Goods and Service Tax (GST), easy understanding part 2


What is Goods and Service Tax (GST)? (part 2)


What is Goods and Service Tax (GST)

GST, frequently asked Questions


This post is 2nd part of information on Goods and Service Tax (GST).  If you have not read first part, Click here to read,  Goods and Service Tax Part 1


Let us continue..


What is VAT (Value Added Tax) ?

In VAT, tax is imposed not on the final output, but tax is on the value addition.  That means whatever value addition you make for a product, on that value addition you have to pay tax to government.

What is Value addition?

In simple words, value addition means output minus input.    For example, let us say, for argument; say VAT rate is 10%.   Here in 1st stage of our example, value addition is Rs.30 minus Rs.10.00 = Rs.20.00. So VAT is Rs.2.00 (ie. 10% of Rs.20.00).

Value Added Tax (VAT)

In stage 2nd of our example, VAT works out again to Rs.2.00 (10% of (Rs.50-Rs.30.00), under 3rd stage Rs.4.00 (10% (Rs.90-Rs.50) and in 4th stage Rs.1.00 (10% of (100-90).   So, total VAT payable in all process is Rs. 9.00 (under all stages of our examples).


What happens after introduction of VAT?

Under Value Added Tax (VAT) regime, the cost of the products decreases.  In other words, this is not tax on tax but tax on value addition.

Here, you might be wondering the reasons behind implementation of VAT instead of previous system by government who loses huge revenue?  What is the motivation of government to introduce VAT?

Under Central excise and sales tax regime, tax accrued by government is Rs.27, whereas after introduction of VAT, the tax to government is only Rs. 9.00. Is not this a loss of revenue to government? Yes, off course this is a loss of revenue to government.  But in Central excise and sales tax regime, there is wide spread of tax evasion.  The tax was evaded at different stages and ultimately the government would even do not get even Rs.9.00 in our example.   But in case of VAT regime, entire Rs.9.00 would be pocketed by government.  Unwanted procedures and formalities can be abolished by simplifying VAT regime.


How does this possible and reasons? 

Let us again go back to our different stages of examples explained above.

Under central excise and sales tax regime, let us assume we will eradicate all these stages.  For example, farmer produces wheat, he grinds the wheat to flour, he himself bakes the flour in to cakes and he sells.   So what is the input cost?  Rs.10.00, and what is the final cost of product? Rs.100.00.  The tax on the output of Rs.100.00 works out to Rs. 10.00 (at 10% as per our example).  So in this example, an amount of Rs.10.00 is accrued by government.  That means if you reduce the number of stages in the entire process, the tax available to government will be less.


But let us take the VAT regime; even if we reduce the successive stages, the tax is on value addition.  That means in this cases, the value added from Rs.10 to Rs.100. That means Rs.90 is added as value addition.  10% of tax on Rs.90.00, that means Rs.9.00. Is not the same amount that the government would get in VAT regime?  Even after the stages reduce, the government gets the same revenue.   That means tax on value addition and not tax on tax.


There is an interesting thing here.  Under all these stages, invoices or receipts have to be maintained. That means, if the baker has to get flour from the miller, he has to ask the miller for invoice.   If the miller does not provide invoice, the baker has to pay tax for the entire amount of his sale invoice value. Here in our example, tax amount for Rs. 90.00 instead of Rs.40.00 (Rs.90 – Rs.50.00) actually to be paid.  In short, invoices must be maintained in each successful stage of transactions by all parties.  So if any tax invaded at one stage, that tax is captured at the second successive stage.   So this is one of the most fascinating successful stages of value added tax (VAT).   This is the reason for introducing VAT to this country and cascading nature where tax on tax is eliminated in turn cost of production decreases.

But again there is problem in VAT.  In India’s case we do not have VAT. The ideal form of VAT has not been practiced by India. We practiced a modified form of VAT.  That is CENVAT at central level and State VAT in state level.


What is the methodology India adopts under VAT?

In case of India, tax on the output cost is estimated.  But whatever the input costs, those input costs are reimbursed back.


What does reimbursement of VAT means?

Reimbursement of VAT means that the tax paid on inputs is reimbursed back.  In our example stage 1, the farmer has to pay VAT only for Rs. 20.00 (ie, Rs.30-10).  In other words tax on Rs.10.00 (input) is reimbursed to farmer.  (This example is only for understanding purpose, as the farmer is exempted in paying VAT in many cases).


So, in our example stage:2,  the value addition is Rs.20.00 (ie., Output of Rs.50.00 minus input of Rs.30.00).  Here, the miller pays VAT of 10% on value addition ie. Rs.2.00.


Let us take, example stage: 3.  The value addition works out to Rs.40.00 (Rs.90.00 – Rs.50.00) and pays VAT of Rs.4.00 (at 10% of Rs.40.00)


Here in example stage:4, the shop keeper pays VAT of Rs.1.00


But there are some issues with VAT.  What are those issues?

