Let's say Mr. A sold goods to Ms. B on which he charged a tax. Ms. B now decides to sell the very same goods to a certain Mr. C. While computing her cost, Ms. B includes the tax paid during the previous purchase (to Mr. A) and thus, the final consumer (Mr. C) ends up paying a tax on tax for the goods he purchases.
Until the government decided to change the status quo, this is how independent India had been computing tax for the last seven decades. Some measures were taken to streamline taxation with the introduction of VAT, excise duty, and service tax a while back, but they have not been enough. A cascading system of taxes like this that make goods and services expensive for the end user and this is exactly why India needs a unified tax like GST.
If GST is a unified tax, then why does it have separate components?
In a federal country like India, it is difficult to implement a single tax all across. As per law, the Centre and states have different responsibilities to perform and the revenue they collect is then allocated to fulfilling these duties. A dual system of GST is in keeping with the Indian Constitution's requirement of fiscal federalism, and allows the Centre and state control over their revenue sources.
Now that we understand the need for separate state and central components for GST, let's take a detailed look at each:
- State GST: Collected by the state on intra-state movement of goods. Abbreviated as SGST.
- Central GST: Collected by the Centre on intra-state movement of goods. Abbreviated as CGST
- Integrated GST: Collected by the centre on inter-state movement of goods. Abbreviated as IGST.
The important thing to remember here is that GST is a consumption-based tax. The state component of the GST is so structured that the tax on goods or services is received by the state in which these goods/services are being consumed in their final form, and not in the state in which they were manufactured. The integrated component or IGST is included to make the movement of goods across state borders easier than before by ensuring a seamless flow of input tax credit from one state to another. Thus, each state will have to deal directly with the Centre in order to settle their tax amounts and not with every other state on the goods supply chain. IGST will also be applied on imports.
How will the different tax components be levied?
There are three different scenarios involving the production and sale of goods/services, and how GST will be levied in each case. They are:
CASE 1: Goods/services produced in a state are sold and resold in the same state
A manufacturer in Mumbai produces electronic goods which are bought by a company also based in the same city. The company then sells these goods to consumers in Pune. Since the sale and resale takes place in the same state, only the CGST and SGST will be levied in this case. In case of the resale (from company in Mumbai to consumer in Pune), the seller can claim input credits on SGST and CGST paid before, and the rest will be claimed as tax by the respective governments.
CASE 2: Goods/services produced and sold in a state are resold in another state
Taking the same example above, let's assume that the company in Mumbai sells the goods outside Maharashtra—maybe to a consumer in Bangalore. The company has already paid SGST and CGST while purchasing the goods from the manufacturer, but will now have to pay IGST when moving it across state borders. The IGST component will be claimed wholly by the central government.
When filing for IGST, the seller takes both SGST and CGST paid earlier as input tax credit.
CASE 3: Goods/services produced are sold and resold in another state
Now, our manufacturer in Mumbai may have other companies located outside of Maharashtra wishing to buy their wares. Assuming that the manufacturer transports the goods across state borders to Delhi and makes a sale there, they will have to pay IGST on the sale. Companies in Delhi who buy the goods and then resell it within Delhi to their consumers will pay both SGST and CGST on the sales made.
The Delhi-based companies will take input credits against the IGST when paying their taxes.
In each of the above scenarios, GST provides full allowance of credits, thus simplifying the tax system and making the entire process more reliable and accountable in keeping with the "one nation, one tax" motto.