Small Businesses, Big Reform

The goods and services tax (GST) was implemented in India on 1 July 2017 subsuming a number of central and state taxes with the primary objective to simplify the indirect tax structure.¹ One of the principal departures from its predecessor value added tax (VAT) is a broader provision of input tax credit (ITC) across the entire value chain, particularly when levied by the centre and the state on a dual collection principle which is likely to remove the erstwhile jurisdictional hurdles to claiming ITC. While the seamless flow of ITC can minimise the cascading of taxes, the principle of reverse charge mechanism (RCM) and a system of invoice matching are envisaged as self-policing mechanisms to control tax evasion. Also, covering a much larger base of enterprises with lower exemption thresholds than before, it is seen as a mechanism to formalise the economy, by bringing informal enterprises under the tax net.

With more than two years since the roll-out of the GST regime, certain issues have come to the fore, which put to doubt the positive expectations regarding this overhauling tax reform. First, the multiple and frequent changes brought out by the GST Council demonstrates that the envisaged GST is far from being a simplification to the indirect tax regime. Second, media reportage and reports published by the industry associations have frequently cited that the impact of GST on the informal sector has been contrary to the expectations. A major repercussion is potentially on informal sector employment, especially with the ­sector reeling under weak demand situation in the country.

Lack of macro data, however, has restricted informed rese­arch on these issues. In this ­paper, I seek to identify the processes and channels through which the micro, small, and medium enterprises (MSMEs) are affected by the GST, drawing insights from primary surveys. I explore issues of coverage, tax rate, selection and exemption of taxation, and subsequently, their effect on the competitiveness and viability of these businesses. The coping mechanisms the units undertook to tide over the crisis they faced as well as the GST Council responses are also discussed.

Data and Methodology

The survey was conducted across 157 ­MSMEs in three cities, that is, Delhi, Mumbai and Surat, between December 2018 and March 2019 using both structured questionnaires and unstructured interviews.

In the absence of a readily available official listing of the MSMEs, a sample framework could not be devised. I used snowballing as a method to identify enterprises. This could ­result in bias as enterprise resource persons might recommend others who face situations similar to them. To avoid this, the first units of survey were selected purposely to ensure diversity in the size structure, product lines, activity, type of business, and so on, based on similar mixed methodology as suggested in Pickbourne (2018) and Pickbourne and Ramnarain (2018). I also used a supply chain framework for tracing the interrelated and interdependent product lines and businesses so as to understand the ecosystem of business relations ­between enterprises, and how this tax regime change affected these existing systems.

Categorising the enterprises: Of the 157 enterprises surveyed, 66% were involved in manufacturing activities, 19% were exclusively trading units, around 2.5% pursued both manufacturing and trading activities, and 12% were perfor­ming jobwork on material supplied to them. Table 1 provides a detailed description of the sample units by product and activity lines.

The sample units were further classified into micro, small and medium (the latter two being clubbed into a single category of small and medium enterprises [SMEs]) by the size of their investment in plant and machinery in case of manufacturing units and equipment in case of service sector units.² Since the structure of GST underlines various exemption thresholds ­according to the turnover of the firms, I categorise enterprises by turnover.³

Table 2 provides a distribution of the enterprises by their plant size and turnover. Around 6% of the units, all in the ­micro category, reported their turnover to be less than ₹20 lakh. Though this category of firms is exempted from registration under GST if their transactions are intra-state, they could choose to register under GST optionally. About 51% of the units surveyed reported a turnover between ₹20 lakh and ₹1 crore. It is important to note that 84% of the units with an annual turnover between ₹20 lakh and ₹1 crore are in the micro enterprise category, while 16% are SMEs. At the time the survey, this category of turnover was eligible for the optional composition scheme if their transactions were intra-state. About 43% of the firms reported their turnover to be more than ₹1 crore; 79% of the SMEs and 19% of the micro units were in this category. At the time of the survey, it was necessary for this category of firms to register under the GST.⁴