Goods and Service Tax: Part i

The Goods and Services Tax (GST) is a proposed Indirect Tax. The Lok Sabha has already passed the GST Bill; however, it is stuck in the Rajya Sabha. Some states are also opposing the GST fearing loss of revenues. The GST Bill, if passed, would transform India into one of the largest unified markets of the world.

To begin with, let us talk about two broad categories of taxes: Direct tax and Indirect tax. We have other different categories of taxes as well like specific tax, progressive and regressive tax but for the purpose to understand GST we will read about direct and indirect tax.

What is a direct tax?

Direct tax is a tax whose tax liability one can’t shift to someone else. For example, you work in a multinational company you draw the salary and on that salary you have to pay tax to the government which is the income tax. This tax is imposed on you the center and it’s you who has to pay the tax because you can’t shift the tax liability on someone else.

So, what is Indirect tax?

Indirect tax is the tax who tax liability on can shift to someone else. Let us read about three important indirect taxes in our country:

a)      Central Excise - Tax on production/manufacture of goods also known as CEN VAT

b)      Sales Tax – Tax on distribution of goods also known as SL VAT

c)       Service Tax – Tax on the production and distribution of goods and services(Those goods and services which are delivered at the same time)

Now these taxes and many other indirect taxes will be subsumed which is known as Goods and Service Tax (GST)

Before going into GST let us discuss what is VAT. What are the limitations of VAT that we have to go to GST. Now let us understand this with the help of an example

The farmer produces wheat and for example puts 10 as input and makes a profit of 20 and sells it for 30. He now sells this wheat to miller who grinds this wheat to make flour that makes a profit of 20 and sells it for 50. Miller now sells the flour to baker at the cost of 50 and the baker adds some other ingredients to bake the cake and sells it by making a profit of 40 for 90 to the shopkeeper. The shopkeeper now sells it to the customer for 100 making a profit of 10.

Let us now presume that central excise/state sales tax rate is 10% and this 10% is imposed on the output. Now imposing this 10% on output i.e. on 30 will be 3, the second stage 5 then 9 and lastly 10 which would sum up to 27. 27 is the tax liability under the stages of central and sales tax regime. The major drawback of this central and sales tax was it was imposed on every output hence increasing the total cost of production. This is where the central government came up with VAT.

 

What is VAT?

 

In VAT, tax is not on the final output but tax is on the value addition i.e. whatever value you add to your product the tax is on the value addition. Now for the argument sake say that VAT is 10%, (Output – Input = value addition) So, 10% of(30-10)=2, hence 2,4 and 1 respectively i.e. tax liability is this case is only 9.

Now you must be wondering that tax liability in case of Central and state tax was 27 but in case of VAT tax revenue is only 9, so this results in loss of revenue. Because in case of Central and state tax there was a lot of tax invasion, the tax was evaded at various stages and hence the government wouldn’t even get 9Rs nut in case of VAT entire 9Rs would be pocketed by the government. But there is problem with VAT here in India; we practice a modified VAT which is called CEN VAT and state level VAT.

     Drawbacks of VAT

In India we tax on the output but whatever the input are, those input costs are reimbursed back. Now what does that mean, for example 10%VAT is imposed on 30 the output of the farmer (Taken from previous example) will be 3, now 10% of the input (10) will be reimbursed back to the farmer i.e. 3-1=2, so 2 is the net VAT that farmer has to pay and so on. But there are some issues with VAT, for instance i am a manufacturer in Punjab and i manufacture Floor Tiles, to manufacture floor tiles i will need raw material and let us suppose i need the raw material from Rajasthan. But whatever the input cost I will have to be reimbursed by the state government but in this case it is interstate movement of goods (Material i am getting from Rajasthan to Punjab) but neither the Rajasthan government nor the Punjab government is reimbursing the input cost. So that is one aspect.

There is one other problem with VAT which is related to central state tax. Which we would discuss in the next part of our GST series.