India recently rolled out a Goods and Services Tax (GST) for a "one-nation, one-tax" mentality. A GST is a value-added tax levied on most goods and services sold for domestic consumption. GST is paid by consumers, but that money then goes to the government from businesses.
According to Clear Tax, France was the first country to implement a GST. Its purpose? To reduce tax evasion. It basically simplifies and lowers the cost of obtaining taxes. More than 160 countries have followed suit, including Brazil, Canada, Germany, Malaysia, U.K. and Singapore.
What is a GST?
Currently, the United States does not have a GST, because it would not ensure autonomy for the states that have their own sales tax rates. But that doesn't mean small businesses in America don't need to know what it is and how it plays into their business. If you're doing business in other countries, it will certainly impact you. [Read related story: Best Tax Software for Business]
Essentially, a GST is a tax on the value added created by a company, according to Gordon Styles, president and CEO of Star Rapid. "GST is an indirect tax which creates one unified, common market. GST is a single tax on the supply of goods and services, right from the manufacturer to the consumer," Styles added.
There are a couple different systems that are utilized by different countries. A single, unified GST system means that a single tax rate is applied throughout the country. There is also something called a dual GST structure, which involves tax collected by the federal or central government, which is then distributed among the states. In that type of system, there is sales tax, and then federal GST is applied on top of the sales tax.
What should small businesses (SMBs) know?
The GST means that once a product is sold, the business owner has to turn around and pay the government the tax dollars spent on the wholesale merchandise.
"I'm a small business that manufactures a wearable product. The materials I buy at a wholesale price now have a tax on it, therefore, costing me more money. I, in turn, have to charge more money for my products in order to cover that tax," said Erin Robertson, founder and inventor of Ta-Ta Towels.
GSTs are highly beneficial to small businesses, according to Styles. "Typically, entrepreneurs who have just started a business have the additional burden of filing taxes before the deadline, and understanding tax credits and payment procedures entirely to run a compliant business."
Styles added that with the traditional taxation structure, there is much room for mistakes, which a tax auditor would want to look further into. This might result in legal implications and hinder the success of the business. The GST helps to simplify this process for small businesses.
Styles also noted that there are two types of GST in a business.
"There is input GST; that is the GST you have been charged by your suppliers, and there is the output GST, or the GST you charge your customer. Under normal trading circumstances, a company will collect more GST than it has to pay out. The difference between the two is then handed over to the government," Styles told Business News Daily.
How can the GST affect a small business?
Since the GST is extra money that you need to pay, it could have a slight negative effect on profitability. There is the option to raise your prices to cover the amount of the tax, but with that, you risk losing your loyal customers.
However, on the positive side, Entrepreneur India explains that the GST has done away with the confusing differentiations between goods and services. This will go a long way in reducing tax-evasion opportunities.
Entrepreneur India says, "GST requires every tax-paying entity to self-assess tax and file its returns on a monthly and an annual basis. Returns are to be filed electronically, which will reduce errors and lapses."
Roberston doesn't seem to be completely sold on the GST, saying that it has the potential to be bad for businesses and consumers, as it costs both parties more money.
"Small businesses should be well informed, because this is something that could really hurt them. This is especially true for businesses in California, where it is already hard to profit, thanks to all of the state taxes," Robertson added.
The difference between a GST for a small business and a large corporation is that large corporations can avoid paying many corporation taxes but struggle to avoid paying GST in countries that implement it, said Styles. This affects small business positively as it levels the playing field, so to speak, for smaller businesses that cannot afford expensive lawyer and accountants to hide their profits overseas or avoid taxes in Delaware.
Advantages and disadvantages
Styles laid out the advantages and disadvantages of a GST for small business.
- It simplifies the system to make the cost of business easier.
- GST would raise money as it is a tax on consumption.
- You end up with a good audit trail. The matching of GST paid by suppliers and that claimed by companies further down the line makes avoidance more difficult.
- A single rate of GST doesn't distinguish damaging activities from non-damaging activities. If you choose, as like India, to have a range of different rates of GST, you can tax bad activities (selling beef) with a higher GST, and zero rate the sale of good activities (selling fresh vegetables)
- GST is a tax on value-added items. Combined with an income tax, this means that the "circular flow" is taxed twice: both income tax and GST, which is a bad thing.
- Complex and unaligned GST systems can be subject to fraud, for example, "carousel fraud" in the EU across borders.