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

The most controversial issue in India at this moment is the Value Added Tax (VAT). Value added tax, a new system of indirect taxation, has been imposed in India from 1st April, 2005. Though it is new and first time in India, it has already been adapted in the first world countries for a long time. Germany is the country who imposed VAT first in the world in the year 1918. In Europe, France is the country who imposed VAT for the first time in the year 1954. U.K adapted this system of taxation in 1973. At this moment VAT is the key source of government’s revenue in more than 150 countries. Nearly 70% of the world’s population is now under the VAT.

Mr. F. Von Siemens, a German Economist, has proposed the concept of VAT first time. Germany adapted this system of indirect taxation as the substitute for “turnover tax”. VAT gathered momentum after its acceptance to European Economic Community (EEC).

Value added is the market price of the output of an enterprise minus the price of goods and services acquired by transfer from other firms. On the other hand, value added is the summation of direct labour, production overhead and gross profit.

Tax charged on value added in each stages of transaction is known as Value Added Tax (VAT). It is an indirect tax applicable instead of sales tax / turnover tax levied in connection with the disposal of goods. VAT is a multipoint, refined or improved turnover tax, unlike the present sales tax which is a single point tax.

The objective of VAT is to abolish the cascading effect of sales tax. The cascading effect of present taxation will be eliminated by the new system of taxation, as there is a opportunity for claiming credit for the amount of VAT paid by the previous business in the supply chain. The sellers are eligible to claim tax credit to recover the tax they had paid on their business at each stage.

From the economist view point, VAT is very rational because it is economically neutral. The challenges on globalisation and liberalization of the developed and the underdeveloped countries will be faced by the VAT. Cascading effect, multiplicity of levies, complex tax structure, high rate of tax, lack of transparency, vertical integration, manufacturer and importer tax, narrow base etc. are the limitations of the existing tax system in India. To avoid these shortcomings, the new system of indirect taxation, VAT, is imposed in India and most of the countries in the world boycotting total turnover tax.

Though VAT rate is specified in each country (where it has been imposed) of the world, some of the common items are on the reduced rate Viz., food, pharmaceuticals, newspapers, electricity, diamonds, gold and silver etc. in most of the countries of the world. The standard rate of VAT in Argentina is 17 per cent. Newspapers and magazines are exempted from VAT to retail business in this country and also a reduced rate of VAT (10.5 per cent) is applicable in respect of goods Viz., gold, silver, some computer equipments and photographic and medical equipments. In China the specified rate of VAT is 17 per cent. There is a reduced rate of VAT, 6 per cent on microchips and diamond related transactions are totally exempted from VAT. In India two basic rates of VAT, 4 per cent and 12.5% per cent, have been imposed. 1 per cent VAT rate is applicable to gold and silver ornaments only. Some goods are totally exempted from VAT. All taxes, excluding entry tax, have been merged with VAT. Due to some organizational difficulties VAT is not imposed on sugar, tobacco and textile. As the prices of the goods like alcohol, lottery tickets, petrol, diesel, and other motor spirit are not fully market determined, the goods are not brought within the purview of VAT. Slabs of VAT rates are shown in the Table-I.

Value added tax is an indirect multipoint tax collected on each sales or resale. It is collected in each stage of transactions. There is a provision of tax credit for tax paid on factor inputs or purchases. VAT is a system of improved turnover tax or refined turnover tax because it avoids the pyramiding effects of tax in production. In case of VAT, incidence of tax is fallen on only the added value at each stage. At this moment VAT covers about 550 goods in India which indicates the wideness of tax base. In India VAT is free in case of export. The rate of VAT starts from zero. Only registered persons can claim tax credit for tax paid on factor inputs or purchases in each stage. Under the provision of GATT, VAT levied on exports is refundable. The units located in ‘special economic zone’ are exempted from VAT. Provision for VAT credit is permissible on production of documents like tax invoices, bill or cash memo. Traders whose yearly turnover is below Rs. 0.5 million will be eligible for total VAT exemption. The existing system of built-in-self-assessment and auditing by dealers has been replaced by the VAT for higher relevance growth in near future. If the variance between the VAT paid on output and VAT paid on input is positive, trader will get the tax refund, conversely he must pay to the exchequer.

