15/07/2013
Value Added Tax (VAT) in India
The VAT began life in the more developed countries of Europe and Latin America but, over the past 25 years, has been adopted by a vast number of developing and transition countries. Ever since the introduction of new economic policies of LPG (Liberalization, Privatization, Globalization) in India under Narasimha Rao’s government, the debate regarding the restructuring of Indian fiscal system also has been initiated. The Indian Economy is on race with other nations due to globalization and its transformation to a market economy. The emphasis on new reforms is to broaden the tax net and make it simple so that a layman can understand it.
VAT is a system of indirect taxation, which has been introduced in lieu of sales tax. It is the tax paid by the producers, manufacturers, retailers or any other dealer who add value to the goods and that is ultimately passed on to the consumer. VAT has been introduced in India to ensure a fair and uniform system of taxation. It is an efficient, transparent, revenue-neutral, globally acceptable and easy to administer taxation system. It benefits the common man (Consumer), businessman and the Government.
Further, VAT enhances competitiveness by removing the “cascading”- “the tax on tax” effect on goods and makes the levy of tax simple and self-regulatory, ensuring flexibility to generate large revenues.
The cascading effect is brought about by the existing structure of taxation where inputs are taxed before the commodity is produced and the output is taxed after it is produced. This causes an unfair double-taxation. However, in VAT, a set off is given for input tax (tax paid on purchases). This results in overall tax burden being rationalized and a fall in prices of goods. A recent IMF study concludes that the VAT can be a good way to raise resources and modernize the overall tax system—but this requires that the tax be well designed and implemented.
VAT works in two different ways:
If VAT registered businesses receive more output tax than the taxes paid as input, they will need to pay the difference to the commissioner of Taxes (State).
If the input tax paid is more than the output tax collected, then-
ü One can carry forward the Input Credit and adjust it against output tax in the subsequent months.
ü One can have the Input Credit refunded at the end of the current or following year, by the Government,
ü One can receive refunds for Input Credit on exports within a period of three months.
For example, input worth Rs.1,00,000/- is purchased and sales are worth Rs.2,00,000/- in a month, and input tax rate and output tax rate are 4% and 10% respectively, then input tax credit /set-off and calculation of VAT will be as shown below.
a. Input purchased within the month: Rs.1,00,000
b. Output sold in the month: Rs.2.00,000
c. Input tax paid: Rs.4,000/-
d. Output tax payable: Rs.20,000/-
e. VAT payable during the month after set-off/input tax credit [(d)-(c)]: Rs.16, 000/-
General terminologies used in VAT
Input tax : This is a tax paid on purchases
Output tax : This is a tax charged on sales
Input Credit : The amount of Input tax that is permitted to be set off against output tax.
According to white paper, there are 550 categories of goods under the VAT system. They are classified into the following four groups, depending upon VAT rate:
VAT @ 4%
The largest number of goods (270) comprising of basic necessity items such as drugs and medicines, agricultural and industrial inputs, capital goods are under 4% VAT.
Exempted from VAT
There are about 46 commodities under the exempted category. This includes a maximum of 10 commodities that each state would be allowed to select, from a broader approved list for VAT exemption. The exempted commodities include natural and unprocessed products in unorganized sector as well as items, which are legally barred from taxation.
VAT @ 1%
This is for specific category of goods like gold, silver etc.
VAT @ 12.5%
The remaining commodities are under the general VAT rate of 12.5%.
Few goods that are outside VAT as a matter of policy would include liquor, lottery tickets, petroleum products, as the prices of these items are not fully market-determined. These Items will continue to be taxed under the sales tax act of the respective states.
Advantages of VAT:
As VAT is a multi-point tax with set off for tax paid on purchases, It prevents repeated taxation of the same product.
VAT has a flexibility to generate large and buoyant revenues, as it levies tax on value additions.
Zero rating of tax on exports is possible in case of VAT
Ability to provide same revenue to the Government with lower rates of taxes.
Tax does not become a cost of doing business.
VAT introduces uniform tax rates across the state so that unfair advantage cannot be taken while levying the tax.
Procedures relating to filing of returns, payment of tax, furnishing declaration and assessment are simplified under the VAT system so as to minimize any interface between the taxpayer and the tax collector.
Disadvantages of VAT
VAT is regressive
VAT is difficult to operate from position of both administration and business
VAT is inflationary
VAT favors capital intensive firms.
Next steps for the VAT
Key issues for the future will no doubt involve the VAT’s implementation in decentralized states and within regional trading blocs, where there are no formal border controls; the proper treatment of the financial sector under the VAT; and reduction of the damage from multiple rates and exemptions, which are even more inconsistent with the basic logic of the VAT. A still more fundamental and as yet little recognized set of issues concerns the relationships between the VAT and income taxes, both domestically and internationally. For all the VAT’s impressive achievements, its potential has still not been fully exploited or, perhaps, fully understood.
