Evaluation of VAT in India and its Justification

Transcription

1 CHAPTER 24 Evaluation of VAT in India and its Justification 24.1 Historical Background Value Added Tax or VAT is a broad based tax levied at multiple stage with tax on inputs credited against taxes on output. VAT was first introduced in France in With this imposition, France became the first European country to implement VAT on an extensive scale. VAT was introduced in Brazil in Mid 1960's then in many European countries in 1970s and subsequently it has been introduced in about 130 countries. In India, most of the States including Union Territories have implemented VAT w.e.f. 1st April, 2005 which has substituted local sales tax laws and various other local levies. It will not be out of the context to mention that VAT had already been introduced under the Central Excise Law way back in 1986 and in Service Tax since Inter sectoral credit is also allowed since 10th September, Under the inter sectoral credit system the assessee is allowed to take credit of central excise duty paid on input/capital goods while making the payment of service tax. Similarly the assessee is allowed to take credit of service tax paid on input services while making payment of central excise duty. VAT in India is not comparable with that of in other countries because it is replacement of State level sales tax and not entire indirect tax structure. VAT in India is a State subject. The States Governments of Madhya Pradesh and Maharashtra had incorporated the concept of tax on value addition in their respective Sales Tax Legislations during the mid 90's, but could not succeed in implementing the same in the desired manner. With the joint efforts of the Central Government and the State Governments, VAT was implemented by a majority of the States with effect from 1st April VAT has replaced the general sales tax structure with the only difference in the manner of its levy. The power to levy tax on sales transactions in the form of VAT is drawn from entry 54 in List II of Seventh Schedule of the Constitution of India by the State Governments. Under VAT, every sale transaction taking place in the course of business is taxed enabling the State Government to collect revenue on value addition at every stage. The cascading effect of VAT, being collected at every stage on the cost of goods, is reduced by providing set off of tax paid on the purchases Evolution of VAT in India India already had a system of tax collection wherein the tax was collected at one point from the transactions involving the sale of goods. The single point tax was collected either at the first stage or at the last stage. The system of collecting tax at first stage had the following disadvantages: (a) Since sales tax was levied and collected at the first stage (i.e., at the stage of the wholesale), the tax rate had to be higher. This encouraged tax evasion and sales tax became a tax on honesty, which means the more the honesty, more the tax liability.

2 Chap. 24 Evaluation of VAT in India and its Justification 727 (b) In case somehow the goods escaped the tax at the first stage, the goods escaped tax net altogether since there was no way by which it could be caught at any subsequent stage. (c) There was ample scope for under-valuation of the value of the goods at first stage, as there was no tax payable at any subsequent stages, even if the goods were subsequently sold at much higher prices. In the system of collection of tax at the last stage also, several weaknesses were witnessed: (a) The tax evasion was maximum since the price charged at the last point of sale increases, which encouraged evasion, even if the tax rates were low; (b) It was difficult to track the goods evading tax since there was no record of their earlier movements and after the last point sale, the goods reached in the hands of the consumers; (c) This also encouraged under-invoicing and involves generation of black money due to cash dealings at the last point of sale. Since VAT is collected at various stages, all the above disadvantages and weaknesses have been overcome, the cascading effect of taxes is eliminated. More transparent structure is made up and compliance are improved. India has been slow in adoption of VAT. In domestic trade taxes, it adopted excise duty and service tax at the central level and sales tax at the State level for this purpose. The State Governments had been indifferent in undertaking any reforms in their sales tax system, although it accounts for approximately 60% of the State's own tax revenue. The existing sales tax system of the States was confronted with many drawbacks and weaknesses. The Task Force known as Kelkar Committee observed that presently, "each State levies multiple taxes on the same item in different names or at different stages e.g. Entry Tax, Luxury Tax, etc." However, it opined that "it is necessary that State VAT should be the tax to unify all the State-level taxes i.e. Sales Tax, Purchase Tax, Turnover tax, Works Contract Tax, Entry Tax, Special Additional Tax, etc. should all be covered under State VAT. The efforts were initiated towards introduction of VAT since last many years. The Committees of States' Finance Ministers (in 1995 and 1998, respectively) and of the Chief Ministers (in 1999) have put forth recommendations to replace sales tax by VAT. This was ratified by the Conference of the Chief Ministers and Finance Ministers held on November 16, 1999 and introduction of State VAT in lieu of Sales Tax was finally scheduled to be made with effect from However, the schedule had to be revised in view of agitative traders' community. The Empowered Committee of State Finance Ministers agreed upon as the revised date of implementation of VAT and it was expected that most of the State and Union Territories will implement VAT from , but it did not happen. Later, the Finance Minister deferred the implementation of VAT for some more time so that more conducive environment may be created and agitative opposition may be set to peace. Besides consensus of all the States over the model law and introduction of VAT on uniform basis was also necessary. On he announced that unless all States conform to model draft law and agreed VAT rates, introducing VAT on will not be possible. He stated that VAT should be implemented all over India. Patchwork will

