"VAT The Innovation: Pay Tax with a smile"
Dr. S. Tameem Sharief  Ph.D,Lecturer and Research Supervisor, P.G and Research Dept of Commerce,
 

VAT is an important Fiscal innovation of the last century and its origin could be traced as far back to the writings of F.VON. Siemens, who proposed it in 1918 as a substitute for the then newly introduced German Turnover Tax France was the first country to introduce VAT in the year 1954 and most of the countries in the world including E.C. countries are having VAT system only. VAT is the choice of member countries of E.C. as the best way to promote neutrality and uniformity of the tax burden and to provide incentives for increased productivity and industrialization. The recommendation of the E.C. Fiscal and Financial Committee that all member countries of E.C. shift to VAT form was completed in 1973. Hence it is a must that our nation also fall in line.

The main feature of VAT is it avoids cascading effect which was inherent under Single Point Tax System. On account of rebating of tax paid under VAT system, which requires maintenance of accounts of tax paid on purchases and sales, it has a self-policing effect. VAT has a novel advantage of transparency of incidence of tax, as the tax component in any transaction is easily identifiable. Because of its anti cascading effect, the number of times a product is traded before reaching a final consumer or how much of a value is added at what stage in production-distribution process are of no consequence under VAT.

The invoice method of VAT in particular is believed to be "self-enforcing" in that it induces businesses to demand invoices from their suppliers to obtain credit for the tax paid on their purchases. This create an audit trail. It is to be remembered by every patriotic Indian that any tax paid to the exchequer goes only towards executing the welfare measures for the poor and the down trodden and thus has more significance and sacred liability attached to it and denial of the same only amounts to stealing from the mouth of the poor.

The advantage of VAT system is it maximise the neutrality of the indirect tax system in relation to production decisions. By rebate of tax paid on inputs, it ensures a zero rate of taxation on inputs, which was not available under TNGST Act. Thus businesses will efficiently maximise their production rather than in a way which is less efficient but which minimises their tax liability. Further businesses will not be faced with incentives to integrate vertically, in order to avoid taxation on the sale of inputs. Also because of zero rate of taxation on inputs, the effective tax rate on the final goods is given by is nominal tax rate.  This makes for a simple and transparent tax system. The averment that VAT will result in inflation is also not acceptable as it merely replaces an existing complicated system of tax on the final product at various levels under Single point system of Sales Tax.

Only for countries with an extremely sophisticated tax administration and a good tax payer compliance ratio, a retail sales tax is an attractive option.

However numerous exemptions and multiple rates has complicated the single point tax system. Under this system politicians try to classify the goods according to 'Luxury' nature. Exemptions thus become based on the nature of the purchaser or the end use of the goods instead of according to the nature of the goods. Retail prices are distorted because different retail mark ups are not taxed and adjustment is made to maximise the untaxed mark ups. Services cannot also be taxed under single point taxation system.

With any tax system, the higher the tax rate, the more incentive there is for tax payers to evade the tax. If the rate of tax is 4% the incentive to evade tax is probably not worth the penalties or prosecution. At 20% rate, the incentive for evasion is very attractive and extremely tempting, inspite of provision of penal sections.

Assuming the given need for revenue on the part of the Government, the form of sales tax that provides the broadest possible base is the one that requires the lowest rate. From this point of view, system of VAT is the best available replacement for single point tax system. VAT system is also less open to lobbying influences, than the retail sales tax system. The objective for introduction of VAT system is to diminish the tax burden on the business sector, to make it more uniform and to simplify taxation and budgetary relationships.

Under VAT relative prices may change but general prices will not change.

The switch over from the single point taxation to VAT may not yield the desired results stated above including tax buoyancy in the initial years of switchover as the tax system has to gain acceptance and stabilize, tax instruments mature and a quantum change in ethics in tax compliance evolves. However in the face of global competition, liberalized economic environment, this major reform brought in by other States of India including Tamil Nadu Government is a necessity.

A broad based VAT, taxes present and future consumption, the same way and is therefore neutral between consumption and saving. A VAT that simply increased revenue would be potentially deflationary, would reduce consumption and probably would reduce the profitability of future investment.

At the same time, such an increase in revenue could be used to reduce the fiscal deficit, reduce the public sector borrowing requirement, allow interest rates to fall and thus stimulate investment.

The first preliminary discussion on State-level VAT took place in a meeting of Chief Ministers convened by Dr. Manmohan 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. First, 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. Second, 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. Third, on the basis of achievement of the first two objectives, steps would be taken by the States for introduction of State-level VAT after adequate preparation. For implementing these decisions, an Empowered Committee of State Finance Ministers was set-up.

