Working capital is the lifeline of a business to carry out day-to-day operations. Managing working capital efficiently is a problem that plagues both small and large businesses. Inability to manage working capital may have adverse effects, including premature closure of businesses.

GST, a comprehensive indirect tax system, is a few months away from rollout. Businesses need to understand the implications of GST on various day to day operations.

Therefore, let us take a look at the ways in which GST impacts the working capital for SMEs and understand how you can use GST to your advantage.

Introduction of “Furtherance of Business” as a concept for Input Tax Credit

Under the current regime, input tax credit is available only on inputs which are used or linked to your taxable output. For example, as a trader, input VAT paid on purchase of goods will be available as credit only on making a taxable sale. However, any tax paid on business overheads is not allowed as credit. For example, service tax paid by a trader on advertising services for business purposes is not allowed as credit, and should be treated as business expenses.

In GST, the concept of input tax credit is broadened to include any input or services “used or intended to be used in the course of or for furtherance of business.  Therefore, businesses will be allowed to claim input tax credit on all such inputs and input services. In the example used above, a trader can claim credit for tax paid on advertising services.

Let us understand this further with a working calculation.

Particulars Current Regime GST
Gross Profit   10,00,000   10,00,000
Indirect Expenses        
Repair and Maintenance *# 1,15,000   1,00,000  
Advertising Expenses *# 1,15,000   1,00,000  
Printing and Stationery** 1,15,000  3,45,000 1,00,000  3,00,000
Net Profit 6,55,000 7,00,000
% of Enhanced Profitability   7%

(*Tax Rate considered @ 15% under current regime.  #Tax rate considered @ 18% under GST- **GST Rate @ 12%)

If you observe, in the current regime, business expenses including the taxes are debited to Profit & Loss A/c. This is because, input tax credit is not allowed on business overheads. Broadly, only on those input services or goods which are directly linked to taxable output, Input tax credits are allowed.

Under GST, businesses will be allowed to claim input tax credit on business expenses which are ‘used or intended to be used in the course of or furtherance of businesses’. As a result, in the above table, only the actual expenses excluding taxes are debited to Profit & Loss A/c.

This concept of “furtherance of business” will reduce your cost of operation, and directly increase the net margins of your business, thereby, strengthening your working capital.

In order to leverage this, businesses need to procure goods or services from registered businesses, and account for the tax paid on business overheads.

Impact on Input Tax Credit

Under the current regime, the value of input credit availed by you is not dependent on the ‘real time’ acceptance of the tax liability by the supplier.

However, under GST, input tax credit will be dependent on your supplier’s compliance i.e. your supplier should file the return declaring the outward supplies along with the tax payment.

If your supplier does not comply, it will cause a major dent to your cash outflow. For some reason, if your supplier fails to furnish the valid return, the input tax credit claimed by you will be reversed and you will be asked discharge it along with interest. There will be a twin blow to your cash outflow:

  • You have already paid your supplier.
  • Since ITC claim is reversed, you have to pay the tax along with interest.

However, there will be some breathing space since the draft law provides a window of 2 months to ratify the discrepancies before reversing the ITC claim.

Therefore, vendor management under GST is very crucial. It will be one of the enabling factors for timely claim of input tax credit on your inward supplies, where the supplier has on-time compliance credibility. You need to re-look at your current vendors, and review and identify vendors who are compliant. GST compliance rating will help you choose suppliers who are better compliant.

What does all this mean?

If you are not disciplined about being compliant, you might lose your customers. Similarly, if your supplier is not compliant, he might lose you.

Under GST, businesses must ensure that they do not default because they might lose their rating, and this might eventually kill the business.