All the different types of taxes levied by the government can be categorised as direct and indirect taxes. Direct taxes are paid in entirety by a taxpayer directly to the government and cannot be transferred or shifted to another person. Income tax which an individual pays directly to the government is an example of direct tax, as the burden of the tax falls flatly on the individual who earns a taxable income and its incidence cannot be shifted to others. Indirect taxes, on the other hand, are those taxes which can be shifted to another person. Value Added Tax (VAT) is an example of indirect tax included in the bill of goods and services that one procures from others. The manufacturer or service provider, who pays the initial tax, later shifts the tax burden to the consumers by including the tax to determine the final price of the commodity or service sold to them. There are other indirect taxes such as Excise Duty, Countervailing (customs) Duty, Service Tax, (State) Value Added Tax/ Sales Tax , Octroi/ Entry Tax and Entertainment tax, the last three being levied by state and local governments and the rest by the federal government.
GST is “one indirect tax” for the whole nation. This will make the entire nation one unified common market. This one tax is meant to bring about a uniform system of indirect taxation as substitute of various such taxes levied by central and state governments as well as local authorities. Hence, GST is touted as one nation, one market and one tax. At present, more than 140 countries have tried this deviant scheme of indirect taxation in one or the other form. France was the first country to introduce GST in 1954.
India made history now, on the midnight of June 30 through the introduction of the bill in Parliament, on Goods and Service Tax (GST), the mother of all tax reforms. As stated above, this biggest tax reform post-independence seeks to amalgamate several central and state taxes into a single tax under one umbrella, to mitigate cascading or double taxation and thereby simplify the current system of indirect taxation. Accordingly, with the introduction of GST, central and state governments are set to abolish all multiple taxes (except customs duty) by simultaneously levying dual GST comprising of central GST (CGST) and state/Union Territory GST (SGST/UTGST) for supply of goods and services within a state or union territory. For all interstate supplies a single integrated GST (IGST), which would be the sum total of CGST and SGST/UTGST, is to be levied. Centre and state governments, except the state of J & K, have enacted laws to levy GST. Being a destination based tax the scheme of GST proposes to levy and collect tax on the basis of location of consumption of goods and services and not on the basis of location of their production. A single tax is proposed to be levied on the supply of goods and services at all stages, right from manufacture up to final consumption. Credits of input taxes paid at each stage will be available for setoff in the subsequent stage of value addition. It makes GST, essentially, a tax only on value addition at each stage. In a nutshell, only value addition will be taxed and burden of tax is to be borne by the final consumer though his invoice will bear only the GST charged by the last dealer in the supply chain, with setoff benefits made available at all the previous stages.
Some substantive features of GST regime: GST works on the principle of Value added tax (VAT) with the basic objective of taxing the value addition at the each stage of business, achieved by allowing tax paid as set off/credit against tax liability on output/income. It is a comprehensive tax, levied on all transactions made for a consideration, in manufacture, sale and consumption of goods and services (except the exempted goods and services), at a national level which, in principle, should not make any distinction between goods and services for levying of the tax. Certain commodities such as Alcohol for human consumption, Petroleum Products (crude petroleum, motor spirit/petrol, high speed diesel, aviation turbine fuel and natural gas) and Electricity have been proposed to be left outside of the purview of GST for the present. Besides taxes on these products, real estate-stamp duty and property tax shall continue to attract taxes as per the structure prevailing before introduction of GST.
Basic methodology of GST is based on the principle of value added tax (VAT). For a simple understanding of the approach, the very common example of making of a shirt, at its different stages, may be considered.
Stage – 1: The shirt maker buys raw material or inputs such as cloth, thread, buttons and tailoring equipment — worth `100 which sum includes a tax of `10. With these raw materials a shirt is manufactured.
Stage – 2: The shirt-maker adds value, say of `30, to the shirt by cutting and stitching it. The gross value of the product (the shirt) becomes (100+30) `130. At 10% rate of tax, the tax payable on output (the shirt) will then be (10% of 130) = `13. But under GST, a tax of `10 has already been included and paid against the price of consumed raw material/inputs and the same can be set off from this tax accrual of `13 on the output. Therefore, the effective GST incidence on the shirt maker is only `3 (13-10).
