Indian Pharmaceutical Sector Hit By VAT Confusion

by Lorys Charalambous, Tax-News.com, Cyprus

16 May 2005

India's new system of value added tax, which replaced a disparate system of sales taxes in April this year in most states, has led to a drop in sales and share price for the country's leading pharmaceutical companies.

First proposed a decade ago, the new tax, seen as one of the most fundamental tax reforms since independence was achieved in 1947, is designed to replace the patchwork of different sales taxes levied by individual states, in an effort to make India’s domestic marketplace more efficient whilst bolstering revenues and increasing compliance. It will also give the central government more control over revenue.

However, the new system has been bad news for the pharmaceutical sector as wholesalers and retailers cut back their orders for drugs in a bid to clear the decks and prepare for the new system. Such a move is also desiged to insure firms against the eventuality that rebates on the sales taxes they paid on inventory purchased under the old system are not forthcoming.

Depending on the type of product, VAT rates for pharmaceuticals range from zero to as high as 12%. However, the rather botched introduction of the tax, which has gone ahead in the face of opposition from thousands of traders, as well as state governments jealously guarding their revenue streams, has meant that the central government is continuing to tinker with the new system in order to pacify the demands of various interest groups, adding to the uncertain outlook for the coporate sector.

This uncertainty has doubtless been a contributory factor in reduced profits at leading pharmaceutical group Ranbaxy. In the quarter ended March 31, Ranbaxy's profits fell 63% from the previous year to R708 million ($16.3 million). Meanwhile, Dr. Reddy's Laboratories, another major manufacturer, last week announced a net loss of R519 million rupees for the same period, compared with a profit of R162 million rupees a year earlier.

Moreover, the share value of both companies has also suffered, sliding by around 13% during the past six months and in the process significantly underperforming the broader Indian market, the BSE 30-Share Sensitive Index, which rose about 7% at the same time.

While the teething problems associated with the introduction of VAT in India are likely to continue to hurt the pharmaceutical sector in the short term, analysts believe that industry will rebound in the longer term.

Indeed, some say that now presents an ideal time for investors looking for value in the sector especially as, in the long run, the new VAT system will eventually bed in and should lead to increased corporate efficiency.

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