Understanding GST & Its Implications

Aug 4, 2016 16:00 IST

Goods and Service Tax (GST) Bill (122nd Constitutional Amendment Bill), which is considered as a biggest indirect tax reform in independent India’s history, was passed by the Rajya Sabha with support from all major political parties except AIADMK.

Goods and Service Tax (GST) Bill

Inception of GST:

The GST buzz started first in the year 2000 when a committee was set up by then PM Atal Bihari Vajpayee, which was mandated with giving the concept of binding entire nation into one tax regime by facilitating the states to switch from sales tax to the value-added tax (VAT) regime. It resulted into state-level VAT replaced sales tax in many states On April 1, 2005, although the tax rate varied from state to state. Subsequently, the same committee was mandated with facilitating all means to states to switch to Goods & Service Tax (GST), in consultation with the Centre. GST works on the exact same principles as VAT, hence in many countries it is in fact called VAT. The major difference between VAT and GST is while VAT rate varied with states, GST would be same throughout India.  Under the Manmohan Singh led UPA govt., the finance ministers promised GST in more cognizable manner, but the proposed deadline extended year on year without any headway.

What is GST?

GST will convert the country into unified common market, replacing most indirect taxes with one tax. GST (Goods and Services Tax) is an indirect tax levied when a consumer buys a good or service. India’s current tax scenario is riddled with various indirect taxes which the GST aims to subsume with a single pan India comprehensive tax, by bringing all such taxes under a single umbrella. GST would have a dual structure a state component administered by states and a Central component levied and collected by the Centre. The bill aims to eliminate the cascading effect of taxes on production and distribution prices on goods and services.

Cascading effect of taxes is caused due to levy of different charges by state and union governments separately. This tax structure raises the tax-burden on Indian products, affecting their prices, and as a result, sales in the international market. The new tax regime will therefore, help boost exports.

In the changed scenario, the following taxes under Centre and States will be subsumed in GST

Central Taxes subsumed by GST

State Taxes subsumed by GST

 Central Excise Duty

Central Sales Tax

Service Tax

State VAT

Duties of Excise (medicinal and toilet preparations)

Purchase Tax

Duties of Excise (medicinal and toilet preparations)

State Cesses and surcharges

Additional Duties of Customs (commonly known as CVD)

Entry Tax (all forms)

Additional Duties of Excise (textiles and textile products)

Entertainment Tax (not levied by local bodies), Luxury Tax

Special Additional Duty of Customs (SAD)

 Taxes on advertisements

Cesses and surcharges in so far as they relate to supply of goods or services

Taxes on lotteries, betting and gambling

How it will Change the Tax system in India?

GST reduces the cascading effect of tax in different stages of production and consumption. For example:

Step 1:

If a Bread Maker procures raw material or inputs such as Wheat or flour, sugar, yeast etc for Rs.100, a sum that includes a tax of Rs 10. With these raw materials, he makes bread. In the process of creating the bread, the manufacturer adds value to the materials he started out with. Let us take this value added by him to be Rs 30. The gross value of his good would, then, be Rs 100 + 30, or Rs 130. At a tax rate of 10%, the tax on output (this Bread) 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 material/inputs (Rs 10). Therefore, the effective GST incidence on the manufacturer is only Rs 3 (13 – 10).

Step 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 (which is basically his ‘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 his 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).

Step 3:

In the final stage, a retailer buys the Bread from the wholesaler. To his purchase price of Rs 150, he adds value, or margin, 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 his purchase from the wholesaler (Rs 15), the retailer brings down the effective GST incidence on himself to Re 1 (16 –15). Thus, the total GST on the entire value chain from the raw material/input suppliers (who can claim no tax credit since they haven’t purchased anything themselves) through the manufacturer, wholesaler and retailer is, Rs 10 + 3 +2 + 1, or  Rs. 16.

What is the current Regime of Taxation (Without GST) in India?

In a present non-GST regime, there is a cascading effect of “tax on tax”, as there are no provision to set-offs for taxes paid on procured products or inputs or on previous purchases.

From the above example of Bread manufacturing, the bread manufacturer buys raw materials at Rs 100 including tax of Rs 10. The gross value of the bread (good) 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/inputs, 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, cannot set off the tax on the sale of his good against the tax paid on his purchase from the manufacturer.

The retailer, thus, 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’s sale against the tax paid on his previous purchase.

The total tax on the chain from the raw material/input suppliers to the final retailer in this full no-GST regime will, thus, 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 Rs 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.

What would be the major implication of GST?

• First, it addresses a serious impediment to our competitiveness. Without the GST, there are multiple points of taxation, and multiple jurisdictions. We also have an imperfect system of offsetting credits on taxes paid on inputs, leading to higher costs. Also there is cascading effect, which hampered the interstate commerce. By bringing the GST. It will enhance the ease of doing business, and make our producers more competitive against imports.

• Second, implementation of the GST is an iconic example of “cooperative federalism”. The States agreed to give up their right to impose sales tax on goods (VAT), and the Centre gave up its right to impose excise and services tax. In exchange they will each get a share of the unified GST collected nationally.

