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Introduction:
VAT or Value Added Tax is, perhaps, one of the most important fiscal innovations
of the 20th century. First it was introduced in France in 1954 (Taxe sur la
Valeur Adjoutee). In Asia, it has been introduced by a large number of countries
such as China, Sri Lanka India etc. At present, more than 160 countries
including those in Latin American, Asian, Africa and the Pacific have a VAT
system in place. Even in India, there has been a VAT system introduced by the
Government of India for about last ten years in respect of Central excise
duties. At the State-level, the VAT system as decided by the State Governments
was introduced in terms of Entry 54 of the State List of the Constitution. The
first preliminary discussion on State-level VAT took place in a
meeting of Chief Ministers convened by Dr. Man Mohan Singh, the then Union
Finance Minister in 1995. In this meeting, the basic issues on VAT were
discussed in general terms and this was followed up by periodic interactions of
State Finance Ministers. Thereafter, in a significant meeting of all Chief
Ministers, convened on November 16, 1999 by Shri Yashwant Sinha, the then Union
Finance Minister, three important decisions were taken.
Before the introduction of State-level VAT, the unhealthy sales tax rate war
among the States would have to end and sales tax rates would need to be
harmonised by implementing uniform floor rates of sales tax for different
categories of commodities with effect from January 1, 2000. In the interest
again of harmonisation of incidence of sales tax, the sales-tax-related
industrial incentive schemes would also have to be discontinued with effect from
January 1, 2000. On the basis of achievement of the first two objectives, the
States for introduction of State-level VAT would take steps after adequate
preparation. For implementing these decisions, an Empowered Committee of State
Finance Ministers was set-up.
Through repeated discussions and collective efforts in the Empowered Committee,
it was possible within a period of about a year and a half to achieve nearly 98
per cent success in the first two objectives on harmonisation of sales tax
structure through implementation of uniform floor rates of sales tax and
discontinuation of sales-tax- related incentive schemes.
After reaching this stage, steps were initiated for systematic preparation for
the introduction of State-level VAT. At this stage,
there were certain developments, which delayed the introduction of VAT. Despite
these developments, most of the States remained positively interested in
implementation of VAT. By the constant efforts of the empowered committee the
states have either introduced VAT act in the state or are in the process of
having it.to know the system of taxation under value added taxation system one
should properly know the clear ambit of value added system so that he can give a
full time cooperation to it.
VAT: Definition
VAT is a multi-stage tax levied at each stage of the value addition chain, with
a provision to allow input tax credit (ITC) of tax paid at an earlier stage,
which can be appropriated against the VAT liability on subsequent sale. VAT is
intended to tax every stage of sale where some value is added to raw materials
and goods, but taxpayers will receive credit for tax already paid on procurement
stages.
In other words the general principles, which guide the value added tax,
are as follows:
General Tax It is a general tax that applies, in principle, to all
commercial activities involving the production and distribution of goods
and the provision of services.
Consumption Tax: It is consumption tax because it is borne ultimately by
the final consumer. It is not a charge on companies.
Charged As A Percentage Of Price: It is charged as a percentage of price,
which means that the actual tax burden is visible at each stage in the
production and distribution chain.
Collected Fractionally:
It is collected fractionally, via a system of
deductions whereby taxable persons can deduct from their VAT liability
the amount of tax they have paid to other taxable persons on purchases
for their business activities. This mechanism ensures that the tax is
neutral regardless of how many transactions are involved
Now while considering the taxation under vat it often comes to our mind
what is value addition on which the tax is imposed and how Value Added
Tax is different from the overall taxation in sales tax.
First let us consider what value addition to a product is or in toto
what is a value added chain. A value addition is an estimated market
value added to a product or material at each stage of its manufacture or
distribution, until it is passed on to the ultimate consumer. The chain
that is formed by such value addition is called value added chain
Suppose following is the value added chain to a product ; fibre-yarn-fabric-garment-retailer-consumer,
then the value added tax is the tax imposed on this value addition. For
example the agriculturist sells the fiber to yarn manufacturer at the
price suppose 100/- and pays 10% tax on it which comes to 10/-. Total
cost to yarn manufacturer will be 100/-. Now he converts into yarn and
sells it to fabric manufacturer at 200/-where tax collected during
output was 20/- (10%). thus market value added to this product is
selling price cost price i.e. 100/- and value added tax payable would
be tax on this value i.e. tax on output price tax on input price i.e.
