VIP Road Chartered Accountants Association

Introduction of Value Added Tax - Life Thereafter
By Bhanu Prakash Agarwal

VAT is perhaps most talked about subject in the economic life of India today. Come 1st April 2005 the life after VAT will not be the same.

There is going to be a radical and structural change in the tax regime after the introduction of Vat in India. VAT unfolds a new era of taxation system, which is different from the existing one.

There has been a growing realization amongst the States and the Centre that the existing sales tax system of levy either on the first point basis or last point basis is not ideal. There exist certain deficiencies in the prevailing sales tax system where due to first point levy the State Government cannot impose tax on the value additions at the different stages of production-distribution cycle. Moreover, this has a cascading effect on the economy resulting in higher prices for the ultimate consumer. The existence of multiplicity of rates and cut throat competition among states offering attractive incentives/concessions etc. to large industrial houses for setting up manufacturing units in their respective territories and various other deficiencies lead to very complex sales tax machinery all over India.

Thus, the Centre and the State Govt. with the unhappy experience of the present sales tax administration have come together and have more or less agreed to move from existing system of levy of sales tax to the more consumer friendly VAT system.

Initially, there was a stiff resistance and lack of agreement among the states to shift to the VAT regime from the existing legal framework and levy of sales tax. However, after two years of sustained efforts and countless meetings between the State Finance Ministers and Centre, a broad consensus has emerged amongst majority of the states to agree to shift to the VAT regime.

Thus, if everything goes according to the plan, then from 1st April 2005 sale transactions would no longer attract the existing sales tax and there would instead be a levy called Value Added Sales Tax under the new system.

This system basically works on the following principles :

Vat would be levied at every point of value addition in the production-distribution cycle till the goods reach the ultimate consumer.

The VAT portion embedded in the input procured by the manufacturers/re-sellers would be eligible for set off from the VAT to be ultimately paid to the Exchequer. Thus, this system indirectly leads to levy of VAT only on the value addition and not on the gross sale. This will remove the cascading effect of taxes prevailing in the existing sales tax regime.

Of course this chain of availing input VAT credit can only be possible if the cycle moves along registered dealers. In other words if in this production-distribution cycle one of the dealers is unregistered, the system of input credit available to the next dealer in the cycle would break then and there.

Upon the effective implementation of the VAT system the unorganized/unregistered market would shrink by the day because any purchases from such dealers would defeat the purpose- the buyers would be at a disadvantage since they would not be able to avail any input credit. The purchases from dealers who are registered under the VAT regime will only be eligible for input credit.

The credit that would be available to the various assesses in this chain would be based on the tax invoice of the selling dealer. The exact procedure of availing credit is in the formative stage and is yet to be finalised.

It is also proposed to have different rates of VAT. Starting from a Nil rate the same would extend to a lower rate of 1% and a general rate of 4%. There also would exist a rate called the Revenue Neutral Rate or RNR which would be around 10% to 12% and would be levied on general commodities except as specified. There also would exist a higher rate of say 20% for demerit goods.

The VAT regime would also provide for simplicity in maintenance of records and administrative and assessment procedures. The dealers would not be required to maintain voluminous records. Instead they would only have to preserve and present sale and purchase documents to claim rebates.

The era of issuing of declaration forms to registered dealers for effecting sales at concessional rates would also come to an end in the VAT regime. The dealers would not, therefore, be required to obtain and furnish these forms which often are a burdensome task.

Drawbacks in the proposed framework

One of the paramount impediment in the proposed VAT regime is the inter-state movement of goods, which under the existing system falls under the purview of the CST regime. A number of meeings held between various state ministers in this respect could not evolve any consensus and, therefore, under the proposed regime CST Act would remain in force and it is yet to be ascertained whether there would be any amendment in the CST Act to facilitate smooth transition to the VAT regime. The proposal of continuing CST along with VAT is foreseen to create enormous practical difficulty. Therefore, a purchase from the outside the state would have a two-fold impact :

i. CST will be levied on such goods (normally @ 4%).
ii. VAT element embedded in the input will not be available for set off to the buying dealer.

This is not at all a pleasant scenario. This may have a serious impact on the inter-state movement of goods.

Secondly, any purchase from outside the state would increase the cost and effectively defeat the underlying principle of VAT. Unfortunately, even the seller would be at a disadvantage because it is being proposed in certain states including West Bengal that in case of dealers selling goods outside the state, the input credit of VAT would be proportionately reduced by the extent of the sale outside the state. Therefore, under the proposed parallel existence of CST and VAT the buyer and seller both are at a great disadvantage where the movement of goods is between two states.

Unfortunately, the whole principle of levy of VAT on destination principle has not been considered and, with the continuation of CST, VAT is proposed by the States to be under the principle of origin.

For effective implementation of VAT, CST ultimately has to be amended, structured or completely abolished and VAT has to be introduced under destination principle. The converse may lead to serious imbalances in the ultimate price of the goods. Let us consider an example. It is proposed to have a general VAT rate in the range of 10% to 12%. Thus an industry which has an effective tax rate of say 3% in the prevailing system would be at disadvantage at such higher rates since it would make the industry uncompetitive. Also as it is proposed to have a different VAT enactment for each State it can lead to a serious disharmony in the provisions relating to levy of VAT, credit of VAT, assessment of the registered dealers and a number of other areas, which would ultimately lead to a chaotic situation.

There already has been an unpleasant experience of the VAT regime which was partially introduced in Maharashtra, Andhra Pradesh and certain other states earlier. But unfortunately, it was introduced in such a slipshod manner that it resulted in complete failure and had to be withdrawn. We can only hope that the proposed introduction of VAT on and from 1st April, 2005 would not leave any gaping holes leading to chaos.

Of course the VAT is not a new concept in the world economy and more than 120 countries including Nepal have successfully implemented the VAT. Thus it is not that VAT is a difficult proposition to be implemented. However it should be introduced with proper safeguards and the impediments as discussed above should be removed.

It can also be hoped that states will sooner realize that the VAT is a principle in which narrow regional consideration would lead to a complete collapse of the VAT. Pragmatism should prevail over dogmatism otherwise no efforts of the states to introduce VAT would take off. There would be a very big psychological barrier in future if the VAT as being introduced in India along with CST leads to chaos.

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