“On 4th
August GST was all over the news. All the news channels were discussing this
historic tax reform that will be effective from 1st 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.
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