Need for VAT
Value Added Tax is one of the most radical reforms that have been proposed for the Indian economy after years of political and economic debate. The reasons for advocating Value Added Tax is that it will replace a complicated tax structure that will also do away with the fraudulent practices. Following are some of the most important benefits if VAT is introduced.
• VAT will encourage and result in a better-administered system that will close avenues of tax evasion. The taxpayers will also be compelled to keep proper records of their sales and purchases. VAT actually provides an incentive to traders for paying taxes.
• VAT avoids the problem of under valuing as all stages of production and distribution are subject to a tax. Under the VAT system, no exemptions will be given and a tax will be levied at each stage of manufacture of a product. At each stage of value-addition, credit can be claimed on tax paid on inputs.
• It does not distort the business decisions as it does away with cascading. Only market forces rather than tax structure will guide vertical integration decisions once VAT is implemented.
• VAT permits easy and effective targeting of tax rates as a result of which the exports can be zero-rated.
• The input tax credit method encourages a system that ensures better tax compliance by generating a trail of invoices that supports effective audit and enforcement strategies.
• As far as India is concerned, VAT, if enforced properly could help in fiscal consolidation for the country. As a steady source of revenue, it could be used for reducing the debt burden in due course.
• Further, any globally accepted tax administrative system like VAT will help India integrate better in the WTO regime.
How VAT works?
Under the existing system, there is a tax levied at each stage of production which results in a ‘tax on tax’ or the cascading effect. Producers try to overcome this tax by vertically integrating their production process, which affects production decisions.
VAT is implemented through a system of tax credits. When the purchaser purchases the goods, he’ll have an invoice which will state the price of the good as well as the VAT paid on it. The tax deducted will be only on the value added at each stage of production. When he sells the goods, he’s given a discount on his VAT obligations that he has already met on the purchase of his inputs. Because an offset for input tax is not given without an invoice for purchase of an input, there is an incentive to demand invoices for any purchases made in the chain of production and distribution. This leads to self-assessment of tax by the tax payer himself. Each tax payer is given an 11 digit Tax Payer Identification number. This is used to make a central database of all the states. The database contains all information regarding the VAT paid on purchase of inputs and the amount to be refunded at the point of sale. In order for this to work, a central IT enabled system should be in place. The intra-state operations of the sales tax department have been computerized in many states and this network can be exploited to demat local statutory forms. Tax information exchange system being planned at the national level would help do the same for the central forms. VAT is charged on all imports at the point of entry and at the same time is refunded to exporters.
Implementation of VAT – A status summary
Despite the obstacles and the delays in the implementation of VAT, it would be worthwhile to recollect what has happened and what has been achieved so far in an attempt to introduce Value Added Tax in India. We examine the status of implementation of VAT in the Southern states specifically. Twenty-two Indian states have drafted the VAT Acts for their respective states and some states like Andhra Pradesh, Karnataka, Tamil Nadu, Haryana and Uttar Pradesh have also modified their draft VAT Act since its inception. However, despite this, the country is not yet close to the implementation of VAT. Haryana is the only State to implement VAT from April 1, 2003. The postponement of the introduction of VAT has been due to the several reasons such as divergent views on the treatment of existing sales tax incentives, treatment of central sales tax under VAT, and more importantly, the lack of preparedness on the part of the states to actually implement VAT. VAT already introduced in AP, Kerala, MP, Maharashtra but, withdrawn. VAT also introduced in Haryana in April 2003 that mopped up a 30% increase in revenue. VAT panel relaxed the threshold limit for traders to Rs. 5-50 lakhs of turnover from the previous stance of Rs. 5-40 lakhs. State VAT will be introduced in April 2003 and 12 states will line up in the phase 1. This system will also be IT enabled which will be developed by the ICICI InfoTech.
A few rate structures under VAT are:
- NIL rates on essential commodities (vegetables, fish, meat etc.)
- 1% for gold, silver and precious stones
- 4% for declared goods and industrial inputs (copper, aluminum)
- 20% for liquor
- Revenue Neutral Rate (RNR) of 12.5% for all other goods
Resistance to change
Humans and society as a whole have a tendency to resist change whether it is for good or bad. They develop an irrational attachment to the existing system even if it is flawed and outdated. Traders are the ones who oppose this new system the most as they have an apprehension that their liabilities will increase. Under the existing system, a large number of small entrepreneurs evade from paying taxes. Under VAT system, this is not easily possible. They also fear that if they opt for the VAT system their real income will be revealed and hence liable for income tax payment. Consumers fear that this will bring about rise in prices. The same apprehension existed in the minds of Australians that prices would rise, but no such thing happened. In fact the new system actually ended up reducing the costs by eliminating cascading taxes to the tune of several billion dollars. Another reason for the delay was the wrangling over the compensation to be paid by the center for the revenue loss for states from the change over. The center has ensured that this will not be so and has assured compensation in case of deficits. If VAT system is adopted there would be no exemptions or incentives. This can adversely affect some business houses. To crown all this there was also political opposition fearing disfavor of the trading community and the resulting political fallout.
VAT – the way forward
In order to make the VAT a thorough success following could be few suggestions.
- The deadline for all legislations and computerizations should be same across the states.
- VAT should be implemented by all the states at the same time.
- Laws regarding VAT should be uniform across all the states and there should be no disparity among the states.
- There should be a monitoring mechanism at the central to overlook the new system.
- A lot of changes have to be made in ancillary legislation (income tax, company law etc.) to ensure VAT compatibility.
Bibliography
- The Indian Express dt. June 24, 2004
- The Economic Times dt. 10-03-04, 15-06-04, 18-06-04 & 27-07-04
- Magazines & journals
Acknowledgement
We express our hearty gratitude and acknowledge the help rendered by Prof. Balakrishnan in preparing this report.