India and modern methods of taxation

INDIA is a developing nation and has become part of Global Economy. To accelerate the growth new economic reforms were introduced from time to time. Somewhere in the mid 1980s, the government of India introduced Value Added Taxation. Here every stage in the process from production to consumption is taxed only to the extent of value added by that stage. Starting in 1986, India moved from an excise regime to a Modified Value Added Tax (MODVAT) and now to a Central Value Added Tax (CENVAT) regime.

VAT earlier seems an imminent reality now put into action w.e.f. 1st April 2005 even though not in full swing. With enactment of Ordinance passed by respective State Assemblies almost 21 States have meet the deadline of 1st April for preparation of VAT bills and of course their implementation. After all, all stakeholders have debated the concept during the last 10 years and it is nobody’s case that we should debate it more for the next 10 years. But the important question remains that whether we have achieved what we intended 10 years ago? Or just we have implemented VAT because already we have unsuccessfully exhausted so many deadlines and Just to avoid another we have compromised with the very basics of VAT. Even though this could be a strategy of the Central Government to initiate the process once and then improve upon with the passage of time but certainly there is a need to explore whether the VAT regime has taxed at the highest rate, then industry will certainly be reluctant to come out with new products and also in the research and development thereof.

Workings of the Value Added Tax 

Value Added taxation works under chain system and creates an incentives for each participant from production to sale and clearly identify his role, because he is only taxable for paying on VAT on addition in value generate. However, a trader can get a tax credit for all his purchases on produce of all his purchase invoices (since those are goods and services for which their producers have already been taxed), and is liable for taxation only on the difference between his purchase and sales invoices.

Also in an ideal VAT, the “destination principle” is applicable also called ‘multiple point taxation’. Taxes are payable to the states where the goods are headed, and in those states, you get credit for the taxes paid previously, even to those states. Under VAT regime, if government manages to ensure that the first point of sale is invoiced then an automatic trail of invoices gets generated whitening a series of transactions. This is important gain of the VAT system.

In the current system i.e. single point taxation, since sales taxes are collected at a single point, evasion at that point costs the government all of the tax. However in VAT taxes are collected across all points of sale; therefore if one person evades taxes the loss to the Treasury is only to the tune of his value addition.

Perhaps the biggest benefit of VAT will translate to better business policy as it could unite India into a large common market. Companies can start optimizing purely on logistics of their operations, and not on based on tax-minimization. By reducing the attractiveness of tax-avoidance, the VAT can potentially increase tax revenues.

Factually it is 1st phase of Ideal VAT and yet to cover a long way. The ultimate impact OF VAT will be come out only after implementation of ideal VAT in totality.

Apocalypse ahead

In the late 1990s, many states, strapped as they were for cash, decided to embrace the VAT’s promise of increasing revenues, and decided to move to VAT in lieu of sales taxes. A lot of not-so-subtle prodding by the centre also helped. But the transition has also been slow and incomplete because of strong opposition from some quarters. Many traders and some state governments are crying hoarse over it, and even some sections of the general public aren’t exactly enthusiastic. Main reasons for this are:

VAT sparkle varies State by state

High production and high consumption – are the two types of states we have -like Gujarat and Maharashtra. ‘Producing State’ means those States who produce more than they consume i.e. goods sent outside the State will be more than goods brought into the State for consumption. ‘Consuming States’ are those which consume more than they produce. Since VAT is a consumption based tax, theoretically, “Consuming States’ will be benefited in the VAT tax regime while ‘Producing States’ will suffer loss of revenue. As ‘Producing State’ does not get tax revenue in respect of goods produced in the State, but consumed out side the State.

Informal economy prevails in India.

A very large number of transactions are not invoiced. Under a value added tax, if a trader cannot produce the invoices for his purchases, he becomes liable for tax on all of his sales invoices, without any credits for prior processes. The taxes for all the previous stages will be incurred at the first point of invoiced sale. Thus there is a real fear that the organized traders who invoice their sales might end up bearing the entire tax burden. As things stand, for a system already come into effect in April 2005,

Cascading Effect

Primarily government has introduced VAT to nullify Cascading effect i.e. tax on tax. But all is in vain as cascading is still there. State Level VAT has been introduced but states has not yet abolished taxes like entry level taxes, Octroi etc. and can use this liberty and may raise the rates of such taxes at their whims and options. This can again start the tax war between the states.
One glaring example is Central Sales Tax still leviable and is not yet abolished which is ultimately resulting in to cascading.

Variation in Tax rates

Implementation of State level VAT is a state subject to earn / attract more revenue to State tax rate war is introduced as different states might be collecting VAT at distinct rates for same commodity.