20-10=10/-.
How to calculate VAT?
VAT is calculated by following method -:
A= Charge on certain Value at a certain rate
B= Ascertained input credit available
VAT Payable = A-B
Illustration No.2
How to compute the tax on this value addition?
Example: (Rate of tax assumed is 10%)
Purchase Price Rs.100
Tax paid during purchase Rs.10 (input tax)
Selling Price Rs.150
Tax collected during resale Rs.15 (output tax)
Input tax credit (Tax paid during purchase) Rs.10
VAT payable (output tax input tax) Rs.5
Total tax collected by govt.
At the time of purchase by the dealer Rs.10
At the time of resale by the dealer Rs.5
Total tax: Rs. (10+5) =Rs.15
Benefits of VAT
Now the next point of consideration is how how beneficial it is? This
can be dealt in Shortcomings of general sales tax.
Major shortcomings in current sales tax structure
The major shortcomings in general sales tax, which necessitated the
adoption of vat, were
1. Cascading effect The current system is replete with weaknesses the
foremost being the cascading effect. Sales tax is levied on the gross
value without allowing any credit or set-off for the taxes paid on
inputs (that is, tax is levied on gross value). Consequently, the
cascading effect results only in increased prices for consumers. Also,
the system has little control over tax incidence. Since there is no set
off of tax paid on purchases, the tax paid on purchases gets embedded in
cost price.
For example: a Manufacturer purchases inputs / raw materials worth Rs.500.00
and pays tax of Rs.50.00 @ 10%. Since he is not getting input tax
credit, he will add Rs.50.00 to the cost of inputs/ raw materials. If he
adds Rs.450.00 towards his labour and service and other expenses to
produce a commodity using the raw materials/ inputs, which also includes
his profit (value addition), the value of his product becomes Rs.1000.00.
When he sells the product, he collects tax, say Rs.100.00 @ 10%, which
contains Rs.50.00 tax collected on value of input which has already been
taxed at the time of purchases, Rs.5.00 i.e. tax on tax of Rs.50.00
paid earlier. In this way, there is double taxation and tax on tax,
resulting in cascading. The product may also be used as an input for
manufacturing another product, further cascading. VAT will eliminate
cascading effect of sales tax
2. Ancillarisation discouraged Cascading increases the cost of
production and makes the product uncompetitive. Further, since the
existing sale tax system is a tax on sale without provision for set off
of tax paid on purchases, it discourages ancillarisation.
Ancillarisation means getting most of parts/ components manufactured
from outside. To avoid paying tax, the large manufacturers instead of
buying parts/ components from outside, manufactures the parts themselves.
This discourages the growth of small-scale industry and increases
concentration of economic power. The system has also an adverse impact
on quality of the product, further reducing the competitiveness of the
goods.
3. Multiplicity of taxes A major defect in the prevailing sales tax
structure, there is in several States also a multiplicity of taxes, such
as turnover tax, surcharge on sales tax, additional surcharge, etc. In
addition, the states levy luxury tax as also an entry tax on the sale of
imported goods. Implementation of VAT in our country is a right step in
this direction and to do away with multiple tax system. Under the
regime of VAT, there should be no other tax such as Additional Special
Tax, Entry Tax, Octroi and Central Sales Tax (CST).
4. Multiplicity of rates Also, there is the problem of multiplicity of
rates. All the states provide for plethora of rates... These range from
one to 25 per cent. This multiplicity of rates increases the cost of
compliance while not really benefiting revenue. Heterogeneity prevails
in the structure of tax as well.
Thus to sum up with the introduction of VAT, benefits can be analysed as
follows:
A set-off will be given for input tax as well as tax paid on previous
purchases
Other taxes, such as turnover tax, surcharge, additional surcharge, etc.will be abolished
Overall tax burden will be rationalised
Prices will in general fall
There will be self-assessment by dealers
Transparency will increase
There will be higher revenue growth
Problems in effective implementation of vat in value added chain
There are certain problems, which are faced by the government of India
to effectively impose the tax in this value added chain.
Some of the
important problems are stated as follows:
1. Central sales tax and its non-vattability The revenue in the C.S.T
transaction goes to the originating state and therefore the destination
state is not willing to grant the input tax credit. The complications
and the cascading effect are brought out through this illustration.
