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Understanding GST & Its Implications

What is GST?

Goods and Service Tax (GST) Bill (122nd Constitutional Amendment Bill), which is considered as a biggest indirect tax reform in independent India’s history, was passed by the Rajya Sabha with support from all major political parties except AIADMK.

GST will convert the country into unified common market, replacing most indirect taxes with one tax. GST (Goods and Services Tax) is an indirect tax levied when a consumer buys a good or service. India’s current tax scenario is riddled with various indirect taxes which the GST aims to subsume with a single pan India comprehensive tax, by bringing all such taxes under a single umbrella. GST would have a dual structure a state component administered by states and a Central component levied and collected by the Centre. The bill aims to eliminate the cascading effect of taxes on production and distribution prices on goods and services.

Cascading effect of taxes is caused due to levy of different charges by state and union governments separately. This tax structure raises the tax-burden on Indian products, affecting their prices, and as a result, sales in the international market. The new tax regime will therefore, help boost exports.

How it will Change the Tax system in India?

GST reduces the cascading effect of tax in different stages of production and consumption. For example:

Step 1:

If a Bread Maker procures raw material or inputs such as Wheat or flour, sugar, yeast etc for Rs.100, a sum that includes a tax of Rs 10. With these raw materials, he makes bread. In the process of creating the bread, 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 Bread) 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).

Step 2:

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).

Step 3:

In the final stage, a retailer buys the Bread 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.


What would be the major implication of GST?

  • First, it addresses a serious impediment to our competitiveness. Without the GST, there are multiple points of taxation, and multiple jurisdictions. We also have an imperfect system of offsetting credits on taxes paid on inputs, leading to higher costs. Also there is cascading effect, which hampered the interstate commerce. By bringing the GST. It will enhance the ease of doing business, and make our producers more competitive against imports.
  • Second, implementation of the GST is an iconic example of “cooperative federalism”. The States agreed to give up their right to impose sales tax on goods (VAT), and the Centre gave up its right to impose excise and services tax. In exchange they will each get a share of the unified GST collected nationally.
  • Third, once the GST is in place, it means a unified, un-fragmented national market for goods and services, accessible to the smallest entrepreneur. Companies need not maintain stock depots to avoid paying interstate taxes. This will free up some capital. All this will add to demand, and also efficiency.
  • Fourth, because the structure of claiming input tax credit is linked to having proof of taxes paid at an earlier stage in the value chain; this creates interlocking incentives for compliance between vendor and customer. No more questions from a vendor: “Would you like that with receipt or without receipt?” Because of this inherent incentive, the total taxes paid, and hence collected, may go up significantly. This provides buoyancy to the GST. In fact, a significant part of the black economy will enter the tax-paid economy.

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