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Inequity and Disharmony in taxation of capital goods under VAT

By

S. Sridharan, VAT Consultant, Madurai

Considering the sharp difference in the State Draft Acts in the definition of the term "Capital Goods" and their eligibility for Input Tax Credit, the Empowered Committee should ensure a uniform definition and eligibility of Input Tax Credit (ITC). The exclusion of ITC on Capital Goods used by Distributing/Trading activity in some States is inexplicable and biased

 

 

 










 

Will VAT become the acronym for Value Added Trouble? I am afraid it will, if impractical provisions proposed in the VAT Draft Acts/Rules are not removed. One such issue is the taxation of Capital Goods under VAT.

Capital goods, in accounting terminology, are generally understood as assets used in the business either by a trader or a manufacturer and includes plant and machinery, tools, buildings, Air Conditioners, motor vehicles and all other assets.

Though much has already been written about the confusion in the definition of Capital Goods and their eligibility for Input Tax Credit in different States, I thought it appropriate to highlight certain aspects that requires immediate attention before the draft VAT Bills become law.

I. Definition of Capital Goods is biased against Trading Activity

I always believed that VAT is neutral as between different tax paying entities and so far as the tax administrator is concerned the tax paid by a dealer is on the value addition, no matter who the tax payer is, be it a manufacturer or a distributor/trader. One of the much professed features of VAT is that all tax paying entities are treated equally and that there shall be no discrimination.

I fail to understand the logic or the reasoning for the denial by most of the States of Input Tax Credit on Capital Goods used by a trader. A distributor/trader needs capital goods like Furniture and Fixtures, Cold Storage facility/ Air Conditioning for storage of goods, special vehicles for transport of goods like perishable commodities that are taxable. Investment in these capital goods may be substantial in some cases. The cost of these goods are definitely factored in the pricing by the dealer and the value addition by the dealer includes the cost of these goods as well. The VAT paid by a dealer includes the cost of these equipments as much as the VAT paid by a manufacturer includes the cost of the Plant and Machinery.

It appears that the drafters of the legislation have been swayed by the definition of capital goods in the Central Excise Act. While Central Excise is a tax on manufacture, VAT is levied on manufacturers as well as traders. The definition of the term must cover capital goods used by manufacturers as well as traders.

It may be noted that in the Accounting Standard AS 10 - Accounting for Fixed Assets issued by the Institute of Chartered Accountants of India, Fixed Asset has been defined as " an asset held with the intention of being used for the purpose of producing or providing goods or services and is not held for sale in the normal course of business"

Input Tax Credit should be made available on Capital Goods used by distributors/traders as well. It is surprising that Trade lobbies have not raised their voice against the discrimination.

II. Need for uniformity in the definition of Capital Goods

A large number of disputes in the present sales Tax Acts relate to classification of Commodities and the rate of tax applicable thereon. With fewer rates and clear-cut classification of Goods in the 4% category, I thought that Tax Professionals would have much less assignments under VAT. It is not to be as at least the interpretation of the term "Capital Goods" will keep tax professionals busy, considering the scope for litigation in the term as defined in various draft Acts.

The list of goods covered and the details of activity specified will give ample room for disputes on the eligibility or otherwise of goods to be classified as "Capital Goods".

Please click to view the analysis of the definition of the term in the various State draft Acts.

The brief list of disparity and the terms that give room for ambiguity and confusion are

1.  Some States specify that the goods should be used in the " manufacturing of goods " while some States specify " manufacture or processing of Goods" and the term " used in the process of manufacture" and " used directly in the manufacture" is also used.

The will be a need to interpret "manufacture" , "processing" , "used directly in manufacture" etc., which will lead to harassment and confusion.

Further, a dealer may use the assets for both trading activity as well as manufacturing activity. For instance in the case of ,say, Material Handling Equipments used by a a granite goods manufacturer. The equipment will qualify as "Capital Goods" eligible for Input Tax credit. Suppose the manufacturer also trades in granite and the same equipment will also be used for trading activity, Will there be a disallowance of the Input Tax Credit on capital goods to the extent the assets are used for trading activity?

Therefore the restriction on the use of Capital Goods only for manufacturing activity needs to be removed.

