India's tax reform is far from straightforward

A new goods and sales tax is an improvement on the current situation, but still too complex

India, one of the world’s fastest-growing economies, is implementing one of the most sweeping tax overhauls in its history this weekend. But cheering investors should be cautious.

The introduction of a countrywide goods and services tax should put India in line with many countries by introducing a unified levy on sales across the nation. Taxes on goods shipped across the vast nation will be charged at their final destination, replacing the current muddled system under which layers of taxes are charged whenever goods cross state borders.

Any reform that lowers the cost and complexity of doing business in India is a positive. Still, following Prime Minister Narendra Modi’s botched demonetization program last year, there is a risk that the rollout could go wrong. The country’s growth and consumption, already hit by the cash cleanup, could be derailed further if companies struggle to adjust.

Like most things in India, the tax too is complicated. Rather than creating a single sales tax rate, as in most countries, charges will vary on different categories of goods, ranging from 5% on mass consumption goods to 28% on consumer durables. Items such as tobacco and luxury cars could face an even higher rate.

The variations mean companies might have incentive to produce lower-quality goods or find some other way to circumvent higher rates on their goods. Moreover, a confusing “anti-profiteering” clause means businesses will have to pass on any upside they gain from lower taxes on their goods by cutting prices. Such clauses haven’t worked well in other countries: In Malaysia, for example, the policy actually contributed to an inflation rise.

The broader upshot is that consumer demand in India faces significant change. More than a quarter of Indian consumer goods, including hair oil, incense sticks, soda and the widely used clarified butter known as ghee, are set to get more expensive while a fifth will get cheaper, according to Goldman Sachs .

For consumer companies with deep supply chains across India, this alters the calculus of doing business. India is a notoriously price-sensitive market. Pharmaceuticals giant GlaxoSmithKline, which has a big business in India, faces lower sales growth in fiscal 2018 because of the tax, analysts reckon; its consumer health-care company will likely have to raise prices or endure thinner margins. Maruti Suzuki, maker of one of the most popular cars on Indian roads, could see prices fall by 2% to 3%, which could hit revenue if a rise in demand doesn’t compensate.

In India, it seems, even reforms supposed to simplify can prove a headache.

Source: The Wall Street Journal