What is GST? Goods and Services Tax Explained

what-is-gst

Goods and Services Tax (GST) is the most remarkable indirect tax reform of post-independent India. It aims to charge a single national uniform tax all over India on all goods and services.

With the introduction of GST, several central and state taxes have been turned down. This new tax regime is transforming India into an integrated national market while incorporating more producers & service providers into the tax slab.

Along with improving the efficiency of the tax collection system, GST has substantially enhanced the growth of government finances.

Goods and services tax has created a continuous chain of set-off from the original producer and service provider to the retailer’s level. Hence it has eliminated the burden of the cascading effects of the indirect tax system.

GST taxes only the final consumer of the goods and services so, the cascading of taxes (i.e. tax-on-tax) is avoided, which results in the reduction of the overall cost.

GST has been designed with a prime objective to provide India with a world-class tax system and expand tax collections. It has also ended the long-established falsifications regarding the differential treatment of the manufacturing sector and services sector.

What is GST?

GST is a multi-stage tax scheme that is comprehensive and applicable on the sale of all types of goods and services. Unlike previous indirect tax systems, GST is collected at the point of consumption and not at the point of origin.

In general terms, GST can be visualised as an all-inclusive, composite, destination-based tax collected on every value addition in the process.

This new tax regime has been implemented across the country since July 2017. The foremost characteristic features of GST include:

Multi-stage taxation system

The supply chain of a product involves multiple stages before it is finally consumed by the end-user. These stages include purchasing raw materials, manufacturing the product, selling the product to the wholesaler and then finally retailer selling the product to the consumer.

GST rate is levied on each & every stage described here, making it a multi-stage tax.

Destination-based tax

Goods and service tax is collected at the point of consumption of goods or services. For example, if the product is manufactured in Delhi and is sold to the final consumer in Maharashtra, then GST will be levied and collected by the Government of Maharashtra and not Delhi.

What are the components of GST/different types of GST?

  • Central Goods and Services Tax (CGST): CGST applies to the intrastate supply of goods and services.
  • State Goods and Services Tax (SGST): SGST, similar to CGST, applies to the transactions of goods and services done within state boundaries.
  • Integrated Goods and Services Tax (IGST): IGST applies to the transaction of goods and services between different states or at the inter-state level.
  • Union Territory Goods and Services Tax (UTGST): This tax is levied on the supply of goods and services in any of the Union Territories in the country. UTGST is collected along with CGST.

The supply of goods or services within a particular state will be accountable under CGST & SGST. This denotes that the revenue collected from such transactions is shared equally between the centre and the respective state.

Before GST was introduced, these transactions were subjected to Value Added Tax (VAT), central excise duty or service tax.

For example, suppose a service provider in Rajsthan has rendered services to a client in Karnataka amounting to Rs. 2,00,000. In this case, only IGST of 18% will be collected on this service. So the service provider will charge Rs. 36,000 as IGST levied by the central government.

How does Goods and Services Tax works?

GST being a multi-stage taxation system, functions in the following manner:

  1. At the manufacturing stage: The manufacturer pays GST on the procured raw material and the value that has been spent to make the product.
  2. At the service provider stage: At this stage, the service provider is liable to pay GST on the amount that has been paid for the product and the value that has been further added to it. But the tax paid by the manufacturer should be reduced from the overall GST amount payable at this stage.
  3. At the retailer stage: The retailer further pays GST on the products he purchases from the distributor, including the margin which has been added to the final price. However, this tax that has been paid by the retailer needs to be reduced from the total GST that is payable.
  4. Final consumer: The consumer pays GST on the product or services that he purchases.

Advantages of GST

With the introduction of the goods & services tax, the cascading tax effect on the sale of goods and services has been removed, which has positively influenced the price of goods. Hence this new GST regime abolished the tax on tax effect, due to which the cost of goods and services has significantly decreased.

It’s noteworthy that GST is a technology-driven tax collection system where the different activities (like registration, refund application, and return filing) need to be done online through the GST portal, which has ultimately accelerated & simplified the tax collection processes.

GST has replaced around 17 indirect taxes that were levied earlier. This simplification of taxes has streamlined the overall process and automatically eliminated the compliance cost for the companies.

The former fragmented market structures across different state lines are now unified, along with a sharp reduction in the cost of goods and services. The onset of the new GST tax regime has helped the un-organised sector to come directly under the regulations of the goods and service tax norms.

How GST has helped in reducing prices?

With the help of an example, we will try to understand how the introduction of GST has reduced the cost for end consumers.

Suppose a manufacturer produces certain goods (tax rate applicable is 10%) worth INR 2,000 and sends them forward to a warehouse for packaging and other finishing works.

The warehouse further adds Rs. 500 to the existing value of the goods. Then these goods are sold to the retailer. The retailer spends some amount on the advertisement and adds a cost of Rs 400 to the goods.

The following table represents how the value of the goods & tax proceeds and the final effect on the price as per the old tax laws.

Cost ParticularsCost (Rs.)Tax at 10% RateTotal cost (Rs.)
At manufacturing stage20002002200
Warehouse further adds Rs 500 for labelling & finishing works27002702970
Advertisement expenses of Rs 400 added by the retailer33703373707
Total29008073707

In this tax system, the tax liability was transferred to every next stage, and the final price ultimately comes on the end consumer. This condition is an example of the cascading effect (tax on tax). Now the tax calculation as per the GST norms is as follows:

Cost ParticularsCost (Rs.)Tax at 10% RateTax liability payable to the governmentInvoice Total (Rs.)
At manufacturing stage20002002002200
Warehouse further adds Rs 500 for labelling & finishing works2500250502750
Advertisement expenses of Rs 400 added by the retailer2900290403190
Total2900  3190

From the table above, it is clear that the taxes already claimed in the previous stages under GST should be adjusted to the next stage of tax liability at the time of filing GST returns. This is known as an input tax credit.

The effect of input tax credit reduces the final value of the goods from Rs. 3707 to Rs. 3190, ultimately reducing the tax burden on the consumers.

In Conclusion

Thus GST is an encouraging step towards transforming India’s economy from the informal to the formal sector. It is essential to utilise experience gained from global economies that have implemented GST in the past to overcome the forthcoming challenges. To know more about the GST registration process, you can click here.

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