3 728 Systematic Approach to VAT Chap. 24 not serve the purpose. In this connection, the Empowered Committee of State Finance Ministers met regularly and brought out a White Paper on State level VAT on This White Paper on State-level Value Added Tax (VAT) was presented in three parts: Part 1: In this part, the justification of VAT and its background had been mentioned. Part 2: The main design of State level VAT. While doing so, it recognized that this VAT is a State subject and therefore the States will have freedom for appropriate variations consistent with the basic design as agreed upon by the Empowered Committee. Part 3: Part 3 discussed the other related issues for effective implementation of VAT. Justification of VAT and Background In the existing sales tax structure, there are problems of double taxation of commodities and multiplicity of taxes, resulting in a cascading tax burden. For instance, in the existing structure, before a commodity is produced, goods are first taxed, and then after the commodity is produced with input tax load, output is taxed again. This causes an unfair double taxation with cascading effects. In the prevailing sales tax structure, several States levying multiplicity of taxes, such as turnover tax, surcharge on sales tax, additional surcharge, etc. With introduction of VAT, these other taxes have been abolished. In addition, Central sales tax is also to be phased out. As a result, overall tax burden will be rationalized, and prices in general fall. In the VAT, a set-off is given for input tax. VAT has replaced the existing system of inspection by a system of built-in selfassessment by the dealers and auditing. The tax structure will become simple. That will improve tax compliance and also augment revenue growth. The VAT will therefore help common people, traders, industrialist and also the Government. It is indeed a move towards more efficiency, equal competition and fairness in the taxation system. The white paper also specified that registration under the State VAT Act shall not be compulsory for small dealers with gross annual turnover not exceeding `5 lakhs. However, the Empowered Committee of State Finance Ministers has subsequently allowed the States to increase the threshold limit for small dealers to `10 lakhs.

4 CHAPTER 25 Design of State Level VAT 25.1 What is VAT VAT is a tax, which is charged on the 'increase in value' of goods and services at each stage of production and circulation. It is also chargeable on the value of all imported goods. It is charged by registered VAT businesses/persons/taxpayers. VAT has replaced a number of other taxes and its introduction has not resulted in either increased prices to final consumers or reduced profitability of business. VAT is levied on the difference between the sale price of the goods produced or the services rendered, and the cost thereof that is, the difference between the output and the input. In other words It is nothing but multi-point Sales Tax. It is collected on value addition only at each stage. Tax paid by the dealer is deducted from the tax payable collected at every point of sale and the tax already paid How is VAT different from the earlier Sales Tax System? Earlier Sales Tax System 1. Tax was levied at the stage of the first sale or at the final stage. Thus it was levied at single stage. 2. Successive sales (resale) of goods on which tax is already paid did not attract tax 3. Dealers reselling tax paid goods did not collect any tax on resale and file NIL returns VAT System 1. Tax is levied and collected at every point of sale. Thus, it is a multi-stage tax 2. Tax is collected at every point of sale and the tax already paid by the dealer at the time of purchase of goods will be deducted from the amount of tax paid at the next sale 3. Dealers reselling tax-paid goods will have to collect VAT and file returns and pay VAT at every stage of sale (value addition) 4. Computation of tax liability is complex 4. It is transparent and easier 5. Sales Tax was not levied at the time of purchases against statutory forms but there was misuse of such forms resulting in tax evasion. 6. Returns and challans were filed separately and the dealers have to give numerous details 5. VAT dispenses with such forms and sets off all tax paid at the time of purchase from the amount of tax payable on sale 6. The returns and the challans are filed together in a simple format after selfassessment done by the dealer himself 7. A large number of forms are required 7. At the most a few forms are required 8. Tax on goods only 8. Tax on goods and services both. 9. Assessment was done by the 9. Self-assessment is done by dealers department 10. Penalty for defaulters/evaders not strict 10. Penalties will be stricter

5 730 Systematic Approach to VAT Chap Liability of tax under existing sales tax system and VAT if charged at each stage To curb the evasion of sales tax, the State Government had desired that instead of levying the sales tax either at first stage or last stage, it should be levied at each stage. However, levying the sale tax at each stage would have resulted into the following two anomalies under the existing sales tax system: (a) Sales tax would have been charged more than once on the same item (b) There would be sales tax on sales tax i.e. it would result into cascading effect. To overcome the above anomalies VAT was introduced so that VAT is calculated by deducting input tax credit from the tax collected during the payment period. 25.3a Input tax credit The tax paid by the dealer on its purchases of inputs and capital goods is eligible for credit while making the payment of VAT on the sale of such goods. Such credit is known as input tax credit. Such input tax credit is allowed as set off from the output tax payable by the dealers on its sale. Thus, VAT is calculated by deducting tax credit from tax collected during the payment period. A dealer cannot claim the input tax credit if the purchases of goods and capital goods are not meant for business. Illustration 25.1 R sells goods to S for `1,00,000. He charges sales 10% on the sale price. S sells the same goods to T by adding `50,000 as his profit and charges sales 10%. Compute the tax payable under: (a) the existing sale tax system assuming sales tax is charged at each stage (b) VAT Solution Tax liability as per existing sales tax system Sales tax Payable Tax liability as per VAT VAT Payable ` ` ` ` Value of sale made by 1,00,000 1,00,000 R to S Add: 10% Sales tax 10,000 Sales Tax Payable 10,000 10% VAT 10,000 VAT Payable 10,000 1,10,000 1,10,000 Cost of goods to S 1,10,000 1,00,000 VAT credit available `10,000 Profit 50,000 50,000 1,60,000 1,50,000 VAT payable Add: 10% sales tax 16,000 Sales tax payable 16,000 10% VAT 15,000 `15,000-10,000 = 5,000 1,76,000 1,65,000 Total sales tax payable `10, ,000 = `26,000

