Goods and Services Tax or GST is a single tax that has subsumed several indirect taxes that were earlier levied on the sale of goods and services. GST is applicable to the manufacture, sale and consumption of all goods and services in India.
This section will cover the following topics
- Why do we need GST?
- How can GST change this?
- Components of GST
- GST Tax Structure
- Benefits of GST
- Impact of GST
- Shortcomings of GST
Why do we need GST?
The previous tax system gave businesses a tough time as it involved multiple taxes, complex compliance procedures, and intervention by several state and central tax divisions. This made it highly difficult to set up a business in India which already stands at the 133rd position when it comes to doing business.
The reason for introducing the GST regime in India is due to the following reasons:
Multiple taxes and tax cascading
In the previous indirect tax regime, up to 20 taxes were levied by the state and the central government before a product reached the end consumer.
At each stage of a supply chain, taxes are applied to 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 is often 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% for each state border it crosses. 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.
How can GST change this?
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.
Comparison of Current Tax Structure vs. GST
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 manufacturer (excluding VAT).
Current Tax Structure
- Imagine a manufacturer selling zinc coated steel buckets, each for Rs.1000 plus a VAT of 10% (which is Rs.100) to a wholesaler located in the same state (let’s call it State 1).
- So, the wholesaler at state 1 buys them for Rs.1100 per piece and increases the total selling price to Rs.2,000 per bucket before selling a few of them to a retailer located in a different state (State 2). Under the pre-GST regime, this interstate sale will attract a Central Sales Tax (CST) of 12% on Rs.2,000 (which is Rs.240).
- The retailer pays Rs.2240 per bucket and then increases its price by 20% (which is Rs.448) and then offers it to local consumers (who are also at state 2) for Rs.2688 plus a VAT of 15% (which is another Rs.403.20).
- The end consumer ends up paying a total of Rs.3,091.20/- per bucket.
Note: Here, we have assumed the VAT rate in state 1 to be 10% while the VAT rate in state is taken as 15%. (Because under the pre-GST system, the VAT rates are different across different states)
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 ITC is broken by the presence of different taxes governed by different authorities. Bottomline - Sellers lose money on taxes at every stage as they don’t get input tax credit or refund on the tax paid on purchase whenever they make a sale.
Now, let’s take the same example, but instead apply the GST model.
- The same manufacturer sells zinc coated steel buckets, each for Rs.1000 plus a GST of 10% (which is Rs.100) to a wholesaler located in the same state (let’s call it State 1).
- So, the wholesaler at state 1 buys them for Rs.1100 per piece and increases the total selling price to Rs.2,000 per bucket before selling a few of them to a retailer located in a different state (State 2). Under the GST regime, this interstate sale will attract an IGST of 10% on Rs.2,000 (which is Rs.200).
- The retailer pays Rs.2200 per bucket and then increases its price by 20% (which is Rs.440) and then offers it to local consumers (who are also at state 2) for Rs.2640 plus a GST of 10% (which is another Rs.264).
- The end consumer ends up paying a total of Rs.2,904/-.
Note: Here, we have assumed the GST on zinc coated steel buckets to be 10%. And so, GST for the bucket throughout India irrespective of whether it is an intra-state sale or inter-state sale will be 10%.
Bottomline - Looking at both the examples, one can see that there is not much difference to the buyer/end consumer. The benefit to the end consumer totally depends on the GST rate associated with a particular item or service under the GST. If we had assumed a higher GST rate for the bucket, the end consumer would have actually paid a lot more than earlier. But then, the real benefit from the GST regime is actually reaped by sellers, manufacturers and traders because the GST allows an unrestricted flow of input tax credits and so they get a refund on the input taxes that they have paid at the time of sale. That said, sellers can pass on this benefit to the end consumer if they choose to by reducing their final selling prices (as they do get their tax money back).
Components of GST
From July 2017, India has been following the dual-GST model which is made up of the following components:
SGST - A form of GST collected by the state government
CGST - A form of GST collected by the central government
Both the taxes will be levied when sale of goods and services takes place within the same state.
If the movement of goods occurs between two different states i.e. an interstate transaction, a combined tax called the IGST or the Integrated GST (SGST + CGST) will be collected by the central government. The IGST will replace the currently levied Central Sales Tax (CST) of 2%.
The tax amount collected as IGST will later be distributed to respective state governments.
For better understanding, let’s take a look at the following scenarios:
Scenario 1: Levy of SGST and CGST
Let us assume that you’re a distributor in Chennai and you buy goods from a manufacturer in Tirupur, Tamilnadu. Since the sale and movement of goods happen within the state, SGST and CGST will be levied on the sale. Also, the distributor gets tax credit on the input SGST and CGST.
Scenario 2: Levy of IGST
Let us assume that you’re a distributor in Belgaum and you buy goods from a manufacturer in Tirupur. Here, the sale and movement of goods happen between two different states, IGST will be levied on the sale.
GST Tax Structure
The four-tier tax structure of GST has the following slabs: a zero rate, a lower rate, two standard rates, and a higher rate. This article is aimed at providing a brief overview of each GST rate.
