Manufacturing contracts to come under tax purview

New Delhi: Adding more to the gloomy syndrome for the small and medium sized companies (SMEs), the large manufacturing outsourcers are asked to deduct a two percent tax on the order value while making payments. "A significant share of manufacturing in sectors like auto, FMCG, pharma is outsourced to SMEs. So, implications of such a move will be huge on the cash flow of these companies as most operate on thin margins," said Amitabh Singh, partner at accounting firm Ernst & Young.

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Many of the companies are seen to outsource their manufacturing part to the SMEs, resulting in a deduction in the revenues of the small firms. The tax cut is part of the changes made to the tax laws by the government. The tax deducted at source (TDS) will be adjusted against the actual tax dues at the time the big firms pay advance taxes or file annual tax returns, reports Economic Times. Through the changes made to the laws, the government expects to widen the tax net and make revenue collections more efficient. Hence, bringing the contract manufacturing deals too under the scrutiny of the income-tax department, who wants to treat these deals as 'work contracts'. These deals are currently referred to as buyer-seller agreements without any tax included, while considering them as contracts will make them liable for TDS.

The move will also trigger some amount of burden on the end user or consumers in terms of high prices of the manufactured commodity. It will raise the working capital requirements which in turn will increase costs for the manufacturers, thus adding on to the burden of the outsourcing companies. The new tax laws will increase the burdens in many sector including fast-moving consumer goods, consumer electronics, automobiles, pharmaceuticals and ready made garments, which mostly depends on the small firms for the manufacturing. Large companies such as Hindustan Unilever and Procter & Gamble are extensive users of outsourcing model, as it allows them to lower costs and focus on marketing, distribution and brand building.