6 Chap. 25 Design of State Level VAT 731 Total VAT payable `10, ,000 = `15,000 In the case of VAT, tax is payable only on value addition of `50,000 i.e. `5,000. Difference of tax: `26,000 15,000 = 11,000. The above difference of `11,000 is due to the following: (1) Sales tax has been 10% on `1,00,000 twice. Hence, the difference amount is `10,000. (2) Sales tax has been charged on sales tax i.e. 10% has been charged on sales tax of Hence, the cascading effect due to extra sales tax 1,000 Total difference 11,000 Illustration 25.2 A mines copper and sells it to a manufacturer B Effect on Prices to final consumer 10% Sales tax 10% VAT Proceeds to the government Effect on Prices to final consumer Proceeds to the government Sales tax of 10% Total Cost to B B converts it into a wire with his labour/profit and sells it to C, a wholesaler at 100% margin Sales tax/vat = 10 Total cost to C C sells to D, a retailer at a 20% mark-up Sales Tax/VAT = 4 Cost to D D sells it to the consumer at 100% mark-up Sales tax/vat = 24 Cost to consumer Total Proceeds to government The first thing we observe from the above table is that with equal tax rates of 10%, the final price to the consumer is 33% i.e. `174 (`702 `528) higher in the traditional sales-tax system. A part of the difference amounting to `77 (`125 `48) is owing to the higher tax receipts of the government. The rest of the difference, `97, is taken by higher profits of the different intermediaries B, C & D. The second thing we can observe is that almost every time the VAT is charged, it is not an expense to the person who pays it, but just an advance to the government via the supplier. This is true for all except the final customer who cannot claim the VAT deduction. Actually, he is the only one who pays the full amount. We also observe from the last two lines of the above table that the consumer is benefited by `174 (`702 `528) in the VAT system whereas the government loses by `77 (`125 `48). 25.3b Incidence of tax where more than one raw-material is used for production The incidence of tax involving more than one transaction can be explained by the

7 732 Systematic Approach to VAT Chap. 25 following illustration:

8 Chap. 25 Design of State Level VAT 733 Illustration R is the manufacturer of two raw-materials viz., X & Y. These two raw-materials have been manufactured by taking the basic produce of mines on which Vat has not been allowed. The selling cost of raw-material X is `100 per kg. and the rate of VAT is 4% whereas selling cost of raw-material Y is `120 per kg and the rate of Vat is 12.5%. 2. S has used 1 kg each of both the above raw-materials by purchasing it from R and manufactured product Z. The quantity manufactured after allowing for loss in manufacturing is 1.8 kg. The aggregate of wages, conversion cost and profit on the sale of produce Z is `500, Thus product Z has been sold for `720 and VAT has been 12.5%. 3. T who has purchased the above product Z from S has sold the same to U for `1000 and VAT has been 12.5%. 4. U sold the product Z to the customer W for `1500 and charged 12.5% Manufacturer S VAT charged ` ` Sale price 12.5% 90 Less: VAT credit % % Net VAT paid 71 Whole seller T VAT charged ` ` Sale price 12.5% 125 Less: VAT credit % 90 Net VAT paid 35 Retailer U VAT charged ` ` Sale price 12.5% Less: VAT credit % 125 Net VAT paid 62.5 Total VAT earned by the State Government ` = Eligible purchases for availing input tax credit The input tax credit is available only when the taxable goods are purchased for the

9 734 Systematic Approach to VAT Chap. 25 following purposes (1) For sale/resale within the State; (2) For sale in the course of inter State trade or commerce; i.e. Goods are sold to any other State or Union Territory of India; (3) To be used as (i) Containers or packing materials; (ii) Raw materials; or (iii) Consumable stores, and the goods so manufactured by the use of the above raw-materials, packing materials are sold within the State or in the course of inter State trade commerce; (4) For being used in the execution of a works contact; (5) To be used as capital goods required for the purpose of manufacture of taxable goods; (6) To be used as (a) Raw materials; (b) Capital goods; (c) Consumable stores; and (d) Packing materials/containers and goods so manufactured by the use of above items are sold in the course of export out of the territory of India. Illustration 25.4 Will the input tax credit be available in the following cases: 1. Purchases within the State and resale of the same goods within the same State. 2. Purchases of raw-material within the State for the purpose of manufacturing a product and the sale of the manufactured product within the same State. 3. Purchase of goods from other States for the purpose of resale within the State. 4. Purchase of raw-material and consumable from other States for the purpose of manufacturing and the sale of such goods within the State. 5. Purchase of goods from within the State for the sale of same goods to other States. 6. Purchases of raw-material and consumables from within State and for the sale of manufactured goods to other States. 7. Purchase of goods from within State for the sale of same goods within the same State and other States. 8. Purchase of raw-material and consumables within State for the sale of manufactured goods within the same State or other State. 9. Purchase of goods from other States and sale of the same goods to other States. Solution 1. Yes; 2. Yes; 3. No, it is not allowed for central sales tax paid; 4. No; 5. Yes; 6. Yes; 7. Yes; 8. Yes; 9. No Coverage of Input Tax Credit and its Set-Off (1) Instant credit of input tax This input tax credit will be given both to the manufacturers and traders for purchase of inputs/supplies meant for both sales within the State as well as to other States, irrespective of when these will be utilized/sold. This also reduces immediate tax liability. (2) Carry forward of VAT credit If the input VAT credit exceeds the tax payable on sales made within the State in a month, the excess credit will be adjusted against Central sales tax payable on inter State sales but if there is still excess left it will be carried over to the subsequent month(s) and the unadjusted VAT credit at the end of the specified period is eligible for refund.

