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GST: An overview of the new tax law

GST | 9 mins read

Because of its not-so-simple tax system, India is one of the most difficult countries to set up and run businesses. According to a study conducted by the TMF group, a global market research firm, businesses operating in India are required to make 33 tax payments every year, which often involves hiring a team of accounting professionals and reviewing mountains of tedious paperwork. One of the businesses surveyed spent 243 hours on tax payments in a single year, time that would certainly be better spent elsewhere.

GST - An overview of the new tax law

With the objective of streamlining the current tax structure, Indian government recently passed the 122nd amendment bill, also known as the Goods and Services tax (GST) bill, which will subsume all currently existing indirect taxes into a single GST tax.

In this article, we’ll be breaking down the concept of GST and how it will simplify taxation for Indian businesses.

India’s current tax structure

To get a sense of the benefits of GST, it is necessary to first understand the problems businesses face under the current tax structure.

Multiple taxes and tax cascading

In the current indirect tax structure, up to 17 taxes are levied by the state and the central government before a product reaches the end consumer.

At each stage of a supply chain, taxes are applied on the total value of the product, even though it has already been taxed at the previous level. This process of taxing already taxed goods is referred to as tax cascading. This happens when the government fails to provide credit for input tax (the tax that was paid at the previous stage) to the consumer who buys the product in the next stage.

This heavy tax cascading increases the amount of tax involved in the making of a product, which often is included as part of the manufacturing cost. This shifts the entire tax burden on the end consumer, who will pay upwards of 30-35% in taxes by the time they buy a product.

Interstate movement of goods is difficult

When goods are moved from one state to another, a Central Sales Tax (CST) of 2% is collected on the total value of the goods at the state border. For example, if you have a textile showroom in Chennai and buy garments from Surat, the truck carrying the consignment will be charged a CST of 2% at the state border. This amount gets added to the cost of the garments that you buy from the manufacturer. On top of all that, the constant taxing of interstate goods delays their arrival, as time is wasted at tax checkpoints at each state border.

Complex compliance procedures

A lack of a uniform tax rate across the country means that Indian businesses today have to comply with multiple tax laws, follow various different tax rates, and face intervention from tax authorities from many states. Businesses that sell goods across states have to maintain a separate record to manage costs according to each state’s tax rate, as well as manage piles of paperwork specific to each state’s tax laws. Failing to comply with all of these rules puts businesses at risk for heavy penalties from the tax department. All of this additional work makes managing interstate taxes complex and stressful, and it often consumes a considerable amount of time, money, and resources.

In order to combat all these issues and take the stress out of taxation, the government task force proposed the idea of Goods and Services tax (GST).

Goods and Services Tax

With the Goods and Services Tax, or GST, to no one has to worry about paying multiple taxes to the government. No matter what kind of transaction you’re dealing with, you will be paying a single tax. GST will be applied to all sales and purchases of goods and services, with the exception of motor spirit and alcoholic liquor.

Beginning July 2017, India will follow the “dual-GST” model, which is used in countries like Brazil and Canada. The “dual-GST” model comprises two tax components: the SGST, or the state GST collected by the state government; and the CGST, or the central GST collected by the central government. When goods are sold within the same state, both the SGST (state tax component) and the CGST (central tax component) are collected. If the sales happens between states then a combined tax called IGST (SGST% + CGST%) is collected.

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How is the GST different?

Instead of applying taxes on the total value of the product at each stage, the GST only imposes tax on value addition. Because it provides credit for the input tax paid at each previous stage of a supply chain, this method considerably reduces the overall manufacturing cost.

Let’s take a closer look at how this works with a simple example.

Imagine a manufacturer who sells LED TVs to a wholesaler located in the same state (we are going to call it State 1).

Note: In this example, we are assuming that all taxes associated with the manufacturing process have been paid and the selling price in the first stage is the final price set by the manufacture (excluding VAT).

