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Published on:

November 7, 2024

Viraaj Vashishth

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GST Rules

What is Cascading Effect in GST?

Cascading effect in GST taxation could be defined as a tax on tax where levies of taxare multiply imposed on the goods or services as they go through several stages within the supply chain. This compounding of tax rates finally increases the price of the end consumer. Such cascading effect had existed in India before the introduction of GST as indirect levies had been made on various levels without sufficient input tax credit. With the introduction of the Goods and Services Tax, the government materialized its objectives of eradicating this problem in the taxation industry.

The Cascading Effect of Tax

An Overview in India before the Fourth Industrial Revolution

Before the implementation of GST in India, the Indian tax system used to incorporate a number of indirect taxes that were imposed on differing levels of production and distribution which resulted in tax cascading. There existed levies such as excise duty, VAT, CST and service tax imposed on several levels with limited areas that businesses can utilize to claim tax credits on taxes paid on inputs. This practice of tax imposed by tax taxation stretches business and consumer costs.

Key Pre-GST Taxes Contributing to Cascading Effect:

1. Excise Duty: It is applicable to the goods produced in India. This duty was paid by manufacturers without any relief for the taxes paid on raw materials.

2. VAT (Value Added Tax): Taxable at the state of sale of goods. While VAT wanted to ensure every stage of value addition is taxed, the absence of ITC for CST and other taxes led to multiple taxation.

3. Service tax and CST: These are taxes applied at different stages where patients were charged a tax on a service but were not properly provided with an ITC.

Impact on Businesses and Consumers:

These taxes had a cascading effect on the price of goods. For Example a manufacture was unable to get any tax for CST or service tax when calculating VAT and thus all these taxes increased consistently at every session and this can be observed in the table below,

Stage	Description	Tax Amount (INR)
Raw Material	Basic Cost + Excise Duty	1000 + 100
Manufacturing	Cost + VAT	1100 + 110
Distribution	Cost + CST (no ITC)	1210 + 50
Retail	Selling Price + VAT	1260 + 126
Final Cost	Total after cascading effect	1386

How GST Eliminates Cascading Effect

The Presentation of the Goods and Services Tax, Implemented in 2017 aiming at averting the cascading effect through introduction of a single tax system with an all round input tax credit system has proved effective. There is no longer a tax on tax effect which burdened purchases making goods and services expensive.

GST and Input Tax Credit (ITC)

According to GST, business can claim an input tax credit on the following:

1. CGST (Central GST) - tax extendable by Central Government.

2. SGST (State GST) - tax payable by State Governments on intra-state Sales.

3. IGST (Integrated GST) – tax levied on transactions between states.

The ITC makes it possible for businesses to manage their GST payment obligations which helps in avoiding double taxation. Here is a scenario demonstrating the working of the GST system in a supply chain.

Stage	Description	GST Rate	Tax Paid (INR)	ITC Claimed (INR)	Net Tax Payable (INR)
Raw Material	Cost Price: 1000	18%	180	-	180
Manufacturing	Cost Price: 1180	18%	212.4	180	32.4
Distribution	Cost Price: 1212.4	18%	218.2	212.4	5.8
Retail	Selling Price: 1218.2	18%	219.3	218.2	1.1
Total Tax	After ITC Adjustment		829.9		219.3

From the illustration, it is quite clear that with the ITC under GST only the net tax is to be paid at each stage, thus eliminating cascading.

Comparison: Cascading Effect in Pre-GST vs. GST Regime

A direct comparison between the pre-GST and GST tax structures highlights the benefits of GST:

Criteria	Pre-GST (Cascading Effect)	GST Regime (No Cascading Effect)
Tax Structure	Multiple Taxes (VAT, CST, Excise)	Unified Tax (GST)
Input Tax Credit Availability	Limited to specific taxes	Available on all inputs
Tax Calculation	Compounded across stages	Based on final sale only
Price Impact on Consumer	Higher due to tax-on-tax	Lower due to ITC

Real-World Example: Manufacturing- Reducing the Cascading Effect

The case can be made for the textile industry by walking through the events before and after GST.

