The government finally made 0% duty for sanitary pads. This is after much demand, back and forth, of this particular tax cut. But the road to hell is paved by GST, apparently.

There seems to be some confusion about sanitary pads going exempt, but lack of input tax credit will make them raise prices. That seems incorrect according to me. I’ll try to explain (based on my “tweetstorm“).

Assume I sell sanitary pads at Rs. 112.

This is Rs. 100 + Rs. 12 GST.

I have input costs of Rs. 70+12% GST = 70+8.4 = 79 (say).

I earn gross profit = 112–79=33.

I pay a net GST to government of Rs 3 (I collected Rs 12, but I’ve already paid Rs 9 on inputs).

My profit is Rs 30.

The government decides to say my product is GST exempt. Now what?

GST free, but no input tax offset

If you think I’ll price my output at Rs 100, you would have to be crazy. Because I have input costs of Rs 79 (remember?). That’s Rs 70 cost plus Rs 9 GST on it. I don’t get to write off the Rs 9 because I don’t collect GST.

If I sell at Rs. 100, I will make Rs 21 profit. Earlier my profit was Rs 30 – why would I make lesser profit?

So, the new logic, assuming I still want to make Rs 30 profit:

I will sell at cost (Rs 70+9 GST) plus profit (Rs 30) = 79+30=Rs 109.

Prices fell, but not so much

My selling price, earlier, was Rs 112.

Now, it is Rs 109.

So there’s a Rs 3 fall. This is not much. It’s like saying what was 112 when we had 12% GST is now Rs 109 at 0% GST, and the costs, profit margins etc. are exactly the same.

This is not the same as saying “Oh, my product is GST exempt now and it was Rs 100+12 GST, so I should cut it down to Rs 100 only”

The caveat: inverted duty

What if I pay 18% on my inputs, but had to charge 12% on my output? This is an inverted duty structure.

Before going GST free:

-I charge Rs. 100 + 12 GST = Rs. 112

-My cost = Rs 70+18% SST = Rs 70+12.6 = Rs 82.6

-I get Rs 12 GST, but I’ve paid Rs 12.6 on inputs, so I don’t pay the government anything, and don’t get a refund either.

-My profit = 112–82.6 = Rs 29.4

If the product becomes GST free:

-My input price = 82.6

-The profit I want (I used to make this) = 29.4

-So my selling price = 82.6+29.4 = 112

-The selling price doesn’t change at all.

You’ll notice that the selling price change depends on the profit I make and my input GST. But it is also true that it’s almost never likely to be that I have to raise prices very much — to keep the same profit.

What happens to pads?

Sanitary pads won’t go down 12%.

Because that’s not how GST is structureed.

The inputs have GST. From a government release, it appears that there’s inputs at 18% (absorbent polymer, glue) and some at 12% (pulp, release paper). These might not add up to a substantial part of the cost: there will be packaging costs, transportation, electricity, machinery and so on. These have GST on them which has to be included in the costing of the product.

However, there’s one area which helps. If they sell their products to wholesalers, who then sell onward to retailers, who then sell it to you. At each of these stages, there’s a GST that would have had to be paid, at 12%.

Now, none of that needs to be paid on transfer because the product being transferred has no GST.

Regardless, the math shows you one thing: the prices of sanitary pads may not go up. But they won’t fall much either.

But hey, it becomes cheaper to import!

Let’s say I make sanitary pads in Sri Lanka. And export to India. The Sri Lankan (or most others) government typically refunds the input taxes of an exporter.

So it costs me Rs. 70 to manufacture a sanitary pad. No more.*

(*Note: There’s a “basic customs duty” of 10% from most countries, but a number of ASEAN and SAARC countries have a free trade agreement with India where their products only get charged the GST, not the basic customs duty. In Sri Lanka’s case, the sanitary pad has been a zero duty item in the agreement, but this might have changed since. Plus there’s freight, insurance and other costs associated with imports. Some countries subsidise their exporters so they might counter the costs of transport etc.)

I can export to India and sell at Rs 100. India has the concept that if something’s charged GST in India, the imported item will be charged the same duty, just to keep things sane.

Earlier, I would have to pay 12% GST and sell my product at Rs 112.

Now, I pay 0% GST (since the item is “zero rated”) and I can sell at 100.

The madness: importing from yourself is actually more efficient

Think of it: the foreign government refunds input duties so I can still make the same margin here and sell at 9% lower (Indian manufacturer’s price was Rs 109, remember?).

It’s so complex that even India is supposed to refund the GST of an exporter. Technically, it would be most efficient to put a ship outside Mumbai, send sanitary pads to that ship (as an export) and immediately reimport it back paying no duty.

This is one way you can sell at Rs 100 and maintain your margins.

And the price also falls, so everyone’s happy.

So what’s going to happen?

Well, we’ll just get cheaper imports. And if you’re considering setting up a factory to make sanitary pads for India, consider Sri Lanka.

If we banned imports altogether, then you’ll see a minor drop in the price, not much more.

This article was originally published on Capitalmind. You can read the original article here.