Chapter 1 – Introduction to GST

Introduction
There has always been a taxation on the sale of goods, called the “Central Sales Tax”. Any person who
would sell goods to anyone would charge a tax on the value of the goods. Later on, a tax was also
introduced on provision of services, called the “Service Tax”. Any person who would provide any
services to anyone would charge a tax on the value of services. Now, both have been merged to what
is known as the “Goods and Services Tax (GST)”. The question arises – Why? Why has there been made
such a major change? What was the need? To get answers to these questions, we need to understand
the problems with the existing taxation system.

Problems With Sales Tax

Suppose A manufactures certain goods and sells them to B (retailer), who does some processing to
these goods, and sells them to C (consumer). The cost sheets are given below:

Particulars A B
Purchase Price - 275.63
Add: Raw Material 150.00 -
Add: Labour 40.00 -
Add: Overheads 20.00 20.00
Add: Profit 35.00 20.00
Total 245.00 315.63
Add: Sales Tax @ 12.5% 30.63 39.45
Selling Price 275.63 355.08

Let’s analyze the price of ₹355.08, i.e., the price at which the goods are sold to the consumer.

355.08

315.63 39.45

275.63 40.00 34.45 5.00

(275.625 × 12.5%)

245.00 30.63
245 × 12.5% 30.625 × 12.5%

30.63 3.83
Double Taxation Tax on Tax

As we can see from the above analysis, there were two major problems with the existing sales tax
system:

1. Double Taxation
2. Tax on Tax (Cascading Effect)

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To eliminate these two problems at intra-state level (within the same state), a taxation system called,
“Value Added Tax” was introduced in 2005. As per this system, the tax was supposed to be levied only
on the “value addition” at each stage.

Notice how A has charged sales tax of ₹30.63 from B. A would deposit this money to the account of
the state government. Now, since B has paid this ₹30.63 to A, he can use this as “Input Tax Credit”.
Therefore, the cost to B would only be ₹245. Now, B would add overheads and profit of ₹40 to it, which
will make the total ₹285. B would then charge sales tax on this amount @ 12.5%, which comes to
₹35.63, and sell these goods to the consumer for ₹285 + ₹35.63 = ₹320.63. Now, when B would deposit
the ₹35.63 to the account of the state government, he would see that he had already paid ₹30.63 to
A, and A had already deposited it to the account of the state government. Therefore, B would subtract
₹30.63 from ₹35.63, and will be required to deposit only ₹5.00 to the account of the state government.
You can see from the above chart that this is exactly what should ideally have happened. This entire
thing can be shown in tabular form as follows:

Particulars A B
Input Tax Credit 30.63
Purchase Price - 245.00
Add: Raw Material 150.00 -
Add: Labour 40.00 -
Add: Overheads 20.00 20.00
Add: Profit 35.00 20.00
Total 245.00 285.00
Add: Sales Tax @ 12.5% 30.63 35.63
Selling Price 275.63 320.63
Tax Deposited to Govt. 30.63 5.00

This can go on for as many middlemen as there are, as illustrated below:

Particulars A B C D
Input Tax Credit 30.63 35.63 41.88
Purchase Price - 245.00 285.00 335.00
Add: Raw Material 150.00 - - -
Add: Labour 40.00 - - -
Add: Overheads 20.00 20.00 20.00 50.00
Add: Profit 35.00 20.00 30.00 100.00
Total 245.00 285.00 335.00 485.00
Add: Sales Tax @ 12.5% 30.63 35.63 41.88 60.63
Selling Price 275.63 320.63 376.88 545.63
Tax Deposited to Govt. 30.63 5.00 6.25 18.75

Therefore, with the introduction of VAT, this problem was solved at the intra-state level. However, the
problem still existed at inter-state level. Let’s understand this. Suppose in the above example only, A
belonged to Uttar Pradesh, and B belonged to Maharashtra. When A would sell goods to B, A would
deposit the sales tax collected to the government of Uttar Pradesh. When B would sell goods to C, he
would have to deposit the sales tax collected to the government of Maharashtra. Now, when C would
want to utilize the sales tax paid by him earlier to A, government of Maharashtra won’t allow it, as A
had deposited it to the government of Uttar Pradesh!

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These three are just like drops in an ocean of problems. There were many other problems like these
as well. There were multiple taxes on goods and services, the credit of tax paid on sale of goods would
not be allowed to be utilized against service tax, and what not! Therefore, the need for GST arose! A
lot of such taxes which were levied separately on goods and services were subsumed in GST.

