What are the differences between GST and VAT?

Most people are accustomed to VAT even if they don’t run a business. For instance, if you make a purchase or go to a restaurant, in the lower part of your bill you will most likely see an extra cost in the form of a percentage (%). This is the value added tax, VAT.

VAT is a consumption tax levied on a product at each stage of the supply chain where the value of the product has been increased. VAT has been a major reform for India’s taxation system when it was introduced in 2005. This change was needed due to issues with India’s previous taxation system, where the cascading effect of taxes had a negative effect on purchases.

This year (2017), another reform is planned to hit the market under the form of GST, short for Goods and Services Tax. This will replace the current indirect taxation system by replacing a line of different taxes, including VAT, with a single unified tax to eliminate the cascading effect that is in place now. This tax will be applied to value addition instead of the total value of the product at each stage in the supply chain, thus making the cost of a product more transparent.

Based on what you’ve read so far this new system sounds similar to VAT, but there are several key differences between them. We’ll have a closer look to understand the changes and impact on Indian businesses.

Taxing intrastate and interstate trade

In the present system, intrastate (same state) trade of goods is taxed with VAT. An interstate (between different states in India) transaction of goods is subjected to a Central Sales Tax (CST) imposed by the central government, plus other local taxes which can be levied by the state that receives the item (where the buyer is located).

If a seller sells goods across multiple states, he or she has to abide by the individual rules of each of those states, which often turns into a logistical nightmare. To make sure they comply with all rules, any cargo truck must stop at every state border for check ups. This results in slower deliveries due to the time spent at borders, which in turn gives the opportunity to corrupt law enforcers to profit from this, through bypassing laws for people who are ready to offer bribes to lower the transit time. Because of this, many traders set up additional warehouses in different states, to reduce transit time and only pay the local VAT.

In the GST system, all interstate transactions will be subjected to IGST (Integrated Goods and Services Tax) only, a single tax that will be split between the centre and the state where the delivery is made. IGST will be applied to all interstate transactions, whether the goods are being sold or just transported between different locations of the same company. Hopefully, this will reduce the delivery time and remove any need for extra border checks.

Tax revenue distribution

Both VAT and GST rates vary based on the type of goods sold, but in the current tax system VAT rates also vary across states due to the each state’s own regulations.This means that every state collects VAT for itself and the central government relies on other taxes for revenue, which results in unequal revenues. In GST all rules are made by the central government which means that states will adopt them uniformly. To distribute revenue more evenly between the centre and the state government, GST will have 2 components, central GST (CGST) and state GST (SGST).

Tax rate

Both VAT and GST systems have different tax rates that apply to products.For instance, basic goods such as food and unprocessed goods that can be found in the average consumer basket (consumer price index) have zero rate tax in both VAT and GST systems. Other mass consumptions items such as coffee or prescription drugs that are now taxed between 4-5 % VAT, will be taxed at 5% under GST. However, items like precious metals that are now taxed at 1-2% will have a GST tax rate of 2-4%. .

Any items that don’t fall into these categories and have been categorised so far under a general VAT rate (between 12.5% and 20%), under GST they will be associated with a standard rate, of either 12% (for example Refrigerators) or 18% (cosmetics). Under the current tax system, demerit (tobacco) and luxury goods have both VAT and additional taxes, such as luxury tax. In GST these same goods will fall under a single 28% tax rate, with some demerit goods having an additional cess on top of GST.

Taxing goods and services

In India VAT is only imposed on the goods sold and is collected by the state, while services are subjected to a service tax, which in turn is collected by the central government. The major difference in GST is that it applies evenly across the country to both goods and services.

Claiming tax credit

Within the current tax system claiming input tax credit gets complicated if your business is spread across multiple states. If you are buying a product in Maharashtra, storing it in your shop in Kerala and selling it to a client from Kerala, you will pay VAT in Maharashtra and your customer will pay VAT in Kerala. So these taxes will be collected by different states, which means you will not be able to claim input tax credit on VAT for this transaction.In the GST system you will be able to claim input tax credit for the situation above and mostly any transaction across state borders.