Working of Input Tax Credit by Financial Express
The change in indirect taxation regime from current taxation to GST (Goods and Services Tax) seems to be a game-changer reform. For consumers, the introduction of the input tax credit (ITC) mechanism will reduce the indirect tax burden on their purchases. It will cause a paradigm shift from individuals paying more taxes to more individuals paying taxes. So, it means an increase in the overall tax base resulting in more revenue for the government.
GST is a destination-based tax as compared to the present principle of origin-based taxation. The new indirect tax regime follows a multi-stage collection mechanism wherein tax is collected at every stage (where value addition is done to product), and the credit of tax paid (input tax credit) at the previous stage is set-off at the next stage of the transaction. Thus, it prevents double taxation, which is the essence of GST.
Under the current taxation regime, there is a plethora of taxes including excise duties, sales tax, purchase tax, entry tax and VAT (Value Added Tax). On the other hand, GST is meant to integrate taxation in India. There are five types of GST viz. Central GST, State GST, Integrated GST, UTGST and compensation cess. However, the real game changer is the introduction of input tax credit mechanism, which is one of the key features of GST. It will help in eliminating the cascading effect of taxes.
To understand the working of this mechanism, you need to have a clear understanding of input tax credit. When you buy raw materials as inputs to manufacture and sell your product, you pay tax on the material/ input. So, when you are required to pay tax on the finished good/output, you can claim the tax credit that you already paid to your vendor/supplier and just pay the balance tax liability.
Now, let us understand how taxes will work differently under the GST regime with the help of the following example.
Firstly, we will look at the mechanism of the pre-GST indirect tax system for inter-state transactions. Let us assume that a simplified tax rate of 10% is applicable on every level from the manufacturer to the retailer.
The manufacturer purchases goods worth Rs 50 and converts it into a product which adds a value of Rs 50 to it. For selling the product, he pays Rs 10 as tax on Rs 100. Hence, the distributor’s price is Rs 110. While selling, the distributor adds a profit margin of Rs 20 and pays 10% tax of Rs 13 on Rs130. Hence, the wholesaler’s price is Rs 143. Assuming that at every further stage the profit margin is Rs 20, the wholesaler will sell it for Rs 179.3 to the retailer who will further sell it to the consumer for Rs 219.23 after adding taxes and profit margins.
Now let’s see how taxes are levied under the GST regime. This time the manufacturer who had purchased raw materials worth Rs 50 will get the credit of taxes paid on the raw material purchase. Hence, when he adds a value of Rs 50 to the product, and the price of the product becomes Rs100, the taxes will work as follows. He has to pay Rs 10 @ 10% on the price of Rs 100 as GST, and he will receive a credit of Rs.5 as input tax credit paid at the time of purchase of raw materials because the raw material supplier will have to pay Rs 5 to the government (assuming that he is not taking credit on purchases). (Rs.50 x 10% = Rs 5). The tax amount at this stage will hence be Rs 5.
Similarly, at the next stage when the distributor adds his profit margin of Rs 20 (100+20), the value of goods will now be Rs 120 and the taxes @10% will be Rs 12. The input tax credit on this will again be Rs 10 that was paid to the manufacturer. Hence, the taxes at this stage will be Rs 12 – Rs10 = Rs 2.
This input tax credit will ultimately reduce the final price to the wholesaler, retailer and the consumer too. Assuming that Rs 20 is added at each stage, tax at the wholesaler stage will be Rs 2, and at the retailer stage will again be Rs 2. Hence, the final price to the consumer for the item will be (160 + 5 + 5 + 2 + 2+2) = Rs 176. This concept of GST being a destination-based tax makes it easy to calculate and carry forward. The price difference is Rs 43 for the end consumer due to the input tax credits received under the GST regime.
Hence, due to avoidance of double taxation at each level, the tax burden on consumers is way less. more
GST is a destination-based tax as compared to the present principle of origin-based taxation. The new indirect tax regime follows a multi-stage collection mechanism wherein tax is collected at every stage (where value addition is done to product), and the credit of tax paid (input tax credit) at the previous stage is set-off at the next stage of the transaction. Thus, it prevents double taxation, which is the essence of GST.
Under the current taxation regime, there is a plethora of taxes including excise duties, sales tax, purchase tax, entry tax and VAT (Value Added Tax). On the other hand, GST is meant to integrate taxation in India. There are five types of GST viz. Central GST, State GST, Integrated GST, UTGST and compensation cess. However, the real game changer is the introduction of input tax credit mechanism, which is one of the key features of GST. It will help in eliminating the cascading effect of taxes.
To understand the working of this mechanism, you need to have a clear understanding of input tax credit. When you buy raw materials as inputs to manufacture and sell your product, you pay tax on the material/ input. So, when you are required to pay tax on the finished good/output, you can claim the tax credit that you already paid to your vendor/supplier and just pay the balance tax liability.
Now, let us understand how taxes will work differently under the GST regime with the help of the following example.
Firstly, we will look at the mechanism of the pre-GST indirect tax system for inter-state transactions. Let us assume that a simplified tax rate of 10% is applicable on every level from the manufacturer to the retailer.
The manufacturer purchases goods worth Rs 50 and converts it into a product which adds a value of Rs 50 to it. For selling the product, he pays Rs 10 as tax on Rs 100. Hence, the distributor’s price is Rs 110. While selling, the distributor adds a profit margin of Rs 20 and pays 10% tax of Rs 13 on Rs130. Hence, the wholesaler’s price is Rs 143. Assuming that at every further stage the profit margin is Rs 20, the wholesaler will sell it for Rs 179.3 to the retailer who will further sell it to the consumer for Rs 219.23 after adding taxes and profit margins.
