Comprehensive Guide to How GST Works in India | Definition; Rates; Objectives

What is GST in India?

GST is a single internal indirect tax law for the whole country. It replaced many indirect taxes in India, for example, excise duty, VAT, services tax, etc. The Parliament created the Goods and Service Tax Act on 29th March 2017 and came into effect on 1st July 2017.

GST is the biggest indirect tax reform in India with 2 basic reasons for One Nation One Tax:

  1. in order to remove all the taxation barriers between states and create a single market that will be open for purchasing
  2. to sell within the country freely. All in all, the working of GST is providing economic freedom to traders to trade without many compliances freely.

Let's take a closer look at what direct and indirect taxation means. Each country's government needs a steady flow of income to run the country properly, and of course, taxes are the main source of this revenue. With the help of taxes, the government can ensure the well-being of a large part of the population.

There are mainly two types of taxes in India:

  • direct tax
  • indirect tax

Direct tax is the income tax levied upon a person's income gained from various sources such as house rent or salaries.

As for indirect tax, we use it on goods and services instead of the income, which increases the overall marked-up price for the good or service. In India, this is called GST (goods and services tax). To put it another way, the Goods and Service Tax (GST) is imposed on India's supply of goods and services. India's Goods and Services Tax Law is a universal, completed and multi-stage destination-based tax levied on every value addition.

Let's know more about how GST works

GST is useful to the ordinary person and how GST works from manufacturer to consumer in two ways:

  1. All the taxes are collected at the point of consumption, which causes decreasing the product's cost.
  2. Less tax burden as tax barriers is broken between the states, which used to happen according to the previous indirect tax.

How does GST Work in India?

We will show you how gst works in India with the specific examples below. There are 4 critical stages you should know:

Stage 1: The Manufacturer

Suppose a trousers manufacturer buys raw material to manufacture trousers worth 1000 INR and 60 INR tax. The manufacturer added the value of 300 INR to manufacture the trousers. Now the total value of the trousers is 1300 (1000+300). Assuming the GST rate on trousers be 5%, that will be 65 INR. The manufacturer can put this applicable GST amount (65 INR) against the tax paid by him/her on the raw material, i.e., 60 INR. Thus, the effective GST rate will be only 5 INR (65-60). That's exactly what makes GST a value-added tax.

Conclusion: The manufacturer must pay GST on the raw material purchased and the value added to create the product.

Stage 2: Service Provider

The following stage is where the goods are given to the distributor or service provider. The distributor buys the same trousers for 1300 INR and adds value to those trousers of around 200 INR. That means that the value of the trousers will be 1,500, that is (1300+200). Under GST, he will need to pay tax around 75 INR (5%) which again can be set off against the tax on the purchased trousers from the manufacturer that is 65 INR. Currently, the distributor's actual tax incidence under GST will be 75-65= 10 INR.

Conclusion: The service provider is the person who has to pay GST on the amount that is paid for the product and the value added to it. Even so, we should remember that the tax that the manufacturer paid can be reduced from the overall GST that must be paid.

Stage 3: Retailer

According to the given example, the retailer adds a margin of 100 INR on the purchase of trousers. The total cost of the product will become 1600 INR (1500 + 100). Under GST, he/she will now need to pay tax (assuming a 5% rate of GST) that will become 80 INR that he can set off against 75 INR tax paid by the salesman. In accordance with this, the tax incidence under GST on the retailer will be 5 INR (80-75).

Conclusion: The retailer will need to pay GST on the product purchased from the distributor and the margin that has been added. It is worthy of attention that the retailer's tax paid can be reduced from the overall GST that must be paid.

Stage 4: Consumer

This amount of 1600 INR is defined for the end client, who will purchase these trousers.

To sum up the part of the article, GST is a value-added tax that guarantees input tax credit benefits on every stage, except the end consumer stage. Therefore, GST is one nation tax that helps economic freedom for the traders.

Conclusion: GST will be paid on the product that has been purchased.

Types of GST and Explanations

There are 4 different types of GST in India:

  1. Integrated Goods and Services Tax, known as IGST - is a tax under the GST applied between 2 states' supply of goods and/or services and imports and exports. Conforming to IGST, the body responsible for collecting the taxes is the Central Government. After collecting taxes, it is further divided among the respective states by the Central Government.
  2. State Goods and Services Tax, famous for SGST - is a tax under the GST used within the same state transactions. In the case of an intrastate supply of goods and/or services, both State GST and Central GST are levied. However, the State GST or SGST is set by the state on the goods and/or services purchased/sold within the state. The SGST Act governs it. The respective state government solely claims the revenue earned through SGST.
  3. Central Goods and Services Tax of CGST - like State GST is a tax under the GST regime applicable within the same state transactions. The CGST Act governs the CGST. The Central Government collects the revenue earned from CGST.
  4. Union Territory Goods and Services Tax or UTGST - is the counterpart of State Goods and Services Tax (SGST), which is levied on the supply of goods and/or services in India's Union Territories (UTs). The UTGST applies to the supply of goods and/or services in Andaman and Nicobar Islands, Chandigarh, Daman Diu, Dadra, and Nagar Haveli Lakshadweep. The Union Territory government collects the revenue earned from UTGST. The UTGST is a replacement for the SGST in Union Territories. Thus, the UTGST will be levied in addition to the CGST in Union Territories.

If you want to read more about types of gst and get a more detailed explanation, read this article.

It is worth mentioning that apart from these, the government has fixed different taxation rates under each, which will be applicable to the payment of tax for goods and/or services rendered.