The wholesaler in State 1 adds value to the product/ adds his or her margin and then sells it to a retailer who is located in another state (let’s call it State 2). The retailer then add his/her profit margin (value is being added to the product) and sell it to a local customer. The retailer also provides TV installation services to customers on top of the sale.

If they were operating under the current tax model, the manufacturer would start the cycle by selling the television to the wholesaler for a selling price of Rs.8000 + a VAT of 14.5% making the total Rs.9160 (VAT is associated to the transaction as both the parties are located in the same state).

The wholesaler located at state 1 would then sell it to the retailer located at state 2 for Rs. 10,000. However, as the television is being sold from the wholesaler to a retailer located in a different states, a CST of 12% (on the entire amount) is applied, and so the retailer actually owes Rs.11200 instead of just Rs.10000. Then, the retailer adds a profit margin of 20% over the purchase value of the television, and sells it to a local customer for Rs.13440 and also charges Rs.500 as installation charges. Hence, a VAT of 14.5% on 13440 and a service tax of 15% on 500 is applied to the transaction, costing the customer Rs.14399.85 per television.

In the above example, you can see that at every stage of the process, the application of tax is non uniform and the process of getting input tax credit is broken by the presence of different taxes governed by different authorities.

GST - An overview of the new tax law

Now, let’s take the same example, but instead apply the GST model.

The manufacturer would start the cycle by selling the television to the wholesaler for a selling price of Rs.8000 + GST of 12% making the total Rs.8960.

The wholesaler located at state 1 would then add value/margin to the product and sell it to the retailer located at state 2 for Rs. 10,000. Here, an IGST of 12% (on the value added which is = Rs.1040) is applied, and so the retailer actually owes Rs.10124.8 instead of just Rs.10000. Then, the retailer adds a profit margin of 20% over the purchase value of the television, and sells it to a local customer for Rs.12148.96 and also charges Rs.500 as installation charges. Hence, a GST of 12% on 12148.96 and a GST of 18% on 500 is applied, costing the customer a total of Rs.12,982.76 per television.

GST - An overview of the new tax law

Looking at both the examples, one can see that the buyer/end consumer pays a comparitively lesser amount under the GST model. The process of claiming input tax credit is also easier as there is only a single tax authority.

Benefits of the GST

Many industrialists and finance experts believe that the GST will transform the way we do business in India. Here’s how the GST would bring major benefits to businesses.

Reduced tax cost and tax credit

The credit for the tax paid at every stage of the supply chain will be given to the buyers, which they can use to offset the purchase they make at the next stage. In addition to reducing the tax burden on the buyer, this will also reduce the manufacturing and selling price of the product.

At the end of the day, this reduction in extra costs will help consumers save more with every purchase, leaving them more satisfied and ready to spend than before.

Free movement of goods

When goods are moved between two different states, a combined tax called the IGST (Integrated GST) will be collected by the central government. This integrated tax amounts to the sum of the SGST and the CGST. For example, if the SGST and CGST are charged at 12% each, then an IGST of 24% will be charged on interstate trade.

This will eliminate the need for businesses to make upfront payments during interstate transactions, to pay CST at state borders. Additionally, the IGST, in conjunction with a fully computerized GST system, will help businesses keep better track of their tax credits during interstate transactions. This will allow for free movement of goods across the country, making India a more unified market. To find out more about inter-state transactions under GST, you can take a look at our GST FAQ.

Automated compliance

In addition to doing away with tax cascading, the GST will streamline taxation with simple compliance procedures. The new tax regime will have standardized tax rates across states and will be governed by a single tax authority: the GST Council. Tax handling will be much easier once the entire taxation process moves to an online platform known as the GST portal. From registering for the GST to filing returns, everything will be done online through the GST portal. This will provide increased self-reliance for small and medium businesses, reducing costs and freeing up resources that were previously spent to manage taxes.

If you’ve got any comments or suggestions you’d like to share with us, feel free to leave your comments below.

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