Goods and Services Tax - GST

What is a 'Goods and Services Tax - GST'

The Goods and Services Tax (GST) is a value-added tax levied on most goods and services sold for domestic consumption. The GST is paid by consumers, but it is remitted to the government by the businesses selling the goods and services. In effect, GST provides revenue for the government.

Also referred to as Value-Added Tax (VAT) in some countries.

BREAKING DOWN 'Goods and Services Tax - GST'

The goods and services tax (GST) is an indirect federal sales tax that is applied to the cost of certain goods and services. The business adds the GST to the price of the product; a customer who buys the product pays the sales price plus GST; and the GST portion is collected by the business or seller and forwarded to the government.

France was the first country to implement the GST in 1954, and since then an estimated 160 countries have adopted this tax system in some form or another. Some of the countries with GST include Canada, Vietnam, Australia, Singapore, UK, Monaco, Spain, Italy, Nigeria, Brazil, and South Korea. India is set to join the GST group on July 1, 2017.

Most countries with a GST have a single unified GST system, which means that a single tax rate is applied throughout the country. A country with a unified GST platform merges central taxes (e.g. sales tax, excise duty tax, and service tax) with state-level taxes (e.g. entertainment tax, entry tax, transfer tax, sin tax, and luxury tax) and collects them as one single tax. These countries tax virtually everything at a single rate.

Only a handful such as Canada and Brazil have a dual GST structure. Compared to a unified GST economy where tax is collected by the federal or central government and then distributed to the states, in a dual system, the federal GST is applied in addition to the state sales tax. In Canada for example, the federal government levies a 5% tax and some provinces/states also levy a provincial state tax (PST) which varies from 7 to 10%. In this case, a consumer’s receipt will clearly have the GST and PST rate that was applied to his or purchase value.

India is proposed to have a dual GST set up in 2017, which will be the biggest reform in the country’s tax structure in decades. The main objective of incorporating the GST is to eliminate tax on tax i.e. double taxation which cascades from the manufacturing level to the consumption level. For example, a manufacturer that makes notebooks obtains the raw materials for, say $10 which includes a 10% tax. This means that he pays $1 in tax for $9 worth of materials. In the process of manufacturing the notebook, he adds value to the original materials of $5, for a total value of $10 + $5 = $15. The 10% tax due on the finished good will be $1.50. Under a GST system, this additional tax can be applied against the previous tax he paid to bring his effective tax rate to $1.50 -$1.00 = $0.50.

The wholesaler purchases the notebook for $15 and sells it to the retailer at a $2.50 markup value for $17.50. The 10% tax on the gross value of the good will be $1.75 which he can apply against the tax on the original cost price from the manufacturer i.e. $15. The wholesaler’s effective tax rate will, thus, be $1.75 - $1.50 = $0.25.

If the retailer’s margin is $1.50, his effective tax rate will be (10% x $19) - $1.75 = $0.15. Total tax that cascades from manufacturer to retailer will be $1 + $0.50 + $0.25 + $0.15 = $1.90.

The current system with no GST implies that tax is paid on the value of goods and margin at every stage of the production process. This would translate to a higher amount of total taxes paid, which is carried down to the end consumer in the form of higher costs for goods and services. Implementing the GST system in India is therefore, a measure that will be used to reduce inflation in the long run, as prices for goods will be lower.