10 Chap. 25 Design of State Level VAT 735 Illustration 25.5 R purchases goods from X for `2,25,000 which includes 12.5%. R sells 20% of goods to T in the same State by adding 25% on cost. Balance 80% of goods are sold to V who is carrying on business in another State. The profit charged in this case was 25% on cost. VAT charged is 12.5% and CST charged is 2%. Compute the input tax credit and its set off allowed to R. Solution Computation of input tax credit and its set off Purchase price of goods in the hands of R 2,25, /112.5 = `2,00,000 Input credit allowable to R `25,000 Sale of goods to T Sale price `2,00,000 20/100 = 40, /100 50, % 6,250 VAT payable 6,250 Cost to T 56,250 Sale of goods to U 2,00,000 80/100 = 1,60, /100 2,00,000 Less: 2% 4,000 CST payable `4,000 2,04,000 Input tax credit available 25,000 Less: VAT payable 6,250 18,750 Less: CST payable 4,000 Balance input credit carried forward to next month 14,750 (3) No input credit on central sales tax paid on purchases from other States There is no credit of CST if inputs are purchased from outside the State. For example if the goods are purchased by Delhi dealer from Mumbai for `1,02,000 which includes CST of `2,000, Delhi dealer will not get input tax credit of `2,000. The cost of purchase in this case shall be `1,02,000. (4) Input credit on stock transfer to other States Stock transfer to branches or on consignment basis does not amount to sale. Therefore, it is not subject to VAT or CST. However, if goods are sent outside State on stock transfer/consignment basis, credit (set off) of tax paid on inputs purchased within the State is available only to the extent of tax paid in excess of 2% as 2% is retained by the State Government. For example if tax paid on inputs is 12.5%, input credit of 10.5% is available. If the tax paid on purchase is 4%, input credit of 2% (4% 2%) is available. However, if the goods are transferred on stock transfer basis to other branches in the same State, full input tax credit shall be available to the dealer. Illustration 25.6 R of Delhi purchased goods from X of Delhi amounting to `6,75,000 which includes 12.5%. R sold the same goods to the following parties 50% of the Goods was sold to S of Delhi by charging 25% on cost. 20% of gross was sold to T who is carrying on business in Mumbai by charging 30% `

11 736 Systematic Approach to VAT Chap. 25 on cost.

12 Chap. 25 Design of State Level VAT 737 Balance 30% of the Goods was transferred by R to his Branch in Hyderabad. Compute the input tax credit and its set off. Solution Computation of input tax credit and its set off Purchase price of goods in the hands of R `6,75, /112.5 = 6,00,000 Input tax credit available `75,000 Less: 2% of the cost of goods on account of Input credit of 30% of the stock transferred to Hyderabad branch which is not allowed `6,00,000 30/100 = `1,80,000 2% 3,600 Balance input tax credit available 71,400 Sale of 50% of goods to S `6,00,000 50/100 = `3,00, /100 `3,75, % 46,875 Vat payable `46,875 4,21,875 Sale of goods to U 6,00,000 20/100 = 1,20, /100 1,56,000 2% 3,120 CST payable 3,120 1,59,120 Carry forward of VAT allowed to next month = `71,400 46,875 (VAT payable) 3,120 (CST payable) = `21,405 (5) Treatment of input tax in case of export sales Export sales are zero rated and thereby exporters are either granted refund of input taxes paid by them or they can adjust such input tax while making the domestic sales. Illustration 25.7 R of Delhi purchased goods from X of Delhi for `11,25,000 which includes 12.5% R sold the goods to the following parties: 90% of the Goods was sold to S of Delhi by charging 20% on cost. 2% of the goods was sold to T of Mumbai by charging 25% on cost CST charged 2%. 2.5% of the Goods was sold to U of Germany by charging profit 10% on cost. No tax was charged. Balance 5.5% goods was transferred to the Branch at Ludhiana (Punjab). Compute the input tax credit and the set off allowed and the VAT & CST payable. Solution Computation of input tax credit and set off Cost of goods to R Input VAT credit 11,25, /112.5 = 10,00,000 1,25,000 Less: 2% of cost of goods on account of input credit of 5.5% stock transferred to Ludiana (Punjab) which is not allowed 10,00, /100 = 55,000 2% 1,100 Balance input credit available 1,23,900

13 738 Systematic Approach to VAT Chap. 25 Sale of 90% of goods to S of Delhi Sale price 10,00,000 90% = 9,00, /100 10,80, % 1,35,000 VAT payable `1,35,000 12,15,000 Sale of 2% goods to T of Mumbai Sale price `10,00,000 2% = 20, /100 25,000 CST payable `500 2% ,500 Sale of 2.5% goods to U of Germany Sale price 10,00, /100 = 25, /100 27,500 Tax payable Nil Tax charged Nil 27,500 Since export sale is a zero tax rated sale, input credit of goods purchased which was sold to Germany can be set off from the VAT payable on domestic sales VAT payable on goods sold within Delhi 1,35,000 Less: Total input VAT credit available after deducting 2% for stock transferred but including input credit on purchases which have been sold to V of Germany 1,23,900 Net VAT payable 11,100 CST payable Purchases not eligible for input tax credit Input credit is not be allowed in the following circumstances: 1. Purchases from unregistered dealers; 2. Purchases from registered dealer who opt for composition scheme under the provisions of the Act; 3. Purchases of goods as may be notified by the State Government; 4. Goods where purchase invoice is not available; 5. Purchase of goods where invoice does not show the amount of tax separately; 6. Purchase of goods, which are utilized in the manufacture of exempted goods; 7. Purchase of goods used for personal use/consumption or provided free of charge as gifts; 8. Goods imported from outside the territory of India; 9. Goods purchased from other States viz. inter-state purchases; 10. Goods purchased are given away as free samples; 11. Goods purchased are destroyed by fire or are stolen or lost; 12. Goods received on consignment sale or on stock transfer from other States; 13. Goods purchased and returned within the specified period; 14. Purchase of automobile and its spare parts and accessories by a person other than a dealer Input tax credit on capital goods Input tax credit on capital goods will also be available for traders and manufacturers. Tax credit on capital goods may be adjusted over a maximum of 36 equal monthly instalments. The States may at their option reduce the number of instalments.

