GST, or Goods and Services Tax is a new tax system that will combine different individual taxes such as VAT, Entertainment Tax, etc. into one single tax. This system is aimed at disincentivizing tax evasion, lowering prices over time, and most importantly- simplifying business operations.
The GST bill (One Hundred and Twenty-second Amendment Bill) was passed by the Rajya Sabha in August 2016 and will be effective in the country from 1st July 2017 (tentative), although it was proposed way back in 2014.
GST will significantly improve the business industry in India, as it will prevent unhealthy competition among different states of India, encourage tax payments, give a boost to Indian exports through tax benefits to small manufacturers, etc. In fact, it is also expected to increase the GDP as well (80 basis point rise according to HSBC). However, what is it exactly, and how does it work?
Before you learn about GST, it is important to first understand how our existing taxation system is structured.
The taxes levied in the country are broadly divided into two categories- direct taxes and indirect taxes. The direct tax, which is also the Income tax, is paid by an individual. However, the indirect taxes are more diverse and further divided into two categories- state taxes and central taxes, collected by the state government and the central government respectively.
As you can imagine, the existing taxation system is quite complicated. More than that the individual taxes, when combined, can end up becoming a huge amount which affects businesses negatively. With GST coming into action all these different taxes will be combined into just one simplified tax.
Although GST is a unified tax structure, it has three components (three different GST taxes) which are:
- CGST, or Central GST: It will take the place of a variety of Central Govt. taxes such as service tax, surcharges on the supply of goods/services, Special Additional Duty of Customs, etc.
- SGST, or State GST: SGST subsumes state govt. taxes such as entertainment tax, VAT, purchase tax, central sales tax, luxury tax, etc.
- IGST, or Integrated GST: IGST applies to import and interstate transactions. It will be shared by both the central and state governments.
So, by now it must be quite clear to you how GST simplifies the current taxation system. But how does it benefit a business and otherwise? Let’s consider an example.
GST works in three steps- from manufacturing to wholesale, and finally retail. Let’s discuss all these 3 one by one:
Step #1: Manufacturing
Let’s say a manufacturer of instant coffee buys raw coffee beans at Rs. 1000 per kg from a supplier. However, this price already contains a 10% tax:
10% of Rs. 1000= Rs. 100 (tax 1)
After producing the instant coffee, the manufacturer adds Rs. 200 to the price, making the final amount 1200. Once again tax is to applied on the price, which at 10% becomes:
10% of Rs. 1200= Rs. 120
Now, the manufacturer has already paid a tax of Rs. 100 when he bought the raw beans. So, according to GST he will only need to pay:
Rs.120- Rs. 100= Rs. 20 (tax 2)
Step #2: Wholesaling
The wholesaler buys the coffee pack at Rs. 1200. He adds an additional amount of say Rs. 100 for profit, making the final price at Rs. 1300. Again, at 10% tax that shall be applied on it the amount would be:
10% of Rs.1300= Rs. 130
However, since Rs. 120 has already been accounted for from the step 1, the effective tax applicable here is:
Rs. 130- Rs. 120= Rs. 10 (tax 3)
Step #3: Retailing
Coming to the final stage, the retail will buy the coffee at Rs. 1300. Since he also has to make a profit on the sale, he adds Rs. 100 to the buying price, making the final rate Rs. 1400.
At 10% rate of tax the tax amount becomes:
10% of Rs. 1400= Rs. 140
Now, since Rs. 130 is already accounted for from the previous two stages, the actual applicable tax is:
Rs. 140- Rs. 130= Rs. 10 (tax 4)
Taking a look at all the three steps, the combined final tax levied would be:
tax 1+ tax 2+ tax 3+ tax 4= Rs. 100+20+10+10= Rs. 140
Thus, a lot of tax money is saved by this system as the redundant taxes are dropped. Calculations have also become simpler this way as there are less numbers to take into account. This is how GST will make doing business a lot easier and simpler.
With GST likely to be implemented from 1st July, it is important that you prepare for the changes. You will need to calculate taxes differently and may also have to change the cost prices and selling prices of your goods and services. That being said, now is a really good time to go digital. With online invoicing and expenses management services you can greatly reduce the overhead and also increase accuracy in the business records. You will be able to track your cashflow