GST in 5 minutes
India just witnessed one of the biggest tax reforms — GST on the 1st of July. After the using demonetisation as a game changer, the government is on a roll out to create a revolution through indirect taxes. After 16 long years of debating the country has finally adopted a unified approach of national sales tax eliminating individual taxes at the state and central level.
The levy of GST marks the economic integration in India.
What is GST?
GST is a single tax system on goods and services. In the previous tax system, tax is levied at every stage of manufacturing, wholesaling and retailing by the respective states and unions. However, the GST system is going to be applicable only on the ‘value added’ at each stage.
Goods & Services Tax is a comprehensive, multi-stage, destination-based tax that will be levied on every value addition.
It is the various steps involved from manufacturing to the final stage. This ideally includes factors like purchase of raw materials, production/manufacturing, wholesaling, retailing and finally selling it to the end user.
Taxes will be levied depending on the place of where these stages are implemented. Basically, at every point of sale.
This is the most impactful aspect of GST. Tax would be levied on value additions at each level- the monetary worth added to achieve the final sale to the end customer. Eg. If a manufacturer wants to make a dress- he would first purchase yarn and then convert it into a dress. So the value of the yarn is increased when the yarn becomes a dress.
This is going to reduce the costing drastically making certain goods and services more affordable to the end users. The supply chain will also benefit set-offs for the taxes paid earlier.
What is state GST and central GST
Within the state transactions- Here there will be a revenue collected by the Central (CGST) + State (SGST) governments
Outside the state transactions- Here the revenue will be collected only by the central governments.
Previously, each state had their own taxation systems like VAT, Excise, central sales tax, etc. This was all be replaced by a single tax- GST.
How does GST work?
If a dealer in Maharashtra sold goods to a consumer in Maharashtra worth Rs.1000. If the goods and service tax rate is 18% (9% CGST and 9% SGST), the dealer would have to collect Rs. 180, of which 90 would go to the central government and 90 would go to the Maharashtra government.
In the same scenario if the dealer from Maharashtra sells goods to a consumer from another state, he would collect 10% IGST that would go directly to the central government.
Why GST was established?
The whole idea behind establishing GST was to subsume various taxes levied at different levels so as to avoid any loopholes and create a transparent indirect tax regime.
Will GST make a difference?
The basis of GST is the ongoing flow of input tax credit along the entire value added chain. At every step of the process, business will now be able to claim the taxes paid in the previous transactions. Input tax credit is the credit an individual receives for the tax inputs used in the manufacturing process.
Imagine a manufacturer of, say, shirts. He buys raw material or inputs — cloth, thread, buttons, tailoring equipment — worth Rs 100, a sum that includes a tax of Rs 10. With these raw materials, he manufactures a shirt. In the process of creating the shirt, the manufacturer adds value to the materials he started out with. Let us take this value added by him to be Rs 30. The gross value of his good would, then, be Rs 100 + 30, or Rs 130. At a tax rate of 10%, the tax on output (this shirt) will then be Rs 13. But under GST, he can set off this tax (Rs 13) against the tax he has already paid on raw material/inputs (Rs 10). Therefore, the effective GST incidence on the manufacturer is only Rs 3 (13–10).
The next stage is that of the good passing from the manufacturer to the wholesaler. The wholesaler purchases it for Rs 130, and adds on value (which is basically his ‘margin’) of, say, Rs 20. The gross value of the good he sells would then be Rs 130 + 20 — or a total of Rs 150. A 10% tax on this amount will be Rs 15. But again, under GST, he can set off the tax on his output (Rs 15) against the tax on his purchased good from the manufacturer (Rs 13). Thus, the effective GST incidence on the wholesaler is only Rs 2 (15–13).
