Input Tax Credit under VAT Laws An Analysis CA. Pradip R Shah pradip@pradiprshah.com It is almost more than five years have passed since Value Added Tax System (VAT) was implemented in the country. A time has come to see as to what was conceived, implemented and the results achieved. It will be interesting to have a look at the development of the system so far and examine in what respect it has achieved the objectives as pronounced by the Empowered Committee (EC), various State and Central Governments in the past. Since the subject of VAT encompass various aspects viz. Input Tax Credit (ITC), rate of tax, registration, assessment etc., it will not be possible to examine all of them in a single paper. However, an attempt has been made herein to examine the most important aspect of VAT viz. ITC with respect to its design, implementation etc. All the states have implemented VAT and made provisions for ITC as per their needs. However, in the process, all of them have substantially deviated from avowed objectives declared in the White Paper (WP) published by the EC. Considering the constraint of space, an attempt has been made herein to examine it with respect to Gujarat Value Added Tax Act (GVAT) only. Justification in WP Before examining the issues of ITC under GVAT, it will be interesting to recall what WP had to say in this respect. While justifying the necessity for VAT system, the WP had stated; 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...in the VAT, a set-off is given for input tax as well as tax paid on previous purchases. In the prevailing sales tax structure, there is in several States also a multiplicity of taxes, such as turnover tax, surcharge on sales tax, additional surcharge, etc. With introduction of VAT, these other taxes will be abolished. In addition, Central sales tax is also going to be phased out. As a result, overall tax burden will be rationalised, and prices in general will also fall. Moreover, VAT will replace the existing system of inspection by a system of builtin self-assessment by the dealers and auditing. The tax structure will become simple and more transparent. That will improve tax compliance and also augment revenue growth. Benefits to follow on introduction of VAT system: a) a set-off will be given for input tax as well as tax paid on previous purchases b) other taxes, such as turnover tax, surcharge, additional surcharge, etc. will be abolished c) overall tax burden will be rationalised d) prices will in general fall e) there will be self-assessment by dealers f) transparency will increase g) there will be higher revenue growth 1
The VAT will therefore help common people, traders, industrialists and also the Government. It is indeed a move towards more efficiency, equal competition and fairness in the taxation system. What have we done? Let us briefly examine each one of the above. a) set-off for input tax as well as tax paid on previous purchases Yes, set-off is being given. However, it is in diluted form. We all know the provisions of S. 11 of GVAT laying down so many conditions. There are numerous provisions which practically dilute the effectiveness of the whole concept of ITC. Under the erstwhile system, set-off was given with respect to certain items and in respect of certain categories of dealers only. If that is the case, what is so unique about VAT system? A time has come to think about it in perspective. Was the system of VAT meant for extension of set-off provisions only? Unfortunately, we have diluted the whole concept and applied it in grotesque form. A look at the provisions of ITC in VAT statutes of most of the States, it appears that ITC is considered as obliging the dealers. It is not appreciated that the dealer has a right to claim taxes paid as ITC. Any attempt to truncate it affects the foundation of VAT system. A glance at VAT system at global level will reveal that ITC is heart of the system. It encompasses not few commodities or certain types of dealers, but looks at the business in holistic manner. If the system has to be effective, it has to be looked into totality rather than in piecemeal manner. b) taxes, such as turnover tax, surcharge, additional surcharge, etc. will be abolished As in the State of Gujarat, almost all the States have started levying additional taxes in one form or other. Reasons offered by all of them are varying. However, as far as dealers and tax-payers are concerned, the system has already started loosing its sheen. c) overall tax burden will be rationalised Looking to development as shown in (a) and (b) above, it remains a moot question whether it can be called a rationalised tax structure. d) prices will, in general, fall As a consumer, all of us know it very well, the commodities wherein the prices have fallen so far. This does not require any proof. This was, and will, always remain a pipedream. e) there will be self-assessment by dealers Yes. The statute provides for the same. However, to what extent the administration is ready to follow the said system? All of us know, as under the old system of Sales Tax, notices are being issued for scrutiny in thousands of cases without looking into the provisions made in this respect under the statute. f) transparency will increase Yes, it has increased. Dealers are required to provide more and more details with respect to sales and purchases. In the name of e-filing lot of time is required to be devoted to compliances like filing of returns etc. As a tax-payer one expects the administration to make use of the data compiled so that honest dealers are not harassed. But the moot question is to what end the database created is being utilised. For example, in many cases, the purchasing dealer is required to prove payment of tax by the seller. 2
