How will GST reduce prices through taxing only the value added?

Let us first understand how the current system works. A manufacturer pays central excise at 20 per cent on a shirt of value ₹100. At the time of sale, another tax VAT is to be paid at 15 per cent to the State government, which should be ₹15 in this case. But the State government charges VAT not on the ₹100 but on ₹120 which is the value of shirt plus the central excise tax that was already paid. So, the VAT rate of 15 per cent in effect becomes 18 per cent, leading to a higher price of the shirt. The current system has many such inconsistencies.

GST resolves the issue by integrating tax systems of central and State governments by introducing a facility to set off taxes paid across the value chain. Consider a simple three-stage operation of a small shirt-making unit owned by a person called Ria. She buys fabric from John, makes shirts and sells them to Vijay, the retailer who finally sells shirts to the end consumers.

The GST rate for fabric is 5 per cent and garments is at 18 per cent. If John, Ria and Vijay are located in the same State, the transactions among them will be considered under the intra-State sale provisions and GST payable would be the total of CGST and SGST.

If one of them is located in a different State, the transaction will be considered inter-State and GST payable would be the IGST, which would be the total of CGST and SGST. The tax liability would remain same in both cases.

Let us see the how the GST is paid at each stage of business operation.

Stage 1: Raw material Purchase. John sells fabric of value ₹1,000 to Ria. He pays GST of ₹50 at 5 per cent on the fabric value of ₹1,000. The total price of fabric shown by John in the invoice given to Ria would be ₹1,050. This includes the basic value of the fabric at ₹1000 and the GST paid of ₹50.

Stage 2: Manufacturing and sale. Ria manufactures shirt using fabric bought from John. Here, she adds ₹100 as value during the conversion of fabric to shirts. Ria pays GST of ₹18 on the value added ₹100. The total price of the shirt shown by Ria in the invoice given to the retailer would be ₹1,168. This includes the basic value of the shirt at ₹1,100 ( ₹1000+100) and GST paid of ₹68 ( ₹50+₹18).

Stage 3: Retail sale. Vijay adds his margin of ₹200 in the price of the shirt. He pays GST of ₹36 on this value (GST at 18per cent on ₹200). The total price of the shirt shown by Vijay in the invoice given to a customer would be ₹1,404.

This includes the basic value of the goods at ₹1,300 ( ₹1,000+₹100+₹200) and GST paid of ₹104(₹50+₹18+₹36). The end consumer pays ₹1,404 for the shirt. This includes the GST of ₹104.

What stands out here? The supplier, manufacturer and retailer, each pays GST only on the value added by them. No one pays GST on the value that includes the tax paid earlier as it happens in the current system.

This feature makes GST superior to the current system and reduces the tax burden on the consumer.

The writer is from the Indian Trade Service. The views are personal. Adapted from his book, ‘The GST Nation: A Guide for Business Transformation’

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