ICRA RESEARCH SERVICES

Corporate Ratings `

INDIAN AUTO COMPONENT INDUSTRY

Impact of Goods & Services Tax (GST) on the Indian Auto Component Industry

IMPACT ANALYSIS

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 Indian Auto Component Industry August 2016

GST positive for the Auto Component Supply Chain

The proposed Goods & Services Tax (GST), recently cleared for implementation in 2017 will be positive for the Indian auto component industry. While apart from
the final GST rate, further clarity is awaited on the implementation process, ICRA expects cost across the value chain to rationalise, benefiting the end consumer.
Benefits from improved transparency and ease of doing business would also improve supply chain efficiency over the longer term. The modus operandi of
implementation of GST could have a short-term impact on the cash flow cycle pertaining to payment of indirect taxes; under the GST system, up-dation/
reconciliation and payment by the seller on the GST network system would be required before the buyer can avail inputtax credit, effectively elongating the
working capital cycle related to indirect tax payments. Final blue-print on implementation, however has to be studied to understand the full implications.

Removal of cascading impact of taxes and seamless input-tax credit to reduce prices of components; tax rate could reduce from 20%+ to the GST rate

One of the salient benefits of implementation of GST would be the removal of the cascading effect of taxes and the ease of availing almost complete input-tax
credit (on all local and state taxes which will be subsumed), particularly on products which require significant inter-state movement. The seamless and complete
pass-through of state VAT (which is current not possible on intra-state sales) and Central Sales Tax (CST) is expected to reduce the ultimate price of the
component, which would be passed on to the Original Equipment Manufacturer (OEM) and ultimately the end consumer/importer. Incidence of taxes would
reduce from the current 20%-26% (intra-state or across states) to 18% (assumed GST standard rate).

Exhibit 1: Value chain and applicable taxes/credit inside the State: Existing system

Effective
Ancillary
Raw Excise cost+ Value- Excise OEM Excise indirect tax
material add+ cost+Value Dealer VAT rate of 25%
(metal) VAT VAT add+Margin VAT
Margin) plus

No input tax credit on

Less: Input tax credit on excise
excise and VAT at each
step

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 Indian Auto Component Industry August 2016

Exhibit 2: Value chain and applicable taxes/credit outside the State: Existing system

Effective
Ancillary indirect tax
Raw Excise cost+ Value- Excise OEM Excise
material add+ cost+Value Dealer rate of 20%
(metal) CST CST add+Margin CST CST
Margin) plus

Less: Input tax Under GST, complete input-tax credits for all taxes (VAT, CST,
credit only on excise and local taxes; all except customs) along the value-
excise chain will lead to tax-efficiency and remove the cascading of
taxes into the basic cost of the product.

GST would be particularly beneficial for backward integrated ancillaries with multiple plants (across states) working on the final product, before it is sold to the end
consumer.

Lowering of logistics costs and easy movement of goods across State borders

Apart from the consolidation of warehouses into larger footprints; with the reduction in the number of checkpoints and subsuming of local taxes (by GST), ease of
transport across the country is expected to reduce the lead time for component ordering and goods-in-transit, thereby reducing working capital requirements.

State specific incentives to attract capital investments

Several auto component and automotive OEMs have expanded operations into states which have offered attractive incentives such as VAT refunds against capital
investments and excise duty exceptions. While further clarity is awaited on the treatment of these capital incentives under GST, there incentives are likely to
continue until they expire.

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 Indian Auto Component Industry August 2016

Organised to Un-organised suppliers

Given the seamless fluidity of input-tax credit, OEMs/ancillaries paying GST would shift procurement to organised players (to avail input-tax credit), thereby
reducing the cost of the end product. Higher tax compliance by the unorganised sector (~15% of industry turnover) and reduced tax differential (between the
unorganised segment and GST) will drive competitiveness for the organised segment. Currently, the unorganised sector has a strong presence in the auto
component replacement market, given their low prices (mainly due to the low compliance with direct/indirect taxes). This is particularly evident in lower-value
added commoditised products like brake linings, sprockets, among others. Consequently, share of spurious spare-parts which could be as high as 40% in certain
components will significantly reduce going forward.

Consolidation of Factories and Warehouses

Over the past few years, auto component companies have been setting up shop close to the customers (OEM) factory. While just-in-time (JIT) supplies and
rationalisation of inventory/cost for the OEM have been a key reason, the taxation system in the country has also supported this model. The supply-chain from the
ancillary to the end dealer (via. the OEM) can move through any of the below illustrated cycles, with option [A] being the least tax-efficient and option [B] the most
tax-efficient. Intra-state invoicing (with a local manufacturing/warehousing operation) allows the OEM to comfortably avail input-tax-credit against excise and VAT
it has paid; an outside-state VAT and CST invoice cannot be set off against further sales by the OEM.

Exhibit 3: Movement of goods from ancillaries to OEMs and vehicle dealers

The OEM cannot

A. Ancillary in
take input-credit
Chennai, Tamil Attracts: Excise Duty, CST OEM located in for CST & local VAT
Nadu Gurgaon, Haryana Dealer

B. Ancillary in Attracts: Excise Duty. Part of the Small assembly/

input-tax credit availed on purchases The OEM can take
Chennai, Tamil manufacturing Local VAT billing (within
within the state would have to be input credit for
the state)
Nadu plant or warehouse OEM located the excise & VAT
returned to the state
in Gurgaon in Gurgaon Dealer
Source: ICRA research

This has lead to several ancillaries building small assembly/manufacturing operations (within the consumption state) around the OEM: like the auto component
hubs around Pantnagar (OEM: Ashok Leyland, Bajaj, Hero Honda, Tata Motors). Further, in case of duty free zones, ancillaries follow the OEM with a
manufacturing set up, as the value-add undertaken inside the state does not attract VAT, thereby reducing the cost for the OEM. Under GST, with the OEM being
able to take input-tax credit on all inputs coming either from within or outside the state, requirement for local manufacturing/warehousing set-ups would reduce
leading to a cost saving for the ancillary, thereby supporting higher margins. While the ultimate consolidation of either the warehouses or manufacturing

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 Indian Auto Component Industry August 2016

operations would be a case-specific business decision taken by the ancillary, GST takes away tax-inefficiencies from this decisionremoving the requirement for
multiple small points of sales, thereby enabling consolidation and scale economies. However, the ultimate benefit to the ancillary would depend on its negotiating
power with the OEMon sharing of the benefits, derived from the increased efficiency across the value chain.

Exhibit 4: Applicable taxes for the industry

Rate
Value-added-tax (VAT) Varies depending on the State (~14.5%)
Central Sales Tax ~2%
Excise duty 5%-12.5% (varies depending on the product)
Several local taxes Entry tax, octroi, local taxes
Source: ICRA research

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 Indian Auto Component Industry August 2016

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