GST - Part 1: Goodness! So Technical!

The Goods and Services Tax to be implemented by 1 April 2015 has been the talk of the town, at least it had been until the unending swarm of rate hikes shifted our attention. Nonetheless, there is still a lot left under the carpet. The government has been airing various misleading advertisements about GST and word from social media has been equally misleading albeit spun in the opposite direction. To do my part to clear any confusion regarding GST and to capitalise on my prior research on GST, I shall write a series of articles on the subject.

Part 1 – What is GST and how does it work?

What is GST?

Goods and Services Tax or GST is a consumption tax. It is collected at every stage of the supply chain but is ultimately borne by the consumer. It is designed to tax the value added at every stage of the supply chain. As such, it is called Value Added Tax or VAT in many countries.

For Malaysia, the GST will be replacing two tax systems, Sales Tax (10%) and Services Tax (6%) at a starting rate of 6% effective 1 April 2015.

How does it work?

First, we must explore the concept of supply chain. A supply chain is a system of organisations, people, activities, information, and resources involved in moving a product or service from supplier to customer. For my example, the supply chain consists of a manufacturer, a wholesaler, a retailer and finally a consumer.

This is what a supply chain looks like without GST:

Without GST, the manufacturer sells goods to the wholesaler for RM1.00, the wholesaler sells to the retailer for RM2.00 and the retailer sells to the consumer for RM4.00. No rocket science there.

Now, let us throw GST into the mix:

With GST, 6% is collected from every stage of the supply chain based on the price at each stage. So the manufacturer sells goods to the wholesaler for RM1.06 now, of which 6 sen (6%) goes to the government. The manufacturer still receives RM1.00. Same goes for wholesaler to retailer at RM2.12 - 12 sen to the government and retailer to consumer at RM4.24 - 24 sen to the government. These are called output tax.

Now, 6 + 12 + 24 = 42 sen, which is effectively 10.5%. So are we taxed more than 6%?

No, the GST component paid for by a business to the previous business in the supply chain, or input tax, is deductible. Look at the diagram below:

For the wholesaler, the 6 sen paid to the manufacturer is deductible. It is offset against the output tax of 12 sen when the it sold goods to the retailer. In the end, the GST payable to the government is 6 sen. The same goes for the retailer, 12 sen paid to the wholesaler is deductible, which is offset against output tax of 24 sen and the GST payable is 12 sen. Add up all the GST payable across the supply chain: 6 + 6 + 12 = 24 sen, which is 6% of RM4.00, the final sale price of the goods.

So, all in all, the manufacturer receives RM1.00, the wholesaler RM2.00, the retailer RM4.00, as it is without GST. The government receives 6% on the final sale price, 24 sen, which is collected from all stages of the supply chain other than the consumer. However, the consumer pays RM4.24 for the goods, and the 24 sen GST is borne by the consumer.

What about standard-rated supplies, zero-rated supplies and exempt supplies?

Standard-rated supplies are goods and services which are charged the standard 6% rate as explained above.

Zero-rated supplies are goods and services which are charged GST at a rate of 0%, which means it is GST-free. Businesses do not charge GST for zero-rated supplies but if any input tax that is paid by the businesses can be claimed. However, this does not mean that prices of these goods and services will not increase after GST is implemented as the costs in manufacturing, transporting, selling, marketing the products might carry GST. Although these costs are deductible, businesses are unlikely to pass on the full savings from the deductions to the consumers. As such, prices of goods and services will still rise despite being zero-rated.

Exempt supplies are charged GST at every stage of the supply chain except where it goes from final provider to consumer. The government tells us that consumers will not bear the GST in this case, which is true, but the GST borne by businesses will most definitely be passed on to the consumers and prices will still increase.

Chong Yu Cheng

Part 1 - What is GST and how does it work?
Part 2 - Is GST a good system and is the government ready for it?
Part 3 - What will GST do to us?