14 Chap. 25 Design of State Level VAT 739 There is a negative list for capital goods (on the basis of principles already decided by the Empowered Committee) which is not eligible for input tax credit Cenvat credit of Excise and Service Tax Excise Duty and Service tax are levied by the Central Government. Whereas VAT is levied by the State Government. Hence, the assessee is allowed Cenvat credit of Excise and Service Tax on input goods/input services while making the payment of Central Excise Duty and Service tax under the Central Law. The Cenvat credit of Excise duty is allowed only when the buyer is also manufacturer of goods. On the other hand, input tax credit of VAT is allowed to every dealer (whether manufacturer or trader) against the VAT payable/cst payable under the State VAT Law Central Sales Tax (CST) & Value Added Tax (VAT) Central Sales Tax is charged by the seller of goods when he makes an inter-state sale i.e. sale made to dealer/consumer in the other States. In this case, goods move from one State to another State. On the other hand, VAT is charged by the seller of the goods, when he makes an intra State sale i.e. sale made a to dealer or a consumer within the same State. 25.9a Who levies CST and VAT CST is levied by the Central Government but it is collected and retained by the State Government from where the movement of goods started. VAT is levied by the respective State Governments and it is collected and retained by the same State Government. Inter-State purchases of goods is not vatable: Goods which are purchased from other States are subject to CST. Such CST is not eligible for input tax credit as CST has been received by other State from where the movement of goods started. Hence, CST paid on purchases from other States is non-vatable. CST charged on the sale made to other States In case of sale made to other States, CST is charged by the selling dealer. Although such CST is levied by Central Government but it is payable to the State Government from where the Goods were sold. A selling dealer is entitled to input tax credit on the purchase made within the State for making sale of such goods to other State. Example R of Delhi sells goods to S of Mumbai (Maharashtra) and S of Mumbai sells the same goods to T of Chennai (Tamilnadu) and T of Chennai sold the same goods to U of Chennai (Tamilnadu). U of Chennai sold the same goods to consumer V of Coimbatore (Tamilnadu). In the above case, State of Delhi will get CST from R on account of sale made by him to S of Mumbai. State of Maharashtra will not allow input tax credit to S of Mumbai as tax was collected by Delhi Government. State of Maharashtra did not get any tax on purchases made from Delhi. State of Maharashtra will get CST from S on account of sale made by him to T of Chennai (Tamilnadu). State of Tamilnadu in this case will not allow input tax credit to T of Chennai (Tamilnadu) as tax was collected by Maharashtra Government. State of Tamilnadu did not get any tax on purchases made from Mumbai (Maharashtra). State of Tamilnadu will get VAT from T of Chennai (Tamilnadu) as the goods were sold within Tamilnadu. But, State of Tamilnadu will not give input tax credit to T as tax on purchases made by T from Mumbai was not received by Tamilnadu State. U of Chennai will get the input tax credit on account of goods purchased from T of Chennai as the Tamilnadu Government got VAT amount from T of Chennai. Further U of Chennai shall pay the VAT on the sale made to V of Coimbatore after setting off the input tax credit. V of Coimbatore is although in the State of Tamilnadu and has paid tax on its purchases but will not get any input tax credit as V is a consumer of goods and not the dealer of goods.

15 740 Systematic Approach to VAT Chap b Rate of CST If the goods are sold to a registered dealer under Central Sales Tax Act, in the other State, the rate of Central Sale Tax shall be levied at VAT rate (local sales tax i.e. LST rate) subject to maximum rate of CST which shall be 2%. In other words, CST rate shall be VAT rate or 2% whichever is less. On the other hand if the goods are sold to any other person in the other State, CST shall be equal to VAT rate of State from where the Goods are sold. It can be illustrated as under: Example VAT Rate in the State Sale to Registered Sale to any dealer in another other person in State another State 1% 1% 1% 2% 2% 2% 4% 2% 4% 12.5% 2% 12.5% Illustration 25.8 Determine how much input credit shall be available to the dealer 'X' in Delhi in respect of the following purchases: (1) Goods purchased from Mumbai `2,04,000 which includes Central Sales Tax 2%. (2) Goods purchased from a dealer in Delhi 'A' `3,00,000. VAT charged 12.5% i.e. `37,500. Total value of purchase invoice `3,37,500. (3) Goods purchased from unregistered dealer `24,000. (4) Goods purchased from a dealer 'Y' under composition scheme `60,000. Y has paid 1% as tax under composition scheme. (5) Purchases from dealer Z in Delhi for `1,50,000. VAT 4% `6,000. Total value of purchase `1,56,000. (6) Purchases from dealer B in Delhi `42,000 VAT is not separately charged in the invoice. (7) Purchase of capital goods `7,20,000. `6,30,000 is price of capital goods and `90,000 is VAT amount separately charged. (8) Goods purchased `62,400 which includes 4% VAT which is separately shown. Such goods have been utilized in the manufacture of exempted goods. (9) Value of goods imported from Germany `6,00,000. Solution Particulars Amount of input credit available (1) No input credit will be available on goods purchased from other States (2) Purchases from dealer 'A' in Delhi 37,500 (3) Purchase from unregistered dealer Nil (4) Purchases from dealer under composition scheme Nil (5) Purchase from dealer 'Z' 6,000 (6) Purchasers from dealer B. VAT not separately charged Nil (7) Purchases of capital goods 90,000*/36 2,500 (8) Purchases of goods used for manufacturing exempted goods Nil (9) Goods imported from Germany Nil Total VAT credit 46,000 * VAT credit on capital goods shall be allowed in 36 equal monthly instalments. Thus `90,000/36 = `2,500 VAT credit on capital goods shall be allowed every month.