Thereafter, this Empowered Committee has met regularly, attended by the State Finance Ministers, and also by the Finance Secretaries and the Commissioners of Commercial Taxes of the State Governments as well as senior officials of the Revenue Department of the Ministry of Finance, Government of India. 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. As a part of regular monitoring, whenever any deviation is reported from the uniform floor rates of sales tax, or from decision on incentives, the Empowered Committee takes up the matter with the concerned State and also the Government of India for necessary rectification.

After reaching this stage, steps were initiated for systematic preparation for the introduction of State-level VAT. In order again to avoid any unhealthy competition among the States which may lead to distortions in manufacturing and trade, attempts have been made from the very beginning to harmonise the VAT design in the States, keeping also in view the distinctive features of each State and the need for federal flexibility. This has been done by the States collectively agreeing, through repeated discussions in the Empowered Committee, to certain common points of convergence regarding VAT, and allowing at the same time certain flexibility for the local characteristics of the States.

Rationale for Introduction of VAT in India

The following table gives an overview of the rationale for introduction of VAT by summarising the basic differences between the operation of sales tax and VAT and the consequent impact of the introduction of VAT :

Besides these advantages, there are few other advantages of VAT sys­tem, which are :

Uniform rates of VAT will boost trade activities and will create a favourable atmosphere for expansion of the economy.

•    Helps in increasing tax revenues. It has the in-built capacity to raise more tax revenues without distorting the existing tax structure and is yet able to widen the tax-base.

•    With '0' per cent VAT on exports .and availability of credit on input tax, it will foster export promotion and helps in export-lead growth.

•    Since there is no tax on tax, cost escalation is avoided and industry becomes more competitive.

•    Avoidance of economic distortions in terms of methods of produc­tion and even location of production.

° Creation of a common market across which goods will flow free of tax - this increases consumer welfare as well as international com­petitiveness.

 •       Enables Government to tax according to the principle of equity.

While it is true that, in absence of any concessional sale, dealers are not required to give any declaration form, the provision of credit for capital goods may well mean that a selling dealer has to determine whether the class of purchasing dealer is that of a trader or an actual user in captive consumption, implying a backdoor entry of some declaration form to distinguish one class of buyer from another.

Though capital goods are liable to tax @ 4%, the Government of Tamilnadu has excluded civil structures from the concessional levy, whereas in the definition of capital goods the term plant and machinery equipment, apparatus, tools appliances, electrical  installation have been included. Hence for the seller whether the goods sold by him will be construed as capital goods is a nerve wracking problem. For example a company may buy fire extinguishers and security cameras for its establishment and whether these are capital goods is a problematic issue as they may not be construed as not directly linked with manufacture, they are for effective monitoring  of manufacture and without such provisions the manufacture will suffer. For instance provision of fire extinguishers  is  a must for safety of buildings and provision of security cameras is the, efficient way to prevent pilferage, effect quality clock and keeping up production schedule.

Different States have incorporated provisions to rob the benefit of self-assessment. For instance, reassessment powers have been provided in VAT enactments of Andhra Pradesh, Karnataka, Delhi, etc. The Commissioner of Commercial Taxes of respective States are also empowered to notify specific dealers/class of dealers/class of goods or in any of the said combination to undergo an assessment in the regular course. At another level, the self-assessment exercise poses considerable problem for those dealers, who manually keep their records.

Under  TNVAT Act, 2006 Sec. 22 (3) provides that the Commissioner of Commercial Taxes can select 20% of the self assessment cases for detailed scrutiny. Similarly Sec. 64 (1) to 64 (5) provides for audit by Commissioner of Commercial Taxes against dealers who have not filed returns, or who claim exorbitant refund of tax or file incorrect returns.

VAT provides input credit for the capital goods. However, different States treat them differently, right from defining these goods to actually granting them exemptions. For instance, while the Maharashtra Act is silent on grant of input credit on purchase of capital goods, the West Bengal Act has prohibited input tax credit on capital goods.  Tamil Nadu VAT Act. 06 grants input tax credit on capital goods over a 3 year period.

While VAT generally helps the industries to become more competitive by eliminating fragmentation due to differential rate structures, it deals a heavy blow to the labour-intensive industries compared to their capital-intensive competitors, since the ratio of value added to selling price is greater for the former.

The justification for implementing VAT on the pretext of reducing cascading effect is open to challenge as cascading has continued due to (i) exclusion of services from the purview of VAT, (ii) non-allowance of input credit on certain universal intermediates like petroleum products, (iii) rebates not being allowed for exempt goods, (iv) non-integration of other taxes which inputs may be subject to/including Central excise and Customs duties, motor vehicles taxes, electricity duty and stamp duty into the VAT, (v) tax paid on inputs purchased by dealers who have opted for the "composition scheme", and (vi) delays and ceilings make input-tax credits partial, particularly for zero-rated exports.

Why VAT should remain?

