Welcome back to the blog series on GST. By now, you would be aware that uninterrupted and seamless chain of input tax credit (ITC) is one of the key features of Goods and Services Tax (GST). In this article, we will explain how the Input Tax Credit mechanism works.
ITC is a mechanism to ensure that the supplier needs to pay GST in cash only on the value addition. ITC mechanism thereby avoids cascading of taxes that is ‘tax on tax’. Under the previous system of indirect taxation, credit of taxes being levied by Central Government was not available as set-off for payment of taxes levied by State Governments, and vice versa.
One of the most important features of GST is that the entire value chain would be subject to only a single indirect tax i.e. GST. GST would comprise of Centre and State/UT levies but will be collected as a single tax at a uniform rate for both inter-State and intra-State supplies. GST will thus subsume a number of State and Centre taxes into a single tax thereby allowing ITC of tax paid at every stage to be available as set-off for payment of tax at every subsequent stage.
Let us understand how ‘cascading’ of taxes took place in the previous tax regime. Central excise duty charged on inputs used for manufacture of final product could be availed as credit for payment of Central Excise Duty on the final product.
For example, to manufacture a ‘pen’, the manufacturer requires plastic granules, refill tube, metal clip, etc. All these ‘inputs’ were chargeable to central excise duty. Once a ‘pen’ is manufactured by using these inputs, the pen is also chargeable to central excise duty. Let us assume that the cost of all the above-mentioned inputs is Rs.10/- on which central excise duty @10% is paid, i.e. Rs.1/-. Now the manufacturer of the pen can take input tax credit of the duty paid on inputs, i.e. Rs.1/- which can be utilised for payment of duty on the pen. If the cost of the manufactured pen is Rs.20/-, the central excise duty payable on the pen @10% would be Rs.2/-. So he will use Rs.1/- paid on inputs (by debiting his ITC credit account) and will only pay Rs.1/- through cash (1+1=2), the price of the pen becomes Rs.22/-. In effect he actually pays duty of Rs.1/- only on the ‘value added’ over and above the cost of the inputs.
However, when the pen is sold by the manufacturer to a trader he is required to levy VAT on such sale. But under the previous system, since these were two separate levies by Central and State government respectively with no statutory linkage between the two, VAT was to be paid on the entire value of the pen, i.e. Rs.22/-, which actually includes the central excise duty to the tune of Rs.2/-. This is cascading of taxes or tax on tax as now VAT is not only paid on the cost of the pen i.e. Rs.20/- but also on tax component i.e. Rs.2/-.
Goods and Services Tax (GST) would mitigate such cascading of taxes. Under this new system most of the indirect taxes levied by Central and the State Governments on supply of goods or services or both would be combined together under a single levy. GST comprises of the following taxes:
a. Central Tax on intra-state or intra-union territory without legislature supply of goods or services or both.
b. State Tax on intra-state (including in 2 Union Territories with legislature) supply of goods or services or both.
c. Union Territory Tax on intra-union territory supply of goods or services or both.
d. Integrated Tax on inter-state supply of goods or services or both. In case of import of goods also the present levy of Countervailing Duty (CVD) and Special Additional Duty (SAD) would be replaced by Integrated tax.
The protocol to avail and utilise the credit of these taxes is as follows:
|IGST||IGST||CGST, then SGST/UTGST|