Value Added Tax

Value Added Tax

The origin of Value Added Tax (VAT) can be traced as far back as the writings of E Von Siemens, who proposed it in 1918 as a substitute for the then newly established German turnover tax. Since then, numerous economists have examined the tax in great contexts. Also, various committees have examined the tax in great details. However for its rejuvenation, the tax owes much to Maurice Faure and Carl Shop. The recent evolutions of VAT can be considered as the most important fiscal innovation of the present century.

VAT was first introduced in France 1954. With the imposition of Taxes Value Adoptee, France becomes the first European country to implement VAT on an extensive scale. It was not, however, at first a complete system of VAT, since it applied only to transactions entered into by manufacture and wholesalers.

What is VAT?

The Value Added Tax is similar to the national sales tax. However, instead of implementing one tax of certain percentage of the time of retail sale, there is a smaller tax, proposed at 5 % added each time the product is resold or when value has been added. For example a tax is added when a product is passed from a manufacture to wholesaler, and again from the wholesaler to the retailer or it is a multi-stage sale tax levied as a proportion of the value added (i.e., sales minus purchases which is equivalent to wages plus profits). It is a sales tax collected by the government (of the state in which the final consumer is located)---- which is the government of destination state on consumer expenditure.

Over 120 countries worldwide have introduced VAT over the past three decade and India is amongst the last few to introduce it. India already has a system of sales tax collection wherein the tax is collected at one point (first/last) from the transactions involving the sale of goods. VAT would, however, be collected in stages (installments) from one stage or another. The mechanism of VAT is such that, for from one stage to another. The mechanism of VAT is such that, for goods that are imported and consumed in a particular state, the first seller pays the first point, and the next seller pays the tax only on the value-addition done--- loading to a total tax burden exactly equal to the last point tax.

Why is VAT Necessary?

India, particularly the trading community, has believed in accepting and adopting loopholes in any system administered by the state or the centre. If a well-administered system comes in, it will close avenues for traders and businessmen to evade paying taxes. They will also be compelled to keep proper records of their sales and purchase. Many sections hold the view that the trading community has been amongst the biggest offenders when it comes to evading taxes. 

Under the VAT system, no exemption will be given and a tax will be levied at each stage of manufacture of a product. At each state of Value addition, the tax levied on the inputs can be claimed back from the tax authorities. At a macro level, there are two issues which make the introductions of 

VAT critical in India.

1. Industry watcher say that the VAT system, if enforced properly, will from 

    Part of the fiscal consolidation strategy for the country. It could, in fact, 

    help address the fiscal deficit problem and the revenues estimated to be 

    collected could actually mean lowering of the fiscal deficit burden for the 

    government. 

2. The International Monetary Fund, in its semiannual world economic 

    outlook released on April 9, 2004 expressed its concern over India’s large 

    fiscal deficit at 10 per cent of the GDP. Further any globally accepted tax 

    administrative system, will only help India Integrate better in the WTO 

    regime.

This is one of the most radical reforms to be proposed for the Indian economy, could finally become a reality after four years of political and economic debate, yet, the biggest hurdle before the government is not making India’s common market’ through a uniform sales tax structure, but removing a complicated tax structure that also allowed for fraudulent practices. The decision to introduce VAT was publicly discussed first at a conference of State. Chief Ministers and Finance Ministers in November, 1999. At that time, the political instability and lack of initiative pushed this reform to the back burner.

The Global experience with regard to VAT was that it promoted efficiency in production by allowing tax credit cascading for inputs and reducing the impact of multiple levies. In the process, it is not only the consumer but also the producer who benefits. Moreover, the government does not lose revenue since the lowering of tax rates is more than offset by increased economic activity.

Why Government proposes to Impose VAT?

Dr. Manmohan Singh, the then Union Finance Minister, in his Budget speech for the year 1994-95 introduced the new concept of service tax and stated that “there is no sound reason for exempting services from taxation, therefore. I propose to make a modest effort in this direction by imposing a tax on services of telephones, non-life insurance and stock brokers”.

