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5/21/2018 Sales Tax, VAT, MODVAT, CENVAT and GST. What's ...

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INDIECONOMICS

Sales Tax, VAT, MODVAT, CENVAT and GST. What's


the fuss about?
Anurag Kataria

Let's get into it.

Sales Tax - Sales tax is collected on retail sales at the time of the sale to the final
consumer, and only the final sale in the supply chain is subject to tax.

Suppose I deicide to set up an "Assignment Copying" shop to help engineers copy


assignments. I charge 100 Rs. for every copy which includes the A4 sheets used, pens
and staplers used etc. which lets say cost me 20Rs.

Let's also assume that Sales Tax rate is 10%. Which means 10Rs out of the 100 need to
go to the government. However, note that I've already paid 2Rs. of sales tax while
buying the papers and I am paying tax on them again ! This means that a total tax of
12Rs. is being paid on every 100Rs.
 This is called Cascading effect.

How do I get rid of this?

Simple, the government should tax only the 80Rs. that I've made copying the
assignments. That is, the government should tax only the money that I've made by
adding the value to those blank A4 sheets. Hence the name Value Added Tax

So the tax payment should be like this.

2 Rs. to the government by the stationary shop owner.


8 Rs. to the government by me.

Total 10Rs tax on 100Rs. This is VAT and was introduced to do away with the
cascading effect of Sales Tax.

So this works great with Indirect Taxes where value is being added but the same
cascading effect also happens in Manufacturing where a company pays excise duty.

Suppose I have a beer making company and I've outsourced the bottling to some
other company. The company pays the government excise duty on the manufactured
bottles and I'm paying the government excise duty on the final product. Which means
that excise duty on bottles is paid twice.

To get rid of this cascading effect, VAT was modified to tax only the value addition on
manufacturing which was called MODVAT.

But making and selling beer also involves a number of services like logo design and
Advertising etc. Since MODVAT only removed cascading effect on goods it was further
modified to remove it from both goods and services. This is CENVAT.

GST

The final Tax structure after all of this considering that some of these taxes are given
to state and some to central government comes out to be very complex which makes
little sense to a common person. To simplify this GST is in the process of being rolled
out.

Here are 10 things you should know about GST.

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1. Officially, the Constitution (One Hundred and Twenty-Second Amendment)
Bill 2014.

2. It was introduced in the Lok Sabha on December 19, 2014 by Finance Minister
Arun Jaitley.

3. The Bill seeks to amend the Constitution to introduce a goods and services
tax (GST) which will subsumes various Central indirect taxes, including the
Central Excise Duty, Countervailing Duty, Service Tax, etc. It also subsumes
State value added tax (VAT), octroi and entry tax, luxury tax, etc.

4. The Bill inserts a new Article in the Constitution make legislation on the
taxation of goods and services a concurrent power of the Centre and the
States.

5. The Bill seeks to shift the restriction on States for taxing the sale or purchase
of goods to the supply of goods or services.

6. The Bill seeks to establish a GST Council tasked with optimising tax
collection for goods and services by the State and Centre. The Council will
consist of the Union Finance Minister (as Chairman), the Union Minister of
State in charge of revenue or Finance, and the Minister in charge of Finance
or Taxation or any other, nominated by each State government.

7. The GST Council will be the body that decides which taxes levied by the
Centre, States and local bodies will go into the GST; which goods and services
will be subjected to GST; and the basis and the rates at which GST will be
applied.

8. Under the Bill, alcoholic liquor for human consumption is exempted from
GST. Also, it will be up to the GST Council to decide when GST would be
levied on various categories of fuel, including crude oil and petrol.

9. The Centre will levy an additional one per cent tax on the supply of goods in
the course of inter-State trade, which will go to the States for two years or till
when the GST Council decides.

10. Parliament can decide on compensating States for up to a five-year period if


States incur losses by implementation of GST.

Okay so why is GST better than sales tax?

1. Since different small parts required by say a car manufacturing can be outsourced
to smaller companies without double taxation it encourages the growth of SSI.

2. Different tax can be collected for different use. For example if copper is being used
to make pots then the tax on it can be kept low but if the same copper is used for
making computers it can be taxed higher. This was not possible in Sales Tax.

3.The GST, widens the base for indirect taxation, and also has the advantage of being
more difficult to evade, easier to administer, and not being income-dependant
beyond a point.

4. It avoids the ‘cascading’ of taxes, thereby cutting production costs, and making
exports more competitive. According to the Union Finance Minister Arun Jaitley,
thanks to these efficiencies, the GST will add 2 per cent to the national GDP.

Why is the GST girdled in controversy?

1. States surrendering their political right – given to them by the constitution – to


determine their own tax rates, since rates will be determined by the centre.

2. As this is an indirect tax it hits the poor people harder.(If a rich person buys 10Rs.
Maggi he is paying 1 Rs. as tax which is the same what a poor person will have to pay.
Ideally a poor person should pay less.)

