GST 101- Definition, Terms, Framework & How it Works

GST has already rolled out from 1^st July, 2017. We are witnessing a revolution in Indian economy and existing taxation system. Myriad speculations are running for the past  few months regarding the Goods and Service tax. (Cannot find legit reference, except for a private website).

Now, let’s delve further into the nuances of GST–

Overview

GST is the acronym for Goods & Services Tax. It is a form of indirect tax that will combine the different taxes charged by the State and Central government into one comprehensive Tax. GST has been introduced under 122^nd amendment of the Indian Constitution as “The Constitution Act 2017”. The GST Council, chaired by current Union Finance Minister Arun Jaitley, has been bestowed with the governance of GST. It has been  officially launched all across India on July 1  by our honorary PM Narendra Modi .

What is GST?

GST is the acronym for Goods & Services Tax. It is a form of indirect tax that will combine the different taxes charged by the State and Central government into one comprehensive Tax. GST has been introduced under 122^nd amendment of the Indian Constitution as “The Constitution Act 2017”. The GST Council, chaired by current Union Finance Minister Mr. Arun Jaitley, has been bestowed with the governance of GST. It has been officially launched all across India on July 1^st  by our honorary Prime Minister,  Mr. Narendra Modi .

GST will combine all these following taxes-

• Commercial Tax
• Central Excise Duty
• VAT or Value Added Tax
• CST or Central Sales Tax
• Food Tax
• Octroi
• Entry Tax
• Entertainment Tax
• Luxury Tax
• Purchase Tax
• Advertisement Tax
• Service Tax
• Taxes on lotteries, betting and gambling, etc.

Major terms related to GST-

• GST– Goods & Services Tax.
• Indirect Tax- the tax whose liability is shared with others.
• Multi-stage tax– Tax that applies to each stage of value addition i.e., right from manufacturing to final sale.
• Destination-based tax– GST framework would vary between inter-state and intra-state level transactions.
• CGST– The acronym for Central Goods & Services Tax. In this case, it’s the Central government which will collect the revenue.
• SGST– The acronym for State Goods & Services Tax. In this case, it’s the State government which will collect the revenue.
• IGST– The acronym for Integrated Goods & Services Tax. In this case, it’s the Central government which will collect the revenue for the inter-state sales.
• UTGST– The acronym for Union Territory Goods & Services Tax. In this case, it’s the Union Territory which will collect the revenue for the inter-state sales
• GST Compliance Rating– refund claims made under GST would be considered on the basis of merit. It would be processed depending on registered taxpayer’s compliance rating.
• GSTIN– It is the acronym for Goods & Services Tax Identification Number. It will be a unique 15 digit code that would be assigned to each businesses falling under GST regime.

GST has introduced two new terms:

• Mixed Supply– Two or multiple individual goods/services supplies, made together by taxable individual for single price. But each item here carries the capacity of being supplied and taxed separately.
• Composite supply-naturally bundled supply made of 2 or multiple goods or services. One would be the principal supply. Unlike mixed supply, the items do not carry the capacity of being supplied separately.

GST Framework:

• India practices dual GST framework
• CGST (Central Goods & Services Tax) & SGST (State Goods & Services Tax) would be levied at intra-state level transactions
• Only IGST (Integrated Goods & Services Tax) would be levied inter-state level transactions
• Exports & SEZ supplies would be zero-rated
• Imports would be processed as inter-state supply

How will GST work?

As we can see from the GST framework above, GST comprises of 3 taxes- CGST, SGST and IGST.

Let’s see how the GST structure works and how would it differ from the existing tax structure:

• Intra-state sale

Existing taxation system

The taxation system for intra-state sale under existing taxation system comprises of VAT + Service Tax/Central Excise.

Under GST taxation

The taxation system for intra-state sale under GST taxation system would comprise of CGST + SGST.

Result

From 1st July, revenue would be shared in between State and Central Government.

• Inter-state sale

Existing taxation system

The taxation system for inter-state sale under existing taxation system comprises of Central Sales Tax+ Service Tax/Excise.

Under GST taxation

The taxation system for inter-state sale under GST taxation system would comprise of IGST.

Result

From  1^st July, there  is levied just one single tax.

Let us check this with an example:

Say, an electronic goods dealer in West Bengal sold a high end speaker system to an individual consumer within the state at Rs. 10,000. The GST rate here would be 18%- 9% CGST & 9% SGST. The dealer will collect something like Rs. 1800, of which Rs. 900 would go to West Bengal government & the other Rs. 900 would go to Central government.

Now, let’s say he sold the same item to some dealer in Orissa at Rs. 10,000. GST rate would be 18% and the dealer here would collect something like Rs. 1800- but as IGST. The IGST would go straight to Centre. No longer, he would have to pay both SGST & CGST.