Here is a brief summary of GST types:

Objectives Of GST

"One Nation, One Tax"

"One Nation, One Tax" is the main goal of the GST updated regime. GST replaced a lot of indirect taxes, which existed under the previous tax. The main benefit of one single tax means each state will have the same rate for a specific product or service.

Subsumption of a majority of the indirect taxes

One of the significant objectives of GST was to subsumption a majority of the indirect taxes. Under GST, all the main indirect taxes were subsumed into one. It significantly decreased the compliance goods on taxpayers and made tax administration for the government easy.

Removing the cascading effect of taxes

Under GST, the tax levy is only on the net value added at every stage of the supply chain. This helped remove the cascading effect of taxes and contributed to the constant flow of input tax credits across both goods and services.

Limiting tax avoidance

The introduction of e-invoicing has further reinforced this goal. Apart from this, because GST is a nationwide tax and has a centralized surveillance system, the clampdown on defaulters is quicker and far more well-organized. Therefore, GST checked tax evasion and minimized tax fraud to a large extent.

Increasing the taxpayer base

One of the most important parts is that GST helped widen the tax base in India. As GST is a combined tax levied on goods and services, it increased tax-registered businesses. Excluding, the stricter laws bordering input tax credits helped bring specific unorganized sectors under the tax net—for instance, the construction industry.

Online procedures to simplify doing business

We can do all GST procedures almost totally online. Everything is done with one click, from registration to return filing to refunds to e-way bill generation. It contributed to the final simplification of doing business in India and made taxpayer compliance easy to a massive extent.

An upgraded logistics and distribution system

A single indirect tax system decreases the need for numerous documentation for the supply of goods. GST minimizes transportation cycle times, develops supply chain and turnaround time, and leads to warehouse consolidation, among other advantages.

Promoting competitive pricing and growth consumption

GST led to an increase in consumption and indirect tax revenues. Having uniform GST rates has contributed to overall competitive pricing across India and globally. Overall, this increased consumption and led to higher revenues.

If you are interested in learning more about Gst objectives go to this article.

Advantages of GST

The new goods and services taxes (GST) regime has a lot of advantages in India. the following are the essential benefits of GST:

  1. Regulating of the unorganized sector
  2. Fewer difficulties
  3. Regulating structure
  4. Simplifying the registration process and returns filing
  5. E-commerce representatives are no longer suffered from dissimilar treatment
  6. Liquidation of the complicated tax effect

Taxes Before GST

Let us see more about the taxes that the GST replaced.

In the former indirect taxation system, there were 2 problems.

  • Firstly, The state and the Centre collected taxes separately. Depending on the state, the taxes were quite different from each other.
  • Secondly, an import tax was set on one individual. The burden was placed on another individual. In the cases of direct taxation, the taxpayer had to pay the tax.

An overview of this will be interesting with the help of a specific example. There is a dress manufacturer, the central government used to levy central excise on the dress that adds to the cost of the dress. Once the customer buys the dress, the state government collects the Value Added Tax. To sum up, the compliance procedure for business was quite difficult, and for the government, it was inconvenient under this indirect tax.

Registration of GST

Every company eligible under GST must register itself in the GST portal created by the Government of India. The registered unities will get a unique registration number called GSTIN.

Registration is obligatory for all service providers, buyers, and sellers. A business that makes a total income of Rs.20 lakhs and more in a financial year must be required to register. The registration process takes 2-6 working days.

GST Returns

GST Returns is a document that includes information about the income that a taxpayer has to file with the authorities. Business people have to file 2 monthly returns and an annual return. This information is essential to calculating the taxpayer’s tax liability. Under the GST, the registered salespersons must file GST returns with details about their purchases, sales, input tax credit, and output GST.

GST Rates

There are GST rates for different goods and services. While some products can be purchased without any GST, there are others that come at 5% GST, 12% GST, 18% GST, and 28% GST.

What are the new Compliances Under GST?

Apart from the online filing of the GST returns, the GST has introduced several new systems along with it.

e-Way Bills

GST introduced a centralized system of waybills by introducing "E-way bills". This system was launched on 1st April 2018 for inter-state movement of goods and on 15th April 2018 for intrastate movement of goods in a staggered manner.

Under the e-way bill system, salespeople, manufacturers and transporters can cause e-way bills for the goods transported from the place of their origin to their destination on a common portal with ease. Tax authorities have also profited as this system has decreased time at checking and helps reduce tax evasion.

E-invoicing

The e-invoicing system was passed on 1st October 2020 for businesses with an annual aggregate turnover of more than Rs.500 crore in any preceding financial years (2017-2018). Furthermore, from 1st January 2021, this system was extended to those with an annual aggregate turnover of more than Rs.100 crore.

These manufacturers must gain a unique invoice reference number for every b2b invoice by uploading it on the GSTN's invoice registration portal. The portal checks the correctness of the invoice. Then, it gives an opportunity to use the digital signature and a QR code.

e-Invoicing admits interoperability of invoices and helps decrease data entry errors. It is designed to pass the invoice information directly from the IRP to the GST portal and the e-way bill portal. It will, therefore, solve the problem regarding the requirement for manual data entry while filing GSTR-1 and assist in the generation of e-way bills as well.

FAQs on Goods and Services Tax (GST)

1. Is it obligatory for all traders to register under the GST?

All traders who earn turnovers is larger than Rs.20 lakh in a financial year will have to register under the Goods and Services Tax (GST).

2. What is the official website to register GST?

Response: In order to register for GST, you need to visit the Indian government's official GST website - www.gst.gov.in

3. What kind of tax is goods and services tax?

Response: (Goods and services tax) GST is an indirect tax, which replaced plenty of indirect taxes in India.

4. What is the main aim of GST?Response: The main goal of goods and services tax (GST) is to simplify taxation.