As a substitute of turnover / sales tax, VAT helps to reduce the tax evasion and also helps to avoid the cascading effect of existing system of taxation. VAT enhances the revenue of government and also reduces the tax burden of consumers and manufacturers. By VAT there is a possibility of collection of tax efficiently. It facilitates domestic trade because export is totally exempted from VAT. It provides concessions to manufacturers in an easier manner. VAT facilitates tax invoices which are maintained by each dealer to get the tax credit. Uniform tax base throughout the country can be achieved by implementing VAT.

It is not acceptable for an individual to keep salaries within the firms for using the firms for personal purposes, though this incentive is provided by the VAT. In order to maintain tax invoices for VAT, dealers should require larger administrative staff. It will increase the cost of human resources. Cost of human resources will increase the prices of the goods. The benefit of merger with the firms will be restricted by this system of taxation. There is no provision of cross verification of documents and complication may arise due to multiplicity of tax rates. VAT goes against the principle of equity in taxation.

Particulars	Purchase in Rs.	Sales in Rs.	Value added in Rs.	VAT
1^st Seller	000	100	100	12.5%
2^nd Seller	100	200	100	08.3%
Manufacturer	200	400	200	16.7%
Retailer	400	650	250	20.8%
Total		650		58.3%

Particulars	Tax On Sale In %	Tax On Credit In %	Net Tax In %
1^st Seller	12.5	-	12.5
2^nd Seller	20.8	12.5	08.3
Manufacturer	37.5	20.8	16.7
Retailer	58.3	37.5	20.8
Total			58.3

VAT system and tax credit system under VAT are shown in the table – II & III by two-nail system. Table – II shows amount of value added and VAT (Input tax) in each stages of transactions (1^st Seller to Retailer). Again table – III shows output tax and tax credit (Output tax minus Input tax) in each stages of transaction form 1^st Seller to Retailer.

Indian business community is now a puzzling situation. They think Vat is a sweet poison which will affect slowly their business. Their objections on the following points – (a) according to VAT input credit will be available only on the goods purchased by the industry within the state, not out side the state. It can create again a cascading effect on tax which is against primary objective of VAT, (b) Rebate on tax paid on capital goods only over a period of three years is too long, (c) as the VAT is charged on each stages of sales though there is provision of tax credit on input tax paid but in some situation it may enhance the price of goods beyond maximum retail price (MRP), (d) VAT abolished the indirect taxes Viz., Turnover tax, Luxury Tax, Octroi tax. They think these taxes should go, (e) computerization for VAT invoicing is inevitable. Small traders who do not maintain computerized accounts will face an obstacle initially, (f) dealers will file VAT return in a self-assessment manner. In spite of that, department is required to audit the return once every three years, (g) the registration process under VAT law requires dealers to deposit their estimated 6 months future tax liability along with photographs of all partners and directors, (h) punishment under VAT law is imposition of fine up to Rs. 1.00 lakh and 6 months imprisonment due to minor offence.

Consumers are worried after imposition of state level VAT. Because it is consensus among the consumers that final burden of VAT will ultimately be borne by themselves for being the fact that it is a tax on consumption. In many respects VAT is similar to a last-point retail turnover tax. So it may be said that the impact of VAT on general customers will be far-reaching because – (a) the tax rate for most of the commodities is 8% in the existing system. It will be increased by 12.5% under VAT. So prices of most of the commodities will increase due to levying tax at every stage of sale, (b) increase in prices of goods would result in increases cost of living, (c) under VAT regime different value additions by different dealers will happen. As a result, customers have to pay different prices for the same goods in different shops, (d) in the short- run, there is no possibility of fall in prices of goods because RNR (Revenue Neutral Rate) has been fixed at 12.5%, which is very high.

To eliminate the shortcoming of VAT and to make it more acceptable the following recommendations should be considered.

(a) The purpose of introducing VAT is to create a unified domestic common market within the country. But due to different tax rates for different schedules and different tax rate for different states defeat the objective of introducing VAT in India. It is desirable that the VAT rate should be uniform in the different schedules and different states.

