How VAT will change the way you spend?

Finance Minister P Chidambaram on Monday released a white paper on Value Added Tax (VAT) which lays down a roadmap for levy of a uniform state-level tax on over 550 items, exempts 46 local and social items and gives states an option to exempt food grains for a year.

Though VAT has been on the anvil for quite sometime now, it was deferred a number of times because of reservations expressed by various quarters including trade lobbies and state governments. The new UPA government which came to power at the Centre last year had vowed to implement VAT within its term.

The VAT, which has been endorsed by States, will be implemented from April this year.

What is VAT?

VAT is a simple transparent tax collected on sales of goods. The states and union territories of India have decided to implement VAT in place of sales tax and a number of other state taxes.

Actuallly, it is a multi-point sales tax and is collected on value addition only, at each stage. The concept is akin to excise duty paid by the manufacturer who, in turn, cliaims a credit on input taxes paid. Excise duty is on manufacture, while VAT is on sale and both work in the same manner, according to the white paper on VAT released. The document was drawn up after all states, barring UP, were prepared to implement VAT from April.

VAT lies at the heart of a drive to reform India’s tax structure under which states are chronically short of money and only three per cent of the country’s billion-plus people pay income tax.

V. A. TAX = OUTPUT TAX – INPUT TAX CREDIT – CREDIT B/F.

Defined:

Output Tax: The amount of tax collected by a dealer on sale of goods effected during the period (Month/Quarter/Year).

Input Tax: The amount of tax paid by a dealer on purchase of goods suring the same period.

Credit C/F & Credit B/F: If the eligible credit for input tax is more than the output tax during a given period, the same shall be carried forward to the next period (Month/Quarter/Year).

This carrying over of tax credit may continue till the end of the next financial year. If there is any excess unadjusted input tax credit at the end of the second year, then the same will be eligible for refund.

What's on Offer?

A full set-off for input tax credit as well as tax on previous purchases will be provided under VAT. All other taxes such as the turnover tax, surcharge on sales tax, additional surcharge, special additional tax will be susumed in VAT. The exception is OCTROI. VAT will replace the sales tax regime in States with a two-tier tax regime of 4% and 12.5%

Who Gains?

State and Central Governments gain in terms of revenue. VAT has in-built incentives for tax compliance-only by collecting taxes and remitting to the government. A seller can claim the offset that is due to him on his purchases. Everyone has an incentive to buy only from registered dealers – purchases from others will not provide the benefit of credit for the taxes paid at the time of purchase. This transperency and in-built incentive for compliance would increase revenues. Industry and trade gain transperancy and reduced need to interact with the tax personnel. For those who have been complying with taxes, VAT would be a boon that reduces the cost of the product to the consumer and boosts competiveness. VAT would be major blow for tax evaders, both manufacturers who evade excise duty payments and traders who evades sales-tax.

How does VAT works?

Value Added Tax (VAT) leads to avoidance of multiple taxation and lowering of taxes for the manufacturers and traders and lowers prices of final goods for consumers.

It basically provides a SET-OFF FOR THE TAX PAID AT EVERY STAGE OF VALUE-ADDITION TO THE GOODS.

Referring to the white paper: VAT is calculated by deducting input tax credit from tax collected on sale during the payment period.

In the present regime, inputs worth Rs 1,00,000 are purchased for producing final goods worth Rs 2,00,000 in a month. Then input tax is paid at four per cent and output tax paid at 10 per cent.

In this, the input tax works out to Rs 4,000 and output tax on sales works out to Rs 20,000.

Under the VAT regime, the levy on sales of final goods worth Rs 2,00,000 would work out to Rs 16,000 (output tax of Rs 20,000 minus Rs 4,000 set off as input tax).

The Input Tax Credit [ITC] will be given to both manufacturers and traders for purchase of inputs and supplies meant for both sale within the states as well as other states, irrespective of WHEN these will be utilised/sold.

It has been further been clarified that FULL SET-OFF (Input Tax Credit) will be given of the taxes paid within the State on purchase of:

• Raw Material
• Trading Goods
• Packing Material
• Capital Goods

However, NO SET-OFF or REDUCED SET-OFF may be granted on such tax paid inputs, which are used in the manufacture of tax-exempt goods. Similar reduction of upto 4% of taxes paid on input has been prescribed on the purchase of goods for use in BRANCH TRANSFER and/or CONSIGNMENT SALES.

