GST (Goods and Services Tax) – Complete Guide for Startups & SMEs

Goods and Services Tax aka GST is scheduled to be in effect from 1st July and will change the way we pay our taxes for sure. The system is a game changer in the Indian taxation system and the biggest tax reform taken in 70 years of Indian history.

Asia’s third-largest economy, after China and Japan, will witness a single taxation system for goods and services after waiting for as long as 10 years. GST rollout will dismantle inter-state barriers to trade in goods and services.

But how will this new tax system impact startups and small business? Will the startup ecosystem reap benefits out of Goods and Services Tax (GST)? Or will it adversely cause harm to the startups and small businesses?

This guide will drive you through the complete system of GST including how will it work, the impact on startups and SMEs and more.

So let’s begin!

What is GST?

Goods & Services Tax is a comprehensivemulti-stagedestination-based tax that will be levied on every value addition. That simply means that business will have to pay taxes on value addition and not on the final value of goods and services.

To understand GST in details let us first discuss various definitions and concepts under this. Let us start with multi-stage.

When an item is available right next to your neighbourhood store or a supermarket for sale, it travels through a chain of stages before arriving at the retailers. The first stage is buying the raw materials followed by production or manufacturing.

If we had a pictorial representation of the various stages, it will look something like this. However, this is the elementary representation. There may be some other stages involved depending on the type of goods and services.

The items are then warehoused by the distributor or wholesaler. The retailer then buys the products from the wholesaler and finally sells it to the end consumer like us. The whole process completes the life cycle of a product – from raw materials to end consumer.

The Goods and Services Tax shall be levied on each of these stages. This makes GST a multi-stage taxation system. However, the taxes will be levied on value addition.

Let us discuss value addition before diving into how the taxes will be levied and what are the different categories and value of taxes for different goods and services.

Let us assume that a manufacturer purchases cotton worth ₹1000 to make shirts. Cotton here is the raw material. After manufacturing the shirt, the manufacturer adds a value of ₹1000. So the final value of the shirt is ₹2000.

The manufacturer then sells the shirt to a wholesaler or warehouse who then adds packaging & labels to the shirt and is responsible for the transportation and distribution of the shirt to various retailers.

The wholesaler adds some value say ₹1000 to the shirt (profit) making the final value of the shirt to ₹3000.

The retailer buys the shirt from the wholesaler at ₹3000 and then adds a value of ₹1000 (his profit) and finally sells the shirt to the end consumer at ₹4000.

GST will be applicable on all these value additions. If the rate of Goods and Services tax is 10 percent (for example) for all of them, the manufacturer will have to pay ₹100 (10 percent of his value addition of ₹1000), the wholesaler too will have to pay a tax of ₹100 (10 percent of his value addition of ₹1000) and retailer will pay ₹100 in this case.

Now let us talk about one more term – destination-based.

Since GST is a destination-based tax, the centre would not levy an excise duty and states would not levy VAT as it was during earlier taxation system. Then there was VAT at the point of sale.

GST will replace all these taxes with a single destination-based tax.

Assume that the shirt was manufactured and warehoused at Chennai and sold in Mumbai. Chennai being in Tamil Nadu will collect GST for manufacturing and warehousing, but lose revenue when the shirt moves out for sale in Mumbai. Maharashtra will collect GST for value addition by the retailer as the product is being sold in Maharashtra.

How Does GST Work?

India is the largest democracy in the world with 1.311 billion people living in the territory. Implementing a completely new tax regime in such a large economy is not easy.

The GST Council has devised a foolproof method of implementing this new tax regime by dividing it into three categories: CGST, SGST, and IGST.

CGST: where the revenue will be collected by the central government

SGST: where the revenue will be collected by the state governments for intra-state sales

IGST: where the revenue will be collected by the central government for inter-state sales

GST is a consumption based tax i.e the state where the goods or services are to be consumed will collect taxes and not the state where the goods are manufactured. We have already explained this above.

IGST is designed to ensure seamless flow of input tax credit from one state to another. One state has to deal only with the Centre government to settle the tax amounts and not with every other state, thus making the process easier.

For example –  A dealer in Punjab sold goods to the consumer in Punjab worth Rs. 1,00,000. The GST rate is 18% comprising of CGST rate of 9% and SGST rate of 9%, in such case the dealer collects Rs. 18000 and Rs. 9000 will go to the central government and Rs. 9000 will go to the Punjab government.

Now, if the dealer in Punjab had sold goods to a dealer in Uttar Pradesh worth Rs. 1,00,000. The GST rate is 18% comprising of CGST rate of 9% and SGST rate of 9%. In such case, the dealer has to charge Rs. 18,000 as IGST. This IGST will go to the Centre.

But how will the tax be adjusted between different states (interstate transactions)?

Suppose goods worth Rs. 1,00,000 are sold by manufacturer A in Punjab to Dealer B in Punjab. B resells them to a trader C in Gujarat for Rs. 1,75,000. Trader C finally sells to End User D in Gujarat for Rs. 3,00,000.

Suppose CGST= 9%, SGST=9%. Therefore, IGST=9+9=18%

Since A is selling this to B in Punjab itself, it is an intra-state sale and both CGST @9% and SGST@9% will apply.

B (Punjab) is selling to C (Gujarat). Since it is an interstate sale, IGST@18% will apply.

C (Gujarat) is selling to D also in Gujarat. Once again it is an intra-state sale and both CGST @9% and SGST@9% will apply.

Read the full content here: GST Guide for STARTUPS and SMEs