There are 2 reasons to get a GST number
- When you are required to by the Tax department
- When it makes economic sense
Tax department requires you to mandatorily get a GST number under certain conditions. If you meet those conditions, you dont have a choice, you just got to get the GST number. We are not going to discuss those conditions here. We are instead going to discuss why you should proactively get the GST number.
Economics of getting a GST number
Lets say you are software freelancer and you make one lakh a month. I am going to graphically represent how much money you make as shown below.
Out of which lets say you have 25k in business expense. What constitutes as business expense. Surprising a lot of things can constitute as business expense and most independant freelancers do not know anything about it. I did not know about it either. Your coworking space is a business expense. Your internet bill is as well. So is your laptop, its servicing, your car, its servicing, uber etc. A lot of things fall into business expense.
For most freelancers, this is how life looks like – I make some money and I spend some in expense. In this case you are not billing GST. You bill one lakh and get exactly one lakh into your account.
At this point lets clear the first misconception about adding GST to your bill.
I thought the client does not want to additional amount to me as GST
If I am charging GST, then instead of giving the client a one lakh bill, I will instead give the client a 1.18 Lakhs bill (18% GST). The client has to pay me more. The client will not be happy. The client will be less interested in working with me.
Wrong. This is what I thought. Apparently not. The client is super indifferent. He does not care at all. Why? Because he can claim the 18% you charged him as input credits from the government. So for him, you are only as expensive as you were before including GST.
Ok. Now you included GST in your bill. Now you have more money coming to your account.
The expense that you were paying before will also have a GST component in it. If you open up a bill for some electronics that you bought, you can see the GST you are paying. The amount you pay includes GST.
So, this is a better representation of your expense. There is a part that goes to the merchant and there is a part that goes to the government. But either way you pay the full amount.
When you charge GST here is how you think it looks like. To you, it looks like you are just collecting GST and passing it on the the government.
If you also represent the GST that your merchant pays to the government in the diagram, it will look like the image above. This diagram above will tell you that something is really wrong. The government is collecting GST from you as well as the merchant that you bought material from.
This is an issue. This is double taxation. How? Business A makes steel. Business B converts steel into iron rods. Business C makes the iron rod into a machined part. Business D uses the part in a car and sells the car. By the time customer buys a car, the same material has been taxed 4 times. The concept of VAT (value added tax) is that you only have to pay for value added(by your business). Business B buys raw material from Business A, adds value to it by converting it to iron rod and pays tax only on the value added, not the entire selling price.
Similarly when you are a freelancer, you are a mini business. You take in some input raw materials(office space, electronics etc) and convert them into value for your client. You pay for only the value added. This means the govt, allows your to claim tax credits from all your expense invoice.
This figure above shows the actual representation where the GST that you paid via business expenses are adjusted with the GST that you collected from the client.
You collected 18k in GST but you will pay a lesser amount to the government as shown in the image above because you claimed the money that you paid as GST in your business expenses as input credits.
this means your net income after expense will increase. You will have more money left in your bank after all the taxes are cleared.
It’s clear that you will get to keep more money for yourself with GST. But how much more money? Imagine getting an 18% discount on everything that you buy for running your business. Would you appreciate that? Of course you would. If you have decent amount of business expense, this is a significant amount of money.
The question for you then is – Is all the paper work and hassle for GST filing worth the input credits? Well we run a software consulting service and our input credits for the last 6 months is 24k. Buy a chair, table, laptop, work related travel on flights etc all of these count as valid expenses.