g) there will be higher revenue growth Yes. In the case of almost all the States, revenue has shown significant growth. However, it can not be attributed to implementation of VAT system. There are varying reasons for the same. To what extent it can be attributed to implementation of VAT is a debatable point. We should not loose sight of the fact that one of the major factors contributing to increase in revenue is inflation. If one removes effect of inflation then only one can get clear picture. However, to attribute implementation of VAT as the cause for growth in revenue will be a too high claim. Implementation of ITC under GVAT Let us examine how the concept of ITC has been implemented under the GVAT system. WP has to say about it as follow: The essence of VAT is in providing set-off for the tax paid earlier, and this is given effect through the concept of input tax credit/rebate. This input tax credit in relation to any period means setting off the amount of input tax by a registered dealer against the amount of his output tax. The Value Added Tax (VAT) is based on the value addition to the goods, and the related VAT liability of the dealer is calculated by deducting input tax credit from tax collected on sales during the payment period (say, a month). The concept of ITC covers following aspects. 1) The claimant i.e. the dealer Under VAT laws all types of businessmen i.e. manufacturers, traders, hirers etc. are liable for tax. Liability to pay the tax is same for all the types of dealers. However, when it comes to the right to claim ITC, GVAT applies differing scales. A dealer manufacturing goods gets preferred treatment. A trader is categorized to lower category. Certain dealers like the one who are not manufacturer in strict legal sense are altogether denied benefit of ITC. Is it rational? 2) Goods / commodities dealt with Partiality is equally visible with respect to types of commodities which are permitted ITC. Look at section 11(3) and 2(19) of GVAT providing ITC on certain types of goods and dealers. (3)(a) Subject to the provisions of this section, tax credit to be claimed under sub-section (1) shall be allowed to a purchasing dealer on his purchase of taxable goods made mentioned in (i) or (ii) above which are intended for the purpose of- (i) sale or re-sale by him in the Sate; (ii) sale in the course of inter-state trade and commerce ; iii).. (iv).. (vi) Use as raw material in the manufacture of taxable goods intended for (i) to (v) above or in the packing of the goods so manufactured; (vii) use as capital goods meant for use in manufacturer of taxable goods ; (19) raw materials means goods used as ingredient in the manufacture of other goods and includes processing materials, consumable stores and 3
material used in the packing of the goods so manufactured but does not include fuels for the purpose of generation of electricity; Processes which are akin to manufacture There are many commodities which require processing before it reaches to the consumer. In some of the cases, there is vast difference between inputs and the output. In many cases there is substantial value addition in the process while in terms of physical appearance, inputs and output remains the same. Due to traditional definition of the term manufacture under sales tax and Excise Duty, these processes have not been termed as manufacturing of the goods. Applying the same definition under VAT, these dealers are denied ITC for various inputs. It is not appreciated that the concept of ITC under VAT is quite different from set-off under erstwhile sales tax laws. A moot question is if the objective of introducing VAT is to avoid cascading of taxes as stated in WP, to what extent such policy of keeping ITC restricted will help? If the policy-makers were really serious about removing totally cascading of taxes, scope of ITC should have been extended to the business as a whole rather than keeping it restricted to few commodities. Let us take another example. In terms of clause (vi) a manufacturer is permitted credit for taxes paid for packing material. What about taxes paid by a trader for purchase of packing material? At times, a trader buys goods traded in bulk and sells in small size packing. For the said purpose, he is required to purchase packing material. However, the dealer, in such cases, will be denied ITC as he is not a manufacturer. Is it equitable? So is the case with various other inputs. Have a look at any business, whether trading or processing of goods, number of inputs goes into making of it. All these inputs attract taxes. Is it not equitable to permit credit for taxes paid on all of them? By denying ITC on these inputs are we not levying taxes on taxes? ITC on Capital Goods Let us take the case of Capital Goods (CG). Under GVAT, taxes paid on purchase of CG is permitted on plant and machinery used for manufacture of goods. However, dealers other than manufacturers are denied the same. Read section 11(3)(a)(vii) (supra). For example, tax paid on a deep freezer required for manufacture of goods is permitted as ITC. However, very same deep freezer, when used by a trader for retail sale of the said commodity, credit for taxes paid is denied. Is it equitable? Let us take another case. In the case of manufacturer, tax paid for machines required for certain processes which are not considered as manufacturing, no ITC is permitted. For example, for the purpose of blending of tea, substantial investment is required in machines for blending and other processes. However, ITC of taxes paid on such machines is not permitted for the reason that it is not a manufacturing activity. Unfortunately, it is not appreciated that, in the business, even purchase of stationery items also add value. If the value added is taxable, how can ITC be denied on commodities which add the value? Case of Loss of Revenue One argument which has always been advanced by the policy-makers is that by extending scope of ITC there will be substantial revenue loss. However, none of the State Governments have come out with any specific data about it. Two issues in this respect are important. a) Credit is being provided for the taxes which have been paid to the Government. Hence, the question of any additional outflow arising on 4
Conclusion: account of providing ITC does not arise. b) Secondly, by extending ITC to all the items used in the business, culture of documenting the transactions is expanded. Will it not bring more dealers and goods in the system? All these, and such other related issues, are emerging in one form or the other in respect of all the State VAT laws. It clearly gives the message that we have made half-hearted attempt in implementing VAT. One only hopes that, these and other issues, will be taken care of while devising the system of Goods and Service Tax Act. 5