Today, we still pay tax-on-tax as Centrally levied indirect taxes such as Central excise are not offset when VAT is paid.
What is indirect tax?
When your salary is taxed, its direct tax. When goods and services you consume are taxed, its indirect tax.
Which are the main indirect taxes?
The major indirect taxes levied by the Central government are customs duty (on imports), Central excise (at factory gates) and services tax. State governments collect value-added tax (VAT) at the point of purchase.
What was sales tax?
Initially, states levied a sales tax at the point of purchase. They had many sales tax categories, more than 10 in some cases. India was politically united but did not have a common market.
How is VAT different from sales tax?
Under VAT, states compressed multiple categories of taxation to just three. They also provided input tax credit on VAT, which means if a manufacturer buys inputs for Rs100 on which tax has already been paid, and sells it for Rs120, it pays tax on the value addition of Rs20. The transition to VAT was an intermediate step to a common market. It was a far-reaching change as it partially reduced the cascading impact of multiple taxes, which makes your purchases costlier.
By the time states introduced VAT, the Union government was providing input tax credit for the indirect taxes under its control. However, because the Constitution gives the Centre and the states exclusive tax domains, the cascading impact of indirect taxes continues, making you pay more than you really need to.
What is the goods and services tax (GST)?
The current situation of a fragmented market makes you pay a higher price for consumption and gives Indias indirect tax architecture an unwarranted influence on business decisions.
Today, we still pay tax-on-tax as Centrally levied indirect taxes such as Central excise are not offset when VAT is paid. Despite VAT, states still function as independent islands when it comes to indirect taxes.
GST is an attempt to completely integrate the indirect tax structure and create a common market for most goods and services. In the proposed system, tax will be levied at the point of consumption and a predetermined amount will be split between the Centre and the states.
The major indirect taxesCentral excise, service tax and VATwill be bundled into GST, which should eventually translate into a lower tax rate. Other indirect taxes such as entertainment tax and cess on taxes are also likely to be bundled into GST.
The state finance ministers discussion paper is the first attempt to come out with a formal proposal for GST to widen participation to other stakeholders such as industry, trade and consumers.