GST and FMCG companies

A thorny GST regulation is hurting FMCG companies. How fair is it?
The government wants companies to pay up for not passing on GST benefits to consumers. But fuzzy regulation that doesn’t answer critical questions is not making compliance easy.
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Soumya Gupta
15 May 2018
 VICTORIA 1/SHUTTERSTOCK
What is happening? One of the more contentious provisions in the goods and services tax (GST) framework is coming home to roost: See-sawing GST rates from last year have created a shadow of “profiteering” on India’s consumer-goods companies. The government has begun asking firms to pay up for having made undue profits by not lowering the prices of several goods by the specific reduction in their tax rates.

After Hindustan Unilever Limited (HUL) and Nestlé India Limited, Procter & Gamble (P&G) India is about to receive a formal notice from the Directorate General of Safeguards (DGS) for not passing on benefits of lower GST rates on several products, two sources aware of the development have told ET Prime. They requested anonymity.

On November 10 last year, the GST Council had dropped rates on 178 items including shampoos, detergents, shaving items, and toothpastes, among others. P&G India owns large brands in these categories, including shampoos Head & Shoulders and Pantene, detergent brands Tide and Ariel, and toothpaste brand Oral B.

In a written reply to ET Prime, a P&G India spokesperson says the company has not received an anti-profiteering notice.

“There will be some excesses, and some wrong decisions will be taken, obviously,” says one of the sources quoted above, who is an executive at a law firm. “I think in the next 6-12 months, this will be the number 1 issue on GST.” MNCs are fronting the wave because they are usually more concerned about local compliance, the source says.

What kind of penalties are we talking about? In January, HUL was the first large consumer-goods firm to report it had received a notice from the DGS and had deposited INR119 crore in the Consumer Welfare Fund to compensate for not lowering prices on time after tax rates were slashed on all goods, including those already in the market.

Now, the DGS has come back to HUL after examining the company’s calculations, and demanded that it revise this payment upwards, according to one of the sources quoted above, who is an executive at an audit firm. HUL has increased its contribution to the Consumer Welfare Fund from to INR153 crore, this person says.

HUL says it has proactively disclosed GST benefits to the tune of INR124 crore and has offered to pay this amount suo motu to the government. This amount is not recognised as revenue and is accounted as a liability as on March 31, 2018. “Due to paucity of time, it was not possible to immediately pass on the benefit of the November 15 GST rate reductions on some of the pipeline stocks to the end consumers. Government authorities have commended this proactive approach taken by HUL,” the company said in a statement. “Further, on behalf of its redistribution stockists, the company offered INR36 crore towards additional realisation, which would have been made by them on their closing stock at the point of transition. This is only a pass-through and has no impact on company’s financials.”

Last week, Nestlé India paid an undisclosed amount to the Consumer Welfare Fund for not immediately passing benefits of lower GST to consumers, according to a report in the Economic Times. The company, in its quarterly earnings announced two days later, did not make a note of this payment.

How does the Indian anti-profiteering regime compare with others? The anti-profiteering provisions as they stand today can be frustrating for companies because they don’t answer some vital questions.

 What exactly constitutes profiteering?
 How long do prices have to be dropped for or held once tax rates are revised?
 How does the DGS compute what component of a company’s rise in margins is coming from lower tax rates and not from other factors such as changes in input prices, or simply, more demand?
"In the absence of clear anti-profiteering guidelines from the government, the interpretation of the provisions is wide open," says Sachin Menon, partner at the auditing firm KPMG. "Advance rulings on this provision remind me of a blind man feeling an elephant."

The biggest problem, he adds, is what constitutes profiteering is not defined and the modus operandi of how companies will be assessed are not in the body of the law, but in the rules that are either presumed or notified later by the government.

Compare this with Australia. Back in 1999, the government of that country introduced two rules to measure profiteering under the GST. These were the dollar margin rule, which stipulated maintaining the same margin before and after GST, and the pricing rule, which restricted price increases for a transition period after GST.

Malaysia followed a different model, a little closer to the one playing out in India.

“Many of the rest [of the companies] were ‘found guilty' as, rather than risk their name being dragged through the courts over a period of time, they decided to settle the matter as quickly as possible,” a note by audit firm Deloitte from July 11, 2015, said. “Little weight is given in the regulations to issues such as supply and demand, and the effect that this has on pricing and profitability.”

Malaysia’s newly elected Prime Minister Mahathir Mohamad promised on May 13 to abolish the GST.

What is the government’s next play? “I see SEBI [Securities and Exchange Board of India] getting active and asking companies if they owe any money to the government and to declare it,” the law-firm source quoted above says. “We’re seeing a phenomenal convergence between various arms of the government and regulatory mechanisms, together forcing companies down on the straight and narrow.”
In the absence of clear anti-profiteering guidelines from the government, the interpretation of the provisions is wide open.Sachin Menon, partner at KPMG
According to both sources quoted above, the DGS is reaching out to all major FMCG firms in India, via formal notices or informally, asking them to compensate under the anti-profiteering clause. ET Prime could not verify the total number of companies the DGS has contacted.

“The department [DGS] was able to take a look at the entire calculation HUL does to arrive at its profits. Based on this, it asked HUL to make an upward revision in its payment [to the Consumer Welfare Fund]. Now, the department is completely privy to how pricing is done in the FMCG sector in India. All it has to do now to make a profiteering case is knock on the doors of every FMCG company and ask specific questions based on these calculations,” the executive from the audit firm says.

How are companies responding? Chief financial officers of major FMCG firms are reaching out to each other informally to discuss how to deal with anti-profiteering notices, the audit-firm executive adds.

“Not everyone will want to go to the government and say, I made this profit, so take my money,” the source says. One of the alternatives that companies are considering taking to the government is dropping prices in sales to distributors, in proportion to the amount that they are deemed to have “profiteered” off lower tax rates. This is because, as noted above, the anti-profiteering law does not specify how and by when prices should be dropped after taxes are lowered.

However, companies seem to have reconciled to the regime for the time being — most have already made back-of-the envelope calculations on how much they might owe in “profiteered” margins, this source says.