The zero rate tax is a nil tax that is applied on goods and services. This is equivalent to tax exemption and does not have any effect on the price of the product. Items that are eligible for zero rate tax are decided by the government.
As per the four-tier tax structure, the zero rate tax will be applied on 50% of the items of the consumer price index (CPI) basket - an index that constantly measures prices of commonly purchased consumer goods and services to measure inflation. The zero rate items could include such items as all food grains, cereals, milk, and other essentials.
Including zero rate as part of the GST structure will keep the prices of basic items in check, regardless of whether the government decides to increase tax rates in the future.
A lower rate of 5% will be applied to the rest of the items in the CPI basket and other items of mass consumption. This, along with the zero rate tax, will help prevent inflation from having much of an impact on zero rate and lower rate items, keeping the prices of all essential items in check.
There are two standard rates that have been finalized by the GST Council: 12% and 18%. Finance Minister Arun Jaitley, in his address to the press, said that the Council had finalized two standard rates in order to keep inflation in check.
Imagine a product, which is currently taxed at 13%, charged a rate of 18% GST. This would increase the price of the product by 5%, leading to inflation. To avoid this, the GST council decided to tax all goods and services that are currently taxed at 9-15% at a standard rate of 12%. Processed foods will also be taxed at 12%. The rest of the goods and services will be taxed the second standard rate of 18%.
All taxable services that are currently charged at 15% will now be moved to the 18% bracket. This could increase the price of a majority of services that are currently offered.
A higher rate of 28% will be levied on white goods. This includes items such as washing machines, air conditioners, refrigerators, small cars, etc.
Previously, the tax on white goods was around 27% (including an excise of 12.5% and VAT of 14.5%), but the cascading effect elevated the tax as high as 30-31%. This will be minimized by the new higher rate of 28%.
The additional cess, which had been a topic of debate since the proposal of the GST rates, is now finalized.
People worried that demerit goods (such as tobacco products and aerated drinks), which were previously taxed at 65% and 40%, would become cheaper and too easily accessible with the new higher rate of GST set at 28%. Keeping this in mind, the new GST structure will collect an additional cess on top of 28% GST. The cess will only be applied on demerit goods like luxury cars, tobacco products, pans, and aerated drinks. The percentage of the additional cess is yet to be determined by the government.
Benefits of 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 states 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.
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.
Impact of GST
Agriculture has always been the root of the Indian economy. With that in mind, the government has zero-rated most agricultural goods such as food grains, cereals and almost 50% of the items in the CPI basket. That said, certain farm produce, like cash crops, dairy or milk based products and processed food grains (like packed rice for instance) may attract a 5% GST. So do farmers need to register themselves under the GST? Well, traditional farmers need not register under the GST. But, farmers who are involved in contractual farming will now be under the purview of GST. And this shift will affect many multi-national fast food chains as they are now required to pay GST on their purchases and this can subsequently affect your bill when you order that burger or pizza after July 1, this year.
Additionally, those buying products from the farmers might be required to pay GST even though the farmer is not registered under the GST. This includes all those middlemen and retailers who trade in agricultural commodities. To summarize:
- The prices of food grains and other essential commodities will, for the most part, remain the same.
- Eating out is going to get more expensive for various reasons - from the taxation on contractual farming to a 3% increase in the tax levied on services to the tax on purchase of agricultural products directly from farmers.
- Contractual farmers, agriculturalists, wholesalers and retailers who sell agricultural products will now be under the purview of GST.
Fast Moving Consumer Goods
Fast Moving Consumer Goods (FMCG) industry includes food, beverages, household and personal care items. These are currently liable to a total tax of >26% (this is the result of a 12.5% excise and a VAT of 12 to 14.5% on top of excise). This excludes most of the agricultural processed products that either enjoy a VAT exemption, or are liable to a lower bracket of taxation (4-5% of the value). With GST at a rate of 12-18%, we will see a drop in the prices of most FMCGs.
More than pricing, the greatest impact of GST on FMCG companies would be on their product distribution and warehousing. As of today, the distribution costs for FMCGs account for up to 7% of business turnover, and to keep it as low as possible, they establish warehouses in every state where they operate (this is done in order to avoid Central Sales Tax, or CST, on interstate sales). Based on demand, the goods are transferred among warehouses and sold to distributors locally.
Under the GST, local and interstate supply would be tax neutral and India would be treated as a single common market. This shift would allow companies to reconsider the location of warehouses from a tax saving standpoint to a market-centric one that offers more savings and faster deliveries.
As one of the biggest contributors to our economy after services, the manufacturing industries are subjected to an array of taxes levied at each level. Imagine the production costs of a manufacturer today when he or she has to pay:
- A 15-20% VAT depending on the state on purchase of raw materials (including Swachh Bharat cess and Krishi Kalyan cess) from a vendor located in the same state, or a combination of CST + Octroi + LBTs at every state border check post on the purchase of raw materials from a vendor located in another state,
- A 10% excise duty on production, and
- A 15% service tax on any services they use.