3. The GST rate of taxation is probably the most controversial aspect.The report of the
13th Finance Commission’s Task Force on GST recommended 12 per cent (7 per cent
for SGST and 5 per cent for CGST). That was in 2010. In 2014, a panel of State
government representatives mooted a revenue-neutral rate or RNR (rate at which tax

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revenues for states and the Centre will remain the same as before GST) of 27 per cent (
12.77 per cent and 13.91 for CGST and SGST respectively.
Both these rates might be unrealistic. A 12 per cent GST will most definitely mean
substantial revenue losses for states, as the general VAT rate for many states hovers
around the 13-14 per cent mark. And from this week, the service tax (levied by the
Centre) has gone up from 12.36 per cent to 14 per cent, a move, ironically enough,
intended to smoothen the transition to a GST regime.
A GST rate of 27 per cent, on the other hand, would impose an enormous tax burden
on the wage-earning classes, and could prove fatal for any elected government.
Understandably, Mr. Jaitley has been quick to clarify that the GST rate would be
much lower than 27 per cent.

To summarise

The GST bill, which is a constitution amendment bill, has been passed by the lok
sabha and is awaiting the approval of Rajya Sabha.

EDIT: Question by User.

Q.1 One of the points made in favour of GST is - avoidance of double taxations
cascading effect. But wasn't this already taken care of in the CENVAT? How is this still
a problem? How does GST solve it?

Q.2 How will the system of different tax collection for different use work in the case of
GST?

Q.3 How does GST widens base for indirect taxation?

Q.4 How is indirect tax evaded now and how will that be curtailed by GST?

Ans 2)  The system of different tax collection for different use work in the same way in
both the GST and VAT. Remember, VAT and GST both are applied at each stage of
production.

Ans 3) GST widens the base by including services. VAT did not include services. In
VAT the standard rate is 12.5 but each state can put a different tax rate on different
products. Subsidising some and heavily taxing others. I wanted to keep this article
simple so I have not gone into how exactly the whole system works. There are actually
two wallets each business will have, one for State VAT and another for Central VAT.
The GST combines them and simplifies the taxing. In fact one of the major reasons we
are shifting to GST is to simplify the tax structure. The GST will include all these
taxes.

Following Central Taxes will be merged into GST

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•Central Excise Duty


•Additional Excise Duties
•The Excise Duty levied for Medicinal andToiletries
•Service Tax
•Additional Customs Duty aka Countervailing Duty (CVD)
•Special Additional Duty of Customs - 4% (SAD)
•Surcharges
•Cesses.

Following State Taxes will be merged into GST

•VAT / Sales tax


•Entertainment tax (except by the local bodies).
•Luxury tax
•Taxes on lottery, betting and gambling. 
•State Cesses and Surcharges (on goods/service)
•Entry tax not in lieu of Octroi.

Exemption from GST

1.  tobacco, alcohol & petro products= No GST


2.  Product made in SEZ going to export = no GST
3.  Product of SEZ sold within India = Yes GST
4.  Imported Items = YES GST
5.  Low GST Tax for essential items (like medicines)
6.  High GST tax for general items (like perfumes)
(These exemptions are much less as compared to those in VAT)

This also means that many of the Cess and Surcharges will be gone.

The more the number of taxes and exemptions the more will be loopholes and
technicalities and consequently tax evasion.

The GST reduces the number of taxes and exemptions. This also in part answers your
Q4.

Another way to widen the base is to include more and more goods under GST. Which
will inevitably mean that basic necessities will get dearer and hence the poor will be
hit harder.

Ans 1) Now that you know that there are two types of VAT - Central and State you are
in a position to understand why there is still a cascading effect in case of VAT.

Suppose I run a business which uses electricity. Electricity like many other things is a
state subject and is taxed by the state. Assume I use 100Rs. of electricity and pay 10Rs.
to state government as VAT. Assume that my final product is something which is
taxed by central government. The price on which I have to pay VAT to the central
government includes the price of electricity on which I've already paid tax to state.
This means there is still a cascading effect !
So naturally the solution is to combine State and Central VAT, which is exactly what
GST does.

Ans 4) Indirect taxes are difficult to evade as compared to a direct tax. In a direct tax
evasion you work alone, you have to somehow show your income lesser than what it
actually is. In sales tax also the evasion is easy since if you sell your goods without bill
the government simply wouldn't know how much you've sold and how much tax you
need to pay.

Indirect tax evasion can work only if you form a cartel where in fake invoices are
circulated. This is because if some company which produces tyres for TATA nano
does not give TATA a receipt of payment of taxes, then tata will have to pay for the tax

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on those tyres when it sells the car. So obviously TATA will purchase those tyres from
a company which dutifully pays it taxes. Forming a cartel is much much harder.
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