Value Added Tax (VAT)
is a general consumption tax assessed on the value added
to goods and services.
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. It is a consumption tax because it is borne
ultimately by the final consumer.
It is not a charge on companies. 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.
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.
In other words, it is a multi-stage
tax, lavied only on value added at each stage in the
chain of production of goods and services with the provision
of a set-off for the tax paid at earlier stages in the
chain. The objective is to avoid 'cascading', which
can have a snowballing effect on prices. It is assumed
that due to cross-checking in a multi-staged tax, tax
evasion will be checked, resulting in higher revenues
to the government.
Over 130 countries worldwide have
introduced VAT over the past three decades and India
is amongst the last few to introduce it.
India already has a system of sales
tax collection wherein the tax is collected at one point
(first/last) from the transactions involving the sale
of goods. VAT would, however, be collected in stages
(instalments) from one stage to another.
The mechanism of VAT is such that,
for goods that are imported and consumed in a particular
state, the first seller pays the first point tax, and
the next seller pays tax only on the value-addition
done - leading to a total tax burden exactly equal to
the last point tax.
India, particularly the trading community, has believed
in accepting and adopting loopholes in any system administered
by the state or the Centre. If a well-administered system
comes in, it will close avenues for traders and businessmen
to evade paying taxes. They will also be compelled to
keep proper records of their sales and purchases.
Many sections hold the view that the
trading community has been amongst the biggest offenders
when it comes to evading taxes.
Under the VAT system, no exemptions
will be given and a tax will be levied at each stage
of manufacture of a product. At each stage of value-addition,
the tax levied on the inputs can be claimed back from
the tax authorities.
At a macro level, there are two issues,
which make the introduction of VAT critical for India.
Industry watchers say that the VAT
system, if enforced properly, forms part of the fiscal
consolidation strategy for the country. It could, in
fact, help address the fiscal deficit problem and the
revenues estimated to be collected could actually mean
lowering of the fiscal deficit burden for the government.
The International Monetary Fund (IMF),
in its semi-annual World Economic Outlook released on
April 9, expressed its concern over India's large fiscal
deficit - at 10 per cent of the GDP.
Further any globally accepted
tax administrative system, will only help India integrate
better in the World Trade Organisation regime.
In the advantages part we will first
look after the broad coverage of VAT in the Indian market.
Then we will consider the level of security the Indian
VAT is having on our revenues. Obviously the selection
of items to be covered by VAT in India will be given
a bullet to think upon and at last we will check out
the co-ordination VAT in India will be having with our
existing direct tax system.
I) Coverage
If the tax is carried through the retail level, it offers
all the economic advantages of a tax that includes the
entire retail price within its scope, at the same time
the direct payment of the tax is spread out and over
a large number of firms instead of being concentrated
on particular groups, such as wholesalers or retailers.
If retailers do evade, tax will be
lost only on their margins because customers that are
registered firms gain nothing if their suppliers fail
to collect tax, except delay in payment; they will pay
more to the government themselves. Under other forms
of sales tax, both seller and customer gain by evading
tax. One particular advantage is that of the widening
of the tax base by bringing all transactions into the
tax net. Specifically, VAT gives the new government
the opportunity to bring back into the tax system all
those persons and entities who were given tax exemptions
in one form or another by the previous regime.
II) Revenue
security
VAT represents an important instrument against tax evasion
and is superior to a business tax or a sales tax from
the point of view of revenue security for three reasons.
In the first place, under VAT it is
only buyers at the final stage who have an interest
in undervaluing their purchases, since the deduction
system ensures that buyers at earlier stages will be
refunded the taxes on their purchases. Therefore, tax
losses due to undervaluation should be limited to the
value added at the last stage. Under a retail sales
tax, on the other hand, retailer and consumer have a
mutual interest in underdeclaring the actual purchase
price.
Secondly, under VAT, if payment
of tax is successfully avoided at one stage nothing
will be lost if it is picked up at a later stage; and
even if it is not picked up subsequently, the government
will at least have collected the VAT paid at stages
previous to that at which the tax was avoided; while
if evasion takes place at the final stage the state
will lose only the tax on the value added at that point.
If evasion takes place under a sales
tax, on the other hand, all the taxes due on the product
are lost to the government.
A significant advantage of the value
added form in any country is the cross-audit feature.
Tax charged by one firm is reported as a deduction by
the firms buying from it. Only on the final sale to
the consumer is there no possibility of cross audit.
Cross audit is possible with any form
of sales tax, but the tax-credit feature emphasises
and simplifies it and is likely to make firms more careful
not to evade because they know of the possibility of
cross check.
III) Selectivity
VAT may be selectively applied to specific goods or
business entities. We have already addressed essential
goods and small business. In addition the VAT does not
burden capital goods because the consumption-type VAT
provides a full credit for the tax included in purchases
of capital goods. The credit does not subsidize the
purchase of capital goods; it simply eliminates the
tax that has been imposed on them.
