In the last three decades, the world has seen explosive growth in regions with once-struggling economies. These emerging markets have benefitted from an increasingly globally connected trading market as well as a push from the outside world to liberalize their economies. South America was once known for civil wars and drug cartels, but economic reforms in countries like Peru, Colombia, and Panama have pulled many out of poverty. Similar reforms are happening across the globe, and it can be difficult to keep up with rapidly evolving labor and tax laws. For example, India has recently enacted a tax reform designed to simplify taxation and lower costs for compliance, called the Goods and Services Tax Law (GST). Here’s what you need to know about GST in India.
History of GST in India
The new legislation took effect on July 1st, 2017, but it’s been in the works for nearly 20 years. Prime Minister Vajpayee established a committee in the year 2000 to draft the law and present to parliament. The goal of the commission was to study the current value-added tax system and to see whether it could be improved. A 2004 task force concluded that changes were needed in the current tax structure and that GST was the solution. After years of reports, commissions, and even a constitutional amendment, the GST passed both houses in 2016 before being implemented in July 2017.
How the GST Works
The GST is a value-added tax (VAT) that applies in every step of production. For example: In the process of baking bread, the baker buys raw ingredients to bake into bread, the packaging company buys the bread and prepares it for market, and the store buys the packaged bread and sells it to the customer.
Each step along the way adds value. The baker adds value to the ingredients by making them into bread. The packaging company adds value by making the bread easy to sell. The market adds value by marketing the product. The GST adds a small tax to the product at each step along the way.
The GST has three different tax components:
- The Central Goods and Services Tax (CGST) is a tax that goes to the central government, which applies to intrastate transactions
- The State Goods and Services Tax (SGST) is a tax that goes to the state, which applies to intrastate transactions
- The Integrated Goods and Services Tax (IGST) is a tax that the state and central government split, which applies to interstate transaction
If the producer and the buyer are located in the same state, then the seller collects both the CGST and the SGST. If they are in different states, the seller only collects the IGST.
How GST Improves Taxation in India
GST replaced a plethora of different state and central taxes levied independently by the different governmental structures such as a state VAT, entertainment tax, service taxes, and many more. GST simplifies the sales tax code down from twelve different taxes to just one system, making compliance much easier.
Perhaps more importantly, the GST ended the cascading effect of taxes in the old VAT system. The old VAT system worked similarly to GST, but it had one major difference: When an item would move along the production process, the tax paid previously became a part of the valuation for future tax purposes.
Here’s an example from the Clear Tax website:
- The manufacturer sells the product to the packaging company for INR 1,000 and collects 10 percent VAT of INR 100
- The packaging company adds INR 300 in value and then sells it to the market for the total cost of INR 1,400 plus tax for a total of INR 1,540
- The market adds INR 500 in value, and then sells it for INR 2,040 plus tax for a total of INR 2,244
At each stage, the tax paid becomes part of the valuation calculation for the next tax. GST allows companies to end cascading taxes. At every stage, the seller is allowed to deduct previously paid VAT. Using transactions, such as the ones previously mentioned, come under the new law, we find the actual tax liability to be much lower.
- The manufacturer sells the product to the packager for INR 1,000 with tax of INR 100.
- The packager adds INR 300 in value and sells it for INR 1,430 with tax only on the added value
- Marketer adds INR 500 in value and sells it for 1,980 with a tax only on the added value.
The difference in tax liability between the two is enormous. In the old system, the total liability would be INR 444, but the new system has one of only INR 180.
If you have operations in India, or are planning on expanding into the country, you don’t need to learn the ins and outs of GST overnight. Work with an in-country partner to help you with your global expansion. Our team at Velocity Global has extensive experience helping companies start-up operations around the world, including in India. We’re here to help. Give us a call today to learn more about what an International PEO in India can do for you.