Illustration
X ltd manufactures automobile components in a factory located in Tamil
Nadu. X Ltd purchases iron and steel, aluminium and other raw materials
from Maharastra. Since these are in the nature of C.S.T purchases, X Ltd
will not qualify for vat credit. Now the automobile components, which
are manufactured, are sold to Y ltd in Maharastra in the course of
interstate trade. Y ltd will not be able to take credit in respect of
the automobile purchases. Y ltd manufactures the cars and sells the same
to dealers in Tamil Nadu charging C.S.T. When the dealer sells the car
in Tamil Nadu it would attract vat in the hands of the dealer without
any corresponding credit. The cascading effect is significant in this
simple transaction and which arises mainly of C.S.T and its non-vattability.This non-vattability also affects the industry adversely. Suppose there
is buyer in Andhra Pradesh, he would rather prefer to purchase the goods
from a local vendor who can charge vat rather than purchasing it
through an interstate transaction the buyer would thus gain in the terms
of cash flow while purchasing it locally. However where the market is
monopolistic the buyer would either purchase it interstate or request an
outstation vendor to open a branch in his state. This would in turn
create an artificial supply pattern and affect market shares of number
of companies.
2. Multiple levies In theory, VAT is supposed to be a tax to end all
taxes. Many of the countries that have adopted VAT do not levy excise
duty, entry tax or luxury tax. This, however, is unlikely to happen in
India. E.g. the white paper indicates that the states that have already
introduced entry tax should make it vattable, this very fact defeats the
whole system of having vat as the only tax on product.
3. VAT in all States VAT system of taxation required to be implemented
simultaneously throughout the country in all States and Union
Territories at the same time. Only 20 states in India have effectively
implemented vat, Chhattisgarh, Gujarat, Tamil Nadu, Rajasthan etc have
not introduced vat in their taxation system. This creates serious
market distortions
4. Uniform VAT Law and procedure India has often been described as a
country with large market. But unfortunately this large market has been
highly fragmented by inter-state barriers. State specific law on sale of
goods further complicates it. The wide divergence in the structure and
practice has hampered free flow of goods and services within the country
and effected competitiveness of Indian Industry. Heterogeneity in VAT
even in forms, returns & declarations creates artificial barriers and
complexities
5. Rates and Classification of goods Non-Uniform rate structure across
the country helps in developing the diversion of trade from one State
to another, creates an unhealthy competition and increasing tax evasion.
It discourages automobile industry to plan and commit long-term
investments. The classification of goods not aligned to central taxes
overburdens litigation. Non- Uniform classification across all States
and central taxes creates an un- favourable environment for any growth
of industry
Suggestions and conclusion
After analyzing the whole scenario of vat it can be rightly suggested
that if the following propositions are carried out effectively it will
surely make the value added taxation a success.
Preparedness for State VAT: It is recommended that a publicity
awareness programme should be started jointly by the Central Government
and the State Governments and the former should extend financial
support for this, if required.
Uniformity of definitions: It is recommended that an attempt should be
made towards uniformity of all State legislations, procedures and
documentation relating to VAT.
VAT to unify all local taxes: It is recommended that with the
introduction of VAT, all other local taxes be discontinued, and the same
should be taken into account in determining the rate of taxation.
Stability and continuity of the VAT regime: It is recommended that for
the stability and continuity of VAT, a VAT Council or a permanent
suitable alternative vested with adequate powers to take steps against
discriminatory taxes and practices and eliminate barriers to free flow
of trade and commerce across the country should be explored.
Conclusion
In India, an Empowered Committee of the Finance Ministers of the States
has been constituted for the purpose of implementing a nationwide State-level
VAT. The Empowered Committee is indeed a unique experiment in federal
fiscal planning and has achieved much in terms of building a consensus
on many of the critical issues relating to implementation of VAT in a
relatively short spell of time. Thus for more equitability i.e. tax
burden shared by all, dealers, more transparency i.e. easy procedures
and only two rates, broadly speaking, Simplicity i.e.- easy computation
and easy compliance, having credit for input taxation i.e. cost
efficiency, having better Compliance - through self-policing, Prevention
of cascading effect through input rebate, and avoiding distortions in
trade and economy uniform tax rates VAT should be adopted in this
chain of value addition with proper implementation . And if this is
carried out effectively for a long term then it can be said without any
doubt that this would be the taxation system which will bring constant
revenue to the government without creating a heavy burden of tax paying
on the consumers.
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The author can be reached at :
parikshitsingh12@legalserviceindia.com
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