16 Chap. 25 Design of State Level VAT Coverage of Goods under VAT In general, all the goods, including declared goods will be covered under VAT and will get the benefit of input tax credit. The only few goods which will be outside VAT will be liquor, lottery tickets, petrol, diesel, aviation turbine fuel and other motor spirit since their prices are not fully market determined. These will continue to be taxed under the any other State Act or even by making special provisions in the VAT Act itself, and with uniform floor rates decided by the Empowered Committee VAT Rates and Classification of Commodities Under the VAT system covering about 550 goods, there will be only two basic VAT rates of 4% and 12.5%, plus a specific category of tax-exempted goods and a special VAT rate of 1% only for gold and silver ornaments. Thus there are four rates for VAT as per white paper: (i) 0% (ii) 1% (iii) 4% (lower rate) (iv) 12.5% standard rate Non-availability of input credit in certain cases In the following cases credit of tax paid on inputs shall not be allowed: 1. Where final product is exempt Credit of tax paid on inputs is available only if tax is paid on final products. When final product is exempt from tax, credit will not be allowed. If credit was availed, it will have to be reversed on pro rata basis. 2. No credit if input lost/damaged/stolen before use Where the inputs have been lost or damaged or stolen before these have been used, credit of tax paid on such input shall not be allowed. If credit was availed, it will have to be reversed. 3. No credit on certain purchase Generally, in following cases, credit is not available (a) Purchase of automobiles (b) Fuel. However, some States are allowing input credit for the same. Goods under VAT From the above discussion, it may be summarized that Goods under VAT can be classified as Taxable goods and non taxable goods (Exempted goods). Taxable goods can be further divided into two parts: (a) VAT able goods i.e. goods for which input tax credit shall be allowed (b) Non-vatable goods i.e. goods for which input tax credit shall not be allowed:

17 742 Systematic Approach to VAT Chap. 25 Goods Taxable goods Non-taxable goods (i.e. Exempted goods) Vatable goods (input VAT credit) allowed Non-vatable goods (input VAT credit not allowed) Goods on which Special rate of VAT is applicable e.g. liquor, lottery tickets petrol, diesel etc. Goods purchased from a dealer under composition scheme (See later) Exempted goods: Under exempted goods category, the empowered committee has listed about 50 commodities comprising of: (a) natural products; (b) unprocessed products; (c) items which are legally barred from taxation; and (d) items which have social implication. Further, a set of maximum 10 commodities out of commodities listed in the exempted category will be flexibly chosen by individual States which are of local importance for the individual States without having an inter State implication. Examples of few exempted categories of commodities are given below: (1) Books, periodicals and journals including maps, charts and globes (2) Blood including blood components (3) Fresh vegetables and fruits (4) Earthern Pot (5) Electricity energy (6) Course grains other than paddy, rice and wheat (7) Fresh plants, saplings and fresh flowers (8) Kum Kum, Bindi, Sindur, etc. (9) All bangles except those made of precious metels (10) Curd, Lassi, butter milk and separated milk (11) Betel leaves (12) Animal driven or manually operated agricultural implements their spare parts, components and accessories

18 CHAPTER 26 Principles, Variants and Methods of Computation of VAT 26.1 Origin/destination principle The following two principles are relevant for implementation of VAT (a) Origin principle. (b) Destination principle. (a) Origin principle: Under 'origin principle', value added domestically on all goods whether they are meant for exports or to be consumed in India is subjected to tax. Hence, if there is value added abroad tax cannot be levied on such value added in India. This principle confines VAT only to goods originating in the country of consumption. Whereas exports are taxable under this principle but imports are exempt. It is mostly used in conjunction with income VAT and is unpopular for obvious reasons. (b) Destination principle: Under this principle, value added irrespective of the place of origin is taxable. All goods are taxed if they are consumed within the country. Consequently, exports are exempt while imports are subjected to tax. Destination principle is normally used along with consumption VAT. In a federal set-up like India, destination principle is preferred for taxation of products consumed within the various States of the country. A very important feature of this principle is that imported goods are treated at par with domestic products whereas in the origin principle imported goods are not taxable and hence it gives preference to goods produced abroad. In the EEC countries, origin principle was once considered for eliminating border controls and problems of valuation, but was subsequently given up as being impractical. Thus the destination principle is now being followed in those countries Variants and Methods of Computation of VAT (1) Variants of VAT VAT has three variants namely, (a) gross product variant, (b) income variant, and (c) consumption variant. (2) Methods of computation of VAT The above variants can be further distinguished according to their methods of calculation, (i) addition method, (ii) invoice method and (iii) subtraction method. (a) Gross Product Variant In case of Gross Product Variant, tax is levied on all sales but deductions on all purchases of raw materials and components (i.e. inputs) are allowed. However, no deduction is allowed for taxes paid on capital inputs like plant and machinery, etc. for taxes with the result that in this variant of VAT, capital goods carry a heavier tax burden