Not only is this tedious, but one can see these taxes being passed on to the end consumer. As a matter of fact, the presence of tax cascading and the restrictions on the flow of input tax credits prevalent within the current tax system has brought about a situation where any product purchased within India contains 30-35% in taxes.
But, the implementation of GST is expected to lower the cost of production and consequently, the prices of finished products for the end consumer. GST allows an unrestricted flow of input tax credits, and hence manufacturers will be given credit for the tax paid on capital goods. GST will be subsuming all those indirect taxes that were governed by different tax authorities making registration and compliance much simpler. Most importantly, the tax at further levels of production is levied only on the value added to an item and not on the whole price and so this effectively brings down the total selling price of an item.
Another major challenge faced by the manufacturing sector today is movement of goods from one state to another state, be it when sourcing raw materials from vendors or when pushing out finished products to customers. This is due to the collection of CST and other entry or local body taxes at each state border that takes up roughly 60% of a truck’s transit time.
This problem will be solved with the implementation of GST. A unified tax called the Integrated GST or the IGST will be collected by the central government when there is movement of goods from one state to another. This will ensure free movement of goods across the country and will also save a great deal of money spent on logistics.
On the downside, many of the small-scale industries of this sector will no longer enjoy excise duty exemptions after July 1, 2017 due to the exemption threshold being brought down from an aggregate turnover of 150 lakhs to 20 lakhs (and 10 lakhs if you are in North East India).
In short, the manufacturing industry will experience lower production costs, lesser litigation and simplification of rules that would promote the Make in India drive, faster sourcing of raw materials and quicker delivery of finished products. That said, the absence of exemptions can hike the prices of products made by small-scale industries.
E-commerce & Supply Chain Logistics
The e-commerce sector is an up-and-coming new sector that is expected to become an $18 billion dollar market by 2018. So, the government has specifically focused on the e-commerce sector. The Model GST Law has a dedicated chapter on how to handle taxes for e-commerce companies. E-commerce companies are classified based on three business models:
- The marketplace model
- The inventory model
- The aggregator model
The marketplace model involves e-commerce companies that showcases products from different vendors. Only companies that operate using the marketplace model are considered as e-commerce operators as per the government regulations and these companies will have to register for GST in every state in which they do business. Additionally, they will also have to file the GSTR8, a return specially designed for e-commerce operators.
But, things are going to be difficult for small e-commerce suppliers, namely the small agencies and brick and mortar stores who also sell their products through online e-commerce sites.
Such small suppliers won’t be eligible for the GST threshold meaning, they will have to pay GST irrespective of their company’s annual turnover. This is applicable even if a company sells only one product through a marketplace e-commerce site.
On the other side, businesses that have their own website through which they sell their own products won’t be termed e-commerce operators. They will come under the inventory model and will be taxed under the standard GST slab.
Finally, businesses that operate under the aggregator model like Ola and Uber will collect tax from their drivers and pay it to the government on their behalf.
On the plus side, GST will eliminate multiple tax levies and allow for deeper penetration of digital services. At the same time, it will be a disadvantage to IT companies that have several delivery centres and offices working together to service a single contract. This is because each centre is required to generate a separate invoice to every contracting party. Also, the GST rate on Saas offerings will now be 18%.
On the bright side, GST will bring down/streamline the prices of handsets across states owing to uniform taxation and lower production and distribution costs. On the other hand, call charges and internet data rates will go up as the GST rate on them will be 18%.
Media & Entertainment
Things are looking bright for DTH providers (Direct to Home dish tv providers), film producers and multiplex players who are currently liable to a non-uniform entertainment tax on top of regular service taxes. This is because the GST regime will bring down the tax levied on their services by 2-4%.
Additionally, the GST will also offer input credits on all taxes levied under this regime; that means more revenue gained for these service providers and a possible reduction in the prices of their services. (Bottom line - You will be able to watch more movies per month in theatres provided they reduce their prices owing to a lesser tax rate. )
Life, health and motor coverage will become more expensive from April 2017 as taxes will go up by 3%.
Air travel in India will see a mixed impact. The tax rate on economy class will drop from 6% to 5% under GST and hence economy class fares will tend to be a bit cheaper. On the other hand, the tax rate on business class will increase from the existing 9% to a standard GST rate of 12%. And so, business class will get dearer.
Shortcomings of GST
According to the model GST law, a business should register for GST in every state where they have an establishment/branch/outlet/warehouse (in simple terms, you must register every billing address that belongs to your company individually). Let’s take an example where you have a business that has nine branches across nine different states which sell goods locally. With GST coming to effect, you will have to register for GST in all the nine states for SGST and register with the central government for CGST. That brings it to a total of ten GST registrations.
No Threshold limit for E-commerce Suppliers
Sellers who sell through e-commerce channels are not eligible for the threshold limit (Rs. 20 lakhs) that is currently available for other businesses. Irrespective of their annual turnover, registration is mandatory and they will have to pay GST. This would affect several brick and mortar stores, who make a few extra bucks by selling their products online.
According to the GST regime, every business should file three returns on a monthly basis and an annual return. This amounts to 37 returns in a fiscal year which can make compliance difficult for businesses due to the significant amount of time spent on filing returns.