In the final stage, a retailer buys the shirt from the wholesaler. To his purchase price of Rs 150, he adds value, or margin, of, say, Rs 10. The gross value of what he sells, therefore, goes up to Rs 150 + 10, or Rs 160. The tax on this, at 10%, will be Rs 16. But by setting off this tax (Rs 16) against the tax on his purchase from the wholesaler (Rs 15), the retailer brings down the effective GST incidence on himself to Re 1 (16 –15). Thus, the total GST on the entire value chain from the raw material/input suppliers (who can claim no tax credit since they haven’t purchased anything themselves) through the manufacturer, wholesaler and retailer is, Rs 10 + 3 +2 + 1, or Rs 16.
Tax system before GST
In a full non-GST system, there is a cascading burden of “tax on tax”, as there are no set-offs for taxes paid on inputs or on previous purchases.
Thus, if we consider the same example as above, the manufacturer buys raw materials/inputs at Rs 100 after paying tax of Rs 10. The gross value of the shirt (good) he manufacturers would be Rs 130, on which he pays a tax of Rs 13. But since there is no set-off against the Rs 10 he has already paid as tax on raw materials/inputs, the good is sold to the wholesaler at Rs 143 (130 + 13).
With the wholesaler adding value of Rs 20, the gross value of the good sold by him is, then, Rs 163. On this, the tax of Rs 16.30 (at 10%) takes the sale value of the good to Rs 179.30. The wholesaler, again, cannot set off the tax on the sale of his good against the tax paid on his purchase from the manufacturer.
The retailer, thus, buys the good at Rs 179.30, and sells it at a gross value of Rs 208.23, which includes his value addition of Rs 10 and a tax of Rs 18.93 (at 10% of Rs 179.30). Again, there is no mechanism for setting off the tax on the retailer’s sale against the tax paid on his previous purchase.
The total tax on the chain from the raw material/input suppliers to the final retailer in this full no-GST regime will, thus, work out to Rs 10 + 13 + 16.30 + 18.93 = Rs 58.23. For the final consumer, the price of the good would then be Rs 150 + 58.23 = Rs 208.23.
Compare this Rs 208.23 — with a tax of Rs 58.23 — to the final price of Rs 166, which includes a total tax of Rs 16, under GST.
Why is GST is a darling of the regime?
Shifting of tax burdens
With the previous tax system, the burden was unfairly skewed towards the end consumers and not manufacturers. Now with GST manufacturers will pay lesser taxes encouraging them to set up factories and create. Once they function efficiently and effectively there will be a greater sense of competitiveness and greater freedom.
Unified tax rates across the country
It is actually not fair that one state pays higher taxes compared to the other. This creates a big gap in the funds collected by the governments. Unified rates are assuring for business, irrespective of the place of business.
There will be no disparity of rates and meaning regarding what is manufacturing and what is service. Economic activities will be economic activities.
Goodbye cascading effect
All these years India has functioned on a tax on tax system. Now with GST there will just be a single indirect tax. It will now enable transparency and reduce corruption developing an opaque system.
Increase in government revenue
It is anticipated that GST will generate more revenues to the government as there will be more people paying taxes. The government will bring about reduction in other taxes and increase is service. Either of these would benefit the common man.
GST taken with a pinch of salt
Highest tax rate
The tax rate that has been decided is extremely high especially those pertaining to the service industry. Even at 18% it is higher compared to other developing countries.
Increased monopoly of Centre
The would be greater centralisation in fiscal matters. The states would lose their autonomy and the decision making power will now be in the hands of the centre. States will now lose their usual revenues made in the previous systems.
The burden on taxpayers
The major burden of taxation will still have to be borne by the end users and not the producers which not favorable for the consumer community.
Overall impact of GST
In India, a majority of the tax revenue collected is indirect though it is getting better over time. GST is what India needed for unifying its indirect tax system. This not only benefits the government but also encourages businesses to participate actively
Almost all countries use the GST taxation system. This will help the country be at par with the tax systems used by foreign countries
GST is aimed at smoothing the process of tax collection as well as improving the Indian economy by removing the discrepancies between the states and creating an integrated system for indirect taxes.
Whether GST is going to be viable or not only time can tell.
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