Anil Khanna, Partner, Wisdomsmith Advisors, elaborates on how the pharma sector is going to be impacted by GST
Now that the GST is a reality, and all the pre-rollout excitement behind us, the focus is firmly on implementation and its likely impact on individual industries, sectors and individuals. Decades ago, Albert Einstein said that hardest thing in the world to understand is the income tax. In today’s Indian context, going by the people’s initial response, he could very well have replaced income tax with GST!
Once initial anxiety goes down, and people get the hang of it, and evaluate calmly, they will realise that GST will have significant positive impact on the pharmaceutical industry, both in medium and long term, which is also been echoed by large section of the industry.
Few fundamental changes it will bring to the pharma industry, in due-course, are outlined below
Overhaul of the supply chain systems leading to substantial efficiencies and cost savings
It is a normal business practice among all pharma companies to have warehouses across each states. Even small to mid-size companies have warehouses across 20-25 cities across India. The reason is fairly simple. In pre-GST days, interstate sale of goods (i.e., sale of goods from state A to state B) attracted Central Sales Tax, which was not creditable to the subsequent buyer, while interstate movement of goods across warehouses of the same company was not subjected to any tax. Thus, pharma companies adopted a decentralised supply chain model to avoid tax incidence.
GST changes the dynamic completely. Since interstate sale of goods would be creditable under GST, pharma companies will definitely review the current supply chain structure, number of warehouses etc. They will move from warehouse in each state to hub-and-spoke model with larger warehouses, and better route planning.
The revised scenario may look something like this:
In the new scenario, savings on account of logistics and distribution / transport could amount to 6-8 per cent, another 10-12 per cent on account of warehousing, and another 25 per cent in inventory holding costs. On an overall basis it could lead to 12-14 per cent savings in the total supply chain cost, a significant savings indeed.
Similarly, there will be opportunities to optimise the sourcing strategies to achieve substantial supply chain cost savings. For example, industry has designed its sourcing strategies with the primary aim of minimising the tax incidence – whether to procure from within the state or from outside the state. Post GST, this is no longer a consideration. Thus, they can source from anywhere in the country, consolidate the sourcing. This will also lead to noteworthy savings on the sourcing side as well.
These savings, have the potential to add at least additional 2 per cent value of the overall pharma market, as well as at least 20 per cent to the profitability as well.
Boost to pharma manufacturing and ‘Make in India’
Firstly, and probably the most important boost would be to the API manufacturing, a critical priority. Currently, more than 90 per cent of the API needed by the Indian industry is imported from China, a precarious situation indeed, also considering geo-political environment.
The reason for this is simple – Inverted duty structure, which undermines the domestic manufacturing of API. Key raw materials imported for domestic production of API are taxed at a higher rate than the imported API making it uncompetitive to make them here, against imports from China. GST rationalises this practice, through input tax credits, which will benefit India in the long run, by developing domestic production capabilities. In early 2000s, the implementation of auto policy and reversion of inverted duty resulted in India becoming an auto manufacturing hub.
Secondly, overall pharma manufacturing may benefit through reduction of cost of technology and the machinery. Currently, the technical machinery and equipment imported into the country to be used for manufacturing are costly, but also, the duty which is levied on them is not allowed as a tax credit under the pre-GST tax regulations. However, with GST this scenario changes. Under GST, duty charged on the import of such equipment and machinery would be allowed as a credit.
Thus the onset of GST may herald an uptrend in the Indian pharma, as well as, healthcare manufacturing, leading to lowering of manufacturing cost.
Impact on pharma marketing
An important element of the prescription marketing is the ‘free samples’ provided by the companies to doctors. In addition, companies also provide ‘free samples’ to government and WHO programmes, as well as patient assist programmes. Under the pre-GST era, while free supplies were subject to central excise (tax on manufacturing), they were not subject to state VAT/CST. Moreover, sometimes stock is transferred for destruction purposes or transferred for relabelling to meet regulatory requirements, and these transfers are also not subject to state VAT & CST. Under GST, these supplies made free of charge or any other intra-company movements, as illustrated above, would be subject to tax. Valuation of such free samples would be based on comparable sales price or cost+ method (since there is no invoice). This will have significant impact on companies’ marketing strategies, marketing budgets and how they spend the money, or to what extent they will continue to do patient assist programmes and so on.
Another impact, as one industry marketing veteran points out is that there could be more focus towards hospitals or nursing homes sales. GST may further fuel the already existing trend towards corporatisation of the healthcare. Even now, in smaller cities, individual doctors are coming together to open small hospitals / nursing homes. Moreover, in future there could be a scenario, where for hospital sales, distributors may be bypassed altogether. Goods straight from manufacturers to stockists to hospitals. Thus further reducing the cost of distribution
Other significant impact
So far distributors, by and large, were not paying any taxes. As in many states VAT on pharma products was on maximum retail price (MRP), which is on a single point. Due to this the distribution channel didn’t not pay VAT. But now they would also be required to pay tax. This would add burden on them. Needless to say, they aren’t a happy community!
Many pharma companies currently work on ‘traders-of-goods’ model. That is, many services they avail which attract service tax, becomes a cost for them. With GST, the service tax paid by them will come back as a refund, thus saving cost.
Of late there has been increasing trend towards Ayurvedic medicines among Indians, especially for day-to-day ailments or other chronic problems like arthritis. However, now Ayurvedic medicines likely to become expensive as they will now attract 12 per cent GST, compared to VAT of 4 per cent and excise of 1.5 per cent earlier. This could impact their adoption.
Summing up, going forward, GST will bring-in significant fundamental changes in the pharma industry. Without doubt, it can be said conclusively, it will be beneficial for the pharma industry, ignoring the current transition troubles.
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