GST Primer: A Step towards GST for SMEs

GST Primer


Through this article, we foresee a feasible path from the chaotic present to GST as well as summarise what is GST, why the Indian design is so special and its near/long-term prognosis.

Unlike the recent shock and awe-inspiring de/remonetisation measures, GST is one of the longest reforms coming, almost for a decade, having been supported across party lines, with some suggesting an increase in GDP due to GST. However, a brief look at the GST shows that unless businesses go digital, they would find it hard to implement GST. It won’t be an issue for large businesses who are well versed in the digital economy and have enough trained manpower to stay on top during the transition. But it is an altogether different ball game for SMEs. For India to be a truly digital economy, it will require a change in the DNA of the country. Right now it is cash in various forms such as payments, bills/ invoices, communications with Government/ Customers/ Vendors and so on. While the remonetisation is expected to give a boost to electronic banking and payments right to the grassroots, the rest of infrastructure needs to evolve at the same pace to make sure the country is not left behind in the new knowledge world. The proposed Indian GST design as we shall see below is a fully digital apparatus, which pre-supposes businesses being ready with digital invoicing, payments, and reconciliations. The key will be to ensure GST readiness for all SMEs and MSMEs as the very large enterprises are already large taxpayers and will need to receive the tax credit on their purchases from smaller players to be able to reduce the ultimate price and ensure tax compliance at the same time.

What is GST and how is it different from the current tax system?

Goods & Services Tax is a destination based tax which has emerged as a key method to collect all indirect taxes in a fair and transparent manner, across the value chain. It is proposed to be implemented on a nationwide basis, under the motto of One Nation, One Tax. Indirect taxes (i.e. taxes not on net income, either personal or corporate) form a major part of India’s tax revenue, given insignificant coverage of direct taxes, at less than 2% of the population. For a resource, a starved country with significant deficits, the simplicity of indirect tax procedures and checking evasion is key to finding better resources for development. Currently, goods and services are taxed separately by various arms of Government. The Central Government for goods (on a production basis), services & import, states on sales basis (goods), municipal bodies (entry tax) etc. The multiplicity of taxes makes tax administration/co-ordination difficult with rampant tax evasion as everything is paper-based. On the other hand, the cascading of tax (the same item being taxed multiple times) leads to unfair burdening of ultimate consumers, due to tax evasion by producers. The resultant production architecture disincentives scale by favouring silos over global scale plants/ logistics/ administration and thereby reduces the competitiveness of the nation versus other competitors. The proposed GST system aims to address this, as well as bring certain unique features which will make Indian indirect tax, a model for the rest of the world.

Below is an Example of how GST will work as compared to the present TAX structure.

Product sold from City A to City B with in the same State 1,00,000 1,00,000
VAT@10% 10,000 N.A.
GST (CGST@5% + SGST@ 5%) N.A.  5,000 + 5,000
Product sold from City B to City C (Interstate) 1,10,000 1,10,000
Profit 50,000 50,000
Selling Price 1,60,000 1,60,000
CST@10% 16,000 N.A.
IGST@10% – CGST-SGST N.A. 16,000-5,000-5,000 = 6,000
TOTAL SALE PRICE 1,76,000 1,66,000

*The above calculations are for illustration purpose only

How does GST work?

GST has 2 key pillars, a system of Input Tax Credit (ITC) and an Administration that is lean and largely technology-driven. The Input Tax Credit simply means that each of the links in a large Supply Chain leading to the final consumer is covered and gets a rebate for tax paid by preceding party. It is unlike the present system, in which there is a central tax on production, and state tax on final sales with a series of taxes in-between with partial set-off being available. GST will eliminate the cascading effect of tax and make the goods ultimately cheaper. However, all this will only be possible if the other pillar is in place, i.e. a system that is very lean to administer and largely technology-driven. This is where GSTN comes in.

What is unique about Indian GST?

GST in some shape and form (or VAT in some jurisdictions) has been prevalent in a number of countries around the world. However, the Indian system is unique as it seeks to create an invoice-to-invoice match, rather than matching of invoices at a gross level, to get Input Tax Credit. This design of the system is expected to ensure that any buyer will choose Sellers, registered with GST, enabling tax credit. Such matching has never been attempted before on a national scale. Hence, this experiment is being keenly watched around the world, including places like EU, Canada etc. which otherwise have very sophisticated authorities. Thus, most enterprises must file returns on a monthly basis of sales and purchases. Each of those would be matched across the entire chain. This will create a gigantic network, as the resulting system will track an item of good, say a car, all through its smallest of subparts (estimates suggest that an average car needs 30,000 components), with the overall tax being subdivided into smaller components in proportion to their value added, which is effectively similar to the net income concept for direct tax, making it fair across the chain. Having said that, like in case of direct taxes, the system provides for very small businesses below a threshold with a waiver on filing returns, or file quarterly instead of monthly, but at the cost that it can’t provide ITC to the Buyer.

What are the short term and long term implications of GST?

In the short term, before April 1st, 2017, there is a race on all fronts, for the administration and Government to resolve outstanding differences/enact laws and frame procedures governing it; GSTN and its constituents to get the new system with its hub and spokes ready; and the final users, i.e. the corporates to change their existing indirect tax compliance. The last part is the most difficult, as the new GST would need redrawing of corporate internal silos, as ITC will need procurement, IT, sales and compliance to align at invoice level which is unprecedented; instead of silos as seen currently. In the short run, this will lead to chaos, till everyone is past teething troubles and gets used to the new architecture. The multi-slab structure is likely to contain inflation while moving towards single rates eventually. The confusion and chaos should eventually lead to stronger tax compliance, digitisation of the entire Corporate Supply Chain and eventually change of entire business models that are currently state-specific, disregarding scale and automation benefits.

The move towards cashless economy announced a few days back, will help accelerate the process of preparedness for GST, as cash sales will be increasingly difficult. This will create buoyancy not only on indirect taxes but eventually drastically reduce the current leakage on direct taxes. In the long term, this can potentially lead to lower taxes on a much larger base leading to a happier society, large automated manufacturing plants which serve the whole country & beyond a single location, substantial improvements in logistics and productivity, and the Government generating adequate resources to provide a truly global standard of living to its citizens.