Part I: What is Vat? And why VAT

Part II: Who benefits from VAT?

Senior finance ministry officials of key states and expert committee members after a recent meeting have confirmed the implementation of Value-Added Tax from June 1, 2003.

With this move, Kerala, Maharashtra, Andhra Pradesh and Orissa have agreed to implement the VAT system.

. . .but several still to finalise details

The states of Delhi, Uttar Pradesh, Rajasthan, Uttaranchal, Haryana, Kerala, Madhya Pradesh and Tamil Nadu are in the process of implementing VAT though it is not clear whether the June 1, 2003 deadline will be met.

Since it is a political issue, these states have placed the responsibility on the neighbouring states, saying that since these states are unlikely to implement VAT regime with immediate effect, they will be unable to implement the same in their own states.

How will VAT be implemented?

One of the key issues relating to the implementation of VAT has been ironed out. The government recently clarified that it will compensate those states for the loss of revenue from reduction of the central sales tax once the VAT regime commences.

Apart from avoiding the cascading effect of taxes and huge tax evasions from the trading community, the introduction of VAT is expected to increase revenues as the coverage expands to value-addition at all stages of sale in the production and distribution chain.

As discussed earlier, India already has a similar tax regime in place. There are some common features with the existing sales tax system, which could make the process of implementation smoother.

Currently, an inter-state retailer (seller) can purchase goods freely (without paying tax) by just filling up statutory forms. Under VAT, he has to pay the local tax, but this would be fully set off from his central sales tax liability.

In case the CST liability is less than the local tax paid, this amount is adjusted against his other VAT liability or can be claimed as refund.

In the case of a manufacturer, local tax is levied on purchases and an equal amount is set off against the sales tax liability on finished goods.

Thus, the only change is the procedure to collect the local sales tax.

In VAT, as with the current system, there will be no local sales tax/VAT levied on inter-state sales or exports. Similarly, in case of inter-state purchase or imports, there will be no set off since no local tax has been paid on such transactions.

In the present system, many traders dealing in goods that are distributed from a particular state are facing problem of double taxation because of withdrawal of footnote facility.

Under VAT, there would be no double taxation as the entire local sales tax levied on the purchases of an inter-state seller is allowed to be set off against the central liability.

Differences: In VAT, all local sales will attract VAT liability. There would be no difference whether one sells to a dealer or the final consumer. He will be charged the same tax, which is equal to the rate of tax applied on the sale price.

Another difference is that, currently, all taxes charged are to be paid to the department. However, under VAT, the seller deducts the tax already paid on the purchases from the tax charged from the customer and pays the balance to the department.

Service tax and VAT

Service tax is likely to witness a major change in the VAT regime. The government has said that it is willing to transfer service tax revenues to the states to compensate for possible revenue losses on account of VAT implementation.

According to a Confederation of Indian Industry representative, there are issues which need to be clarified.

"The industry must take initiatives and contribute towards the implementation of VAT. And it is not just the industry/trade associations or large corporations which need to be concerned. The smaller industries and small and medium enterprises must also show their interest get involved in the process of VAT implementation," he says.

VAT software, accounting systems

A computerised tax collection system and administration system will need to be in place even as VAT is introduced.

India has already developed a VAT software framework to usher in a VAT regime. The software is to be based on the tax-invoice method and in conformity with accepted international practices.

The software is being implemented and tested in Andhra Pradesh, Assam and Maharashtra.

It has check-post information system to monitor intra-state and inter-state goods management and also turnover tax and central sales tax.

The software built is to facilitate easier adoption in the prevailing conditions. This is essential because the VAT regime is to be adopted across the country at one go.

"This may become the single largest hurdle if the government is looking for a specific deadline. It is not a state issue, so the planning procedure could extend towards July 1,"an industry source said.

As with the central sales tax system and income tax, it would involve computerisation of the necessary administrative departments concerned and pave the way for a transparent and smooth tax paying process.

VAT panel need

Experts have called for the creation of a VAT Council (or a permanent suitable alternative) vested with adequate powers, to take action against discriminatory taxes and practices and eliminate barriers to free flow of trade and commerce.

As with other tax regimes, the government will have to consider not just state, but national-level administrative systems, an independent council and even tribunals would have to be explored to ensure stability and continuity of VAT.

The international experience

The experiences of developing regions such as Argentina, Brazil, Columbia, Ghana, Indonesia, Thailand, Southern Mediterranean Region and Zambia are for India to learn from.

In Brazil, which has a federal set up like India, the federal and state governments levy VAT. The issue of distribution of revenue between the federal government and the originating and consuming states still remains an issue though the VAT regime was implemented in the 1970s.

The system appears to have failed in the African nation of Ghana, when first introduced in 1995 due to inadequate preparation and failure to educate the people concerned.

Implementation of VAT in Indonesia and Thailand has been a success story due to careful planning and simple system of record keeping, tax rates and tax administration.

The consequent high compliance levels and revenue buoyancy had even led to a reduction in corporate taxes.

The larger nations like China, some central and eastern European countries, and Russia too have implemented VAT.

In federal economies such as Argentina, Austria, Germany and Mexico, VAT is centrally administered with a revenue sharing mechanism.

In the United Kingdom, VAT was introduced in 1973 at a standard rate of 10 per cent. There are sections of UK's industries which say that the VAT system has become more complicated.

It is a tax on consumer expenditure, therefore businesses (where they are VAT registered and fully taxable) do not bear the final costs of VAT. They are able to charge VAT on the supplies that they make (output VAT) and recover VAT on purchases that they have made (input VAT).

What will change by June 1?

Not much, considering the lethargy with which decisions on controversial issues are taken. Thus, one should not take the June 1 deadline as sacrosanct and the process could be delayed by a few weeks.

However, the industry and the corporate view appears to be positive and this is crucial for VAT to succeed.

Another positive is that some of the other states will have time to iron out differences at the political level and educate factions of the trading community, which feels that the monitoring (and corruption at the department level) would increase.

The next two to three months will provide time to the expert committees and senior finance ministry officials to test the software and accounting system for VAT.

What would critically help is a large-scale education platform for the trading community and the consumer at large, who would wish to understand the complete details relating to VAT.

It must be noted that in the UK, Germany, and the Eastern European countries, the Internet and print media have been used effectively, with specialised VAT-related consultancy available through these media.