It may be noted that a VALID TAX INVOICE is a must to claim Input Tax Credit.

ITC on Opening Stock of Goods:

All tax-paid goods purchased on or after April 1, 2004 and still in stock as on April 1, 2005 will be eligible to receive input tax credit, subject to submission of requisite documents. Re-sellers holding tax-paid goods on April 1, 2005 will also be eligible.

VAT will be levied on the goods 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 availble over a period of 6 months.

Treatment of Exports:

Exports are treated as Zero Rated. Thus, although no tax is collected on export sales, tax paid within the State will be refunded in full, and this refund de within Three months.

Inputs procured from Other States:

Tax paid on inputs procured from other States through Inter State sale and stock transfers will not be eligible for credit. Thus, THERE IS NO SET-OFF OF CST.

Compulsory Issue of Tax Invoice, Cash Memo or Bill:

Every Registered Dealer, having turnover of sales above an amount specified, shall issue to the purchaser SERIALLY NUMBERED Tax Invoice with the prescribed particular's showing therein the amount of tax charged separately.

Who Pays?

All dealers registered under VAT and all dealers with an annual turnover of more than R.5 lakh will have to register. Dealers with turnovers less than Rs.5 lakh may register voluntarily.

Relevat Provision on Registration:

• Compulsory registration of dealers having gross turnover above Rs.5 lakh.
• There will be provison for voluntary registration.
• All existing registered dealers will automatically be registerd under the VAT Act of respective State.
• A new dealer will be allowed 30 days time from the date of liability to get registered.

How to Pay?

VAT will be paid along with monthly returns. Credit will be given within the same month for entire VAT paid within the state on purchase of inputs and goods. Credit thus accumulated over any month will be utilised to deduct from the tax collected by the dealer during that month. If the tax credit exceeds the tax collected during a month on sale within the state, the excess credit will be carried forward to the next month.

Central Sales Tax:

In an ideal VAT regime, there is no room for CST.

Small Dealers & Composition Scheme:

Small dealers, with annual gross turnover NOT EXCEEDING RS.50 LAKH, who are otherwise liable to pay the VAT, shall however the option for a composition scheme with payment of tax at a small percentage of gross turnover. The dealers opting for this scheme will NOT be entitled to input tax credit. They will not issued TAX INVOICE. Instead, they will issue a bill or a cash memo.

Abolition of Other Taxes:

All other existing taxes such as, Turnover Tax, Surcharge and Special Additional Tax would be abolished.

Other Details:

• Tax Payer’s Identification Number (TIN) : 11 digits
• Returns
• Self-Assessment
• Departmental Audit
• Penal Provisions

What are the Problems of the Present Tax Regime?

Under the current system of taxation, most of the taxes are collected when the consumer purchases the product. As such, the big consuming states mop up most of the taxes, including the cascaded taxes from previous stages the product has been through.

The problems in the present tax system. He takes the example of selling matches made in Tamil Nadu in Uttar Pradesh.

The problems in carrying out this simple business can be many under the present tax system. “First you will have to buy matches from your counterpart in Tamil Nadu, paying Central Sales Tax (CST) to the government there. The CST is a state-of-origin tax, payable to the state in which the goods originate in an interstate sale. Next you must ship the matches across 2000 km to UP, pay an entry tax to the state of UP and follow it up with a 10 per cent local sales tax (LST) to the same government when you sell it.

“In addition, you may pay octroi to the municipality – or tehbazari to the panchayat – where you sell the matches. If you sell items that attract surcharges or luxury taxes, then you'll have to pay even more agencies than the three or four applicable to matches.”

There are three problems with this system. First, there is a mixture of origin taxes (the CST) and destination taxes. This combination leads to double taxation of a single transaction, which inhibits inter-state commerce. As a result, India, despite being one large nation, is in fact a fractured market.

Every inefficient producer in the country is protected from his rivals from other states by the sum of state of origin and entry taxes, which can go up to 11 per cent in certain categories. In the end, the consumers will have to bear the higher costs.

