stvat.com - A Comprehensive Resource on Sales Tax VAT in India

A good sales tax system should be conducive to economic efficiency, provide stable and predictable source of revenues and be simple to administer and comply with. The current single point sales tax system fails in all of these aspects. Economists have examined several alternatives of commodity taxation and found that to sustain a continuos economic growth, the only rational alternative for the existing sales tax is the Value-Added Tax (VAT).

In this paper I have proposed a sales tax structure for the state of Madhya Pradesh which will replace the present commercial tax, central sales tax, entry tax, professional tax and hotel tax administered by the commercial taxes department of Govt. of Madhya Pradesh. The proposed structure consist of a VAT applied at a single rate to a comprehensive base of goods sold in the state and some select services consumed in the state along with a dual rate Special Additional Tax (SAT) imposed at the first point of sale on selected commodities. The primary focus of this paper is to workout the revenue implications of the proposed tax structure, by adopting Turnover Approach as suggested by National Institute of Public Finance and Policy (NIPFP), New Delhi.

VAT is now operating in more than 115 countries including developing countries. It is widely agreed that a good VAT extends through the retail stage, is as broadly based as possible, permits registered dealer full and immediate tax credit of the VAT on inputs (including capital goods) from the VAT on output, limits the extent of rates differentiation and is imposed on the destination principles.

Most countries supplement the VAT by additional tax levies on certain products (such as Motor fuels, Tobacco and Alcohol) either for revenue reasons or to discourage their consumption (because of the external costs imposed by their consumption on the society). These levies are generally levied at relatively higher rates at the first point of sale and, are additional to the VAT, which applies to a prices inclusive of such levies. Because these levies are not a part of the VAT system, no input rebate is allowed to manufacturer or dealers acquiring the affected goods as business inputs or as goods for sale. Given that the production and distribution of such goods is regulated, it has been relatively easy for goods to enforce payment of tax at high rates.

Obviously the taxes on the luxury products serve the same function as a higher VAT rate. 34 countries complement their VAT with an intermediate excise system that includes luxury products in the base. Some of these countries are;

Asia and Oceania :- Bangladesh, China, Indonesia, Korea, Nepal, Philippine, Thailand.

Three types of excise systems (in some countries called business or consumption taxes) are distinguished;

Limited excise systems comprise the traditional excise goods like Tobacco products, Alcoholic beverages and petroleum products. Some food products such as Sugar, confectioneries, various beverages like coffee, tea and cocoa.

Intermediate excise system covers a large number of luxury products in addition to the items covered under a limited system, such as cosmetics, furs, precious stones, audio vedio equipment and house hold appliances. Obviously taxes on these products serve the same function as a higher VAT rate.

An extended excise system include in its base the commodities covered by a limited system and an intermediate system but also a large number of producers goods.

It is suggested for the State of Madhya Pradesh to adopt the above structure and supplement VAT by a special additional tax on certain products. The SAT would be levied at the first point sale only. It would be a mechanism for introducing some variation in the tax rates at the first point of sale, while maintaining the over all simplicity of the VAT at the subsequent points of sale. Multiple rates are feasible at the first point of sale, as the dealers at that level deal in a limited number of goods and have the resources to track various categories of their purchases and sales. This is not the case at the retail level where dealers carry a large variety of items in their stock/inventory. In this structure, additional revenues from the SAT would also allow the VAT rates to be kept as low as possible.

In the Indian scenario the most important criteria for the selection of goods to be subjected to the SAT are the feasibility and economic desirability of imposing the tax i.e. that they be produced and marketed through the organized sector (that is known to comply with the tax laws) and that there is an economic justification for subjecting them to higher tax rate.

These commodities meet both the criteria mentioned above. They are currently produced and distributed by government enterprises. The economic justification for their taxation at higher rate is the 'external' costs imposed by their consumption on the society.

Production and marketing of these commodities is also regulated and the supplementary tax on them should be levied as essentially as a fresh of royalty charge on the sale of natural sources owned by the state. It would be inappropriate to provide an input rebate for the supplementary tax on these since no rebate would be allowed had the charge been collected in the forms of a royalty or a selling price for the resource.

There are a few additional products that flow through the organized sector and which could be made subject to the SAT at the first point of sale in order to keep their combined tax burden (VAT + SAT) approximately the same as under the current system. These items could be made subject to SAT at a lower rate. The items that could be included in this category are cement, LPG and motor vehicles.

