INDIA June 08 2017 3:32 PM
MUMBAI (Scrap Register): On 1st July, India’s labyrinth of taxes will be replaced with a simple, nationwide Goods & Services Tax (GST). This is the biggest fiscal reform since India’s liberalization in the early 1990s. While gold consumers will face a slightly higher tax rate, and the industry will go through a period of adjustment, we see the net impact on the gold industry as being positive.
The gold supply chain should become more transparent and efficient, and the tax reform could boost economic growth, which we see as supporting gold demand, according to the World Gold Council.
The tax on gold is set to increase from 1st July 2017. Prior to GST being implemented, the overall tax rate on gold jewellery stands at 12.2%. This is made up of 10% customs duty, 1% excise duty, and 1.2% VAT.
GST replaces the excise duty and VAT components, but sits on top of the import duty. The headline gold rate of 3% announced on 3rd June has been welcomed by the industry, as it is significantly lower than many had feared. And, on the face of it, represents only a modest tax increase.
But when we delve a little deeper, the effect of the tax is a little more complex. There are two important GST rates which will affect the industry. The first is the 3% tax on gold products, such as jewellery. In addition, there is an 18% tax on services that will apply to firms and individuals providing manufacturing services across the gold supply chain. This is a significant part of the industry.
Taking these two rates into account, our analysis of the supply chain indicates the effective tax rate consumers face could increase to between 13.5 -14%. This range depends on whether the jewellery is manufactured in-house or is outsourced. Firms manufacturing jewellery in-house will have an advantage.
This, however, overlooks the broader tax efficiencies GST will bring. A key benefit of the new regime is that a firm can offset the tax it pays against its revenues using input tax credits and double taxation throughout the supply chain should be eliminated. Jewellers, for example, will now be able to use input tax credits from any goods and services used in the process of selling jewellery.
Any tax efficiencies gained in the supply chain will be passed on to the consumer. One might be concerned firms could use input tax credits to fatten their margins. But anti-profiteering legislation will ensure this is policed, and that firms pass on the benefits to the end consumer.
The devil is in the detail when it comes to tax. While the GST rates have been announced, there are several areas where greater clarity is required. But there are still some key themes worth highlighting.
We see consumer behavior changing in response to GST. Our econometric analysis spanning 26 years of data illustrates that higher taxes act as a headwind to gold demand.2 But the tax should also change the industry to the benefit of the consumer.
Consumers currently get a bad deal. The industry is highly fragmented, dominated by small independent retailers where under-carating is rife. While most analysts think of India’s jewellery market as being dominated by 22k, the reality is that most of the jewellery sold has less gold in it than advertised.
GST will bring greater transparency to the supply chain, and bring more of the gold market into the formal sector. We expect this to make it harder for retailers to under-carat their customers.
And separately, a slew of measures from the Bureau of Indian Standards is pushing the industry towards mandatory hallmarking, which will also tackle the issue of under-carating.
The direction of travel seems clear to us: India’s gold market is becoming more organised and transparent, and it is likely GST will accelerate this process. This should be good for consumers. They can have more faith in the gold products they are buying, and this in turn can support gold demand in the years to come.
Recycling at risk
GST could also affect India’s large gold recycling market. Selling gold to a jeweller is now a taxable transaction, for which the jeweller is liable. The jeweller pays the tax which is offset by the input tax credit they receive. This will make this part of the market more transparent.
But this transparency may come at a cost. The tax authorities will know who has sold gold and how much they have sold.
It will be interesting to see how consumers and retailers respond. This part of the market might clam up. Or some consumers and jewellers may try to conduct the transaction under-the-counter so it does not get captured by GST.
A more efficient supply chain
Firms across all product categories are re-jigging their supply chains in response to GST. Overall, supply chains are likely to become more efficient. This is true of the gold industry. Under the current tax regime, for example, inter-state sales of jewellery attract an irrecoverable central government sales tax. To avoid this, firms have set-up warehouses in states where they conduct business so sales are booked intra-state, rather than inter-state. This is inefficient. Businesses often have multiple warehouses across India, with high logistical costs and they often hold excess levels of inventory.
Under GST, while inter-state stock transfers will be taxable, the tax can be reclaimed once the goods are sold. If, for example, a large nationwide retailer had excess jewellery stock in one state and wanted to transfer it to a store in another state, it would pay IGST, which it can then off-set against sales revenue. Being able to reclaim the tax removes the incentive to maintain stock in multiple warehouses across India, and will allow retailers to become more efficient by consolidating warehouses and holding lower levels of inventory.