2.  While Plant and Machinery and equipments are listed as goods that qualify as capital goods, the purchase of right to use such goods is included in some Acts. Some of the States have specified the term to have the same meaning as in the Income Tax Act. Gujarat has adapted the definition in Excise Rules but includes the equipment and appliances meant for use in an office.

3. Some States require that the capital assets should be capitalised in the books of accounts

Capital Goods, in the present sales tax parlance, is normally understood as assets purchased not for resale but for use in the business and includes parts and accessories of the assets that are bought for maintenance or for replacement as spares. In most of the States concessional rate of tax have been granted for purchase of capital assets and the concession extends to parts and accessories as well. So far under the present sales tax Act the list of eligible capital goods were notified.

The requirement that the assets should be capitalised in the books of accounts is an undesirable restriction , not compatible in VAT , as Input Tax Credit will be denied on spares and replacements which are not capitalised in the books of accounts. There is no such restriction under CENVAT.

4. Some of the States have specified a minimum monetary value for the goods to qualify as "Capital Assets".

The fixation of a minimum monetary value for capital assets is inexplicable. There will be instances where each of the capital asset may be less than the minimum prescribed limit, but the manufacturer will need to install and use a minimum quantity of the small value assets to carry on manufacturing activity. The sum total will be more than the minimum monetary value prescribed.

5. Some of the States have used the expression " manufacture of Goods for taxable sale"

The restriction of input tax credit on assets used only in the manufacture of goods for taxable sale leaves unanswered the question as to what happens if a portion of the goods manufactured are despatched on stock transfer. By using the words " manufacture of goods for taxable sale", stock transfer will not be covered and there may be a reverse credit of the Input Tax Credit taken on machinery if a part of the goods manufactured are despatched on stock transfer. This restriction " for taxable sale" may be removed to avoid complications.

While most of the States have defined Capital Goods, Andhra Pradesh has defined the term for the limited purpose of payment of tax on capital goods on closure of the business.

In my opinion the definition of the term in the Karnataka Draft Act reproduced below is comprehensive though the monetary ceiling requires reconsideration.

SECTION 2(7)

In this Act unless the context otherwise requires:-

(7) ‘Capital goods’ means plant, including cold storage and similar plant, machinery, goods vehicles and equipment or any other goods, whose total cost is not less than an amount to be notified by the Government or the Commissioner, and used in the course of business other than for sale.

In this definition the words "any other goods "will cover all capital goods and the expression " and "used in the course of business other than for sale" will cover manufacturers as well as traders.

III. Impractical provisions relating the period of set off of Input tax Credit on Capital Goods

Normally Input Tax Credit should be available in the month of purchase. In the Case of capital goods several States have spread over the adjustment against output tax for periods upto three years as can be seen from the following table:

State

Period

Assam

Three years

Bihar

Depreciation under the IT Act for the relevant year to be claimed in 12 monthly installments.

Goa

Two years. 1/24th in each month

Karnataka

To be specified

Orissa

Three years

Pondicherry

Five years

Model VAT Bill

Three years

While the concern of the States of the possible revenue impact on the granting of Input Tax Credit in the first month is appreciated, the practical difficulty in enforcing the provision and the onerous record keeping responsibility on the dealers seems to have been lost sight of.

The tax department will need an army of inspectors to verify the claim of input tax credit as there will be additions in every month in each factory. For each asset a separate record will have to be maintained. In a particular month the dealer will have to include the 36th,35th,34th,33rd installment and so on and this definitely is not simplification of procedures in VAT.

Even in Central Excise the set off is allowed on a yearly basis over two years. The VAT on capital assets may not be more than 10% of the revenue and the State Governments should come forward to allow set off in the month of purchase for existing businesses.

The restriction if any may be made applicable to newly set up business where Input Tax Credit claim on capital goods has been accumulated of more than a year. In such cases the claim may be allowed over the number of years in which ITC had been accumulated.

IV. Denial of Input Tax Credit on Capital Assets used in Works Contract

Some of the States like Assam have provided that purchase of capital goods required for execution of works contract shall not be eligible for input tax credit.

Input tax credit should be made available on works contract as well if works contract is taxable under the VAT Act of the respective State.

The denial will automatically disappear if the restriction on the requirement of capital assets to be used in the manufacture or processing of goods is removed.

Trade Bodies should strongly represent to the Empowered Committee and the State Governments to remove the anomaly in the treatment of Capital Goods under VAT.

25/02/2003

 

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