Next, a direct and very significant off-shoot of this fractured market is extended transit times and increased inventory holding by companies. In the example of the matches being sold in UP, the lorry carrying the goods would have to pass through Tamil Nadu, Andhra Pradesh, Maharashtra, Madhya Pradesh and Uttar Pradesh. At each state border it would have to wait for inspectors to clear paper work and ascertain if any tax is payable. Usually, the process takes days, if not weeks. These stoppages lead to enhanced working capital outlays by companies and reduced profitability.

A third problem, is that, since the taxes are levied on the selling price, one has to pay tax on all the other taxes paid previously. For example, the CST paid to Tamil Nadu also attracts a sales tax in UP; this is referred to as 'cascading of taxes'. This cascading is worsened by the fact that although entry taxes, LST, luxury tax and octroi all flow to the same government they are levied sequentially, each being layered upon all its predecessors. This has distorted the policies of nearly all companies in India. State boundaries, rather than logistical efficiencies, guide their redistribution strategies. A firm which would be well served with a single godown in Delhi to serve all of Haryana, Western UP and Delhi, would instead open one godown in each of the three states, and ship goods through intra-company transfers between them.

The first 'sale' happens in the state of consumption, and the CST applicable on interstate sales is avoided. Not only did this lead to greater costs and lower efficiencies, worse still inter-state smuggling became a big business.

What are the Rates of VAT

According to the white paper: A two-tier tax system is proposed.

The new VAT prescribes a rate of 4% on a range of 270 items, including drugs and medicines and industrial products, and 12.5% on many other items.

The VAT, which has been endorsed by States for implementation from April this year, will be one per cent on bullion and four per cent on foodgrains with states given the option to exempt foodgrains in the first year.

What will be Covered by VAT?

All business transactions carried on within a State by individuals, partnerships, companies etc. will be covered by VAT.

MORE THAN 550 ITEMS would be covered under the new VAT regime of which 46 natural and unprocessed local products would be exempt from VAT, a PTI report quoted West Bengal Finance Minister and VAT panel chairman Asim Dasgupta as saying.

ABOUT 270 ITEMS including drugs and medicines, all agricultural and industrial inputs, capital goods and declared goods would attract 4% PER CENT VAT.

The remaining items would attract 12.5 PER CENT VAT. Precious metals like gold and bullion would be taxed at one per cent.

Considering the difficulties faced by the tea industry, it was decided that tea-producing states would be given an option to levy 12.5 per cent or four per cent subject to review in 2006.

Petrol and diesel would be kept out of VAT regime, which covers only marketable items,

Dasgupta was quoted as saying that the panel was yet to take a view on CNG.

Following opposition from some of the states, it was decided that states would have option to either levy four per cent or totally exempt food grains but it would be reviewed after one year.

Three items – sugar, textile and tobacco – covered under Additional Excise Duties, will not be under VAT regime for one year but the existing arrangement would continue.

The VAT panel relaxed the threshold limit for traders coming under VAT regime from RS.5-50 LAKH OF TURNOVER from the previous stance of Rs.5-40 lakh. Traders within this limit can pay a composite VAT rate of 1% but would not be entitled to input tax credit.

What are the Benefits of VAT?

Uniform rates of VAT will boost fair trade. Because of 100% self-assessment, the taxpayers’ need to visit the tax department offices will be reduced.

The industry will be helped by this new system in that the system of input tax credit will promote production efficiency of investments. Investment decisions will not, therefore, be based on tax differentials, tax holidays etc.

On the exports front too, there are benefits. With zero rating of exports, the rate of tax on export goods will be zero and yet credit will be given on tax paid on inputs. This will make India’s exports more competitive.

From the consumer point of view, VAT should not lead to price rise as there will be no tax on tax.

“VAT is 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. In the current system, since sales taxes are collected at a single point, evasion at that point costs the government all of the tax. By reducing the attractiveness of tax-avoidance, the VAT can potentially increase tax revenues.”

However, he says, the biggest benefit of VAT is that it could unite India into a large common market. This will translate to better business policy.

Companies will start optimising purely on logistics of their operations, and not on based on tax-minimisation. Reduced transit times and lower inventory levels will boost corporate earnings.