GST Basics — What, Why, and How It Works

Learning Objectives

• Understand what GST is and why India adopted it in July 2017
• Distinguish between CGST, SGST, IGST, and UTGST
• Identify the GST rate slabs and which category your goods/services fall into
• Understand the concept of "supply" in GST law
• Know who can opt for the Composition Scheme and its restrictions

What Is GST?

GST stands for Goods and Services Tax. It is a single, unified indirect tax that replaced a complex web of central and state taxes in India — VAT, Service Tax, Excise Duty, CST, Entry Tax, Octroi, and about a dozen more.

GST was introduced on 1st July 2017 under the 101st Constitutional Amendment. The guiding principle: one nation, one tax, one market.

Why Did India Need GST?

Before GST, a product passed through multiple tax layers. A manufacturer paid Excise Duty. The wholesaler paid VAT. The retailer paid Entry Tax. Each tax was calculated on the price already inflated by the previous tax — a phenomenon called tax on tax (cascading effect). This raised costs without adding value.

GST eliminated this by allowing a full Input Tax Credit (ITC) chain — every registered business claims credit for the GST paid on its purchases and pays GST only on the value it adds.

GST vs VAT — Key Differences

The Dual Structure — Centre and State Together

India is a federal country. Tax powers are divided between the Centre and the States. GST respects this by splitting into two simultaneous levies:

For intrastate transactions (within the same state):

• CGST — Central GST collected by the Central Government
• SGST — State GST collected by the State Government

Both are levied at equal rates. If GST rate is 18%, you pay 9% CGST + 9% SGST.

For interstate transactions (between two states):

• IGST — Integrated GST collected by the Centre. The revenue is later shared with the destination state.

For Union Territories without a legislature (Andaman, Dadra, etc.):

• UTGST — Union Territory GST, levied instead of SGST.

Visual: Where the Money Goes

┌──────────────────────────────────────────────────────────────────────┐
│   INTRASTATE SALE — Sunrise Retail → Digital Hub (both Telangana)    │
│                                                                        │
│   Sale: 30 phones × ₹16,000 = ₹4,80,000  |  GST @ 18%              │
│                                                                        │
│      Sunrise Retail collects:                                          │
│      ┌─────────────────────┬──────────────────────┐                  │
│      │  CGST ₹43,200        │  SGST ₹43,200         │                 │
│      │  (9% of ₹4,80,000)  │  (9% of ₹4,80,000)   │                 │
│      └────────┬────────────┴───────────┬───────────┘                 │
│               │                        │                               │
│               ▼                        ▼                               │
│      CENTRAL GOVT           TELANGANA GOVT                             │
│      (Union Budget)         (State Revenue)                            │
└──────────────────────────────────────────────────────────────────────┘

┌──────────────────────────────────────────────────────────────────────┐
│   INTERSTATE SALE — Sunrise Retail (Telangana) → CloudStore (Karnt.) │
│                                                                        │
│   Sale: 20 phones × ₹16,500 = ₹3,30,000  |  GST @ 18%              │
│                                                                        │
│      Sunrise Retail collects:                                          │
│      ┌────────────────────────────────────────────┐                  │
│      │          IGST ₹59,400 (18% of ₹3,30,000)  │                  │
│      └──────────────────────┬─────────────────────┘                  │
│                              │                                         │
│                              ▼                                         │
│                    CENTRAL GOVT collects IGST                          │
│                              │                                         │
│                    ┌─────────┴──────────┐                             │
│                    │  IGST shared with  │                             │
│                    │  KARNATAKA (dest.) │                             │
│                    │  based on consumption principle                   │
│                    └────────────────────┘                             │
└──────────────────────────────────────────────────────────────────────┘

Key rule: Money always flows to where the CONSUMPTION happens, not where goods originate.

GST Rate Slabs

GST uses a tiered rate structure. Every good and service is classified under one of these slabs:

HSN Code System: Every good has an HSN (Harmonised System of Nomenclature) code that determines its GST rate. Services have SAC (Service Accounting Code). You must mention the correct HSN/SAC on every tax invoice.

Understanding "Supply" in GST

GST is levied on supply — not on manufacture or sale alone. Supply is a broader concept.

Supply includes:

• Sale of goods or services
• Transfer, exchange, barter
• Rental or lease
• Import of services (even if free)
• Activities done for a consideration

Taxable supply: Any supply on which GST is levied (most goods and services).