The VAT proposed for Madhya Pradesh is a classical one. It should replace present commercial tax, entry tax, central sales tax, hotel tax, professional tax and some selected services. It would be calculated by the invoice-credit method and extend to retail stage. It would be consumption-type, and destination-based. Under the invoice-credit method, all registered dealers charge tax on their taxable local sales and claim a credit for tax paid for inputs used in making the taxable sales. The input tax credit is allowed only if the tax paid on the purchases is supported by a valid invoice issued by a registered dealer. No credit is allowed where the goods are tax exempt or are purchased from an un-registered dealer, or from a dealer outside the state not subject to tax within the state. Registered dealers remit the net difference to the government on a periodic basis. Extension of the tax to the retail stage means that good attract tax every time they are sold in the state, regardless of whether the sale is the first, second, third or subsequent point. The system of input tax rebate eliminates double taxation of goods. The final tax burden on a good under such a system is equivalent to the tax that would be charged under a single stage tax at the last point of sale to the consumer. A consumption-type VAT allows full input tax rebate in respect of plant, machinery and equipment, raw materials, other inputs used in production, manufacturing and processing, and goods for resale. Finally, the destination-basis means that no tax is charged on exports or inter-state sales.

In the interest of tax neutrality, and to minimise complexity in tax administration and compliance, the tax base should be as comprehensive as possible. It is proposed that only the goods of basic necessities as mentioned in Annexure 1 should be exempt from VAT and some select services should also be brought under VAT but the ultimate goal of tax reform should be to design a VAT return that is so simple that dealers in general, and general merchant in particular, do not require any professional help for completing it and that it does not take more than one to two hours to complete. The goal of a simple return can be achieved only if the tax base is comprehensive and includes all the goods typically carried in the inventory of general merchants.

Thus the structure proposed for Madhya Pradesh would consist of a VAT applied at a single rate (10%) to a comprehensive base of goods sold within the state along with some select services consumed in the state, and a dual rate SAT (20% and 10%) imposed at the first point of sale on select commodities consisting of demerit goods, luxuries, and other items with high revenue potential that are sold at the first point through the organised sector. This structure allows appropriate variation in the overall tax rates to meet the social and revenue objectives of the government, while preserving the simplicity of the VAT design. The structure of tax rates of VAT and SAT is illustrated.

VAT scheme is expected to enlarge the existing tax base to an extent in view of capturing of the value at the low end of a commodity's value-chain. However to decipher exactly, a study of the existing tax base as well as the enlarged base that will be available after the switchover is required. Although the Bureau of Economics and Statistics of the State Government are estimating the State's GDP, detail with regard to the consumption and its pattern in the State are not easily available. There is no model to forecast consumption. In the absence of these, it is possible to arrive at an assessment of the enlarged value-added base that will be available for VAT only through a lot of approximations and micro studies in commodity and dealers.

In its report of the Reforms of Domestic Trade Taxes in India, the NIPFP has suggested two methods for estimating the tax base while switching over to VAT vix; the consumption approach or the Turnover method. Both approaches are handicapped in view of the under reporting of consumption or turnover by consumers / dealers and hence cannot help in understanding the present compliance levels. Any tax base determination on that base would not, therefore, guide the tax administrator to understand the consumption potential and hence the real tax base; if the tax system is being fine tuned by adopting VAT then there shall be only marginal and undecipherable tax evasion.

There is no consumption-forecasting model at the moment available to sales tax administration. The consumption of the commodity sourced from local production is not easily ascertainable. Under VAT, the tax officers are to be well informed on the quantum of tax mobilized on inputs or intermediaries, the likely tax credit or refund claims etc. It shall also be equipped to anticipate the tax receipts at later stages of the value chain of a commodity from an already determined input- output ratio. Thus an alternative model that is based on a study of value chain, input-output ratio, trade practices and the consumption profile of the commodity has to be developed as an alternate reference to cross verify tax base that may be determined through the above models. This model would also help in developing a rational model of Audit in VAT.

A system to aggregate the turnover in respect of the commodities from which the tax is realised is in existence of the commercial tax department. According to this system, the total turnover, the exempted turnover and the taxable turnover details as per the quarterly tax statement filed by each individual dealer is complied commodity-wise. The department, for formulating the Taxation Policies in the Annual Budget, mainly uses this information. Although the information that is available is not free from certain errors, still the same could be used to workout a probable impact of VAT on revenue realisations. By using the assumptions and the formula suggested by the NIPFP in its report, a statement showing the impact of VAT on revenues is worked out taking the 1999-2000 as the base year and the details are furnished in Table 1.

