How will GST work-explain with an example - Kotak Bank
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GST is a single tax on the supply of goods and services. That means the end consumer will only bear the GST charged by the last dealer in the supply chain. Several economists and experts see this as the most ambitious tax reform since independence. GST will eventually replace all indirect taxes levied on goods and services by the central and state governments, and is expected to liberate India of its complex indirect taxation structure.

Let's try and understand how GST will function throughout the value chain:

How did indirect taxes functioned earlier?

India’s constitution has divided the current taxation power fairly between the centre and states. Both enjoy their own share and exclusivity on respective taxes. Most goods attract a wide range of taxes including:

1. Central Taxes:

    a. Central Excise duty

    b. Duties of Excise (Medicinal and Toilet Preparations)

    c. Additional Duties of Excise (Goods of Special Importance)

    d. Additional Duties of Excise (Textiles and Textile Products)

    e. Additional Duties of Customs (commonly known as CVD)

    f. Special Additional Duty of Customs (SAD)

    g. Service Tax

    h. Central Surcharges and Cess

2. State Taxes:

    a. State VAT

    b. Central Sales Tax

    c. Luxury Tax

    d. Entry Tax

    e. Entertainment and Amusement Tax

    f. Taxes on advertisements

    g. Purchase Tax

    h. Taxes on lotteries, betting and gambling

    i. State Surcharges and Cess

To add to that, one has to pay a "tax on tax" throughout the value chain as well. However, in the current tax structure, businesses are not allowed to take tax credits, which leads to a high probability of double taxation at every step of the supply chain. This not only increases the taxes to as high as 24-27%, but also raises the end cost of the goods or services significantly.

How will GST transform the present indirect structure?

GST is an attempt to remove the geographical barriers and create a single market that is open to all, to buy, sell, import, and export within the country.

However, the impact of GST will not be uniform and will vary from one sector to another. The common man will benefit in two ways: first, all the taxes will directly be collected at the point of consumption, and second, consumers won’t have to pay a 'tax on tax'.

This way multiple tax points would be removed, cascading tax system would be eliminated and the eventual tax paid would be reduced in most cases. This in turn would lead to reduction in the cost of production, and by extension an increase in profits for the businessmen. A part of these benefits will eventually be passed on to the end-consumer as well.

How will GST work?

A product has to go through different stages before it reaches the end consumer, and there are several taxes applicable throughout this process. However, this situation will change in the GST regime. Here’s an illustration to understand how:

Stage 1: Manufacturing

Take apparel manufacturing as an example and 10% as the GST applicable.

The manufacturer buys raw material worth INR 500 that is inclusive of the GST of INR 50 (10% of 500).

He then adds his own value of INR 50 to the materials during the manufacturing process. This brings the gross value of the product to INR 550.

Now, the total tax amount on the output of the apparel comes to INR 55 (10% of 550) In the current tax system, the manufacturer would be required to pay a tax of INR 55; however, under GST he can set some of his tax off as he has already paid it while purchasing the raw materials. Therefore, the final GST that the manufacturer will incur will be of INR 5 (total tax amount till now minus the tax he has already paid) i.e. INR 5 (55-50)

Stage 2: Wholesale

Here, the apparel is passed from the manufacturer to the wholesaler at a gross value of INR 550 that is inclusive of the GST of INR 55 (10% of 550). The wholesaler then adds his value (his margin) of INR 50 making the total INR 600 (550 + 50). This brings the total tax amount on the final to INR 60 (10% of 600). Like the manufacturer, the wholesaler too can set off this tax amount with the tax that he has already paid for while purchasing the goods from the manufacturer. Thus, the final GST for the wholesaler would be INR 5 (60 – 55)

Stage 3: Retailer

In this final step, the retailer buys the apparel from the wholesaler at a gross value of INR 600 that is inclusive of the GST of INR 60 (10% of 600). He then adds his value or margin of INR 50 making the total cost of the goods INR 650. The GST applicable here is INR 65 (10% of 650), but since the retailer has already paid a tax while purchasing the goods, he can set it off. Thus, the final GST incidence for the retailer would be INR 5 (65 – 60).

At the end, since the retailer will sell the product at INR 650, the GST paid by the customer would be INR 65(10% of 650) only. This number would have been much higher in our current tax structure.

Thus GST can be a win-win scenario that will benefit the entire value chain and make it easier for both businesses and consumers. To know more about GST, check our other articles in the series.

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This Article is for information purposes only. The views expressed in this Article do not necessarily constitute the views of Kotak Mahindra Bank Ltd. (“Bank”) or its employees. The Bank makes no warranty of any kind with respect to the completeness or accuracy of the material and articles contained in this Article. The information contained in this Article is sourced from empanelled external experts for the benefit of the customers and it does not constitute legal advice from the Bank. The Bank, its directors, employees and the contributors shall not be responsible or liable for any damage or loss resulting from or arising due to reliance on or use of any information contained herein. Tax laws are subject to amendment from time to time. The above information is for general understanding and reference. This is not legal advice or tax advice, and users are advised to consult their tax advisors before making any decision or taking any action.