Exempt supply: Supply where GST rate is Nil (0%). Example: fresh vegetables. No tax, but also no ITC on inputs used for exempt supplies.

Zero-rated supply: Exports and supplies to SEZ. GST rate is 0% but the supplier can still claim ITC — unlike exempt supplies.

Composite supply vs Mixed supply:

• Composite supply — a bundle where one item is the principal supply. A phone sold with a warranty is a composite supply; GST rate of the principal item (phone = 18%) applies to the whole bundle.
• Mixed supply — independent items sold together. Highest rate applies to the whole bundle.

Sunrise Retail — Case Study Application

💼 Sunrise Retail Pvt Ltd Kiran Sharma walks into a CA's office for GST advice. Here is how the CA classifies Sunrise Retail's business:

Business type: Trading of consumer electronics — falls under GST as a taxable supply of goods.

Product classification with HSN codes:

Key classification decisions:

1. Apr 10 — Sale to Digital Hub, Secunderabad (Telangana): Intrastate → CGST 9% + SGST 9% on ₹4,80,000 = ₹43,200 CGST + ₹43,200 SGST

2. Apr 12 — Sale to CloudStore, Bangalore (Karnataka): Interstate → IGST 18% on ₹3,30,000 = ₹59,400 IGST

3. Apr 5 — Purchase from TechWorld, Mumbai (Maharashtra): Interstate purchase → IGST 18% on ₹12,00,000 = ₹2,16,000 IGST (claimable as ITC)

Reverse Charge Mechanism (RCM): Sunrise Retail pays rent for its Madhapur office from an unregistered landlord. Under RCM, if the landlord is unregistered, Sunrise Retail must self-assess and pay GST on rent under reverse charge. However, if the landlord is GST-registered and issues a proper tax invoice, standard forward charge applies. (In our case study, the landlord is registered → standard invoice at ₹30,000 + 18% = ₹35,400.)

Worked Example — How GST Eliminates Cascading

Old system (VAT era):

• TechWorld manufactures a phone, pays Excise Duty 12% on ₹10,000 → cost ₹11,200
• Sunrise Retail buys at ₹11,200, pays VAT 12.5% on ₹11,200 → pays ₹1,400 VAT. No credit for excise paid.
• Total tax burden: ₹1,200 + ₹1,400 = ₹2,600 on a ₹10,000 item = effective 26% tax

GST system:

• TechWorld manufactures a phone, charges GST 18% on ₹10,000 = ₹1,800 GST. TechWorld pays ₹1,800 to government.
• Sunrise Retail buys, pays ₹1,800 GST → but claims full ₹1,800 as ITC.
• Sunrise Retail sells at ₹16,000, charges 18% GST = ₹2,880. Sunrise Retail pays ₹2,880 − ₹1,800 ITC = ₹1,080 net.
• Total tax paid by all parties: ₹1,800 (manufacturer) + ₹1,080 (Sunrise Retail) = ₹2,880 = exactly 18% of ₹16,000.
• No cascading. Consumer pays only one layer of tax embedded in the price.

Composition Scheme

The Composition Scheme is designed for small businesses who want to pay a flat rate of GST without the burden of regular return filing.

Eligibility: Registered dealers with aggregate turnover ≤ ₹1.5 Crore (₹75 Lakh for some states).

Rates under Composition:

Restrictions:

• Cannot supply interstate goods
• Cannot issue Tax Invoice (issue Bill of Supply instead)
• Cannot claim ITC
• Cannot make supplies exempt from Composition
• Must display "Composition Taxable Person" on all invoices and signboards

Can Sunrise Retail opt for Composition? No. Their projected turnover is ₹1.2 Crore — under the ₹1.5 Crore limit. However, they sell interstate (to Bangalore) which is prohibited under Composition. So they must register as a regular taxpayer.

Mixed Supply vs Composite Supply — Getting the Classification Right

A bundle of goods or services almost never falls cleanly into one HSN/SAC code. The law splits these bundles into two buckets — composite and mixed — and the rate that applies to the bundle depends entirely on which bucket the bundle lands in.

The Naturally-Bundled Test

The first question to ask: "In the ordinary course of business, would these items normally be sold together?"

