What is VAT ?
VAT - Global Meaning
Globally, VAT is regarded as a tax that is best levied by the Central government - a condition that is difficult to meet in a federal finance system such as ours. It is true that 123 countries have adopted VAT, but most of them have unitary systems of government. VAT is a centrally-administered tax with a revenue-sharing mechanism. It is hard to visualise VAT as a revenue-neutral measure, or one where the states will not lose out in relation to the present system, in a federal set-up.
If VAT is Centrally administered, the tax base is quite wide, comprising imports, production and different stages of sales. If the base is divided between the Centre and states, the chain is broken, making tax evasion easier and affecting the states' tax base. In countries where VAT is administered by a federal government, revenue collection on imports accounts for a larger portion of total VAT revenues. In an IMF study of 22 developing countries, it was discovered that in about two-third of them, more than half the VAT revenue was collected from imports. In Pakistan and Bangladesh, VAT collection from imports was 64 per cent of the total proceeds from the tax. As tax evasion on bulk imports is difficult, it also helps in checking tax evasion at subsequent stages of the tax chain.
VAT - in India
VAT will replace the present sales tax in India. Under the current single-point system of tax levy, the manufacturer or importer of goods into a State is liable to sales tax. There is no sales tax on the further distribution channel. VAT, in simple terms, is a multi-point levy on each of the entities in the supply chain with the facility of set-off of input tax - that is, the tax paid at the stage of purchase of goods by a trader and on purchase of raw materials by a manufacturer. Only the value addition in the hands of each of the entities is subject to tax. For instance, if a dealer purchases goods for Rs 100 from another dealer and a tax of Rs 10 has been charged in the bill, and he sells the goods for Rs 120 on which the dealer will charge a tax of Rs 12 at 10 per cent, the tax payable by the dealer will be only Rs 2, being the difference between the tax collected of Rs 12 and tax already paid on purchases of Rs 10. Thus, the dealer has paid tax at 10 per cent on Rs 20 being the value addition in his hands.
Purchase price - Rs 100
Tax paid on purchase - Rs 10 (input tax)
Sale price - Rs 120
Tax payable on sale price - Rs 12 (output tax)
Input tax credit - Rs 10
VAT payable - Rs 2
VAT levy will be administered by the Value Added Tax Act and the rules made there-under.
VAT can be computed by using either of the three methods detailed below
- The Subtraction method:- The tax rate is applied to the difference between the value of output and the cost of input.
- The Addition method: The value added is computed by adding all the payments that is payable to the factors of production (viz., wages, salaries, interest payments etc).
- Tax credit method: This entails set-off of the tax paid on inputs from tax collected on sales.
States such as Andhrapradesh, Kerala, Maharashtra, Madhyapradesh, Delhi and Haryana have experimented with VAT albeit in a limited manner, covering only limited goods. The experiments never had the full-fledged features of VAT and were only concoctions. These states have even called off their experiments owing to different reasons. If one analyses why VAT or its variant failed in Maharashtra, which was the only state to come closer to a true VAT regime, the following reasons emerge:
1. Dual methodologies of computation of VAT credit Error! Hyperlink reference not valid. , one for the Manufacturing stage and the other for the trading stage, thus breaking the audit trail. It may be noted that one of the advantages of VAT system, as we would be dealing later on, is the audit trail that is created in the VAT chain.
2. Presence of a large number of tax deferral and holiday schemes, which resulted in a narrow base. It may again be noted that under VAT, which is multi-point, the tax rates have to be reasonably low, and lower tax rates presupposes that the tax base is wide. These two features were not present in the Maharashtra tax regime.
3. Low level of awareness among traders, and even administrators, giving rise to fears and apprehensions. Owing to this, there was considerable consternation among the trade, which gave rise to open revolt against the system.
4. Partial implementation of the ideal VAT with the existing system coexisting even under this regime.
5. Increased burden on retailers of Bookkeeping and compliance.
6. Multiplicity of rates of tax under the VAT regime.
7. Drop in revenue for the State Government, though there are no studies attributing such reduction to the system of taxation.
Central VAT (CENVAT)
The Modvat Scheme was replaced by a new set of rules called CENVAT Credit Rules 2002.
A manufacturer or producer of final product is allowed to take CENVAT credit of duties specified in the Cenvat Credit Rules , 2002.
( 1. The Cenvat Credit in respect of inputs may be taken immediately on receipt of the inputs.
2. The Cenvat credit in respect of Capital Goods received in a factory at any point of time in a given financial year shall be taken only for an amount not exceeding fifty percent of the duty paid on such capital goods in the same financial year and the balance of Cenvat Credit may be taken in any subsequent financial year.