IV) Co-ordination
of VAT with direct taxation
Most taxpayers cheat on their sales not to evade VAT
but to evade personal and corporate income taxes. The
operation of a VAT resembles that of the income tax
more than that of other taxes, and an effective VAT
greatly aids income tax administration and revenue collection.
It is interesting to note that when Trinidad and Tobago
set out to introduce VAT it chose one of its top income
tax administrators as the VAT Commissioner.
It must be stressed once again that
if properly implemented VAT can ultimately lead to a
reduction in overall rates of tax.
Revenues will not be sacrificed but
would in fact be enhanced as a consequence of the broadened
tax base. This does not seem to be a bad idea at all.
The main disadvantages which have
been identified in connection with the Value Added Tax
are:
I) VAT is regressive
It is claimed that the tax is regressive, ie its burden
falls disproportionately on the poor since the poor
are likely to spend more of their income than the relatively
rich person. There is merit in this argument, particularly
if it attempts to replace direct or indirect taxes with
steep, progressive rates. However, observation from
around the world and even Guyana has shown that steep
tax rates lead to evasion, and in the case of income
tax act as a disincentive to effort.
Further, there is now a tendency in
most countries to reduce this progressivity of taxes
as has been done in Guyana where a flat rate of income
tax has been introduced. In any case VAT recognises
and makes room for progressivity by applying no or low
rates of tax on essential items such as food, clothes
and medicine. In addition it allows for steep rates
of tax on luxury items, although this can create problems
for administration and open opportunities for evasion
by way of deliberate misclassification, a problem incidentally
not peculiar to VAT, and which takes place extensively
in the area of customs duties.
II) VAT is too difficult to operate
from the position of both the administration and business?
(a) The administration
It is often argued that VAT places a special burden
on tax administration. However, it is worth noting that
wherever VAT was introduced one of its effects was the
rationalisation and simplification of the previous indirect
tax system and its administration. Each of the previous
indirect taxes such as customs duties, purchase tax
and excise duties replaced by VAT had its own rate structure
as well as a different tax base and separate administrative
procedure. The consolidation and incorporation of numerous
indirect taxes into the VAT would simplify the rate
structure, tax base, and administration of the indirect
tax system, thereby eliminating the overlapping auditing
practices that had plagued those systems.
In addition, the abolition of a number
of alternative indirect taxes releases experienced personnel
to focus on a single tax. It also means reduction in
the number of forms used, legislation to be applied
and returns and accounts with which the business person
has to contend.
2) VAT is too
difficult to operate from the position of both the administration
and business?
(a) The administration
It is often argued that VAT places a special burden
on tax administration. However, it is worth noting that
wherever VAT was introduced one of its effects was the
rationalisation and simplification of the previous indirect
tax system and its administration. Each of the previous
indirect taxes such as customs duties, purchase tax
and excise duties replaced by VAT had its own rate structure
as well as a different tax base and separate administrative
procedure. The consolidation and incorporation of numerous
indirect taxes into the VAT would simplify the rate
structure, tax base, and administration of the indirect
tax system, thereby eliminating the overlapping auditing
practices that had plagued those systems.
In addition, the abolition of a number
of alternative indirect taxes releases experienced personnel
to focus on a single tax. It also means reduction in
the number of forms used, legislation to be applied
and returns and accounts with which the business person
has to contend.
(b) Business
It is true that the VAT is collected from a larger number
of firms than under any form of income tax or single
state sales tax; to the typical smaller firms the complexities
of the tax and the need for more extensive records (for
example, to justify deductions) are likely to prove
serious.
However, it is often overlooked that
businesses already function with considerable administrative
responsibility for a number of laws including the National
Insurance Act and the Income Tax Act.
Under the Income Tax (Accounts and
Records) Regulations of 1980 every person, without exception
is required to maintain detailed and extensive records
of all its transactions. Compliance with this will certainly
ensure compliance with VAT regulations, and since there
is an actual benefit to be derived from accounting for
VAT paid on input there is an incentive for proper record-keeping.
As we have noted before, VAT also
allows for the exemption of small businesses from the
system.
Under any form of sales taxation,
small businesses have to be granted special treatment
because of their inability to cope with the requirements
of keeping adequate records which larger enterprises
can handle at a reasonable cost. The intent of the special
treatment is to reduce the administrative burden on
small enterprises, but not the taxes that normally would
be charged on the goods and services they supply. The
revenue loss at the final link in the commercial cycle
is limited only to the value added at that stage ,whereas
in the case of income tax or sales tax the entire tax
is lost. To recover the loss from exemptions, a flat
tax on turnover may be applied.
