From the number of queries we @ vakilsearch are getting about GST, there still clearly is a lot of confusion about GST. Particularly about "Input Tax Credit". Here, I've tried covering the very basics. Hope it'll help!
What is GST?
The Goods & Services Tax (GST) is a multi-stage, destination-based tax that will be imposed at every instance of value addition to the product.
What does it mean?
Every item goes through multiple steps in the production chain. The purchasing of raw materials that are needed to make a product is the initial stage. Then comes the production or the manufacture. Next, is the warehousing of the materials, the sale of the product to the retailers and the final stage is when the retailer sells this product to the end of finishing the cycle. The GST will be levied at each and every stage of this process and hence it is referred to as a multi-stage tax.
Let us assume that the entire manufacturing process of a particular product is happens in Karnataka and the final sale is in Delhi. The tax is levied at the point of consumption, so the state of Karnataka will get the revenue in the manufacturing and the warehousing stages, where as it will lose the revenue when this product travels out of Karnataka and reaches the end consumer in Delhi. This means that Delhi will earn the money made on the final sale, because the GST is a destination-based tax and this revenue will be collected at the final point of sale which is in Delhi.
What is the present model?
The structure of the Indian tax is presently divided into two parts – Indirect and Direct Taxes. The Direct Taxes are levied where the liability cannot be passed on to someone else. For the Indirect Taxes, liability of the tax can be passed on to someone else. Which means that when a shopkeeper must pay VAT on his sale, he can pass on the liability to the consumer. So, the consumer not only pays the price of the item but also the VAT on it so that the shopkeeper can deposit this VAT to the government. Hence, the consumer ends up paying not just the price of the product, but also the tax liability, and therefore, he has a higher outlay when he buys an item.
This happens because the shopkeeper pays the tax when he buys the item from the wholesaler. To get that amount back, and to make up for the VAT he must pay the government, the shopkeeper passes this liability to the customer who pays the additional amount. At present there is no other way for the shopkeeper to recover the amount he has paid from his own pocket during the transactions and therefore, he is left with no choice but to pass on the liability to the customer.
What is the new model under GST?
This issue will be addressed after the Goods and Services Tax is implemented. It has a system of Input Tax Credit which allows the sellers to claim the tax already paid, so that the final liability on the end consumer is reduced.
CGST: Revenue collected by the Central government
IGST: Revenue collected by the Central government for the inter-state sales.
SGST: Revenue collected by the State governments for the intra-state sales
This new system allows for easier collection of the revenues and it reduces the red tape involved in submitting the tax returns and such as it reduces the number of taxes a person pays.
Input Tax Credit - A hypothetical scenario:
To understand this better, we first have to understand the concept of Input Tax Credit. It is the credit a person receives for the tax he has paid on the inputs used in creating the product. Hence, if there is a 10% tax that the individual has to submit to the government, then he can subtract the amount he has already paid in taxes at the time of the purchase and submit the balance amount to the government.
Let us look at hypothetical numerical example. For the purposes of this theoretical example, let us assume that there is no profit or loss involved.
Say a bag manufacturer pays Rs. 100 to buy raw materials. If the rate of taxes is set at 10%, then he has to pay Rs. 20 as tax. So, the cost of the bag has now become Rs (100+20) = 120.
At the next stage, the wholesaler buys the bag for Rs. 120, and then adds the labels and the branding to it. By doing this, he is adding value. Hence, his cost increases by say Rs. 40. On this, he has to pay a 10% tax, and the final cost therefore becomes Rs. (120+40) = 160 + 10% tax = Rs. 186.
Now, the retailer pays Rs. 186 to buy the bag from the wholesaler because the tax liability has been passed on to him. He now has to package the bag and when that happens, he is adding value yet again. This time, let’s say his value add is Rs. 30. Now when he sells the bag, he adds this value (plus the VAT he has to pay the government) to the final cost. So, the cost of the watch becomes Rs. 247.6. The breakup for it is as follows:
Cost = Rs. 186 + Value add = Rs. 30 + 10% tax = Rs. 216 + Rs. 31.6 = Rs. 247.6
So, the customer pays Rs. 247.6 for a bag the cost price of which was only Rs. 170 (Rs 100 + Rs. 40 + Rs. 30). The tax liability was passed on at every stage of the transaction and the final liability comes to rest with the customer. This is called the Cascading Effect of Taxes. Here a tax is paid on tax and the value of the item keeps increasing every time this happens.