Suppose I am a manufacture of tiles in Delhi.  I manufacture Tiles.  To manufacture tiles, I need raw material.    Suppose I get raw material from Rajasthan.   Here, whatever the input cost, I have to be reimbursed by government.  But in this case, it is interstate movement of goods- interstate movement of raw material.   When I get raw materials from Rajasthan to Delhi, neither the Rajasthan government nor Delhi government is reimbursing the input cost. This is one aspect.  There is another problem with VAT.  This problem is related to Central Sales Tax.  Now the idea of Central Sales Tax is inconsistent with the idea of goods and service tax.

What is the central Sales Tax?  For example, there is movement of goods from Karnataka to Tamil Nadu. On the boarder of these two states, the central government levies central sales tax, let us says 2%, and collects this tax and sends this amount of tax to the originated state.  In this case, the amount of tax is sent to Karnataka.  But what happens to this system of tax collection? For example, the goods from Karnataka are valued at Rs 10.00. After imposition of central sales tax it becomes 12 and it is possible in Tamil Nadu, these goods will not be competitive in the competitive nature of Tamil Nadu economy.  So this is discrimination of part of government those goods originated from different state and those goods that have been sold in the different state.   That means in Indian case, there has to be a seamless movement of goods.

Not only the above problem, but there is another problem.  The recent media research report proves that dwell time on interstate movement of goods is exorbitant.  Means, it takes huge time to move goods from one state to another especially in check post to clear central sales tax issues.   60% of extra time wasted as parking at interstate check posts, researchers say due to present sales tax and excise duty system.


What is the solution for the above issue on tax collection? 

The solution is central sales tax has to be abolished, all indirect taxes to be abolished.  What are these indirect taxes?  For example, I go to a restaurant.  I list out the items that I have to drink and eat.  At the end, I do not have only to be paid on the items I have consumed, but I also have to pay VAT, let us say 14.5%, I have to pay service tax, some time I also have to pay entertainment tax, some time I also have to pay education Cess etc.  That means there is very complexity.  Why are we having these much indirect tax on consumer?  Why not simplify this tax regime so that all these indirect taxes are subsumed in to one tax.  That is what Goods and Service Tax going to do.   How does GST work? Click here:  GST, Goods and Service Tax in brief and simple.

It is a destination based tax on consumption of goods and services.  It is proposed to be levied at all stages right from manufacture up to final consumption with credit of taxes paid at previous stages available as setoff.  In a nutshell, only value addition will be taxed and burden of tax is to be borne by the final consumer. 

GST, Goods and Service Tax in brief and simple. Click here.

This post explains about Goods and Service Tax (GST) in simple language.  Would you like to add more information about GST to make people understand easily?


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Deepak Pillai: Fantastic explanation.....apart from political reasons, what are the core differences. Also some states on agree mode and others looking differently !!!

himanshu jain: Best explanation

Krishna: The way of explanation about GST in simple way is great.

Sanyam Jain : I own and operate a small business in New Delhi whereby I import and sell musical instruments to businesses and directly to customers. I also host and organize music clinics and music shows and provide music consultation services. A) Musical Instruments The current base import duty rate on musical instruments is 10% and after applying Counter Vailing Duty (CVD) and other slabs, the total import duty imposed is approximately 29.5%. The Delhi VAT rate applicable is 12.5%. Under CST, musical instruments will be taxed at 28%. Question 1 - What would be the total tax burden (in USD) on me to import a product worth $100, on which shipping paid is $10? Question 2 - Currently, if I need to sell a product to a Delhi based business, all I need to do is acquire the business's VAT No. and issue a tax invoice. Similarly, if I need to buy a product from a Delhi based business I need to provide my VAT number to the supplier and can later avail the credit. Interstate purchases and sales are done using C-Forms How would local and interstate sales and purchases work under GST? B) Entertainment Tax Currently for hosting and organizing events, different rate of Entertainment Tax is applicable in different states. Question - What would be the applicable rate(s) of entertainment tax under GST? C) Music Consultation Services Question - What would be the applicable rate of tax on music consultation services? Any help provided will be much appreciated

Ngvaishnaw: Sir, In the above Example you are saying that in second stage miller will pay addition of 20(50-30)& he pay Rs.2 for tax ok, but a kirana merchant purchase daily and how can he know the purchase amount that should be deducted in selling price and remaining profit will be taxable as per law

HARI PARKASH SINGHAL: There is 5% GST on registered branded pulses. Simply printed a brand name on the begs are exempted, being unregistered brand. Suppose 'Double Horse' is a Registered Brand name of 'A', related to 'Moong Dal'. 'B' also used to print 'Double Horse' on 'Toor Dal' bags, but it is not a registered brand of 'B', 'B' sold his goods to 'C' and the Taxman (the Taxman might have the list of registered brand names with them) detained these goods, being untaxed with a brand name. Is there liability of tax.

Sanyam Jain : What would be the total tax burden (in USD) on me to import a product worth $100, on which shipping paid is $10? The current base import duty rate on musical instruments is 10% and after applying Counter Vailing Duty (CVD) and other slabs, the total import duty imposed is approximately 29.5%. The Delhi VAT rate applicable is 12.5%.

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