In the larger businesses with proper
staff and computers, the task is really one of double
entry book-keeping and any additional work is hardly
ever noticed.
3.) VAT is inflationary?
Some businessmen seize almost any
opportunity to raise prices, and the introduction of
VAT certainly offers such an opportunity. However, temporary
price controls, a careful setting of the rate of VAT
and the significance of the taxes they replace should
generally ensure that there is no increase if any in
the cost of living. To the extent that they lead to
a reduction in income tax, any price increases may be
offset by increases in take-home pay.
In any case, any price consequence
is one time only and prices should stabilise thereafter.
4.) VAT favours
the capital intensive firm?
It is also argued that VAT places a heavy direct impact
of tax on the labour-intensive firm compared to the
capital- intensive competitor, since the ratio of value
added to selling price is greater for the former. This
is a real problem for labour-intensive economies and
industries.
All business transactions
carried on within a State by individuals, partnerships,
companies etc. will be covered by VAT.
"More than 550 items would be
covered under the new Indian VAT regime of which 46
natural and unprocessed local products would be exempt
from VAT", a PTI report quoted West Bengal Finance
Minister and VAT panel chairman Asim Dasgupta as saying.
About 270 items including drugs and
medicines, all agricultural and industrial inputs, capital
goods and declared goods would attract four per cent
VAT in India
The remaining items would attract
12.5 per cent VAT. Precious metals like gold and bullion
would be taxed at one per cent.
Considering the difficulties faced
by the tea industry, it was decided that tea-producing
states would be given an option to levy 12.5 per cent
or four per cent subject to review in 2006.
Petrol and diesel would be kept out
of VAT regime in India, which covers only marketable
items.
Dasgupta was quoted as saying that
the panel was yet to take a view on CNG.
Following opposition from some of
the states, it was decided that states would have option
to either levy four per cent or totally exempt food
grains but it would be reviewed after one year.
Three items - sugar, textile and tobacco
- covered under Additional Excise Duties, will not be
under VAT regime for one year but the existing arrangement
would continue.
The Indian VAT panel relaxed the threshold
limit for traders coming under VAT regime from Rs 5-50
lakh of turnover from the previous stance of Rs 5-40
lakh.
Traders within this limit can pay
a composite VAT rate of one per cent but would not be
entitled to input tax credit.
6. What is the difference between Sales
Tax and VAT?
VAT is levied on all goods & services
while sales tax is only levied on goods. Thus, a lower
tax rate is needed to collect the same amount as sales
tax. VAT has no cascading effect. The VAT mechanism
of auto-control reduces tax evasion, therefore enhancing
income tax collection. VAT is levied at import.
Input generally mean goods purchased by a dealer in
the course of his business for re-sale or for use in
the manufacture, processing, packing/storing of other
goods or any other business use. The tax paid on inputs
is known as Input Tax. It has been defined in Section
2(xvii) of the Model VAT Bill, 2003 thus: "Input
tax means the tax paid or payable under this Act by
a registered dealer to another registered dealer on
the purchase of goods in the course of business for
resale or for manufacture of taxable goods or for use
as containers or packing material or for the execution
of works contract."
It is the credit for tax paid on inputs. Every dealer
has to pay output tax on the taxable sale effected by
him. The basic formula of VAT is that every dealer pays
tax only on the value addition in his hands. In simple
words input tax credit is the mechanism by which the
dealer is enabled to set off against his output tax,
the input tax. Dealers are not eligible for input tax
credit on all inputs. There are certain restrictions
and conditions on the eligibility of input tax credit
as it is stipulated in the respective State legislation.
9. What are
the `sales' not liable to tax under the VAT Act?
Since the VAT Act applies only to sales within a State,
the following sales shall not be governed by the VAT
Act:
a) sale in the course of inter-State
trade or commerce which shall continue to be liable
to tax under the Central Sales Tax Act, 1956;
b) sale which takes place outside the State; and
c) sales in the course of export or import.
Retail dealer is not specifically defined in most of
the draft VAT legislation of States. To some extent,
a dealer will be considered to be engaged in the business
of selling at retail if 9/10ths of his turnover of sales
consists of sales made to persons who are not dealers
and if any question arises as to whether any particular
dealer is a retailer, then the officer in charge shall
be refered for.
11. In the VAT regime, will stock transfer
be more beneficial than inter-State sale?
In so far as a decision as to
whether goods should be stock transferred and then sold
to customers by the branch or should direct inter-State
sales be effected, there can be no generalisation. The
decision has to be taken on a VAT impact analysis of
each individual business.
The tax implications to be considered
are:
In the case of inter-State sale, the buying dealer has
to pay a non-VATable CST while the selling dealer will
get the benefit of input tax credit.
In the case of stock transfer,
though there is no tax on the inter-State movement,
the input tax credit will be restricted to the tax
paid on inputs in excess of 4 per cent.