19 744 Systematic Approach to VAT Chap. 26 as they are taxed twice i.e. at the time of purchase of such capital goods and at the time of sale thereof. (b) Income Variant In case of Income Variant, tax is levied on all sales but deductions for taxes are allowed on the following: (1) purchases of raw materials and components (i.e. inputs) (2) tax on depreciation on capital goods Credit of tax paid on purchase of the capital goods is allowed in the ratio of depreciation over the life of the asset. The depreciation to be provided is dependent on the life of an asset as well as on the rate of inflation, therefore there are many difficulties connected with the variant in measuring depreciation. (c) Consumption Variant In case of Consumption Variant, tax is levied as all sales but deduction for taxes allowed on the following: (1) purchase of raw-materials and components (2) capital goods Thus, gross investment is deductible in calculating value added. This variant of VAT does not distinguish between capital and current expenditures hence there is no need to specify the life of assets or depreciation allowances for different assets. However, input tax credit on capital goods is being allowed by the States in 24/36 instalments. The consumption variant of VAT is most popular and widely used variant among the three variants of VAT. The reasons behind the preference of this variant over the other are as under: (a) This variant is tax neutral as it does not affect decisions regarding investment because the tax on capital goods is also set-off against the VAT liability. (b) The consumption variant is convenient from the point of administrative expediency as it simplifies tax administration. (c) It does not cause any cascading effect. Thus, VAT is payable under the above 3 variants as under: Gross product variant VAT payable on sales VAT credit allowed on inputs goods only. Income variant VAT payable on sales VAT credit allowed on input goods and proportionate VAT credit allowed on depreciation on capital goods. Consumption variant VAT payable on sales VAT credit allowed both on input goods and capital goods. Illustration 26.1 R submits you the following information. Compute (a) the selling price of the product (b) cost to the consumer (c) VAT payable to Government under: (i) Gross product variant (ii) income variant and (c) consumption variant. Solution ` Purchases of Raw-material and component 4,00,000 4% VAT on the above purchases 16,000 Purchase of capital goods being machinery (life 10 years) 12,00, % VAT on the above machine 1,50,000 Direct and Indirect Expenses 3,00,000

20 Chap. 26 Principles, Variants and Methods of Computation of VAT 745 Profit 20% on total cost VAT payable on sales 12.5% Case I: Gross product variant Computation of cost Raw-material cost 4,00,000 Direct and Indirect expenses 3,00,000 Depreciation on Machine 10% of `13,50,000 (VAT credit not available) 1,35,000 Total cost 8,35, % of cost 1,67,000 (i) Sale price 10,02,000 Add: VAT 12.5% 1,25,250 (ii) Cost to consumer 11,27,250 VAT collected from consumer 1,25,250 Less: VAT credit on purchases 4% on `4,00,000 16,000 (iii) VAT payable 1,09,250 Income variant Raw-material cost 4,00,000 Direct or Indirect Expenses 3,00,000 Depreciation on machine 10% of `12,00,000 (VAT credit available) 1,20,000 Total cost 8,20, % profit 1,64,000 (i) Sale price 9,84, % VAT 1,23,000 (ii) Cost to consumer 11,07,000 VAT collected 1,23,000 VAT credit for purchase of raw material 16,000 Proportionate VAT credit allowed on depreciation 1,50,000 1,20,000/12,00,000 15,000 31,000 (iii) VAT payable 92,000 The balance VAT credit of `1,35,000 shall be allowed in subsequent 9 years proportionately. Consumption Variant Raw-material cost 4,00,000 Direct and Indirect Expenses 3,00,000 Depreciation on 10% of `12,00,000 (VAT credit available) 1,20,000 Total cost 8,20,000 Profit 1,64,000 (i) Sale price 9,84, % 1,23,000 (ii) Cost to consumer 11,07,000

21 746 Systematic Approach to VAT Chap. 26 VAT collected 1,23,000 Input credit on purchase 16,000 VAT credit on capital goods 1,50,000 1,66,000 Balance credit available 43,000 (iii) VAT payable Nil Note. Most of the States are allowing VAT credit on capital goods in 24 to 36 monthly installments instead of the full amount at one time. (2) Method for Computation of tax There are several methods to calculate the 'Value Added' to the goods for levy of tax. The three commonly used methods are as under: (A) Addition method (B) Invoice method/tax credit method, and (C) Substraction method. (A) Addition method In this case VAT is levied only on the value of addition made by a manufacturer or a dealer which will also include profit charged by him. Illustration 26.2 R purchases raw material for `1,00,000 (excluding VAT of `4,000) and incurred the following manufacturing and trading expenses: ` (1) Direct and indirect manufacturing expenses excluding depreciation 80,000 (2) Depreciation on assets used for manufacturing activities 10,000 (3) Trading expenses 15,000 (4) Depreciation on assets used for purposes other than manufacturing 4,000 (5) Profit 20,000 VAT payable 4% on sales Compute the tax payable by following the addition method. Solution Total additional cost incurred for the goods manufactured and sold `80, , , , ,000 1,29,000 VAT 4% on `1,29,000 5,160 (B) Invoice method/tax credit method Tax credit method involves payment of tax by the seller i.e. manufacturer or dealer at full selling price and credit of tax is allowed, which he has paid at the time of purchase. Thus, the tax is levied on full sale price, but credit is given of tax paid on purchases and effectively, tax is levied only on 'Value Added' only. It's an easy and simple way to ensure that tax is paid. It helps elimination of cascading effect of tax on consumers. Illustration 26.3 R a 'manufacturer' sells goods in Delhi to 'S' a distributor for `10,000. R was not entitled to VAT credit on the purchases of raw material as the raw-material was not liable for VAT. S, the distributor sells the same goods to whole sale dealer T for `12,000 (which includes freight and other expenses `1,500 and his profit `500). T sells the same goods to dealer U for `13,000 and V sold the same goods to consumer V for `15,000. Compute VAT payable at each stage assuming rate of VAT at each stage is 12.5%.