3. The Cenvat credit shall be allowed even if any inputs or capital goods as such or after being partially processed are sent to a job worker for further processing, testing, repair etc. and it is established from the records that the goods are received back in the factory within180 days of their being sent to a job worker.
4. Where any inputs are used in the final products which are cleared for export, the Cenvat Credit in respect of the inputs so used shall be allowed to be utilised towards payment of duty on any final product cleared for home consumption and where for any reason such adjustment is not possible, the manufacture shall be allowed refund of such amount.)
MODVAT
Modvat stands for "Modified Value Added Tax". It is a scheme for allowing relief to final manufacturers on the excise duty borne by their suppliers in respect of goods manufactured by them. eg ABC Ltd is a manufacturer and it purchases certain components from PQR Ltd for use in manufacture. POR Ltd would have paid excise duty on components manufactured by it and it would have recovered that excise duty in its sales price from ABC Ltd. Now, ABC Ltd has to pay excise duty on toys manufactured by it as well as bear the excise duty paid by its supplier, PQR Ltd. This amounts to multiple taxation. Modvat is a scheme where ABC Ltd can take credit for excise duty paid by PQR Ltd so that lower excise duty is payable by ABC Ltd.
The scheme was first introduced with effect from 1 March 1986. Under this scheme, a manufacturer can take credit of excise duty paid on raw materials and components used by him in his manufacture. Accordingly, every intermediate manufacturer can take credit for the excise element on raw materials and components used by him in his manufacture. Since it amounts to excise duty only on additions in value by each manufacturer at each stage, it is called value-added-tax (VAT)
The modvat credit can be utilized towards payment of excise duty on the final product.
When the scheme was first introduced, it covered only some excisable goods. Gradually, the scope of the modvat scheme has been enlarged from time to time under various notifications. From 16 March 1995, all excisable goods can take the benefits.
Idea to include
Items Covered in Indian VAT
Some states like Delhi have imposed VAT on diesel at 20%, which is higher than the 12% sales tax charged earlier. Similarly, Delhi imposed VAT on LPG at 12.5%, which is also higher than the previous sales tax rate of 8 percent.
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 Indian 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 four per cent VAT in India.
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 in India, 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 Indian 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 one per cent but would not be entitled to input tax credit.
What is the difference between Sales Tax and VAT?
VAT is levied on all goods & services while sales tax is only levied on goods. Thus, a lower tax rate is needed to collect the same amount as sales tax. VAT has no cascading effect. The VAT mechanism of auto-control reduces tax evasion, therefore enhancing income tax collection. VAT is levied at import.
What is input tax?
Input generally mean goods purchased by a dealer in the course of his business for re-sale or for use in the manufacture, processing, packing/storing of other goods or any other business use. The tax paid on inputs is known as Input Tax. It has been defined in Section 2(xvii) of the Model VAT Bill, 2003 thus: "Input tax means the tax paid or payable under this Act by a registered dealer to another registered dealer on the purchase of goods in the course of business for resale or for manufacture of taxable goods or for use as containers or packing material or for the execution of works contract."
What is input tax credit?
It is the credit for tax paid on inputs. Every dealer has to pay output tax on the taxable sale effected by him. The basic formula of VAT is that every dealer pays tax only on the value addition in his hands. In simple words input tax credit is the mechanism by which the dealer is enabled to set off against his output tax, the input tax. Dealers are not eligible for input tax credit on all inputs. There are certain restrictions and conditions on the eligibility of input tax credit as it is stipulated in the respective State legislation.
What are the `sales' not liable to tax under the VAT Act?
Since the VAT Act applies only to sales within a State, the following sales shall not be governed by the VAT Act:
a) sale in the course of inter-State trade or commerce which shall continue to be liable to tax under the Central Sales Tax Act, 1956;
b) sale which takes place outside the State; and
c) sales in the course of export or import.
Who is a retail dealer?
Retail dealer is not specifically defined in most of the draft VAT legislation of States. To some extent, a dealer will be considered to be engaged in the business of selling at retail if 9/10ths of his turnover of sales consists of sales made to persons who are not dealers and if any question arises as to whether any particular dealer is a retailer, then the officer in charge shall be refered for.
In the VAT regime, will stock transfer be more beneficial than inter-State sale?
In so far as a decision as to whether goods should be stock transferred and then sold to customers by the branch or should direct inter-State sales be effected, there can be no generalisation. The decision has to be taken on a VAT impact analysis of each individual business.
The tax implications to be considered are:
In the case of inter-State sale, the buying dealer has to pay a non-VATable CST while the selling dealer will get the benefit of input tax credit.
- In the case of stock transfer, though there is no tax on the inter-State movement, the input tax credit will be restricted to the tax paid on inputs in excess of 4 per cent.
Tags:-VAT notes, VAT in INDIA
