An ideal alternative to Central Sale Tax in the VAT Regime

There is unanimity among all concerned with VAT implementation that VAT should ideally be levied on the basis of destination principle and to achieve this goal inter-state sales tax in its present form needs to be abolished. At present, the central sales tax is levied and collected by the state of origin, creating serious economic distortions, which further undermines India’s effort to promote its share in the global trade. Under the proposed VAT regime where full input tax credit is allowed for the locally acquired goods, the existence of non-creditable CST on inter-state purchase of inputs would continue to promote the cascading of tax. This would lead to geographical integration of markets, increase in cost of manufacture and serious economic distortions, which would seriously retard the common market in the country and render the Indian goods non-competitive in the global market. This situation may eventually discourage domestic manufacture of goods and promote imports into India, especially since most of the developed countries tax imports into their country and zero-rate their exports whereas we follow exactly the reverse path.

Under the present sales tax system, the distortion caused by the levy of 4% CST on inputs is neutralized by the denial of input tax credits on locally acquired inputs to the extent of 4%. The present local sales tax laws allow the manufacturer to procure the inputs at a concessional rate of 4% local sales tax or avail refund of tax in excess of 4% in the case of locally procured inputs. This system partially addresses the distortion to the extent that the choice between local and inter-state purchase of inputs is neutralized, while leaving aside the issue of tax cascading.

If non-creditable CST on inputs co-exist with the proposed VAT where credit of tax paid on inputs is fully available, it would be a serious concern to the Indian industries. This would cause steep rise in non-productive expenses of the industries to ward off the economic distortions created by the new system such as opening of new depots all over India, increase in logistics and compliance cost, geographical re-location of input and ancillary manufacturers etc. eventually contributing to increased cost of production and overhead expenses. This may raise serious doubts regarding the credibility of VAT regime in the minds of the stakeholders and may even cause the failure of new VAT regime. Hence, if the complete economic benefits of sales tax reforms are to be achieved, then the CST has to be abolished.

The abolition of CST does not mean that there will not be any tax on inter-state sales. The proposed abolition is aimed at zero-rating the input tax even under the inter-state sales as it is proposed in the case of local inputs under the VAT regime. Under the proposed system, the tax paid on inter-state purchase would be available to the manufacturer as input tax credit so that there will not be any effect of cascading of tax in the cost of finished goods or distortions in the choice between local and inter-state purchases. Under the present system of CST it may not be possible to achieve this objective as the destination state will not agree to give the credit of input tax collected by the state of origin unless the tax collected by the origin state is passed on to the destination state. Because of this reason, consuming Indian states are opposed to giving credit of CST on inputs to the manufacturer whereas the exporting states are not willing to surrender their right to tax the inter-state sale. We are now facing the challenge to address the revenue concerns of both the parties.

Dr. Satya Poddar, the eminent economist and international expert on VAT, has made a few observations about the revenue concern expressed by the sate during one of the seminars sponsored by the World Bank. He had stated that it is inappropriate to focus on the revenue impact of the individual components of tax reform, which would invariably contain many elements with offsetting revenue effects. What matters is the net revenue impact of the overall reform package. As illustrated in the NIPFP report, it is feasible to design revenue neutral VAT based on the destination principle. The loss in revenues due to elimination of the CST can be more than offset by suitable adjustments in the tax rates, broadening of the tax base, and improvement in tax compliance. There could be a net gain in revenues where a distortion-free tax system induces higher investment and economic growth. The retention of a cascading tax, even at a reduced rate, would be a source of complexity in the tax system and would not be conducive to improvement in tax compliance. If so, the net revenue impact of such a tax could be negative. That is, the apparent revenue collections from the application of the tax could mask the revenue losses resulting from the shrinking of the tax base through behavioral changes. Finally, it is likely that both the cascading of taxes and selective reduction in their burden through industrial incentives would be found to be in contravention of India’s obligations under multilateral trade agreements. If so, the States may have little choice but to give serious consideration to more neutral forms of tax design.

Under the above circumstances, if we have to think about an effective system at national level to zero-rate the inter-state sales, it should address the following concerns of the government and the industry;

• The system should be economically neutral which means that the tax system should not distort the economic behavior and market choices otherwise made by consumers and producers.

• The system should not undermine the fiscal autonomy of the state in administration of tax and should not heavily depend on inter-jurisdictional co-operation.

• The system should foster uniformity in compliance procedures for trade between and within the exporting and consuming state.

• The system should have low administrative and compliance cost

• It should address the issue of cross-boarder VAT leakage.

Keeping the above features in mind and also taking into consideration the complexity involved in the federal structure of Indian Union, we suggest the following system viz. CInter-State VAT (VATI-VAT), which in our opinion would address the concern of the government and the industry. Dr. Poddar and Eric Hutton, has proposed a similar system during a presentation at the national tax conference in Baltimore as also NIPFP, in its report on reform of domestic trade taxes in India.

