to this fact. The impact in the job work sector will be crucial because for the first time an industry, which is mostly un-initiated in taxes, will be exposed to a tax structure. While this requires considerable training, the tax authorities must also be mature to put forward a non-tax-adversarial regime.

It is imperative that a toddler ought not be shown the stick at the first instance as that would only lead to stunted growth in later stages as an adult.