GST for 10th Grader (Part -1)

“On 4^th August GST was all over the news. All the news channels were discussing this historic tax reform that will be effective from 1^st April 2017. There were many articles, videos that were floating all around to confuse me and I thought, it’s high time I discuss this with you to understand what GST is! All I know is GST stands for “Goods and Services Tax” and it will simplify tax structure in India. Beyond this, I want you to explain everything from scratch”, said Apruva.

There are major 2 types of Taxes 

1. Direct Tax

 2. Indirect Tax

Direct Tax – This is tax levied on the Individual’s or Corporate’s Income. For Individual different tax slabs are applicable where the rules for the Corporates are different. The Tax is collected directly from the entity on whom it is imposed. 

Indirect Tax – This tax is collected on sales/manufacturing of Goods (Tangible Items) or Services (Intangible Items). Indirect taxes are called so because they are collected indirectly from consumers by the government through intermediaries, who are the first payers of the tax to the government.

GST will replace majority of Indirect taxes with a Uniform Tax. There are many types of indirect taxes but for the simplicity of understanding lets discuss the below 4 major ones because of which there is a need to have GST.

Sr no	Originally Known as	Changed to	Revenue Source for
1	Sales Tax	VAT	State Government
2	Excise Duty	CENVAT	Central Government
3	Inter State Central Sales Tax	-	Central Government but given to State producing the Goods
4	Service Tax	-	Central Government

Need for GST (Cascading Tax Effect)

The primary need for GST is to avoid the cascading tax effect. Let’s understand what does this mean. We will learn about the indirect taxes, why some of them were changed and why the changes were not enough to address the core issue.

Sales Tax (Which is now changed to VAT)

Sales Tax was levied on the sales of Goods collected by State Government and levied every time a good is sold. Different state can charge different tax rates. For simplicity let’s assume it to be 10%.

Imagine a typical supply chain model of Cars. Cars are produced in a Factory, sold to distributors/dealers which then sell them to consumers. Let’s say the manufacturer sets the price as ₹ 3, 00,000. When it is sold to distributor in the same state, government would levy 10% tax on it i.e. ₹ 30,000. This amount will be passed on to distributor and so the total cost for him is ₹ 3, 30,000. When the distributor would sell it to consumers, he will add his profit margin. Let’s say he decides profit to be 50,000 so the selling price of the car is 3, 80,000. Again 10% tax is applicable on this which makes the price of Car, ₹4, 18, 000 (3, 80,000+38,000) which is paid by consumer.

Now let’s break this 38,000 that consumer had to pay as taxà 30,000 + 3,000 + 5,000. If you observe carefully values of 30,000 (10% of 3, 00,000) and 5,000 (10% of 50,000) can be easily explainable. But where did this 3,000 come from?? This is tax on tax (10% of 30,000). This was the major pain point which would make the end cost that consumer had to pay higher. So VAT was introduced.

In VAT Input and Output Credit was introduced. Input credit is the one that is calculated when good is purchased. Output credit is the one that is calculated when the good is sold. The total Tax payable by the entity is “Output Credit- Input Credit.

Let’s understand this again with the same example, when the distributor purchased item for 3,30,000 , he had paid 30,000 as tax which he will received as Input Credit. The valued added by him (his profit) was 50,000. The tax consumer has to pay now is on price of 3, 50,000 (3, 00,000+50,000) which comes out be 35,000.So the total tax for consumer which was 38,000 (30,000 + 3,000 + 5,000) is now only 35,000 (30,000 + 5,000). So consumer will get the car at 3, 85, 000 (3, 50,000+35,000) Vs 4, 18,000 earlier.

Though state government will receive less tax, this will help lower tax and will boost the consumer demand and more cars will be sold. From the distributor point of view he collected 35,000 from consumer which is his output credit but has 30,000 as input credit so now he has to pay the difference (output- input à35,000- 30,000) 5,000 as additional tax to government.

Excise Duty (Which is now changed to CENVAT)

Similar problem existed for excise duty as well which is levied on the manufacturing of the goods by central government. To manufacture car, company has to manufacture tyres, engine, Seats etc. and needs to assemble the same. Each time a good was manufactured, company had to pay excise duty causing cascading of the taxes. This was removed through CENVAT where similar credit system was used.

Service Tax

Now in order to sell his car manufacturer will have to do advertisement on which service tax is applicable. Manufacturer often needs to talk to distributor, there will be service tax on telephone/mobile bills. Take help of external consultants which will again mean paying service tax on the services provided them etc. So for the service tax paid by the manufacturer for selling his car, does he get input credit, “NO”! So the cascading of tax will continue, this will be added as cost while deciding the price to be sold to distributor and end consumer will have to pay more.

Inter State Central Sales Tax (CST)

When the goods are sold from one state to another CST is applicable which is actually revenue of center but is given to state where the goods are manufactured. In our case when Manufacturer in Maharashtra sells it to distributor of Madhya Pradesh he will have to pay CST. Let’s assume it to be 2%. So 2% of 3, 00,000 i.e. 6,000 will be paid by distributor in Madhya Pradesh. Does the distributor get any Input Credit for CST paid, “NO”! The cascading effect continues and it will be treated as cost which consumers will have to pay.

So though part of the cascading of tax is removed in current system there is still some amount of cascading that is existed in the system, primarily because we treat “Goods” different from “Services” and Interstate sell of goods which GST plans to address.

We discussed need of GST here. We will discuss how GST will solve this problem when we meet next time”. Did not want to confuse Apurva too much.