The Ministry of Finance has recently been in the spotlight for its contrary stance on granting an exemption to the Goods and Services Tax (GST), a move which numerous sectors of the industry have been lobbying for. The primary reasons offered by the Ministry of Finance for this position highlight serious anticipated repercussions, not only financially for states, but also for businesses with rising consumer prices.
Potential Impact on State Finances, Manufacturing Costs, and Compliance Burden
Offering a GST exemption could create severe financial ramifications for state budgets due to blocked Input Tax Credit (ITC). This happens when manufacturers incur GST on inputs, but are unable to recoup these costs through ITC as the final product becomes tax-free. The consequence would be an escalated manufacturing cost, resulting in higher prices for products.
Further complications arise for manufacturers, who would then need to maintain separate records for inputs and goods utilised for the item’s production, thereby increasing their compliance burden.
Unintended Incentive for Imports
Another concerning outcome of a GST exemption is the inadvertent advantage it offers to imports over domestically produced goods. Imported goods do not attract input taxes, unlike local goods, rendering them cheaper in comparison. Previous instances, such as when a GST exemption was approved for sanitary napkins, elucidate the difficulties experienced by domestic manufacturers as a result of such policies.
Understanding Goods and Services Tax
The Goods and Services Tax (GST) is essentially an indirect tax that applies to the supply of all final goods and services. It replaced previous indirect taxes including excise duty, Value Added Tax (VAT), service tax, luxury tax, among others. Being fundamentally a consumption tax, GST is imposed at the point of final consumption.
Applicable at each sale point in the supply chain, GST is only charged on value addition. The tax paid in acquiring goods or services (i.e., on inputs) can be deducted later from the tax applicable on the supply of final goods and services. This offset tax is termed the input tax credit.
Benefit of Input Tax Credit
To fully comprehend the Input Tax Credit benefit, consider a shirt manufacturer who acquires raw materials- cloth, thread, buttons or tailoring equipment worth Rs 100, inclusive of a tax of Rs 10. Once the shirt is made, value addition by the manufacturer is Rs 30, making the gross value of the shirt Rs 130.
With a tax rate of 10%, the tax on this output amounts to Rs 13. However, under GST, this tax can be set against the tax already paid on the raw materials (Rs 10). Consequently, the effective GST incidence on the manufacturer is only Rs 3 (Rs 13 minus Rs 10). Here, the input tax credit for the manufacturer is Rs 10. This demonstrates how the GST mechanism circumvents the cascading effect or ‘tax on tax’, reducing the end consumer’s tax burden.
The ongoing discussion surrounding the GST exemption demonstrates how critical an understanding of the tax structure and its implications is for both lawmakers and citizens. It showcases the importance of scrutinizing policy changes thoroughly to dissect their wide-ranging implications on different stakeholders.
Last Modified: February 7, 2024