[Goods and Services Tax] Part 2: GST explained

Hello everyone. In the previous part, we discussed the system of indirect taxation prevalent before 1^st of July. In this part, we will see what changes the GST system brings to the table. I strongly recommend that you read the first part before proceeding. 

What is GST?

GST has been defined as any tax on supply of goods and services other than on alcohol for human consumption. It has three important properties:

- It has a one nation-one tax structure. This means it will subsume many indirect taxes like VAT, CST, Excise, Service tax, etc.

- It is a destination based tax. This means the taxing authority is the place where goods are supplied to and not where the sale originates.

- It has a VAT like structure. This means that taxes paid at previous stages will be available as setoff at the subsequent stage.

Normally when you (the consumer) buy something, you will see two components of GST – Central and State. This is because when a sale is made within a State (say Tamil Nadu), GST will be shared between Center and the State. In case the sale takes place across two States, IGST (Integrated GST) will be levied.

Under CGST, the present central taxes of Central Excise Duty, Central Sales Tax CST, Service Tax, Additional excise duties, etc. will be subsumed. Please keep in mind that the revenue collected under CGST is for the Centre. Similarly, under SGST, the indirect taxes at the state level will be subsumed. These include VAT, luxury tax, entertainment tax, taxes on lottery, etc. The revenue collected under SGST is for the state government. IGST is charged on the movement of Goods and services across the states. For e.g. if the goods move from Tamil Nadu to Kerala, IGST will be levied. The revenue collected from IGST is shared by the state government and central government as per the rates fixed by the authorities. In order to ensure smooth operations, the goods & services to be taxed as well as other essential design features of the GST would have to be common between the Center and the States.

GST and its administration

GST will be administered by the GST council. It will be the apex policy making body consisting of Central and State ministers in charge of the finance. The Council will make recommendations on model GST laws, its rates, place of supply rules and any other matters relating to GST. It has been alleged in the past that GST will lead to surrender of financial sovereignty of States to the Center. This is misrepresentation of truth. Yes, the states earlier had the right to tax transactions in their territory. Now it is both center and the states through the GST council which will levy taxes. They have not surrendered their sovereignty rather both the center and states have ‘pooled their sovereignty’ together to streamline and better manage the taxation of goods and services in India. The Centre will levy IGST on inter-state supply of goods and services. States will have the right to levy GST on intra-state transactions. Petroleum and petroleum products, i.e., crude, high speed diesel, motor spirit, aviation turbine fuel and natural gas, shall be subject to GST from a date to be notified by the GST Council. Still they are under the earlier system. It has also been decided that the Area upto 12 nautical miles will be under Central administration. However, States can collect tax on economic activities carried therein. Stamp duties which are levied on legal agreements by states, will continue to be levied separately.

So what are the expected Benefits of GST?

The main benefit that is expected is that it will be a simple and efficient taxation system. This should encourage tax compliance.  Besides, GST will also help in creating a wider tax base. This is necessary for lowering tax rates. In the current system, since compliance is low, the honest tax payer pays not only his own share, but also of the evader.

Elimination of multiple taxes and their cascading effects will lead to a reduction in price, provided the tax rates do not increase. The system of input tax credit (ITC) which allows for offsetting of all indirect taxes paid at earlier stage is the biggest reform. Earlier, since central and state taxes were completely isolated from each other and were administered separately, there was no scope of offsetting taxes paid to the center or state against the other. (Refer to the illustration in part 1). Harmonization of center and state tax administrations would also reduce duplication of efforts and cut red-tape. Additionally, the new automated system of GSTN would reduce errors and ease up the return filing procedure.

Challenges in the current system

Most important one is the multiple slabs of GST rates. In the current model, there are 4 rates of 5%, 12%, 18% and 28%. Besides, there are number of items such as raw agricultural produce which is zero rated and some luxury goods and those with negative externalities which attract a cess over and above the rate of 28%. This has made the system highly complicated. A silent drawback of this system is that of lobbying. Many producers or service providers, especially in the food processing sector would want their products to be zero rated or so. This may give rise to unscrupulous classifications in order to escape taxation. One more drawback of the earlier system which GST does not address adequately is the number of compliance forms to be submitted to the authorities. Certainly the compliance and registration for firms operating in multiple states has become easier, but not to the extent expected. For example, a firm operating in say 20 states will still have to submit like 400 odd documents, although most of them would be automated. So there is still scope of improvement here.

