How GST Impacts Manufacturing of Mobile Phones in India

Existing Tax Regime

In the year 2016, the total volume of mobile phones manufactured in India has peaked to 180 million units (IIMB - Counterpoint Report of Nov 2016). This is a 125% increase compared to the previous year. This has resulted in a total industry turnover of $ 11.6 billion and helped in the creation of 50K jobs. The exponential increase is due to the incentive proposed by the government in the budget of 2014-15. In this budget, the finance ministry had proposed a concessional excise duty rate (output tax on manufactured goods) of 1% on phones manufactured in India, whereas, those imported were charged @ 12.5%. Also, all components used for manufacturing mobile phones were exempted from customs duty. This differential duty structure has increased the cost of importing mobile phones from outside compared to those manufactured in India by approximately 10%. Later on, to promote manufacturing of some key components of mobile phones, the government in the budget of 2015-16 raised the customs duty for chargers, batteries, and headsets from 0% to 12.5% and brought them at par with the mobile phones.

GST Regime Announced 

Then in the middle of this year (2016), the government announced that from 1st April 2017 it will migrate the current tax regime to a more efficient Goods and Service Tax (GST) regime. The purpose of GST is to remove the cascading effect of the current tax structure on the overall prices of goods & services. For example, in the current model, customs duty increases the cost of goods, as it is not deductible from the output tax (excise, sales tax, VAT etc) to be paid subsequently by manufacturers, traders, and distributors. On the other hand, GST reduces the tax burden on all intermediaries by allowing them to deduct their input tax liabilities from their output tax. The consequence of this is far-reaching, as the proposed GST system will make the current incentive structure to promote manufacturing in India totally dysfunctional.

Impact of GST on Manufacturers

To understand the rationale, let's go through the following scenarios. Let's say a GST rate of 18% is levied on mobile phones and the components are charged @ 5% (GST council has decided on four slab rates for GST, and 5% is the lowest). Assume that a manufacturer imports components worth Rs 100. He pays an input tax of Rs 5/- (5% of 100). He then adds Rs 20/- (Rs 10 for value contribution and Rs 10 for profit margin) and sells the phone to the distributor at a price of Rs 120/-. At the time of sale, the manufacturer is obligated to pay an output tax of Rs 21.6 (18% of 120). He collects this amount from the distributor. But, to the government, he (the manufacturer) pays only Rs 16.6 (21.6 – 5 = 16.6), as he is entitled to a credit of the input tax (Rs 5/-) that he has already paid. Hence, the total tax paid by the manufacturer to the government is Rs 21.6 (18% of 120). Now the distributor sells the phone to the consumer at a base price of Rs 140/- (adding his cost and profit margins). The distributor is obligated to pay a tax of Rs 25.2 (18% of 140) which he collects from the consumer. To the government, he pays only Rs 3.6 (25.2 – 21.6 = 3.6), as he is entitled to a credit on the input tax already paid to the government through the manufacturer. Thus, the manufacturer ends up paying GST at the full rate of 18% of his selling price to the distributor even though the components he used for manufacturing the phone were initially taxed at a lower rate. The situation does not change even if this rate (GST for components) is initially set to Zero - as the manufacturer will have nothing to seek credit from the output tax he is obligated to pay at the time of sale. This is precisely the reason why the current incentive model (differential duties rates between components and mobile phones) will stop working.

Impact of GST on Traders

Now, let's consider that a trader imports the same mobile phone at a cost of Rs 110/- . For the purpose of apple to apple comparison, this is set equal to the cost of the manufacturer. He (the trader) pays a tax Rs 19.8 (18% of 110) as customs duty. He then sells the phone to the distributor at a price of Rs 120 (same rate as the manufacturer). Now, the trader is obliged to pay an output tax Rs 21.6 (18% of 120), which he collects from the distributor. But, he pays an output tax of Rs 1.8 (21.6 - 19.8 = 1.8), as he is entitled to a credit of input tax already paid - paying a total tax of Rs 21.6. Hence, the impact of GST on both the importer and the manufacturer is same i.e Rs 21.6 (18% of 120). Thus, the GST regime levels the playing field between the manufacturer and the trader and provides no incentive to the manufacturer to make mobile phones in India.

Enabling Incentives under GST Regime

Hence, with GST kicking in, the government will have to deal with this problem innovatively. If not addressed, it might pose a huge risk on "Make in India" program of the government going forward. Since India is a signatory to the ITA - 1 (Information Technology Agreement), it cannot raise the basic customs duties for components being imported for manufacturing of mobile phones, as it has done for other sectors, for example, automobile. One way to address this situation is to provide a direct refund to the manufacturers on taxes paid, based on some well-defined criteria.  The criteria could be linked to the amount of local value added by the manufacturer in the overall manufacturing process compared to the imports. The refund could be proportionately increased if more value is added locally. This will motivate the manufacturers to make more investments locally, thereby creating more high-quality jobs and saving of precious foreign exchange - in alignment with the larger objective of "Make in India" and "Design in India" program of the government. 

(Views expressed are of my own and do not reflect that of my employer)