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How does GST Eliminate Tax on Tax?

With high expectations set from GST, a long list of benefits is being anticipated as a result of GST law. One such benefit is removal of the ‘cascading tax effect,’ which means eliminating ‘tax on tax.’ If you observe the current regime of indirect tax system in India, you will notice that the input credit chain is broken at certain points. For instance, CST (Central Sales Tax) is applicable on interstate trade, but it is otherwise non-creditable. Even a manufacturer is causing the chain to break by charging excise duty on sale to a dealer. But, where is it being credited? Levying tax on tax from production to consumption, leads to a situation wherein a consumer has to bear the load of tax on tax and inflationary prices as a result of it.

Interstate Sales

Following the previous tax structure, let’s assume a Manufacturer ‘Patel Industries’ sells Band saw machine from Gujarat to a Dealer ‘Hooda & Sons’ in Gurgaon, Haryana. Patel Industries is liable to collect both Excise Duty and Central Sales Tax at the rate of 12.5% and 2% respectively, since it comes under the inter-state sale. Now, further Hooda & Sons sells the same band saw machine to a manufacturer ‘Hitech Industries’ in Manesar, Haryana. Now, since the following sale is an Intra-state sale and has to happen on VAT, even though Hooda & Sons will be able to pass on the excise benefit to Hitech Industries, the 2% CST cost will become the part of the cost for Hitech Industries thereby escalating system cost and undue leakage.

Intrastate Sales

Although VAT was introduced in 2005 to overcome this cascading effect of taxes, and it even eliminated it from the State Indirect Tax, but due to certain central taxes, the problem of tax on tax persisted. The current VAT law does not permit excise duty and cess paid on purchases to be set off against supplier’s liability, which is added into system thereby increasing system costs in intra-state transactions as well.

Let us illustrate this through an example. Assume a motorcycle manufacturer, Rhonda Motorcycles. In the current tax regime Rhonda motorcycle sells motorcycle to its distributor Dev Automobiles at Basic Cost Price of ₹1,00,000 and current tax of 10% Excise + Cess and 10% VAT. Here, after 20% margin and 10% VAT to the customer, Dev Automobiles sells the motorcycle to end consumer in same state at ₹1,45,200.

Let us now assume that post GST, the overall taxes continue to remain @ 20%. Once GST regime comes in excise duty and cess will be replaced by CGST, and therefore it will be allowed to be set off against supplier’s liability. Now, Dev Automobiles will be able to sell the same motorcycle to the end consumer at ₹1,44,000.

Therefore, the end consumer gets benefited from the removal of tax on tax levy with GST implemented.

The above mentioned example is a very small fraction of the value chain, in contrast to the movement of goods that take a longer channel. GST in India allows for seamless flow of tax credit online, and aims to eliminate this cascading effect of all indirect taxes in the supply chain from manufacturers to retailers, and across state borders.

GST is set to become one of the biggest fiscal reforms that our country is going to experience. This paradigm shift in the indirect tax regime, will impact all businesses, whether small or large.

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