• Yes, naturally bundled with one item clearly the primary purchase → Composite supply → Tax at the rate of the principal supply
• No, just packaged together to clear inventory or attract a buyer → Mixed supply → Tax at the highest rate of any item in the bundle

Composite Supply — Examples and Treatment

A composite supply has one principal item plus incidental items that wouldn't be sold separately in the normal course of business.

The buyer is fundamentally buying the principal item — the rest exists only to support the principal purchase.

Mixed Supply — Examples and Treatment

A mixed supply is two or more independent items packed together — items the buyer could and would buy separately if they wanted to. The highest rate of any item drives the whole bundle.

The giveaway: each item has its own market and its own buyer. They're together only because the seller chose to bundle them at a single price.

The Single-Price Test

Both composite and mixed supplies share one feature — the bundle is sold for a single, indivisible price. If the invoice shows separate line items, separate prices, and the buyer could remove one before billing, it's not a bundled supply at all — each line item is taxed separately at its own rate.

Diwali Gift Hamper @ ₹3,500 (single price)
  → Mixed supply → 18% on ₹3,500 = ₹630 GST

vs.

  Chocolates    ₹500   (18%)
  Dry fruits    ₹800   (12%)
  Cookies       ₹400   (18%)
  Soft toys     ₹600   (12%)
  Stationery    ₹500   (18%)
  Loose pack    ₹500   (no goods, just packaging — typically incidental)
  ───────────────────
  → Each item shown separately → tax each at its own rate
  → 18% on ₹1,400 + 12% on ₹1,400 = ₹420 + ₹168 = ₹588 GST

The difference between ₹630 and ₹588 might look small on one hamper, but at scale (a Hyderabad sweet shop sells 4,000 Diwali hampers) it compounds into lakhs.

Compensation Cess — Quick Primer

Some goods carry GST plus an additional levy called Compensation Cess — an extra tax stacked on top of the highest GST slab (28%) to compensate states for revenue loss after GST roll-out.

When it applies: Luxury items, sin goods, and select demerit goods. Not every 28%-bucket item attracts cess — only those specifically notified.

Rate range: 0% to 400% (yes, cess can exceed 4x the base price on extreme sin goods like flavoured chewing tobacco).

The ITC Cross-Utilisation Rule

This is the single trap that catches most accounting teams new to cess:

• Cess ITC can only offset Cess output — never GST.
• GST ITC can never offset Cess output — even if you've stockpiled CGST/SGST/IGST credit, you still pay Cess in cash.

A car dealer pays Cess of ₹2.5 Lakh on a luxury SUV import.
They have ₹6 Lakh of IGST ITC available.

Wrong: "I'll use my IGST ITC to clear the Cess."
Right: Cess of ₹2.5 Lakh must be paid in CASH. The IGST ITC stays untouched
       until there's an IGST output liability to offset.

(One tiny exception: when the dealer SELLS the SUV, the Cess they collect from the buyer can be reduced by their input Cess credit — so Cess ITC vs Cess output works fine. Just no crossing between Cess and the regular GST trio.)

Where it appears on documents:

• Tax invoice: separate column "Compensation Cess" alongside CGST/SGST/IGST
• GSTR-1: a dedicated Cess column on every applicable invoice row
• GSTR-3B: separate Cess fields under Section 3.1 and Section 4
• Electronic Cash & Credit Ledgers: separate Cess ledger from GST ledgers

Practical note for Sunrise Retail: Mobile phones, laptops, and electronics — none of these attract Compensation Cess. So Sunrise Retail will never deal with Cess in its own invoices. But if Kiran ever buys a luxury company car (engine >1500cc), the dealer's invoice will show 28% GST + 22% Cess, and the ₹3-4 Lakh of Cess gets blocked under Section 17(5) (motor vehicles) — a real cash hit with no recovery.

Practice Exercise

Exercise 1: A textile trader in Maharashtra sells sarees to a buyer in Maharashtra at ₹50,000. Sarees are taxed at 5%. Calculate CGST and SGST payable.

Exercise 2: Sunrise Retail wants to sell 10 laptops (HSN 8471, 18% GST) to a customer in Andhra Pradesh at ₹55,000 each. What type of GST applies and how much?

Key Terms

Checklist — what you should now be able to do:

• Identify whether a transaction attracts CGST+SGST or IGST based on the states involved
• Look up the correct GST rate slab for any product using its HSN code
• Explain the cascading elimination mechanism with a worked example
• Determine whether a business qualifies for the Composition Scheme
• Classify supplies as taxable, exempt, or zero-rated