Understanding Value Addition in GST
Goods and Services Tax (GST) is levied on the value added at
each stage of the supply chain. This ensures that tax is paid only on the
incremental value added to a product or service, preventing double taxation and
cascading effects.
What is Value Addition?
Value addition refers to the increase in the value of a
product as it moves through different stages of production and distribution.
Each entity in the supply chain adds some value, whether through manufacturing,
packaging, branding, or sales, and GST is charged only on that incremental
value.
Step-by-Step Breakdown of GST on Value Addition
To better understand how GST applies to value addition,
let's take the automobile industry as an example.
Stage 1: Raw Material Supplier
- A
steel manufacturer supplies raw materials to a car manufacturer.
- The
supplier charges GST on the steel provided.
- The
car manufacturer can claim Input Tax Credit (ITC) on the GST paid.
Stage 2: Car Manufacturer
- The
manufacturer uses raw materials to build a car, adding value through
labor, design, and technology.
- Sells
the car to a wholesaler, charging GST on the final price.
- Claims
ITC for the GST paid on raw materials.
Stage 3: Wholesaler
- The
wholesaler purchases cars from the manufacturer and adds value through
storage, marketing, and distribution.
- Sells
the cars to a retailer, charging GST on the new selling price.
- Claims
ITC for the GST paid to the manufacturer.
Stage 4: Retailer
- The
retailer purchases cars from the wholesaler and adds value through
customer service, showroom experience, and financing options.
- Sells
the car to the final consumer, charging GST on the final retail price.
- Claims
ITC for the GST paid to the wholesaler.
Stage 5: Consumer
- The
consumer buys the car at the final price, which includes GST.
- Since
consumers are the end-users, they cannot claim ITC.
Example: How GST Reduces Tax Burden
Before GST, multiple indirect taxes such as excise duty,
VAT, and service tax led to tax-on-tax situations. With GST, businesses claim
ITC at each stage, significantly reducing the tax burden and ensuring a fair
pricing system.
For example, a manufacturer that makes notebooks obtains
the raw materials for, say, Rs. 10, which includes a 10% tax. This
means that they pay Rs. 1 in tax for Rs. 9 worth of materials. In the process
of manufacturing the notebook, the manufacturer adds value to the original
materials of Rs. 5, for a total value of Rs. 10 + Rs. 5 = Rs. 15. The 10% tax
due on the finished good will be Rs. 1.50. Under a GST system, the previous tax
paid can be applied against this additional tax to bring the effective tax rate
to Rs. 1.50 – Rs. 1.00 = Rs. 0.50.
In turn, the wholesaler purchases the notebook for Rs. 15
and sells it to the retailer at a Rs. 2.50 markup value for Rs.
17.50. The 10% tax on the gross value of the good will be Rs. 1.75, which the
wholesaler can apply against the tax on the original cost price from the
manufacturer (i.e., Rs. 15). The wholesaler's effective tax rate will, thus, be
Rs. 1.75 – Rs. 1.50 = Rs. 0.25.
Similarly, if the retailer's margin is Rs. 1.50,
his effective tax rate will be (10% x Rs. 19) – Rs. 1.75 = Rs. 0.15. Total tax
that cascades from manufacturer to retailer will be Rs. 1 + Rs. 0.50
+ Rs. 0.25 + Rs. 0.15 = Rs. 1.90.
|
Stage |
Cost Price (Rs.) |
Value Addition (Rs.) |
Selling Price (Rs.) |
Tax @10% (Rs.) |
Input Tax Credit (Rs.) |
Effective Tax (Rs.) |
|
Manufacturer |
10 |
5 |
15 |
1.50 |
1.00 |
0.50 |
|
Wholesaler |
15 |
2.50 |
17.50 |
1.75 |
1.50 |
0.25 |
|
Retailer |
17.50 |
1.50 |
19 |
1.90 |
1.75 |
0.15 |
|
Total Tax |
- |
- |
- |
- |
- |
1.90 |
This table outlines how tax is credited and
effectively passed along the supply chain while ensuring no cascading effect
under GST.
Conclusion
Value addition in GST ensures a transparent, fair, and
efficient taxation system. By allowing tax credits at every stage, GST
eliminates cascading taxes, making goods and services more affordable for end
consumers.
Stay tuned for the next blog post: Destination-BasedTaxation in GST Explained!
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