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How is input tax credit calculated?

LiveMint logoLiveMint 04-06-2017 Ashwini Kumar Sharma

From 1 July, GST would be charged on almost all the goods and services that we consume. There are five different GST rates—0%, 5%, 12%, 18% and 28%—which are prescribed for various goods and services. In the present regime, different taxes are charged at different stages of manufacture and trade of the goods and services. Going forward, almost all these 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 and how it works.

Inputs refer to materials or services that a manufacturer procures or avails in order to manufacture a product or services 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 services is called the output tax. Given that GST is charged on both goods and services, input credit can be availed on both goods and services. “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, chief executive officer and founder, Cleartax. 

For example, if you have a business and the product (or service) sold by you attracts 18% tax. And you use input goods (and services) in the course of your business. Then, you can reduce the taxes you have already paid on purchase of these inputs from the tax due from you (of 18%), explained Gupta. Manufacturers will add tax only on the value addition done by them and not on the entire value of the product.

Let us take the example of a manufacturer who makes steel utensils such as plates, spoons, etc. Let us assume that the manufacturer had bought raw steel worth Rs500 to make a steel pressure cooker. He also bought other raw materials for Rs100. Now, the GST for steel is 18%. Let us also assume that the other raw materials will be charged at 28%. 

Now, on the steel he would have paid GST of Rs90, and Rs28 on other materials. So the total input tax paid by manufacturer was Rs118. 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 Rs800 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 Rs144 and the manufacturer should invoice it for Rs944. But that is not what will happen under GST.

The manufacturer had already paid Rs118 as GST at the time of purchasing the raw materials. So, out of the total Rs144 that should be chargeable as GST, the manufacturer should subtract the Rs118 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 Rs26 on the steel utensil instead of Rs144, that is, GST calculated on the value of the good, minus the amount of tax already paid. Therefore, if the manufacturer wants to sell the utensil at Rs800, he should charge GST of Rs26. Further down the chain too, distributors and retailers should charge GST only on the value or margin that they add to the product, to avoid calculating tax on tax.

“The concept is nothing new as it already exists under the present indirect taxes [regime], that is, service tax, value added tax (VAT) and excise duty. Only its scope has been widened under GST,” said Amit Maheshwari, partner, Ashok Maheshwary & Associates LLP. However, as per current rules input tax credit cannot be claimed for Central Sales Tax, Entry Tax and Luxury Tax and so on. In addition, some manufacturers and service providers cannot claim the Central Excise duty. Besides that, “under the present regime, cross-credit of VAT against service tax/ excise—or vice versa—was not allowed. But under GST, since these taxes will be subsumed into one tax, there will not be restriction of setting off this input tax credit,” added Maheshwari.

The input tax credit is expected to bring down the overall taxes charged on the product at present. “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.

Maheshwari agreed, “This will benefit the ultimate consumer as the cost of production or services for service providers, traders or manufacturers will get reduced due to availability of more input tax credit and this will help in bringing down the price of goods or services to that extent.”

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