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Cascading Effect: Indirect Tax Structure Before GST
Cascading Effect: Indirect Tax Structure Before GST
Cascading Effect: Indirect Tax Structure Before GST
Mr Aditya Vikram
Advocate
Cascading tax effect is also termed as “tax on tax”. This effect occurs when a good is
taxed on every stage of production. Such a good is taxed till it is finally sold to the
consumer. This means each succeeding transfer of good is taxed inclusive of the taxes
charged on the preceding transfer. As a result, the final consumer bears the burden of
the multiple taxes imposed on every stage of production. Such a situation leads to
inflationary prices.
Thus, ‘Tax on tax’ plagued the indirect tax structure of India prior to GST. So to
understand such an effect, it is imperative to figure out:
• the tax structure in the previous indirect tax regime and
Custom Duty
It is an indirect tax levied on import of goods (called import duty). However, such a tax
is also imposed on export of goods (called export duty) in some cases .
Service Tax
It is an indirect tax levied by the Central Government on services provided by the
service providers. Such a tax is collected by the service providers from the recipients of
service and hence paid to the Central government.
X Ltd sold cars to a car dealer in Maharashtra in one of the transactions under previous
indirect tax system. Following are the taxes levied by Centre and State Government
under the previous indirect tax system:
• The Central Government levied Central Excise Duty on the manufacture of cars
• State government of Maharashtra levied VAT/CST on the sale of bicycles
• Again, the State Government of Maharashtra levied Octroi on the entry of goods
into a particular state
• Cost of car of the car dealer = Rs. 5,50,000 (Cost of the Car + Excise Duty)
• Dealer’s Margin @ 10% = Rs. 55,000
• VAT @ 12% = Rs. 72,000 [5,50,000 + 55,000] * 12%
• Invoice = Rs. 6,77,600
Now, when the car dealer sells the car to the end consumer, he takes cost of car plus
excise duty as the total cost of the car. He then adds his dealer margin to the total cost to
reach at the sales price. And finally on this sales price, he charges value added tax, to
work out the invoice price for the end consumer.
This was the scenario under previous indirect tax regime. If you look carefully, the car
dealer takes Rs. 5,00,000 (cost) plus Rs 50,000 (excise) as his total cost, to which he
adds his dealer’s margin to get the sales price of Rs. 6,05,000. A VAT amount of Rs
72,600 is further added to this sales price, leading the end consumer to pay tax on tax.
[(cost + excise + margin)] * vat%. This is what is called the cascading tax effect. With
excise duty included in the cost of the car dealer, to which he adds his margin as well as
the VAT amount, the tax on tax effect tends to increase the price of the good under
question for the end consumer.
Now, let’s understand how GST advocates a unified national market and overcomes the
cascading tax effect.
So let’s compare previous tax regime with the GST system. As we can see, all the
stakeholders in the supply chain suffered under the previous indirect tax regime.
However, under GST, only the end consumer bears the burden of tax.
Therefore, effective GST paid by the dealer to the government will be the difference
between GST on Output and GST paid on input.