In this method, the starting point is the "Total Taxable Turnover" i.e. total turnover data of goods subjected to sales tax at present in the state of Madhya Pradesh. The taxes that proposed VAT system would replace in the state of Madhya Pradesh comprises Commercial Tax, Central Sales Tax, Entry Tax, Professional Tax, Luxury Tax and Additional Duties of Excise In Lieu of Sales Tax (ADEILST).

The revenue impact of proposed VAT has been estimated using a detailed database on taxable turnover and sales tax collections for the year 1996-97. This database has a breakdown for 112 commodity groups of dealers paying annual tax more than Rs. 24000/- per annum. I have quantified the revenue implications of the proposed model for VAT in MP with the features mentioned in 7.2 above by making certain realistic assumptions. Detailed analysis is given in the Table 1. The key assumptions made in arriving at this estimate are as follows :

- Value addition beyond the first point of sale is 15% of taxable turnover at the first point of sale.

- Additional turnover from base broadening measures is Rs. 5771 crores at the first point of sale.

S No.	Description	Amount
1. CST zero-rated 2. With services (at 10% Tertiary sector) 3. One VAT rate of 10% 4. Two SAT rates - SAT 1 @ 30% (20% SAT+10% VAT), SAT 2 @ 20% (10% SAT+10% VAT)
A	Total Revenue For the Year	3303.23
	i) Commercial Tax (CT)	2113.00
	ii) Central Sales Tax (CST)	470.19
	iii) Share in ADEILST	107.00
	iv) Entry Tax	428.44
	v) Professional Tax	179.60
	vi) Hotel Tax	5.00
B	Taxable Local Turnover (LT)	23678.00
C	Input in B (51% of B)	12076.00
D	Input Tax in B (4% of C)	483.00
E	Taxable Local Turnover Net of Input Tax (B - D)	23195.00
F	Base Broadening -	5771.00
	i) Due to withdrawal of exemptions(based on NIPFP study)	2750.00
	ii) Due to inclusion of new commodities which are presently not taxable	1050.00
	iii) Due to addition of services^* (10% of share of service sector in NSDP i.e. 10% of 32.3% of 61019)	1971.00
G	Total Taxable Local Turnover (E + F)	28966.00
H	Inter-state Sales Turnover (CST / 0.4)	11755.00
I	Consignment Transfers (Estimated turnover based on 96-97 figures of 10349 crores (30% of this)	13455.00
J	Total of (H + I)	25210.00
K	Input Tax in J (4% of 51% of J)	532.00
L	Total Turnover (G + J - K)	53644.00
M	Turnover of importers (40% of E)	9278.00
N	Inputs Qualifying for VAT Rebate (21% of L - M)	9317.00
O	Single Rate of VAT (%)	10.00
P	Tax on Local Turnover Liable to VAT -	3928.90
	i) SAT 1 - 3570 @ 30% (20% SAT + 10% VAT)	1071.00
	ii) SAT 2 - 3183 @ 20% (10% SAT + 10% VAT)	636.60
	iii) VAT - 22213 @ 10%	2221.30
Q	Tax Rebate on N (N x 0 / 100)	931.70
R	Net Revenue (P - Q)	2997.20
S	^**VAT on Sugar, Textiles and Tobacco (10% on 1485)	148.50
T	Gain from capturing Value Added in multistage taxation (O times 15% of 49% of G)	221.91
U	Revenue loss due to rising of the threshold limit to Rs. 3 lacs p.a. (1% of R)	30.00
V	Total Revenue Under VAT (R + S + T - U)	3319.41
W	Gain in Revenue under the proposed State VAT (V-A)	16.18

^* Contribution of Tertiary Sector (Service Sector) is 32.29%. The NSDP for the year 1997-98 is 61019 crores on current prices. In this calculation only 10% of contribution of service sector has been added in the tax base.

^** The turnover of Sugar, Cloth and Tobacco for the year 1999-2000 has been estimated by CCT office to Rs. 322, 840 and 321 crores respectively.

The tax turnover approach is described briefly in Annexure 2. Computation of tax rebates on inputs is explained in Annexure 3.