Significance of GST implementation- Input Tax Credit

First of all, we must understand the framework of existing indirect tax structure in India. Since GST too is an indirect tax, the comparison would be easy to understand once you gather an idea about the existing  indirect taxation system in the country

As mentioned earlier (check GST Terms), Indirect Tax is the one where the tax liability is shared with others. It means, when a seller pays VAT, he passes on his VAT liability to his buyer. Thus, under the existing system, the customer needs to pay for the product he buys and also for VAT -so that the seller is able to submit his VAT to government. More precisely, added to price of the purchased item, the consumer shares seller’s tax liability as well, that altogether hikes up his overall buying price.

It’s because, the seller had to pay a tax while he purchased the item from wholesaler. To recover the tax & also the VAT that he would pay to government, the seller makes his consumer pay an additional amount. Under the existing taxation system, it’s the only way for this seller to recover the sum that he paid out of own pocket. Thus he passes the liability on to his buyer.

But GST would change the scene for better. It comes with the facility of Input Tax Credit that would permit a shopkeeper to claim tax paid to wholesaler. As a result, the burden of tax burden that he would share with his buyer would decrease.

So, what is Input Tax Credit?

It refers to the credit which a person receives for tax he paid on inputs utilized in manufacturing a product. For example, if the person has to pay 10% tax to government, he would be able to subtract the sum he has already paid as tax during the purchase of the item. So, under GST, he would just have to pay the residual amount to government. As his tax burden lowers down, the tax liability that he will pass on to his buyer, would reduce as well.

Let’s check out the whole thing with a detailed example-

Below is the scenario we see under current taxation system

Say, a bag manufacturer buys raw materials at Rs. 100. The tax rate is 10% which means the manufacturer pays a tax of Rs. 10. So, the final price of the bag now comes to Rs. 110 (100 +10).

Next, the wholesaler purchases the bag from manufacturer at the stated Rs. 110. When the bag comes to him, he adds to its value by adding labels. Now, the price of the bag would rise up by something like Rs. 40. Moreover, the wholesaler would have to pay 10% tax which will make the final price of the bag Rs. 165, i.e. 150 (110+40) + 10 percent tax.

Based on the above calculation, the wholesaler would charge Rs. 165 from the retailer buying the bag from him. He has to share the tax burden with retailer. Now, the retailer would invest in a catchy package for the product to make it appealing for the buyer. It means, he would add further value to the bag which automatically hikes up the price by say Rs. 30. Besides, the retailer has to pay VAT (10%) to government. When he will sell the product, the overall price of the bag would come to Rs. 214.5- i.e. 165 + 30+ 10 percent tax= 195 + 19.5 (VAT)= 214.5.

So, under current taxation system- a consumer is paying Rs. 214.5 for one bag whose cost price is Ts. 170 (110+40+30). As we have discussed earlier, the retailer’s tax burden here passes on to  buyer which increases the overall buying price of the bag. This process is called Cascading Tax Effect- the system where one tax is being paid on another tax which consequently raises the product’s value each time throughout the process.

The scene will change with GST. How?

Unlike the current system, GST will enable a person to claim the credit for the tax he had already paid to gather input- be it for manufacturing or wholesaling or retailing. It’s all because of the maxim called Input Tax Credit.

Let’s get a detailed picture-

When a wholesaler would buy the bag from manufacturer, he would pay his usual 10 percent tax on cost price. Then, he would add value and increase the price by Rs. 40. Next, as we know, the wholesaler is supposed to pay 10 percent of the price as tax to government. Under the current system, it would mean Rs. 14 (10% of 140). But, here comes the twist. Under GST, he would have to pay just Rs. 4 instead of Rs. 14. It’s because the upcoming tax will allow him to subtract the sum he had already paid as tax to manufacturer & pay only the residual amount to government as tax. So, Rs. 10 would be the wholesaler’s input credit.

Now, the wholesaler would sell the bag at a price of Rs. 154 to the retailer instead of Rs. 165 as we saw the case in the previous example. It means reduced share of tax liability with the retailer. When the bag will come to retailer, he will again add value to the bag of say Rs. 30. The price would now be Rs. 170. We know he would have to pay tax (10%) to government. But with GST, he now has his input tax credit that will lower his tax burden. The retailer had already paid something around Rs. 14 while sharing the tax liability of his wholesaler. So, under GST, when it comes to paying tax to the government, he can easily subtract that Rs. 14 right from the amount he is supposed to pay to government (10 percent of 170= 17). So, it comes to Rs. 3 (17-14). Thus, the final selling price of the bag would be Rs. 187 (140+30+17) instead of Rs. 214.5 as we saw in the previous example.

Final Words

• GST will reduce tax burden by lowering Cascading taxation effect. In simple words, it will decrease degree of tax liability at every stage which will in turn lower down the final buying price for the consumer.
• Exempt several small traders & service providers from tax with higher registration threshold. The threshold will increase to Rs. 20 lakhs from Rs. 5 lakh (VAT) and Rs. 10 lakh (Service tax) as we see at present.

Simplifying the whole taxation system with a single uniformed tax structure.