List of Taxes Subsumed in GST

Central Taxes State Taxes
Central Excise Duty State VAT
Duties of Excise (Medicinal and Toilet Luxury Tax
Preparation)
Additional Duties of Excise (Goods of Special Entry Tax (all forms)
Importance)
Additional Duties of Excise (Textiles and Textile Entertainment and Amusement Tax (except
Products) when levied by the local bodies)
Additional Duties of Customs (commonly known Taxes on advertisements
as CVD)
Special Additional Duty of Customs (SAD) Purchase Tax
Service Tax Taxes on Lotteries, Betting, and Gambling
Central Sales Tax State Surcharges and Cesses so far as they relate
to supply of goods and services
Central Surcharges and Cesses so far as they
relate to supply of goods and services.

How GST Solved the Problems at Inter-State Level

GST is a destination-based consumption tax. India has adopted a Dual GST Model in view of the federal
structure of the country. Under GST, whenever there is an inter-state supply of goods or services, the
supplier charges IGST, i.e., Integrated Goods and Services Tax. On the other hand, whenever there is
an intra-state supply of goods or services, the supplier charges CGST as well SGST, i.e., Central Goods
and Services Tax, as well as the State Goods and Services Tax. The sum of CGST and SGST is
approximately always equal to IGST. The idea is, that for every transaction, tax should go to the Central
Government, as well as to the Government of the consuming state. Following questions will make the
concepts clear.

Question 1

Mr. A, a manufacturer in Rajasthan has supplied goods valued at ₹1,00,000 to Mr. B, a dealer in
Rajasthan. Mr. B supplied the said goods to Mr. C in Rajasthan after making value addition of 20%. You
are required to determine the tax payable by Mr. A and Mr. B in respect of the said transactions
assuming the rate of GST is 18%. Also determine the amount of revenue by Central and State
Government.

Solution

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 Particulars A B
Purchase Price - 1,00,000
Add: Value 1,00,000 20,000
Total 1,00,000 1,20,000
Add: CGST @ 9% 9,000 10,800
Add: SGST @ 9% 9,000 10,800
Add: IGST @ 18% - -
Selling Price 1,18,000 1,41,600

Particulars CGST SGST CGST SGST

Output Liability 9,000 9,000 10,800 10,800
Credits Availble - - 9,000 9,000
Tax Paid 9,000 9,000 1,800 1,800

Total Revenue 10,800 10,800

(To Centre) (To State)

We can see from the above that equal amounts of tax have been received by the Central Government
as well as by the Government of the consuming state. Now, let’s look at a transaction where different
states are involved.

Question 2

Mr. X, a manufacturer in Rajasthan has supplied goods valued at ₹1,00,000 to Mr. A, a dealer in
Rajasthan. Mr. A supplied the said goods to Mr. B in Madhya Pradesh after making value addition of
20%. Mr. B further supplied the goods to Mr. C of Madhya Pradesh after making value addition of 20%.
You are required to determine the tax payable by Mr. X, Mr. A, and Mr. B in respect of the said
transaction assuming the rate of GST is 18%. Also determine revenue earned by Central and State
Government.

Solution

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Particulars X (Rajasthan) A (Rajasthan) B (Madhya Pradesh)
Purchase Price - 1,00,000 1,20,000
Add: Value Addition 1,00,000 20,000 24,000
Total 1,00,000 1,20,000 1,44,000
Add: CGST @ 9% 9,000 - 12,960
Add: SGST @ 9% 9,000 - 12,960
Add: IGST @ 18% - 21,600 -
Selling Price 1,18,000 1,41,600 1,69,920

Particulars CGST SGST IGST CGST SGST IGST CGST SGST IGST
Output Liability 9,000 9,000 - - - 21,600 12,960 12,960
Credits Available - - - 9,000 9,000 21,600
Credit Utilisation
CGST 9,000
SGST 9,000
IGST 12,960 8,640
Tax Paid 9,000 9,000 - 3,600 - 4,320
As far as this Rajasthan Government Now, the Central
transaction is will transfer the ₹9,000 Government will transfer
concerned, to the Central ₹8,640 to the Madhya
everything is fine, Government, because it Pradesh Government, and
because, till now, is clear that goods are B will deposit ₹4,320 to
we know that goods not finally consumed in the Madhya Pradesh
Remarks are being consumed Rajasthan. So, ₹9,000 Government's Account.
in Rajasthan. So, received earlier by
₹9,000 should be Rajasthan doesn't
received by Central belong to it.
Government, and
₹9,000 by Rajasthan
Government.

Flow of Credit Among the Governments

Transaction Central Rajasthan Madhya Pradesh
Mr. X to Mr. A 9,000 9,000
Mr. A to Mr. B 3,600
Rajasthan to Central 9,000 (9,000)
Mr. B to Mr. C - - 4,320
Central to Madhya Pradesh (8,640) 8,640
Total 12,960 - 12,960

Thus, we can see from the above that both Central Government and the Government of the consuming
State are receiving equal amounts of tax.

Notes:

• The credit of IGST can be utilized against the liability of CGST or SGST, and vice versa.
• However, the credit of CGST cannot be utilized against the liability of SGST and vice versa.
• GST is levied on the “supply” of “goods” and “services”.

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