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The shift from the informal to the formal sector

LiveMint logoLiveMint 03-10-2017 Harsha Jethmalani

Hailed as a game changer for the organized sector, the goods and services tax (GST) will accelerate formalization across industries.

With increased compliance, a shift of business from the unorganized to organized sectors would translate into increased market share for the latter.

Sectors such as apparel, tiles and sanitaryware, plywood, textile, footwear, logistics, electrical equipment, and plastics have a higher composition of unorganized firms.

Larger companies in these sectors stand to benefit as the cost advantage unorganized firms earlier enjoyed, mainly by evading taxes, would cease under the new tax regime.

Since it has been only three months of GST implementation, it is difficult to estimate the quantum of market share increase for listed companies post-July. On the other hand, higher cost of compliance has taken a toll on the financial health of small and medium-sized firms in unorganized sectors.

This is especially so because the informal economy was already in distress after demonetization. According to tax experts, these firms have seen a sharp rise in working capital requirements.

While some firms in the unorganized sector may see their profits erode, some others may fail to survive. This may have an adverse impact on employment and consequently on demand. Economists say the informal or unorganized sector accounts for nearly 50% of India’s gross domestic product and is responsible for more than 80% of total job creation in the country.

Meanwhile, a final decision on E-way bills implementation date is pending. E-way bills would aid large companies operating across India on the logistic costs front, but offset some of the cost advantages of regional and small firms.

As the share of unorganized firms in several sectors is quite large, a meaningful surge in tax revenues was anticipated as they shift to the formal economy.

But teething troubles relating to transition, filing returns and claiming input tax credit, currently give limited clarity on whether GST collections so far have met expectations.

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