The experience of VAT has proved that the concern regarding the erosion of revenue of the States is somewhat misplaced. The provisional tax-revenue data furnished by States/Union Terriroties showed that during 2005-06, the tax revenue of 25 VAT implementing States/ Union Terriroties registered a growth rate of about 13.8 per cent over 2004-05, which was higher than the Compound Annual Growth Rate (CAGR) of sales tax revenues of these States/ Union Terriroties for the last five years up to 2004-05. Further, during first seven months of the year 2006-07 (April-October), the tax revenue of 30 VAT implementing States/ Union Terriroties has registered a growth rate of 26.1 per cent over the corre­sponding period of the previous year.

Even Tamilnadu which adopted VAT from 1.4.2007 has shown a growth rate of nearly 17% as stated in the Tamilnadu Assembly during budget session.

•   VAT permits reliance on an indirect tax whose regressive effects may not be as visible, and therefore helps the Government provide direct tax concessions to individuals and corporates with the ostensible intent of providing incentives to save and invest.

•   Use of VAT raises the possibility of using invisibility to levy relatively high rates across a very broad base of commodities, without the need to provide exemptions, deductions and exclusions associated with income and corporate taxes, which would help garner large Government revenues through a squeeze on the broad mass of the population while conveying the impression of being a Government that is non-intrusive, by reducing direct taxes on the specious grounds that it would trigger higher private savings and investment.

•    The primary and foremost reason for continuing with VAT lies in the goal of having a goods and sales tax (GST), which would almost altogether eliminate cascading of taxes, excise, service tax and sales VAT.

•    Despite the issues listed above, some realignment of production costs with comparative advantage across States will result, especially when the CST is removed.

How to improve effectiveness of VAT?

Accepting the reality that VAT is necessary and is here to stay one must look forward to cure the inherent defects to make it more effective. Some of the solutions may be :

•    Computerisation of the system would ensure the success of VAT, which depends on its containment of false claims for VAT refund. In fact, a recent report by the National Council of Applied Economic Research (NCAER) estimates that an electronic payment mechanism will save time and transport costs and other costs equivalents, equivalent to 1.06 per cent of the GDP.

•    Provision of granting automatic input-tax relief to the exporters.

•   To reduce the rate war without affecting the fiscal autonomy that a State enjoys, the States should be allowed to choose their VAT rates on commodities which are not prone to trade diversion (low value, transportation difficult), rate war and a race, and to commodities that are susceptible to these tendencies (high value, easily trans­portable) the States should apply uniform rates.

•   Uniformity must be brought with respect to the definition of various terms among the State laws.

Central Sales Tax is levied under the provision of the Central Sales Tax Act, 1956, on the sale of goods in the course of inter-state Trade and Commerce. The CST is levied by Central Government by virtue of entry 92A of the Union list, but the revenue is assigned to the States within which the tax is leviable, by virtue of article 269 of the Constitution. The CST is leviable in the originating State i.e., the State from which the movement of the goods commences and is collected and appropriated entirely by such State. The CST Act is administered by the States by virtue of Provisions of Sec. 9 of the said Act.

CST having an origin based tax is inconsistent with VAT which is a destination based tax. Moreover CST results in cascading of tax since it is not rebatable against VAT. In view of the above, there was consensus of opinion amongst all VAT implementing States, that CST should be phased out. This is also a pre-requisite for introduction of an integrated goods and Service Tax (GST) which the GOI proposes to introduce by 2010. The empowered Committee of State Finance Ministers constituted by GOI been making efforts towards this end since July, 2000. Finally, a consensus had been arrived at between the Central Government and the State Government so the road map for phasing out CST as also on the package of compensation for the States for revenue loss on this account.

Hence it was proposed to phase out levy of tax under CST from 4% to 3% from 1.4.2007, which had been given effect to and from 3% to 2% from 1.4.2008, which had not been given effect to till date as modalities for compensation to the States on loss of 1% has not been agreed upon, from 2% to 1% from 1.4.2009 and 0% from 1.4.2010 from which date GST will come to vogue. The Centre has  permitted States to levy tax on tobacco which was in the list of declared goods. Though the State Government could have taxed tobacco and its products from 1.4.2007, on it was taken away from Fourth Schedule of TNVAT Act, 2006, the Govt. of Tamilnadu vide GO MS No.146 CT & R (B2) Dept/ 8.8.2007 exempted the products of beedi, beedi tobacco, tobacco leaves, sruff and cheroot.

Some of the important sections TNVAT Act, 2006 are as follows:

There are four schedules. The first schedule consists of goods taxable @ 1%, 4% and 12.5%. The second schedule consists of goods taxable at given point. These are of nature of alcoholic liquor, turbine fuel, diesel, kerosene. These are of nature of alcoholic liquor, Turbine fuel, Diesel kerosene. Third schedule consists of compounded rates for restaurants, hotels and sweet stalls. The fourth schedule relates to exempted goods.  

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