• Third, once the GST is in place, it means a unified, un-fragmented national market for goods and services, accessible to the smallest entrepreneur. Companies need not maintain stock depots to avoid paying interstate taxes. This will free up some capital. All this will add to demand, and also efficiency.

• Fourth, because the structure of claiming input tax credit is linked to having proof of taxes paid at an earlier stage in the value chain; this creates interlocking incentives for compliance between vendor and customer. No more questions from a vendor: “Would you like that with receipt or without receipt?” Because of this inherent incentive, the total taxes paid, and hence collected, may go up significantly. This provides buoyancy to the GST. In fact, a significant part of the black economy will enter the tax-paid economy.

What would be the GST Rate?

The rate for GST is as yet undecided, but it would be in a range that would make exports competitive. A sub-committee of the Empowered Committee of state finance ministers had proposed revenue-neutral rates (RNR) for the Central and state components at 12.77 per cent and 13.91 per cent, respectively, taking the effective GST rate to 26.88 per cent. This is much stiffer than the 14-16 per cent in most countries as well as the recommendation of a taskforce of the Thirteenth Finance Commission of 12 per cent (7 per cent for state GST and 5 per cent for central GST). However it is expected that GST rate won’t be more than 18%.

Under the GST Constitutional Amendment Bill, the President shall constitute the GST Council. GST Council shall constitute of the union Finance Minister (chairman) and MoS in charge of Revenue; Minister in charge of Finance or Taxation, or any other Minister, nominated by each state. Decision will be made by three-fourths majority of votes cast. Centre shall have a one third of votes cast; states shall together have two-thirds.

Mechanism for resolving disputes arising out of its recommendations may be decided by the Council itself.

The GST Council shall make recommendations on:

• Taxes to be subsumed

• Exemptions

• Model GST laws, Principles of Levy, etc.

• Threshold for exemption

• Rates, including floor and bands

• Special rate/rates for specified period

• Date from which GST to be levied on crude, high speed diesel, natural gas, aviation turbine fuel and petrol

• Special provisions for the Northeast, J&K, etc.

What are the issues with GST in India?

The main issue with GST in India comes from states. States have been vehemently opposing the “One Nation, One Tax” system as they claim it would reduce their revenue. For instance, states earn nearly 50 per cent of revenues from levies on petroleum products. Concerns have mounted over potential losses due to subsuming of state levies into GST. States have raised concerns of revenue loss due to the phase out of the CST, which they have pegged at Rs 34,000 crore.

On a theoretical level, RNR for GST would ensure that there are no losses to either the state or the Centre. Indirect tax collections are in fact expected to go up on the back of better tax compliance under the regime. But as a sweetener, the Centre has agreed to include a provision on compensation for a period of three years on losses arising out of GST to states in the Constitution amendment Bill.

The FM has also promised Rs 11,000 crore to states as CST compensation in this fiscal. Further, to give fiscal autonomy to states, the Centre will collect taxes from traders having a turnover of over Rs 1.5 crore while the states will tax those having a turnover between Rs 25 lakh and Rs 1.5 crore.

Another challenge associated with GST is a conflict between producer state and consumer state. As GST is destination based tax system, therefore consuming state will receive the more revenue, and producing states or developed states will get less revenues. It will also discourage the producing state to produce more goods.

So, all good now!

Legally speaking, we still have to wait for  the Lok Sabha to pass the GST Bill (which is not the same as Constitution Amendment Bill) and the states have to pass their own GST bills. If we are looking at 1st April 2017 to roll out the GST, all this technical glitches have to solved by or before March 2017. If we look into the details of GST and its implementation on deadline it seems there are still miles to go.  Full fledge rolling out of GST requires following steps to be completed before 1st April 2017:

1. Changes made to bill in Rajya Sabha will have to be again approved by Lok Sabha.

2. The bill needs to be ratified by a majority of the states(15/29). Following this it will be sent to President for Assent (Under Art.111)

3. After Presidential assent, a GST Council comprising the representative from state and Centre will be setup.

4. The council will help codify Central GST and State GST law which  would be passed by Parliament and state assemblies.

5. GST network, the IT backbone of GST, to felicitate online registration, tax payment and return filling would be introduced.

6. GST network would create an online portal. The portal will begin migrating date of existing taxpayer under the current VAT/Excise, Service Tax regime.

7. All businesses will be given a GST identification number a 15 digit code comprising their state code and 10 character PAN.

8. The GST network has already validated the PAN of 58 Lakh businesses from the tax department.

9. Government is already enabling “Master Trainers” who would train accountant, Lawyer and tax officials on the new system.

The current GST is an improvement over the current scenario but it is not perfect. We still won’t see a 100% free flow of credits due to the Dual-GST structure. Further, all goods need to be brought under GST, to reap full benefits, and one expects that after GST rolls out and stabilises, states will agree to bring in goods like Alcohol and Petrol.

In the end, we must realise that although GST is a huge reform, the current version is an incremental reform, which shows us the path to the ultimate destination of having a perfect GST. It is hard to say whether Indian can achieve a perfect GST, given the inherent complexities of our structure, but going forward we must hope that we move closer and closer to the target.

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Read more Current Affairs on: GST , Goods and Services Tax , Unified common market , indirect taxes

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