GST is an indirect tax that has subsumed most of the indirect taxes in India. Moreover, it is a type of value-added tax as it levy on different stages such as manufacturer, sales and consumption of goods or/and services. It is important how GST works in India and how the older indirect taxes used to work in India.
The taxation power in India is divided between the State and Centre. These powers are distributed among them as per the area where they can levy tax. Moreover, in India, there are two types of taxes direct and indirect taxes.
In the previous indirect taxation system, there were two problems. Let us understand these problems with an example, a shirt manufacturer manufactures a shirt, now the central government used to levy central excise duty on the shirt that adds to the cost of the shirt. Once the customer buys the shirt the state government collected the VAT (Value Added Tax). The compliance procedure for business was complex and for the government, it was cumbersome under this indirect tax regime.
GST is the biggest indirect tax reform in India was introduced in India with a motive of One Nation One Tax to remove all the taxation barriers between states and create a single market that will be opened to purchase and sell with in the country freely. Ultimately, the GST is providing economic freedom to Traders to freely trade without many compliances.
However, GST is beneficial to the common man too in two ways:
- All the taxes are collected at the point of consumption decreasing the cost of the product.
- Less tax burden as tax barriers are broken between the states and there is no cascading effect that used to happen in the previous indirect tax regime.
Let us understand how GST works?
Stage 1: The Manufacturer
If a shirt manufacturer buys raw material to manufacture a shirt worth 1000 INR and 60 INR tax. The manufacturer added the value of 300 INR to manufacture the shirt. Now the total value of the shirt became 1300 (1000+300). Assuming the GST rate on shirt be 5% that will be 65 INR. This applicable GST amount (65 INR) can be set off by the manufacturer against the tax paid by him on the raw material i.e., 60 INR. Hence the effective GST rate applicable will be only 5 INR (65-60). This makes GST as a value-added tax.
Stage 2: Distributor or Service Provider
The next stage is the stage where the goods are given to the distributor or service provider. The distributor buys the same shirt for 1300 INR and adds on the value to that shirt of around 200 INR. Now the value of the shirt will be 1,500 that is (1300+200). Under GST he will need to pay tax around 75 INR (5%) which again can be set off against the tax on the purchased shirt from the manufacturer that is 65 INR. Now the actual tax incidence under GST on the distributor will be 75-65= 10 INR.
Stage 3: Retailer
This the second last stage where the retailer gets the goods from the wholesaler or service provider. Taking the same example, the retailer adds a margin of 100 INR on the purchase of a shirt. The total cost of the product will become 1600 INR (1500 + 100). Under GST he will now need to pay tax (assuming a 5% rate of GST) that will become 80 INR that can be set off by him against 75 INR tax paid by wholesaler. Now the tax incidence under GST on the retailer will be 5 INR (80-75).
Stage 4: End Consumer
This amount of 1600 INR is borne by the end consumer purchasing this shirt.
Through the above examples are given in How GST works in India? We can conclude that GST is a value-added tax that provides benefits of an input tax credit on every stage excluding the end consumer stage. Hence, we can say that GST is one nation one tax providing economic freedom to the traders.