- December 25, 2015
- Posted by: Upinder Singh
- Category: GST, Supply Chain
Governments earn revenue through taxes. In India different governments have been given constitutional rights to collect tax revenue like – Central Government, state governments, municipal committees. To avoid taxes, the tax payer plans his activities in such a way that the incidence of tax is reduced. Taking the case of manufacturing, transportation and sale of goods, the above is applied on:
- Additional excise duty
- Service tax
- Countervailing duty
- Special additional duty
- Central sales tax
- Value added tax
- Entertainment tax
- Luxury tax
- Tax on lottery
- State tax
- Entry tax
- Local body tax
In addition, any of these may also impose tolls on travelling on highways owned by any of the bodies. While all governments collect taxes, some also queer the pitch by giving tax breaks on setting up manufacturing or service units in their states. These are in the form of SEZ or tax breaks on setting up manufacturing plants.
Honest tax payers try to comply with the rules, and have to maintain or engage experts who help them navigate to file returns, claim tax credits, litigation etc. However, the tax payers strategy is not limited to only tax filing, but also to intricate planning of how to avoid the incidence of tax or at least delay it. This is done by :
- Setting up manufacturing plants in states giving tax breaks – though it may be costlier to transport raw material and finished goods from there
- Setting up warehouses in each state, bypassing economies of scale, to avoid CST in selling goods from one state to another.
- Carry more inventory at different stocking points What results in a complex and inefficient supply chain. This increases the warehousing and logistics costs. There are long delays in transit, as there are long documentation processes.
And finally everybody loses, as the final price of the product bears the burden of this inefficiency. The diagram below shows possible simplification of the entire supply chain.
The implementation of GST provides an opportunity to revisit and redesign the supply chain. All the levers discussed above can be optimized using GST as the catalyst. The following pages of this chapter will give a practical guideline of how to achieve this. Further, the cost of compliance also reduces as three different teams are now converged into one. Let us take the case of an automotive product to demonstrate the case.
The same can be extrapolated to any kind of domestic industry.
Number of active stock keeping units (SKU) : 400
Number of plants : 2
Mother warehouses : 2
C&F’s/warehouses : 26
Total no. of units sold : 1,444,218
Total revenue : INR 5,560,729,511
Total supply chain transportation costs : INR 142,268,555
Total warehousing costs : INR 45,698,461
Average revenue per unit = INR 3850
Average supply chain cost per unit to serve : INR 130
Desired service level : 90%
Days of on hand inventory : A class items : 45 days, B and C class : 60 days
The analysis of the current supply chain
The basic flaw in the pre GST supply chain is to keep atleast one warehouse in the state of sale. This is done to avoid central sales tax, which would apply if sale is taking place across states. This supply chain structure leads to increase in stocking points thereby increasing warehousing costs, inventory in the system, transportation costs and more staff required for compliance.
Let us not see how an optimized supply chain can be designed just because GST can be the catalyst. Designing an optimal supply chain configuration that can meet the expected growth rates is a challenging task, especially in India. While customers demand improvements in each aspect at ever lower prices, producers and distributors in India are facing increasing competition in nearly every product category. The traditional methods of supply chain design and management do not always apply in the Indian context, owing to its complex tax regulations, non-standardized transportation, uncertainties across the value chain, and low rate of technology adoption.
Nevertheless, those companies who have embraced these complexities and designed their supply chains in India to efficiently move products from sourcing through fulfillment are reaping the rewards of the market size and growth potential that India offers.
The impact of GST will be dependent upon the business model of the organization. Namely:
- National Operations versus state Operations
- Centralized versus decentralized distribution
- Import versus domestic procurement strategy
Complex Tax Structure
To say that India’s tax regime has a significant impact on supply chain design is an understatement. Transaction taxes (import/entry, manufacture and sale of goods and provision/receipt of services) have a direct and tangible impact on the cost of goods or services. The taxation structure in India is complex, with products typically being taxed twice: once by the central government and then by the respective state governments.
The Central Sales Tax (CST) effectively encouraged many companies to operate a warehouse in each state rather than pay CST while shipping to customers or stores across state boundaries. Excise Duty, a structure of selective regional exemption, complicates logistics design by creating a skewed manufacturing footprint in India.
Companies are likely to resort to deploying production operations in regions which offer exemptions to excise duty in spite of incurring higher logistics costs, time-to-market and working capital. Further, the impact of varying Value Added Tax (VAT) structure in different states, customs exemptions in Special Economic Zones (SEZ), Service Tax and corporate tax make supply chain design and optimization all the more challenging. As the tax and regulatory issues in India evolve, manufacturers and distributors must adjust their footprint and supply chain strategies, requiring greater flexibility and awareness than in most other markets.
In the case of the said company, the following analysis was found:
The warehouses being specific to a state, were not optimally located. The ideal location of a warehouse is at the center of gravity of its customers it serves. Hence the distance quantity product should be evaluated. Additionally, based on the service level, the maximum radius can be determined, which will determine the secondary transportation time.
As a result there were at least three warehouses in places like Delhi, Gurgaon and Ghaziabad, each holding inventory and safety stock. The primary transportation was good, but could still be optimized. The size of trucks could be increased as well as the frequency of transportation could be reduced. Further analysis could be done on sales pattern to stock and transport those products that were having more variability.
So how will all this change with GST?
With the implementation of GST, the following affects will be noted :
- No additional tax on interstate sales
- There will be no cascading effect of taxes
- Fewer large warehouses will be required
- There will be lower inventory carrying costs due to larger, fewer warehouses
- Freight operations will be consolidated
- Freight costs will be reduced due to fewer trips
- Buffer stocks will reduce as delays in transportation at state chungi’s will reduce.
Modeling taxes and duties
Supply chain network optimization tools like can help model all taxes in the supply chain. The software can then help the organization take a decision that can help in lowering costs even in this complex tax structure. The complex taxation environment in India skews the network footprint towards fiscally beneficial locations. All the different taxes and duties need to be modeled differently for a network optimization exercise. For instance, excise duty can be added to the modeled product cost with exempt locations incurring only input cost.
On the other hand, income tax, levied on plant-level incomes, should be minimized separately in the overall objective function. Alternatively, income tax could be loaded on to production costs after careful examination of various plant-level cost elements. In transportation and warehousing, CST, VAT and Octroi play an important role. Modeling CST, a tax on inter-state movement of goods, requires knowledge of source and destination locations and whether a lane is inter-state or intra-state. In order to overcome this tax, manufacturers typically move goods to a warehouse in each state as internal stock transfer and sales that take place are then shown as intrastate transactions.
Octroi, a tax levied on entry of goods into a town or city, forces manufacturers to locate warehouses outside city limits and move the goods into the city only when actual sales take place (to avoid paying taxes on inventory inside city limits). Thus, Octroi may lead to addition of a tier in the supply chain and consequently higher costs. However, Octroi has been phased out in most Indian states. Use of network modeling softwares like Supply Chain Guru ™ can incorporate all the complexities of the tax structure and still suggest the most optimal network. Effect of GST on Network Models Rationalization of excise duty rates and the expected implementation of Goods and Services Tax (GST) could significantly tilt the cost-benefit equation of the manufacturing location decision for certain firms.
For instance, for products with an MRP of Rs 100 and raw material costs of Rs 40 the net excise payable (assumed at central GST rate of 8% and discounting recoverable excise paid on raw material) would be ~Rs.1.60. Factoring in inbound and outbound logistics costs, excise exemption benefits might be overridden by logistical efficiency criteria, compelling firms to rethink their manufacturing and distribution strategy.