Stage – 3: At the next stage, after the good (the shirt) is purchased by the wholesaler from the manufacturer at `130, the latter adds his margin (surplus) of, say, `20 to the good, the gross value of the shirt he sells, thus, becomes `130+20= `150. Tax payable at 10% on of the wholesaler’s output (`150) will be `15. But under GST, from the tax of `15 payable on his output he is entitled to set off the tax of `13 already included and paid in the preceding stages on the good purchased from the manufacturer. Thus, the effective GST incidence on the wholesaler’s output is only `2 (15 – 13).
Stage – 4 (Final): In the final stage, a retailer buys the shirt from the wholesaler. He adds value or margin of, say, `10 to his purchase price of Rs 150. The gross value of his sales, therefore, comes up to `150+10 = `160. The tax on his output at 10% rate shall be `16. But by setting off the tax paid on his purchase from the wholesaler (`15) against this tax now payable (`16), the effective GST incidence on the output of the retailer comes down to `1 (16–15).
Thus, the cumulative GST on the entire value chain from the raw material/input suppliers (who can claim no tax credit since they are assumed to have not purchased anything themselves) through the manufacturer, wholesaler and retailer is, `10+3+2+1=`16. The final incidence of tax falls on the final buyer (consumer) of the shirt. Against this cumulative tax of `16 on value additions realised at various stages of the value chain under GST the total tax payable under the erstwhile central excise/sales tax regime would have been `10+13+15+16=`54.
In the above simple illustration the difference in the tax incidence under the two regimes – central excise/sales tax and GST – clearly arises out of double taxation in the former where the raw material taxed at the first stage i.e. Rs.10 gets again included in the tax at the second stage, again at 3rd stage and finally at the 4thstage. This is what is called cascading effect i.e. tax on tax till the level of the final consumer. One main objective of Goods & Service Tax (GST) is to eliminate this cascading effect in indirect taxation.
One interesting take here in administration of GST is that invoices must be maintained in each successful stage of transactions by all parties to claim Input Tax Credit (ITC). If any tax is evaded at one stage, the same is captured at the next successive stage. For easy compliance a robust and comprehensive IT system would be the foundation of the GST regime in India. All tax payer services such as registrations, returns, payments etc., are designed to be made available to the taxpayers online.
Benefits of GST regime:
- Removal of cascading effect in indirect taxation will ensure seamless tax credits throughout the value chain and across boundaries of States. This would reduce hidden costs of doing business making it more competitive.
- GST will ensure that indirect tax rates and structures are uniform across the country, thereby increasing certainty and ease of doing business and making choice of location of business, tax neutral.
- With a comprehensive IT system in place for administration of GST making all operations online, tax compliance will be much easier and cost effective.
- Business will be immensely benefited by embracing the ‘one nation, one market, one tax’ regime. The existing indirect taxation system created borders within borders where tax laws, tax rates differed from state to state leading to distortions in the allocation of resources and indirect taxes. Unavailability of Tax credits for interstate transactions was a major hindrance in taking business decisions.
- The GST regime will facilitate free movement of goods, reduced transportation time and costs with elimination of entry tax and Octroi.
- Reduction in transaction costs of doing business would eventually lead to improved competitiveness for trade and industry.
- The subsuming of major Central and State taxes in GST, phasing out of Central Sales Tax (CST) and comprehensive set off of input goods and services would reduce the cost of indigenously manufactured goods and services. This will enhance competitiveness of Indian goods and services in the international market giving a boost to Indian exports.
- GST rates for most FMCG goods having been kept lower compared to the previous rate should lead to more demand and increased consumption in the sector.
As worked out in the simple illustration provided above it is apparent that indirect taxes accruing to the government under the erstwhile central excise and sales tax regime appear more than what would accrue in the GST regime indicating a loss of revenue to the government. But in real terms there existed wide spread of tax evasion in the central excise and sales tax regime. This evasion is not possible in the GST regime as a robust IT infrastructure is the backbone of the tax administration in this regime. There is an inbuilt mechanism in the design of GST that would incentivise tax compliance by traders. The IT systems in place, by bringing down cost of collection of tax revenues of the Government, will lead to higher revenue efficiency. This gain in efficiency of revenue collection, prevention of leakages and elimination of cascading effect of indirect taxation is expected to provide relief in overall tax burden on consumers. Finally, there is a scenario of the state governments suffering some loss in revenue collection in the GST regime. To overcome this loss, central government has decided to offer 5 year compensation to states.