Under the new model, there is a method to claim the credit for the tax paid in acquiring input. In this the individual who has paid a tax can claim the credit for this tax when he submits his taxes.
In the above example, the wholesaler buys from the manufacturer, he pays a 10% tax on his cost price because this liability has been passed on to him. He adds value of Rs. 40 on his cost price of Rs. 100 and this gets up his cost to Rs. 140. Now he has to pay 10% of this price to the government as tax. But one tax has been already paid by him to the manufacturer. So, this time instead of paying Rs (10% of 140=) 24 to the government as tax, he subtracts the amount he has already paid. He deducts the Rs. 20 he has paid on his purchase from his new liability of Rs. 24, and only pays Rs. 4 to the government. So, the Rs. 20 becomes his input credit.
When he pays Rs. 4 to the government, he can pass on the liability to the retailer. So, the retailer pays Rs. (140+24=) 164 to him to buy the bag. After this, the retailer then adds value of Rs. 30 to his cost price and pays a 10% tax on it to the government. When he adds value, his price becomes Rs. 194. If he now has to pay 10% tax on it, he passes on the liability on to the customer. He already has the input credit because he has paid Rs.24 to the wholesaler as the latter’s tax. So, he now reduces Rs. 24 from his tax liability of Rs. (10% of 194=) 29.4 and then has to pay only Rs. 5.4 to the government. And therefore, he can now sell the bag for Rs. (164+30+5.4) 199.4 to the customer.
Every time an individual was able to claim the input tax credit, the sale price for him went down and the cost price for the person buying this product reduced because of a lower tax liability. The final value of the bag also went from Rs. 247.6 to Rs. 199.4, thus reducing the tax load on the final customer.
Hence the Goods & Services Tax should have a two-pronged benefit. It will help reduce the cascading effect of taxes, and by allowing the input tax credit, it will help reduce the burden of taxes which will hopefully reduce prices.
What does the Goods &Services Tax replace?
The GST replaces numerous different indirect taxes like:
1. Advertisement taxes
2. Central Excise Duty
3. Central Sales Tax (CST)
4. Entertainment Tax
5. Countervailing Duty
6. Luxury tax
7. Entry Tax
9. Service Tax
10. Purchase Tax
11. Value Added Tax (VAT)
12. Special Countervailing Duty
13. Taxes applicable on lotteries
GST is normally applicable to Businesses
All kinds of manufacturing, trade, commerce, vocation, profession or any other such activity, regardless of their total frequency or volume are included in the term “Businesses”. Supply of the goods and the services for starting or closing a business are also included in it. The Services refers to anything other than goods.
The GST is applicable to persons in certain cases
The term “Persons” includes but is not limited to: HUFs, Individuals, LLP, Company, Co-operative societies and Trusts.
However, the GST is not applicable to Agriculturists. Agriculture has been defined to include horticulture, floriculture, sericulture, raising of grass, crops or garden produce. Poultry farming, dairy farming, stock breeding, rearing of seedlings or plants or gathering of fruits are, however, not included in it.
Cases in which GST registration is compulsory:
When the turnover of the any business exceeds Rs. 20 lakhs in a financial year, the GST registration and collection becomes necessary. However, the threshold limit in the north-eastern states is Rs. 10 lakhs.
The aggregate turnover is the total value of all the exempt supplies, taxable supplies, exports of goods and/or services and the inter-State supplies of a person having the same PAN, to be calculated on an all India basis and this excludes taxes, charged under the CGST Act, SGST Act and the IGST Act.
Cases where GST registration is necessary irrespective of turnover
• For all businesses providing inter-state supply of goods/services
• For all businesses who supplies goods/services in a taxable territory but don’t have a fixed place of business. These are called casual taxable persons. These registration are valid for a period of 90 days.
• For a business who supplies goods/services and has no fixed place of business in India. These are referred to as non-resident taxable persons. These registration are valid for a period of 90 days.
• For a person who is required to pay tax under the reverse charge mechanism. This mechanism is used when the person who receives the goods/services pays the tax instead of the supplier having to pay it.
• For agents or other person who supplies on behalf of any other registered taxable persons
• For a distributors or an input service distributors who may have the same PAN details as the office of the supplier. This person is an officer of the supplier, he receives the supplies and issues the tax invoice to distribute the credit of the CGST/SGST/IGST.
• For an e-commerce operator
• For any person who supplies via an e-commerce operator except when it is a branded service
• For an aggregator supplying services under his own brand name
• For a business supplying online database and information access or retrieval services from any place outside India to a person in India, other than a registered taxable person.