Concept of Revenue Neutral rate

It is the tax rate that allows the government to receive the same amount of revenue despite the change in tax laws. Currently, the total incidence of indirect tax in most of the states is about 30%, which includes 12% excise, 14% VAT and other taxes, depending on the good. Under the GST regime, if the average incidence of taxation comes out to be, say 20%, the government will lose out on revenue. Moreover, there with the system of input tax credit (ITC), any tax paid at earlier stage will be offset at a later stage, i.e. one can claim a return of tax from the government if one presents the invoice (similar to the concept of VAT which I have discussed in Part 1). This will also lead to reduction in revenue collection for the government. Therefore, the effort was to make sure that tax rates are such that revenue of the government does not decrease. The average GST rate which ensures this is called revenue neutral rate. It is the rate at which tax revenue will remain the same, despite allowing input credits, exemptions, etc.

Now calculating RNR is not the same as simply adding the current state and central taxes together. For example, having a combined tax rate of say 30% (~12% of center and ~18% of states) would be considered too high. As such, there would be less incentive for people to comply at such a high rate. Therefore, RNR should be such that it inspires compliance as well. It should thus take into account the expected benefits such as widening of tax base in its calculation.

Ideally, one would have wanted only one rate in GST which is RNR. We have ended up having multiple. The rationale was – combine all the taxes levied and put the goods into those tax slabs which are closest to their existing rates. Political compulsions of competitive populism have forced such absurdities like different rates for rasmalai, gol-gappe and samosa. Eating in an AC restaurant attracts higher rate than a non-AC one. Morning shows of bhai ki movies which cost less than Rs. 100 will attract lesser tax rate as compared to evening shows. Same movie, same hall, same bullshit. Socialist hangover.

GST on international trade- Imports and Exports

Since GST is a destination based tax, exports would be zero-rated as the sale is not made in India. Zero rated does not mean exempt. They will be eligible for full duty drawback. Of course they will have to pay customs duty. Please note customs duty is not part of GST. Imports would attract tax in the same manner as domestic goods and services. They will be subjected to a basic customs duty when they enter the territory of India. After that, they will be subjected to IGST.

At last let us compare the GST system with the existing system through the same illustration which we took in the previous video. The bat was sold from UP to a wholesaler in Maharashtra, say Nagpur, who sold it to a showroom in Mumbai for selling to a final consumer. Assume cost of manufacturing the bat to be 100 rupees with each party in the transaction wanting to earn a profit of 100 rupees. Further assume a GST of 10% (CGST and SGST of 5% each) and an IGST of 10%.

First, the manufacturer sells it to the wholesaler for Rs. 200+taxes. Since it is an interstate sale, IGST @10% is levied. Hence the cost for the wholesaler is 220 rupees. Next, the retailer in Mumbai purchases the bat for Rs. 320 + taxes. Tax in this case will be 5% CGST and 5%SGST, i.e. Rs. 32. Now this will be offset against the tax already paid, i.e. 20 rupees. Therefore tax paid is 32-20, equals 12 rupees. Thus, the retailer purchases it for 320+12=332 rupees. Finally, the consumer will pay Rs. 432+taxes. Again, 5%SGST and 5%CGST will be levied and offset by the tax already paid. Hence, the tax incidence is 43.2 minus 20 minus 12, i.e. Rs. 11. Hence the final cost to the consumer is 432+11, equals 443 rupees. 

Tax under new regime:

Tax under old regime:

As can be clearly seen, the bat which cost Rs. 477 in the previous regime will cost only Rs. 443 in the current regime, assuming the tax rates remain the same. This is possible only because of this offsetting mechanism - central and state taxes being offset against each other.

I hope that with this illustration, your conceptual understanding of GST is clearer. If you have any doubts, do let me know and I will try to address them.

Thank you very much. Cheers!