Classroom – Goods and Services Tax 101 (GST)

Last week, the Indian Parliament passed what would be the single most important tax reform after 1947, the GST bill, which will, according to Anand Mahindra, unleash the tiger.

“In 1991, a new liberalized India was born. I believe 2016 will propel India to reach its true potential. After the sweeping FDI reforms in June, the Rajya Sabha passed the landmark GST Bill last week, which I truly believe will unleash the ‘caged tiger’ – India’s huge common market – which for inexplicable reasons, we had kept divided,”


What is GST?

The Goods and Services Tax (GST) is one single tax on any supply of goods or services. When the GST comes into effect, our current indirect taxation method, a bane for businesses and boon for corruption, will give away to a cleaner direct method that will replace a dozen indirect taxes levied by both the center and the state. It will encourage tax compliance and streamline tax credits. The dozens of taxes currently levied are VAT, CST, central excise, state excise, service tax, CVD, SAD so on and so forth.

How would it work?

It works by a system of set-offs and credits. Let’s start with a pencil manufacturer. He buys raw materials, wood, lead and rubber worth Rs 100 which includes a tax of Rs 10. He uses the raw materials to make a box of pencils. In the process of making a pencils, he adds value of Rs 30, and will therefore sell the box of pencils for 130 rs.

At a tax rate of 10%, he will then have to pay Rs 13 as tax output. However under GST, he can set the 13 against the 10 he already paid in effect and only pay the difference of Rs 3.

The Pencil manufacturer has of course now sold that pencil to a wholesaler for Rs 130. The wholesaler adds a margin of Rs 20 and sells it on to a shop for Rs 150. Let’s assume he pays another tax of 10% which would make it Rs 15. But again GST would mean, he offsets the Rs 15 against Rs 13 of tax already paid. His effective tax outflow is only Rs 2.

Finally the box goes to the retailer for Rs 150, who adds value by way of Rs 10 and sells it to you for Rs 160. The gross tax on this would have been 10% or Rs 16. But the retailer again, offsets Rs 16 against the total of rs 15 that has been paid so far and pays Rs 1 in taxes.

Before GST, there was a lot adding taxes on taxes and something that should have cost you only Rs 160, would have ended up costing you Rs 208 because no one wants to actually bear taxes themselves. Currently we have a VAT system, where there is some offsetting but VAT does not cover Luxury and entertainment tax or octroi.

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