The taxes that the proposed VAT system would replace in Madhya Pradesh comprise, commercial tax (CT), central sales tax (CST), entry tax (ET), additional duties of excise in lieu of sales tax (ADEILST), professional tax (PT) and hotel tax (HT). The relevant revenue figure for the year 1999-2000 are reported in line A in Table 1.

Methodology for calculation of various components is briefly explained below:

The taxable turnover figure for the Madhya Pradesh commercial tax has been compiled in the office of commercial taxes commissioner. The revenue and turnover of the dealers paying annual tax more than 24,000/- is 1159 crores and 15662 crores respectively. The turnover of the dealers who had paid tax less than Rs. 24,000/- in a year has been worked out by dividing the revenue from these dealers by the average tax rate. Taxable local Turnover so obtained is reported in line 'B' of the Table 1. On the basis of above calculations, the local taxable turnover for the year 1996-97 is estimated to be Rs. 18797 crores. Taking annual growth in taxable turnover as 8%, the local taxable turnover for the year 1999-2000 has been estimated to be Rs. 23678 crores.

Taxable local turnover figures include tax on inputs. In order to obtain the tax exclusive base relevant for a VAT system, input tax has to be taken out from the taxable local turnover. As per the study of NIPFP and other matrix available for the year 1989-90, the all India input-output ratio, for taxable commodity is 51%. I presume that for MP state also this ratio would be same as there are no known factors specifically present in MP I should change this ratio substantially. So the value of inputs included in the local taxable turnover has been worked out by multiplying the figure given in line B and input-output ratio, that is, 51%. The figure so obtained are reported in line C of Table 1.

Estimation of input tax has been obtained by multiplying the inputs turnover by the rate of tax on inputs as shown in line D of the Table 1. At present the general rate of input tax is taken @ 4%.

This has been obtained by subtracting the input tax from the local taxable turnover as shown in line E of the Table 1.

It has been presumed that under VAT regime there will be no tax concessions either in the form of exemptions are deferments. As per study conducted by Indira Rajaraman^* and others of NIPFP on "Industrial Incentive Schemes of Government of Madhya Pradesh", the tax base of Rs. 2750 crores will be available due to withdrawal of these incentives.

Similarly by including new commodities like grains, exercise books, seeds etc. which are presently not taxable the tax base has been estimated to be increased by 1050 crores.

The states do not have the power to levy taxes on services. In my calculation I have presumed that the services like motor repairs, nursing homes, computer consultancy services etc. are available for taxation under VAT to the extent of 10% of the contribution of the Tertiary sector to the NSDP of the state of Madhya Pradesh. For the year 1997-98 NSDP at the current prices is 61019 crores. The contribution of service sector to NSDP is 32.29%. 10% of contribution of service sector to NSDP has been estimated to Rs. 1971 crores.

Thus the total additional turnover that will be available for taxation under VAT due to withdrawal of industrial incentives, inclusion of new commodities which are not presently taxable and addition of services has been estimated to 5771 (2750 + 1050 + 1971) crores. This is reported in line F of the Table 1.

Under a VAT system, while revenue would be collected from only local sale of taxable goods, tax rebate is to be allowed for all local purchases or taxable inputs used in the production of taxable goods, whether or not the final product is sold locally. Therefore, input rebate had to be estimated in respect of total turnover comprising sales in Madhya Pradesh, inter-state, sales outside the state and exports outside the territory of India.

The value of inter-state sales from the state of Madhya Pradesh was estimated by dividing the revenue from CST by rate of 4%, which is the ceiling rate on such sales. The estimate is given in line H. Similarly, the figures of sales outside the State has been estimated on the basis of figures collected by CCT office for the year 1996-97. It has been presumed that consignment turnover increases @ 10% per year. The estimated turnover of Rs. 13455 crores for the year 1999-2000 are reported in line I. The estimate of input tax in inter-state transactions and sales outside the State are reported in line K. Total turnover was obtained by adding to the figures of total local turnover (reported in line G), inter-state sales (reported in line H) and sales outside the State (reported in line I) and subtracting input tax borne by the latter (line L shows the total turnover figures).

In estimating the value of inputs qualifying for VAT rebate, it should be noted there is no input rebate for the following: -

Consequently, rebate would be available only for the purchase of locally produced taxable inputs used in manufacturing of taxable goods. Data of turnover of importers and local purchased goods were not available. In the present exercises, after discussion with senior officials of Commercial Tax Department, as a rough case, 40% of the "taxable local turnover net off input tax" was assumed to be the turnover of importers. These figures are reported in line M.

