Goods and Services Tax (GST) Bill Explanation

The Goods and Services Tax (GST), the biggest reform in India’s indirect Tax structure since the economy began to be opened up 25 years ago is now a reality. Here’s how GST differs from the current regimes, how it will work, and what will happen if Parliament clears the Bill.

Stage 1 - 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 the value added by him to be Rs 30. The gross value of his good would then be Rs 100 + 30, or Rs 130. A tax rate of 10%, the tax on output 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 materials (Rs 10). Therefore, the effective GST incidence on the manufacturer is only Rs 3 (13-10).

Stage 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 (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 this 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).

Stage 3 - In the Final stage, a retailer buys the shirt from the wholesaler. To his purchase price of Rs 150, he adds value 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 this purchase from the wholesaler (Rs 15), the retailer brings down the effective GST incidence on himself to Rs 1 (16-15). Thus, the total GST on the entire value chain from the raw material suppliers through the manufacturer, wholesaler and retailer is Rs 10 + 3 + 2 + 1 or Rs 16.

Scenario in Non-GST Regime – 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. If we consider the same example as above, the manufacturer buys raw materials at Rs 100 after paying tax of Rs 10. The gross value of the shirt 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 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 can’t set off the tax on the sale of its good against the tax paid on his purchase from the manufacturer. The retailer 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 sale against the tax paid on this previous purchase.

The total tax on the chain from the raw materials suppliers to the final retailer in this full no-GST regime will 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 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.

Present Scenario – Currently, we have Value Added Tax (VAT) systems both at the Central and State levels. But the central VAT or CENVAT    mechanism extends sets offs only against central excise duty and service tax paid up to the level of production. CENVAT does not extend to value addition by the distributive trade below the stage of manufacturing, even manufacturers can’t claim set off against other central taxes such as additional excise duty and surcharge.

VATs cover only sales. Sellers can claim credit only against VAT paid on previous purchases. The VAT also does not subsume a host of other taxes imposed within the states such as luxury and entertainment tax, octroi, etc. Once GST comes into effect, all central and state level taxes and levies on all goods and services will be subsumed within an integrated tax having two components, a central GST and a state GST.

This will ensure a complete, comprehensive and continuous mechanism of tax credits. Under it, there will be tax only on value addition at each stage, with the producer/seller at every stage able to set off his taxes against the central/stage GST paid on his purchases. The end-consumer will bear only the GST charged by the last dealer in the supply chain, with set off benefits at all the previous stages.