Loss of Input Tax credit on Closing Stock (As on 31st March, 2005) in some cases

Provisions of VAT law have prescribed that input tax credit can be available on the stock lying as on 31st march 2005. And that also which is purchased with in the period 01 one year starting from 1st April 2004 on purchase invoices. Input tax credit vanished where corresponding purchase invoices on the bases of which input credit can be availed not available with the person taking such input tax credit. Moreover, credit on more than one year old stock is not available.
Government is evoking cascading in case of stock lying on 31st March 2005 on which input credit is available and VAT tax is payable at the time of sale of such stock afterwards.

Opportunity Loss made tax Credit Notional entry

Purchaser can avail credit of input tax and utilize such credit for the payment of VAT on ultimate disposal of goods. We can calculate opportunity loss suffered on account of time period involved when credit is taken and its utilization.

Discourage Investments

Government has specified list of articles on which VAT rates are 12.5%, 8%, 4% & 0% and left rest of the articles in the list of 12.5% that is in the highest. This ultimately put off the fortitude on the path of growth and development in the field of research and development.

28 States separate’ laws

Now a day’s area of business is not compressed to local boundaries of State but is extended to each and every corner of India. The principal criticism of the VAT law is that if each state were to set up its own rates of value added taxation, the Indian businessman would have to navigate through 28 state laws and applicable rules.

No mechanism granting automatic input tax relief on Exports

Though exports are kept exempt from tax, however there is no mechanism to grant relief of tax paid at the earlier stages on the inputs. Only refund route has been prescribed which otherwise considered ass a daunting task, ultimately resulted in harassment of exporters.

Lacks uniformity among States

Though basic concept of all states are same in VAT Acts, provisions in respect of credit of tax on Capital Goods, Credit allowable, credit when goods are sold inter state may not be uniform. Even definitions of terms like ‘business’, ‘Sale’, ‘Sales price’, ‘Goods’, ‘Dealer’, ‘Turnover’, ‘Input Tax’ etc. may not be uniform.

Varying tax burden

VAT is a multi-point taxation system hence tax burden on any commodity will vary widely depending on the number of stages through which it passes in the chain from first producer to the ultimate consumer.

Central Govt. to compensate States losses but what happens to losses suffered by customers

In the event of revenue loss (if any) incurred by State Central Government to compensate such losses, according to an agreed formula. But the question arises What happen to losses suffered by customers due to excessive imposition of taxes? And How Customers be benefited.

State of ambiguity

Central Government has implemented VAT in a haphazard manner and had not considered the aspect of communicating and imparting knowledge among masses and most importantly among business community. All this resulted into ambiguity in general public as no body is aware of what impact it will made on goods and economy as a whole.

Other effects

• Still most of the states claim their right to impose other non sales taxes (like luxury and entry taxes).
• VAT or no VAT that is effectively a cascading of taxes.
• CST, the main state of origin tax, stays for at least the first year, although there is a commitment that it will be phased out. And as long as the CST stays corporate cannot go about rationalizing their distribution networks.
• Also staying in place is the traditional Indian tax disease – exceptions and exemptions. Politics has played no small role in this. So while textiles are not VAT-able pharmaceuticals are. Industry groups and trader associations, depending on the political health of the state governments, have negotiated themselves these exceptions and exemptions.

Lacks basis of Classification

With the VAT system in operation only 550 items are covered under Harmonised System of Nomenclature (HSN). But Empowered Committee on Value Added Tax is lively to extend the list of items coming under VAT from present level of to 2000 to remove anomalies and bring in uniformity across states. Though the VAT white paper released on January 17 refers to about 550 items coming under VAT, some States like Maharashtra and Haryana already classify over 1 JOO items as industrial inputs and outputs.

Transfer of Business

To survive in competitive environment uniformity in tax rates is must otherwise it leads to a mess. There is no uniformity in the tax structure as prevailing in various States for same product, this will resulted into shifting of business to other states where tax burden are less.

The stringent penal provisions have been proposed in the VAT law. Though I am not against the imposition of such provisions considering the heavy evasion of taxes in our country, but at least during the transition phase, little leniency is desirable. This will enable the traders at large to come under VAT regime without fear of penal action.

Though there may be many more drawbacks in the proposed VAT which can be listed here but I admit that it is always easier to find shortcomings in any legislation than the benefits it is going to accrue. However, VAT in its present form certainly requires much therapy to give a growth oriented tax regime.
Mere Change of name or even change of system will not work to attain the desired results. We have to change the mind set of not only of Government, bureaucrats but also of businessmen and Customers as well. I believe awareness and regular involvement of all effected persons is very much essential.