Inter-State Value Added Tax (C VATI-VAT):

The C VATI-VAT would essentially be a destination-based tax system for inter-state trade, aimed at providing full input tax credit to inter-state purchase of inputs and re-sale goods. It will maintain an effective trail of inter-state movements in the absence of boarder controls, including branch transfers. It also would prevent the cascading of taxes, re-establish the output tax-input tax credit chain for inter-state transactions and thereby strengthen the audit trail under VAT regime to check evasion. It would motivate the buyer and the seller to comply with the requirements as well as provide incentives to both exporting and consuming state to monitor the compliance independent of each other. It also provides new avenues for revenue to the origin state even under the C VAT I-VAT under VAT regime, without affecting the VAT chain as also provide a trail of stock transfers to both exporting and consuming state. C VATI-VAT would be essentially an improved version of the P-VAT or CPT suggested by Dr. Poddar and NIPFP. This system does not impose an extra burden on the seller or the buyer, than it exists today. The proposed C VATI-VAT would meet all the above criteria of an effective VAT regime.

Pre-requisites under C VATI-VAT :

Under the proposed system all registered dealers will be required to maintain a deposit account with the state government through designated banks, similar to the Personal Ledger Account maintained by the manufacturers under CENVAT scheme. The dealer would deposit an ad-hoc amount in the government treasury under a prescribed challan and take a credit of the same in the PLA. The present C form and F form procedures will be de-controlled and converted into tax paying document-cum-proof of export, which can be printed by the registered dealer, with necessary controls and conditions, as applicable, as in the case of CENVAT invoices. The C and F forms will be entirely different than the existing C and F forms in its concept and utility. The form " C" will be issued only in case where the goods are procured for the purpose of consumption as an industrial input or for re-sale. The form "F" can be issued only for the purpose of branch transfer goods, which in turn are to be used for industrial consumption or for resale. The nos. of the C and F forms will be controlled and the condition of self-certification by the authorized persons will be introduced to make the dealer accountable for proper management of the system. These forms i.e. both "C" and "F" will be in quadruplicate as in the case of CENVAT invoices. A prescribed format with particulars as mentioned below will be made mandatory for the forms C and F;

a. Name and address of the dealer / importer
b. Registration number
c. Date of the document
d. Description of the goods
e. Qty of goods transferred
f. Value of goods
g. Amount of C VATI-VATI-VAT debited to PLA
h. PLA debit entry number and date
i. Name / address and the registration number of the consignor

How C VATI-VAT works in inter-state sale transaction:

As and when the registered dealer procures industrial inputs or finished goods from other states, he will prepare form "C" in advance with prescribed particulars and then debit the PLA with the amount of tax as applicable. The form "C" would bear the reference PLA debit entry no. The purchasing dealer shall retain the original of form "C" where as the duplicate, triplicate and the quadruplicate shall be forwarded to the seller in other state. On receipt of the form "C" in triplicate, the selling dealer shall retain his copy (may be quadruplicate), where as the duplicate and the triplicate copies shall accompany the consignment as a proof of payment and export. The sales tax administration at the border may endorse the document and capture the data so that a data base of such inter-state movement may be created, which can be useful in tracking the consignment.

Once the goods are received by the buying dealer, he can claim the credit of the tax paid by him in his VAT return and set it off against his VAT liability. In no case the buying dealer shall be allowed to credit the PLA account, other than to rectify a clerical error.

However, in the case of goods, which are not falling under the category of industrial inputs, and re-sale goods, the facility of form "C" or "F" will not be available. The goods in other category may not affect the VAT chain as most of these goods are procured for final consumption or use and as such may not create any cascading of taxes even in the origin state. Since, the "net exporting states" are very much concerned about the revenue loss that they may incur due to a destination based inter-state sales tax system, we suggest that such sales may continue to be taxed by the origin states. This we hope would bring down their objection to a destination based inter-state VAT system significantly.

How C VATI-VAT works in branch transfer:

In case of branch transfers, the receiving branch shall prepare form "F" in advance with relevant particulars and debit the PLA for the amount equivalent to the tax payable in the case of a sale. The value of goods being transferred may be the transfer price. The procedure to be observed shall be the same as in the case of a sales transaction. On receipt of the goods the recipient dealer shall claim the credit of the tax paid through PLA, in the VAT return and set that off against the VAT payable.

Such system would provide a credible trail of the inter-state movement of goods under a VAT regime. In a computerized environment it may not be difficult to capture the data of inter-state movement at the entry/exit point of each state. This system also eliminates the requirement of an entry tax under the VAT regime, which may create additional burden on the dealers to comply with the requirement.

The only issue that may arise under this system may be in the case of inter-state movement of goods other than the category of sale or stock transfer. In our opinion, the remedy to this may be the "waybill mechanism" which is followed by West Bengal government in the case of movement of goods by un-registered dealer. Under this mechanism the sales tax authorities shall issue the waybill to the consignee, who in turn shall forward it to the consignor. Such waybill shall control all other dispatches other than under forms "C/D" and tax paid at origin state. Thus the states can control the inter-state movement and effectively check evasion, while pre-empting the cascading of taxes under VAT regime. The concern of loss of revenue of the developed states, will also get addressed to some extent.

Even though the point of levy is shifted to consuming state, the producing states would still earn higher revenue as higher production would also lead to higher employment, overall development and ultimately high consumption levels in the same state. The higher consumption level would also lead to higher revenue for such state coupled with an effective mechanism to check evasion. In such scenario, the choice of location for manufacture to great extent would depend upon better infrastructure, low labor cost and other non-tax incentives provided by the states. This would also give an equal opportunity for all the states to boost the production and thereby consumption levels which should ultimately result in overall growth of all the states and removal of the regional disparities.