(b) Under VAT law tax authority is empowered by a discretionary power. It should be abolished.

(c) As the taxes like Entry Tax, Luxury Tax, Cess etc. do not fit with the VAT, so those should be eliminated as early as possible.

(d) It is desirable that the Central Sales Tax (CST) should be abolished gradually. A timeframe for this must be set.

(e) VAT should impose simultaneously in each state of India. The system must be simple, transparent and easy to understand.

(f) Registration process for VAT should be homogeneous in each state. Dealers who are already registered should be exempted from registering their names again for VAT, depositing registration fees and requisite papers.

(g) An independent constitutional authority should be established to facilitate the concept of common market and introduction of VAT.

(h) In the present situation there is a possibility of increase in prices of few goods beyond Maximum Retail Price (MRP). So there must be a proper mechanism for levying VAT to avoid the problem.

(i) There should be no distinction between capital purchases or purchases for resale or purchases by service industry.

(j) Input credit should not only be granted on purchases within the state. It should also be allowed to the purchases out side the state.

(k) In order to get input credit under VAT dealers should keep record of all transactions.

(l) There should be a co-ordination between state VAT and taxation of service sector with excise duty.

(m) VAT council for each state should be constituted by the Government as early as possible and the Finance Minister of each state should select the members of the council.

(n) States should not levy VAT in such a way that may obstacle for free flow of goods across states.

Value Added Tax (VAT) is a refined or improved system of indirect taxation. Though it is imposed in India on and from 1^st April, 2005, most of the countries of the world have accepted it a long time ago. If this system of taxation is imposed properly, the consumers, traders and government will be benefited. Consumers will be benefited by the reduced and reasonable prices of the goods. Traders will be benefited by the reduced and reasonable prices of the goods. Traders will be benefited by the input tax credit system of VAT. And government will be benefited by earning more revenue by this system instead of existing system of indirect taxation. VAT restricts the cascading effect of taxation, minimizes the tax evasion, decreases the prices of goods, increases the revenue of government and frame a rationalized tax structure. Self-assessment by the dealers will increase transparency which helps common people, traders and industrialists.

The experience of the countries where VAT has been imposed long ago is encouraging and it gives more advantage to both taxpayers as well as government than other systems of taxation. The traders and industrialists are not against VAT, but against the half-hearted effort taken by the government. Imposition of VAT instead of Sales Tax cannot be implemented on short notice. It requires a nationwide information and awareness-campaign in regional languages for better understanding of VAT system.

The success of value added tax fully depends upon, proper planning and preparation, examination in detail, the administrative, organizational, audit related issues, relating to electronic data base, several transitional issues, fully acceptance of the people of the society, availability of efficient officers, and sound ethical policies in business1.

The experience of India after three months of imposition of VAT is very encouraging. On 10th July, 2005 the Chairman of the VAT Empowered Committee said that government revenue is increased by average 15%. The highest rate of increase is 30% in Delhi and the lowest rate of increase is 3% in Andhra Pradesh. The revenue is increased by 7% in West Bengal. The statistics shows the success of imposition of VAT instead of sales tax.

To face the challenges of globalisation and liberalization like other countries India cannot remain silent about the VAT because it is an instrument to move towards free market economy. So it is imperative to say that the decision of the Government of India about the imposition of VAT is, no doubt, correct and judicious.

1. Akash S.B. & A.S. Shiralashetti, "Value Added Tax : A SWOT Analysis",Southern Economist, Vol. 43, No. 23 & 24, Apirl 1 & 15,2005, P. 11.

2. N.K. Prasad & A.K. Prasad, Principles And Practice of Cost Accounting, Book Syndicate Private Ltd., Calcutta,Edi. 1993, P. 863.

4. Dr, Arvind Kumar, Puspendra Mishra Bhupesh Kumar Shah, June, 2004, Indian Journal of Accounting, Vol. XXXIV (2).

5. Muhopadhyay, "VAT : A Closer Look", EPW, Feb. 17-23, 2001, Vol. XXXVI, No. 7, P. 552.