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The design of State-level Value Added Tax (VAT) has been worked out by the Empowered Committee through several rounds of discussion and striking a federal balance between the common points of convergence regarding VAT and flexibility for the local characteristics of the States.
The State-Level VAT as elaborated in the White Paper on State-level Value Added Tax by the Empowered Committee of State Finance Ministers, has certain distinct advantages over the existing sales tax structure. The VAT will not only provide full set-off for input tax as well as tax on previous purchases, but it will also abolish the burden of several of the existing taxes, such as turnover tax, surcharge on sales tax, additional surcharge, special additional tax, etc. In addition, Central Sales Tax is also going to be phased out. As a result, the overall tax burden will be rationalised, and prices, in general will fall. Moreover, VAT will replace the existing system of inspection by a system of built-in self-assessment by traders and manufacturers. The tax structure will become simple and more transparent. This will significantly improve tax compliance and will also help increase revenue growth.
While this State-Level VAT has all these advantages, it is a state subject derived from entry 54 of the State List, for which the States are sovereign in taking decisions. In arriving at these decisions on VAT, the states, through discussion in the Empowered Committee, have found it in their interests, to avoid unhealthy competition and have certain features of VAT to be common for all the States. These features will constitute the basic design of VAT. At the same time, the States will have freedom for appropriate variations consistent with this basic design. Thus there is an element of balance between the much-needed commonality and the desired federal flexibility embedded in the VAT structure.
Benefits
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 with input tax load, output is taxed again. This causes an unfair double taxation, the ultimate brunt of which is borne by the consumers. But in the VAT, a set-off is given for input tax as well as tax paid on previous purchases. Again, in the prevailing sales tax structure, there is in several states also a multiplicity of taxes, which under VAT will be abolished. 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.
Joining the International Mainstream
For these beneficial effects, a full-fledged VAT was initiated first in Brazil in mid 1960’s, then in European countries in 1970’s and subsequently introduced in about 130 countries. In Asia, it has been introduced by a large number of countries from China to Sri Lanka. Even in India, there has been a VAT system introduced by the Government of India for about last ten years in respect of Central Excise duties. At the State-level, the VAT will now be introduced in terms of Entry 54 of the State List of the Constitution. In fact, one state, Haryana, has already introduced VAT on its own with good results on revenue growth.
Understanding VAT
The essence of VAT is in providing set-off for the tax paid earlier, and this is given effects 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 the tax collected on sales during the payment period.
This input tax credit will be given for both manufacturers and traders for purchase of inputs/supplies meant for both sale within the state as well as to other states, irrespective of when these will be utilised/sold. This also reduces immediate tax liability. Even for stock transfer/consignment sale of goods out of the state, input tax paid in excess of 4 per cent will be eligible for tax credit. If the tax credit exceeds the tax payable on sales in a month, the excess credit will be carried over to the end of next financial year. If there is any excess unadjusted input tax credit at the end of second year, then the same will be eligible for refund. Input tax credit on capital goods will also be available for traders and manufacturers.
All tax-paid goods purchased on or after April 1,2004 and still in stock as on April,2005 will be eligible to receive input tax credit, subject to submission of requisite documents. Resellers holding tax-paid goods on April 1,2005 will also be eligible. VAT will be levied on the gods when sold on and after April 1,2005 and input tax credit will be given for the sales tax already paid in the previous year. This tax credit will be available over a period of six months after an interval of 3 months needed for verification.
Registration
Registration of dealers with gross annual turnover above Rs.5 lakh will be compulsory. There will be provision for voluntary registration. All existing dealers will be registered under the VAT act. A new dealer will be allowed 30 days time from the date of liability to get registered. Small dealers with gross annual turnover not exceeding Rs.5 lakh will not be liable to pay VAT. States will have flexibility to fix this threshold limit within Rs.5 lakh. Small dealers with annual gross turnover not exceeding Rs.50 lakh who are otherwise liable o pay VAT, shall however have the option for a composition scheme with payment of tax at a small percentage of gross turnover. The dealers opting for this composition scheme will not be entitled to input tax credit.
There will be no need for any provision for concessional sale under the VAT Act since the provision for set-off makes the input zero-rated. Hence there will be no need for declaration form, which will be a further relief for dealers.
Coverage of Goods
In general, all the goods, including declared goods will be covered under VAT and will get he 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 sales tax act or 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.
Under the VAT system covering about 550 goods, there will be only two basic VAT rates of 4 per cent and 12.5 per cent, plus a specific category of tax-exempted goods and a special VAT rate of 1 per cent only for gold and silver ornaments etc. Thus the multiplicity of rates in the existing structure will be done away with under the VAT system.
Under exempted category, there will be about 46 commodities comprising natural and unprocessed products in unorganised sector, items which are legally barred from taxation and items which have social implications. Included in this exempted category is a set of maximum of 10 commodities flexibly chosen by individual states from a list of goods which are of local social importance for the individual states without having any inter-state implication. The rest of the commodities in the list will be common for all the states. Under 4 per cent VAT rate category, there will be the largest number of goods (about 270) common for all the states, comprising items of basic necessities such as medicines, and drugs, all agricultural and industrial inputs, capital goods and declared goods. The remaining commodities, common for all the states will fall under the general VAT rate of 12.5 per cent.
Helping Hand
Finally it needs to be carefully noted that although introduction of VAT may, after a few years, lead to revenue growth, there may be a loss of revenue in some states in the initial years of transitions. It is with this in view that the Government of India have agreed to compensate for 100 per cent of the loss in the first year, 75 per cent of the loss in the second year, and 50 per cent of the loss in the third year of introduction of VAT, and the loss will be computed on the basis of an agreed formula.
*Assistant Information Officer, PIB, Raipur
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