Now let’s see how taxes are levied under the GST regime. This time the manufacturer who had purchased raw materials worth Rs 50 will get the credit of taxes paid on the raw material purchase. Hence, when he adds a value of Rs 50 to the product, and the price of the product becomes Rs100, the taxes will work as follows. He has to pay Rs 10 @ 10% on the price of Rs 100 as GST, and he will receive a credit of Rs.5 as input tax credit paid at the time of purchase of raw materials because the raw material supplier will have to pay Rs 5 to the government (assuming that he is not taking credit on purchases). (Rs.50 x 10% = Rs 5). The tax amount at this stage will hence be Rs 5.
Similarly, at the next stage when the distributor adds his profit margin of Rs 20 (100+20), the value of goods will now be Rs 120 and the taxes @10% will be Rs 12. The input tax credit on this will again be Rs 10 that was paid to the manufacturer. Hence, the taxes at this stage will be Rs 12 – Rs10 = Rs 2.
This input tax credit will ultimately reduce the final price to the wholesaler, retailer and the consumer too. Assuming that Rs 20 is added at each stage, tax at the wholesaler stage will be Rs 2, and at the retailer stage will again be Rs 2. Hence, the final price to the consumer for the item will be (160 + 5 + 5 + 2 + 2+2) = Rs 176. This concept of GST being a destination-based tax makes it easy to calculate and carry forward. The price difference is Rs 43 for the end consumer due to the input tax credits received under the GST regime.
Hence, due to avoidance of double taxation at each level, the tax burden on consumers is way less. more
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Oct 31
Present system of a plethora of taxes have been replaced by another not so Good & Simple Tax in the form of GST. The laws in India are devised in a way so that bureaucracy & organized extortion is not eliminated. To feed this organized evil, the whole economy and people have to pursue corrupt practices. Since everybody is forced directly / indirectly to become part of a corrupt system, nobody dares to open their mouth and juggernaut of organized corruption rolls on and devastates everybody's life & peace having a lingering ill effect on the moral of the populace. That is why we require really simple & comprehensive taxation system for running the Government which is small & efficient in its job and truly becomes the Government of, by & for the people. Please read on: The whole GST is a half-baked concept. If you are media savvy, you will know that most of the taxes what we pay goes towards paying the huge battalion of Government servants in Centre, States & Local bodies and in all sorts of places whose output is to harass the citizens. The pathetic condition of the Government Depts can be understood only when you visit them. Normally, you cannot get access to any Dept. without facing some touts or glorified consultants. Go to Motor Vehicles Dept of any state and try to get anything done. Unless you pass through these channels you will have a tough time to get anything done. And regarding Income Tax Dept, the amount collected by Govt. from Individuals & Companies do not add up to the cost of maintaining the Dept. Their sole purpose is to finger salaried class & people who oppose the vested interests in positions of power. The tax evaders grease off the palms of decision makers regularly and keep the chain of black money going. The Government has produced after about 17 years of deliberation a GST system which is an absolute nuisance and nobody will know what is happening. It has replaced an already existing cumbersome system with another one equally complicated and it is not a "GOOD & SIMPLE TAX" as being highlighted. The Government in its enthusiasm of doing some spectacular photo-finish reforms has totally forgotten the simple logic that if any system is simple it will work & the chances of failure will be more if it is complicated. Like any other thing, Indian psyche is to copy & not to innovate. I present below a simple system which will be a real path-breaking reform and will benefit everybody except the vested interests i.e the political class & bureaucracy who wants to have a complicated system so that nobody can understand what is happening and keep everybody confused, so that they can milk the masses all the way to the bank. Recent glorious sample is DEMONETIZATION. Even after 6 months of the hyped event nobody knows what the outcome of the whole exercise is except that BJP has swept the important state assembly elections. Now, my suggestions are briefly given below. 1. The Government will fully come out from all commercial activities including Railways, Healthcare & Education. All present public sector / Govt establishments are to be privatized with Government holding 49% of ownership. 2. Income Tax for Individuals & also companies to be totally abolished. So it will reduce conspicuous consumption & all savings will go to Bank and used for development. 3. Only source of tax to the Government will be a Transaction Tax which will be levied only for Goods & services sold to the final individual consumers. In any consumable goods & services category, there will be only two slabs one lower one for mass consumption & other one Luxury which will be much higher. 4. Goods will be only in 3 categories: ready consumable, ready consumable / intermediary and Intermediary. No tax for Intermediary use, Transaction tax only for ready consumables used by Individuals. 5. No Transaction tax for Capital goods used for production/business. Example: Commercial vehicles used for Goods/public transportation. 6. Movement of goods & services will be seamless throughout India as there will be no tax barriers and no question of producing or consuming states. All expenses of the Central, State & Local bodies will be distributed from the collection of Transaction tax from the whole country. There will be substantial reduction of no. of employees in the Govt. & will result in huge saving in public expenditure. 7. All commercial enterprises have to enter in a Govt. maintained centralised system day-to-day activities of the business and the data thus collected will be used for planning by Govt. & private sector for efficiency. 8. The concept starts from the fact that ultimately all activities carried out by Individuals are transformed into Goods & Services to be consumed by the Individuals only. So, is it simple enough or not? Whole detailed concept is available on request. more
Jul 11
It is easy to criticize whenever some new thing is being introduced by the present Government without understanding the good things that may come up with the new system. By this new GST, today no trader can avoid or evade paying tax. The loopholes are well plugged now. Let us wait for sometime before making any adverse criticism more
Jul 12