22 Chap. 26 Principles, Variants and Methods of Computation of VAT 747 Solution ` ` ` Sale by R to S Sale price 10,000 Input VAT credit VAT payable available 12.5% 1,250 Nil 1,250 12,500 Sale by S to T Sale price 12, % 1,500 1,250 1,500 1,250 = ,500 Sale by T to V Sale price 13,000 1,500 1,625-1,500 = 125 VAT 12.5% 1,625 14,625 Sale by U to V Sale price 15,000 1,625 1,875 1,625 = 250 VAT 12.5% 1,875 Cost to consumer V 16,875 Total tax payable to the Government = `1, = `1,875 Thus, the Government will get tax on the final retail sale price of `15,000. However, the tax will be paid in installments at different stages. At each stage, tax liability is worked out on the sale price and credit is also given on the basis of tax charged in the purchase invoice. If the first seller is a manufacturer, he will get the credit of tax paid on raw materials, etc. which are used in the manufacturing. From the above illustration, it is clear that under this method tax credit cannot be claimed unless and until the purchase invoice is produced. As a result, in a chain, if at any stage the transaction is kept out of the books, still there is no loss of revenue. The department will be in a position to recover the full tax at the next stage. Thus, the possibility of tax evasion, if not entirely ruled out, will be reduced to a minimum. However, proper measures should be implemented to prevent the production of fake invoices to claim the credit of tax at an earlier stage. It is said that in this method the beneficiary is the trade and industry because in the above example, the total tax collection at the various stages is `6,250 (`1, , , ,875) whereas tax received by the State is only `1,875. The set-off available is also tax paid. If the profit margin is to be kept at the Constant level then the set-off will have to be considered to avoid cascading effects of taxes. Illustration 26.4 Manufacturer A of Mumbai sold product X to B of `1000 per unit. He has charged 2% on the said product and paid `80 as freight. B of Delhi sold goods to C of `1250 per unit and charged 12.5%. C of Delhi sold goods to D, a `1500 per unit and charged 12.5%

23 748 Systematic Approach to VAT Chap. 26 Solution B Liability of VAT ` Cost of product X purchased from Mumbai ` (CST) + `80 1,100 (Credit of CST shall not be allowed under VAT) Sale price 1,250 VAT payable C Liability of VAT Purchase price exclusive of VAT 1,250 VAT credit to be taken Sale price 1,500 VAT 12.5% VAT credit allowed Net VAT payable (C) Substraction method Under subtraction method, the purchase price is deducted from selling price and tax is paid on the net amount only i.e. value added. Thus, when the tax is paid on net amount, dealer's margin is disclosed. This method is unpopular and cumbersome. It is practically impossible when various inputs are used in the manufacture of numerous outputs. It is also not preferred by dealers as their margin gets disclosed. The substraction method can be divided into: (a) Direct substraction method: In this cases aggregate value of purchases exclusive of tax are deducted from the aggregate value of sale exclusive of tax. (b) Intermediate substraction method: In this case aggregate of value of purchases inclusive of taxes deducted from the aggregate value of sale inclusive of tax. Example Suppose a manufacturer sells goods to a trader for `220 which includes tax 10%. The trader sells the same goods to a consumer for `308 which also includes tax 10%. The tax in this case shall be worked as under: Direct subtraction method Sale price exclusive of tax ` (Purchase price exclusive of tax) = Value addition `80 Tax `8 Intermediate subtract method Taxable turnover shall be = [88 10/110] Tax payable `8. In the above system also, the incidence of tax is at each stage. The subtraction method of computing VAT is normally applied where: (a) the tax is not charged separately and (b) the same rate of tax is attracted on all purchases including consumables and services added at all the stages of production/distribution.

24 Chap. 26 Principles, Variants and Methods of Computation of VAT Advantages of VAT VAT being a broad based tax levied at multiple stages is generally perceived as an explicit replacement of State sales tax for raising additional revenue for the Government. The purpose of a tax system is to bring in revenues to the Government. Tax revenues can be raised in many ways. However, the main characteristic of good tax system should be The tax system should be fair or equitable; It should cause the least possible harmful effects to the economy and to the extent possible, it should promote growth to the economy; It should be simple both for its compliance by the payer and for its administration by the Government; It should be income elastic. Keeping in view the above objectives, VAT is being implemented in various States in place of the local sales tax payable by the seller. VAT is also expected to be more effective and efficient for every person including Government, manufacturers, traders and consumers and hold the following advantages: (i) Easy to Administer & Transparent This system of charging tax is easy to administer because of its simplicity. It also reduces the cost of compliance by the dealers and is transparent, as tax is to be charged in every bill and there will be no local statutory forms. (ii) Less Litigation There will be no litigation with respect to allowability of items, as under VAT no items will be specified in the registration certificate of the dealer. The dealer will be allowed to purchase any of the items of his choice in which he intends to deal. He will also be allowed to purchase any item he requires as raw material for the purpose of manufacturing or for packing. (iii) Tax Credit on purchase of Capital Goods The dealer will be allowed to purchase capital goods for manufacturing after paying VAT and will be entitled to get set off tax paid on such purchases from his VAT liability, which will arise on the sales made by him. (iv) Abolition of Statutory Forms There are no forms under VAT. Therefore, all problems related to forms automatically get resolved. Dealer will not have to make visits to department to get these forms issued. Similarly, there will be saving to the department both in terms of cost and in terms of time. Assessing Officers will be saving lot of time which otherwise was being wasted in issuance of statutory forms, and now this can be utilised for other useful purposes including monitoring of tax collection and better administration. Tax collection cost of the department will go down. There will be a direct reduction and the amount spent on the cost of paper and printing of statutory forms will become NIL. Secondly, the department will also be able to serve more dealers with existing staff and that too more efficiently. (v) Self-Assessment Dealers are not required to appear before the Assessing Authority for their yearly assessments, as under VAT there is provision for self-assessment. All the cases will be accepted by the department as correct and only a few will be selected for audit as is being done by Income Tax Department and Excise Department at present.