The recent increase in the goods and services tax (GST) on finished products such as apparel, textiles and footwear will have financial implications for the Micro, Small and Medium Enterprises (MSMEs) which have a significant footprint in that space, said tax experts.

The Finance Ministry on November 18 notified a 7 percent increase in the goods and services tax (GST) applicable on finished products such as apparel, textiles and footwear from 5 percent to 12 percent, effective January 2022.

GST rate on fabrics has been increased to 12 percent from 5 percent and that on apparel of any value has been increased to 12 percent, compared to earlier when pieces priced up to Rs 1,000 were subject to 5 percent GST.

As per MSME registration portal Udyog Aadhaar, the total textile manufacturing MSMEs registered between September 2015 to June 2020 were 6,51,512 while apparel MSMEs were 4,28,864.

The GST hike will create greater stress on the working capital requirements of the industry, especially the MSMEs, experts said.

Jatin Arora, Partner, Phoenix Legal said, “Tax rate increase could put additional financial burden on the MSME section of the industry, which is already under stress due to slower sales and higher input costs. It may also lead to increase in cost for end consumers.”

“However, the decision to bring uniformity in tax rates across the supply chain should help the industry in the long run by releasing the blocked working capital in form of accumulated ITC,” Arora added. 

The objective behind the proposed increase is to correct the anomalies associated with the refund of Input Tax Credit (ITC) on account of inverted duty structure. 

Inverted duty structure means higher taxes on input and lower tax on output or final product. In simple terms, businesses face higher GST rates on raw materials than on finished products. The GST Council has addressed the issue of inverted duty structure for many industries, however it still persists for footwear, textiles, pharmaceuticals and fertilizers.

Refund of the unutilized ITC under inverted duty structure of GST has been a long-pending issue for businesses because of higher levies on raw materials compared to the finished goods.

“By removing the cost differential that existed, the effect is that all apparel and footwear will attract a higher tax rate. It will be the MSMEs that get hit the hardest as there will be a increase in the prices of these products. Working capital requirements will also increase,” said Shashi Mathews, Partner, Induslaw. 

Mathew further noted that a difference in rate of tax on the basis of price was crucial for small players as it helped them to keep the cost low for a sector that was producing non-premium/non luxury items.