Pre-GST Scenario:

1. MRP of raw material bought: Rs 1000 + Excise 100.

2. Total cost (for it does not have a direct relationship to itc) I: 1100.

3. A further VAT imposed on the sale price only added to the already existing tax costs which made the price which the final consumer paid exceed Rs 1300 on account of cascading.

The `PostGST’ Scenario:

1. MRP of raw material bought: Rs 1000 + GST Rs 180.

2. GST Rebate Rs 180 on gross raw material purchase costs: GST Rs 180.

3. Terminal tax liability settlement depends upon value addition alone which invariably translates into lower costs as well as the selling price which on average should be in the range of 10-15 percent less.

Shortcomings in Total Removal of the Cascading Effect in GST

Yet even if the cascading effect is managed to some extent due to GST, certain difficulties still exist in relation to ITC restrictions and compliance that still needs to be addressed:

1. Limitations on ITC claims - There are some assets and segments on which ITC may not be claimed such as some of the capital goods leading to residual cascading.

2. Substantial Compliance Issues for Small and Medium Enterprises: Small enterprises have more troubles in the area of managing the ITC claims and contributing to the cross state transactions under the purview of GST.

You can also read- Profitable MSME Business Ideas in India

‍3. Properties of Cross border transactions: Other issues such as claiming ITC on interstate sales also create problems and are detrimental more to the small vendors.

Conclusion

With the implementation of GST, the issue of cascading taxation has been considerably resolved because of the single tax system and the availability of input tax credit across the supply chain. In spite of that, some challenges do remain, but the GST system has offered much relief from the torment of compounded taxation and made the prices of goods and services cheaper. With the progress in GST, refinements in ITC compliance and eligibility will further improve its effectiveness and may make one more optimistic regarding the vision of a future without cascading taxes.

FAQs

1. What is GST’s cascading effect?

The cascading effect means abrogation of ‘tax on tax’ owing to input tax credit for such businesses claiming in their credits input tax paid on purchases therein.

2. How is the cascading effect of tax revenue under GST eliminated?

Cascading tax effects under GST are eliminated by allowing for input tax credit (ITC) at all the various levels of the supply chain, and this entails that tax on inputs are never lost in tax on sales.

3. What was the cascading effect in Indian taxation before the introduction of GST?

Earlier, different taxes of indirect nature were levied but each tax was levied at different points and did not have ITC, resulting in taxes being multiplied leading to greater charges for goods and services.

4. List some benefits in GST due to absence of a cascading effect.

Cascading form of tax being absent in GST decreases tax cost burden on enterprises, lower cost prices to consumers, heightens the degree of lucidity within the tax structure of the system.

5. In what way is the effect of cascading in tax under GST is different from the previous tax structure?

However, in the earlier regime’s circumstances, the effect of the central and state taxes was cumulative given that no input credits were available for the respective taxes levied.

6. Can you explain the cascading effect with the help of examples in the context of taxation?

A good example is VAT on excise duty to goods that were already taxed before the inception of VAT, leading to double tax costs.

7. Is it possible to fully eradicate the cascading effect in GST?

Although the layering of taxes changes and significantly decreases due to the adoption of GST, certain limitations on ITC claims may create some residual layering in specific cases.

8. What more can be done to eliminate the cascading effect that is so commonly witnessed in most tax systems including GST?

Cascading effect challenges are such as ITC limitation on certain categories of inputs as well as intricate compliance processes that are likely to cause the cascading effect not to completely disappear.

9. Is there any business which does not get affected by the cascading effect in GST?

For most businesses that operate under the compliant zone, the cascading effect is less, however small scale businesses without registered ITC compliance may find it difficult to operate in interstate commerce.

10. How do you think consumers have gained from GST with regard to the cascading impact of taxes on goods and services?

The introduction of GST and its structure has reduced the tax-on-tax impact on the cost of goods enabling the consumers to afford the services and goods, cheaper in the end.