To estimate the local purchase of inputs, ratio of such inputs to outputs is needed. This ratio can be viewed as a multiple of three ratios :-

The first two ratios were derived from All-India Input-Output Matrix for the year 1989-90, which are 51% and 68%, respectively. For the ratio of local purchase of inputs to total inputs, the data relating to 185 large dealers of Madhya Pradesh were used. After discussion with senior officials of the Department and using this data set, it was found that the ratio of local purchase of inputs to total inputs is approximately 60%. Thus, the ratio of local purchase of taxable inputs to output of taxable goods works out to 0.51 x 0.68 x 0.60 = 21%. The estimate of inputs qualifying for VAT rebate was obtained by applying this ratio of 21% to the total turnover net off turnover of importers. This is reported in line N.

Now, gross revenue under a VAT system can be obtained by applying the single VAT and dual SAT rates to the local taxable turnover. Similarly, the tax rebate can be obtained by applying the VAT rate. In the proposed model SAT -1 goods comprising of petrol, diesel, timber, tendu leaves and raw opium will be subjected to 20% SAT and 10% VAT, whereas SAT-2 goods comprising of motor vehicle, cement and LPG will be taxed @ 10% SAT and 10% VAT. The other commodities including declared goods (but excluding exempt commodities) are to be taxed at a single rate of 10% VAT. The revenue accruing on account of these rates are reported in line P. The rebate was also estimated by applying the VAT rate to inputs qualifying for VAT rebate. The estimates are shown in line Q. Net revenue figures were derived by subtracting tax rebate from the gross revenue. This is given in line R.

The revenue that will likely accrue from textiles, tobacco and sugar on reversion of these commodities to the states from present tax rental agreement with the Centre has been estimated to Rs. 148.50 crores and are reported in line S. This has been obtained by adding the turnover^* of sugar (332 crores), cloth (840 crores) and tobacco (321 crores) for the year 1999-2000 and multiplying these by single VAT rate of 10%.

*The turnover figures are cloths tobacco and sugar for the year 1999-2000 have been collected by CCT office.

The gain from the value added in the process of distribution of goods, i.e. from trade margins of wholesalers and retailers was taken to be 15% of the first point sale value of commodities. It has been mentioned in the "Revenue implications of alternatives VAT rates and derivation of revenue neutral rates - Technical Note", by Pawan K. Aggarawal and A.V.L. Narayana (1995) of NIPFP, New Delhi, that on the basis of data of receipts of trade account of Directorate of Trade Establishments, value added in distribution of goods worked out to about 16% at the All-India level. The estimates of revenue gained from value added in the process of distribution of goods due to multistage taxation are given in line T.

The estimates which are made in line S indicate that the State of Madhya Pradesh would have revenue gain, if the power to tax sugar, textile and tobacco is transferred to the State as contemplated under the VAT system proposed above. The State will get higher revenue from these items under a VAT regime, than it has been getting from ADEILST.

Under the present sales tax system, the threshold limit for other dealers in the State is Rs. 1 lac and Rs. 50,000/- for importers and manufacturers. Raising this limit to threshold level of Rs. 3 lacs under the VAT regime would obviously result in some revenue loss due to exclusion of value added by those dealers whose gross turnover falls in the range of present threshold level and proposed level. However, the loss on this account is likely to be insignificant and is assumed to be around 1% of the current revenue of the State. Estimates of revenue loss on this account are given in line U.

Total revenue likely to be obtained under VAT by the State was finally obtained by adding to the net revenue from total taxable local turnover (P), the revenue from sugar, textiles and tobacco (S), the revenue from value added multistage taxation (T) and subtracting from this total, the revenue loss likely to be entailed from the proposed increase in threshold limit for registration under VAT. This figures is reported in line V. Gain in revenue from the change to a VAT regime is shown in line W.

From Table 1, it would be seen that State of Madhya Pradesh may be able to obtain a revenue gain of more than 16 crores by substituting the present commercial tax, entry tax, central sales tax, hotel tax, professional tax and some selected services by a full-fledged State VAT having a single rate VAT of 10% on all commodities (including some services) and two rates SAT (20% and 10%) on select 8 commodities, even without any compliance improvement.