Service tax had been levied on the recommendations made in early 1990s by the tax reforms committee headed by Dr. Raja Chelliah. The Committee pointed out that the indirect taxes at the central lever should be broadly neutral in relevation to production and consumption of goods and should, in course of time cover commodities and series. The committee felt that the country should move towards full-fledged Value Added Tax (VAT) system covering services and commodities. Service tax must a part of VAT at the central level. It envisaged that at the central system a tax could be levied on services that enter into the productive process. The committee emphasized the importance of moving towards VAT, for making the system of indirect taxation broadly revenue neutral in relation to production and consumption and widening the tax base by covering exempted commodities. It is felt that VAT mechanism would mitigate the burden of service tax and take care of the cascading effect on the ultimate customers. VAT aims to cut multiple layers of state and federal taxes and impose uniform tax rates across the country. Over 120 countries which have adopted VAT have seen their revenue increase. Indian needs more revenue to plug its deficit.

Retail Community Protest

Small businessman and traders are likely to be badly hit by the new system as many of them have used loopholes in the current system to avoid paying taxes. A section of the retail community went on strike, stating that some anomalies linked to the proposed VAT system have not been addressed. A High Power Committee including Senior State Finance Ministers, had pointed out the anomaly to the government. However, the centre continues to ignore the suggestion and this makes the situation more difficult. The government is looking at the while issue through a single dimension (of collecting revenues). The retail community will be hit by the multipoint VAT system.

No Extra Paperwork for Retailers

There are sections of VAT system which ensure lesser paperwork for the retailer community. There will be no local statutory forms under VAT. The existing sales tax system requires dealers to maintain account by sales and purchase, and the VAT system also requires maintenance of only such accounts. Further, the Central Sales Tax Act would be amended and there would be a single-page form common for local and central Acts. The return would be required to be filed quarterly, as is being done currently.

Some Points against VAT

The state government’s concerns may be seen as political lobbying. Since large section of the trading community has protested against VAT, both the BJP and Congress have not made any categorical statement for or against VAT. Instead, they have tried to befriend the trading community. Each party sings a different tune in different states in this matter. It would also mean less tax evasion and more earning for the states. But no political party can afford to ignore the agitating trading community, which becomes a vexed issue for the political parties.

• The power to enhance the rate of tax will rest with the Finance Department of the state. The industry feels that this will be largely misused and rates could be increased at the wishes of the bureaucrats, ignoring the stipulations. 

• The bureaucracy will have full control over every dealer and trader, and will have the authority to inspect not only the books of accounts, but verify cash or stock too. This is absurd, feels the industry.

• The department will have the power to attach provisionally any money which is due or which may become due into the course of any inquiry, inspection or proceeding.

• The revocation of such an attachment is possible only after the submission of a back guarantee. Though it is provided such an attachment will cease to have effect after the expiry of one year, the commissioner has the power to extend this period up to two years.

• Getting refund of the VAT would be a cumbersome procedure.

• There will be no set-off on interstate sale.

• The new VAT provisions give power to the authorities to create check and balance at their discretions.

• No redressed system or recheck.

Advantages 

(i) A 5 % tax is levied at each stage of production of goods. 

(ii) The total tax is built into the cost of goods.

(iii) Exports are not taxed.

(iv) All imports are taxed.

(v) It allows multiple rates and exemption of goods from other 

countries.

(vi) This form of tax is used by many other industrialized countries 

currently.

Disadvantages

(i) It would be similar to the National Sales Tax, but it would be more 

complicated to administer and collect.

(ii) It would also tax goods and medicine as does the national sales 

tax.

The experience from various practices adopted by different countries couple with principle of taxation applicable to VAT suggest two-fold lessons for the non VAT countries in general and such developing countries in particular.

First, it proclaims the sum of choice such as types of VAT, depends upon the superiority of a particular choice. Hence most of the VAT countries have adopted a particular type (such as consumption variant) only. 

Secondly, some of the issues connected with the past experience of country concerned are extremely important to decide the issues related of the administration of VAT.