Input tax credit under GST: An explainer
From July 1, Goods and Service Tax (GST) would be charged on almost all goods and services.
Going forward, almost all indirect taxes will get subsumed under GST. Further, because of the input tax credit provision, only value additions at various stages will be taxed. Let’s read more about what is input tax credit.
WHAT IS INPUT TAX CREDIT?
Inputs refer to materials or services a manufacturer procures or uses in order to manufacture a product or service which is the output.
The taxes paid by a manufacturer, while buying the raw material or services, are known as input tax and similarly, the tax collected on the sale of the product or service is called the output tax. “Input tax credit means that a business can reduce the taxes it has paid on inputs from the taxes it has to collect on output,” said Archit Gupta, CEO and founder, Cleartax.
Let us take the example of a manufacturer who had bought raw steel worth ₹500 to make a steel pressure cooker. He also bought other raw materials for ₹100. Now, the GST for steel is 18%. Let us also assume the other materials will be charged at 28%.
Now, on the steel, he would have paid GST of ₹90, and ₹28 on other materials. So the total input tax paid by manufacturer was ₹118. Next, after taking into account the cost of making a pressure cooker out of the raw materials and including a reasonable profit, the manufacturer decides to sell it to a distributor at ₹800 plus GST.
Going by a simple rate calculation, if the GST on a steel utensil is 18%, then the tax on it should work out to ₹144 and the manufacturer should invoice it for ₹944.
But that is not what will happen under GST.
The manufacturer had already paid ₹118 as GST at the time of purchasing the raw materials. So, out of the total ₹144 that should be chargeable as GST, the manufacturer should subtract the ₹118 that he has already paid (which he can claim as input tax credit).
So, after taking into account the input tax credit, he should charge a GST of ₹26 on the steel utensil instead of ₹144, that is, GST calculated on the value of the good, minus the amount of tax already paid. The input tax credit is expected to bring down the overall taxes charged.
“Now, since input credit will be available to the seller at each stage, the final cost of the product must come down. Therefore, if input credit mechanism works efficiently, final consumers may see cost reduction (since tax is not embedded in value, its credit can be availed),” said Gupta.