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What is VAT? And why VAT

Salil Panchal/Morpheus Inc. in Mumbai | April 12, 2003

Value-Added Tax, one of the most radical reforms to be proposed for the Indian economy, could finally become a reality after four years of political and economic debate.

Yet, the biggest hurdle before the government is not making India 'a common market' through a uniform sales tax structure, but removing a complicated tax structure that also allowed for fraudulent practices.

The decision to introduce VAT was publicly discussed first at a conference of state chief ministers and finance ministers in November 1999. At that time, the deadline of April 2002 was agreed upon to bring in VAT.

However political instability and a lack of initiative pushed this reform to the backburner.

Now a year later, despite a backlash from the trading community and some political circles, there appears to be a realistic scope for VAT to be introduced.

Twelve states have so far passed legislation to implement the VAT regime and of these five have sent their Bills for Presidential assent.

Let us explore VAT and what it means.

What is VAT and why is it so critical?

VAT is a sales tax collected by the government (of the state in which the final consumer is located) which is the government of destination state on consumer expenditure.

Over 120 countries worldwide have introduced VAT over the past three decades and India is amongst the last few to introduce it.

India already has a system of sales tax collection wherein the tax is collected at one point (first/last) from the transactions involving the sale of goods. VAT would, however, be collected in stages (instalments) from one stage to another.

The mechanism of VAT is such that, for goods that are imported and consumed in a particular state, the first seller pays the first point tax, and the next seller pays tax only on the value-addition done leading to a total tax burden exactly equal to the last point tax.

Why VAT is necessary

India, particularly the trading community, has believed in accepting and adopting loopholes in any system administered by the state or the Centre.

If a well-administered system comes in, it will close avenues for traders and businessmen to evade paying taxes. They will also be compelled to keep proper records of their sales and purchases.

Many sections hold the view that the trading community has been amongst the biggest offenders when it comes to evading taxes.

Under the VAT system, no exemptions will be given and a tax will be levied at each stage of manufacture of a product. At each stage of value-addition, the tax levied on the inputs can be claimed back from the tax authorities.

At a macro level, there are two issues, which make the introduction of VAT critical for India.

Industry watchers say that the VAT system, if enforced properly, forms part of the fiscal consolidation strategy for the country. It could, in fact, help address the fiscal deficit problem and the revenues estimated to be collected could actually mean lowering of the fiscal deficit burden for the government.

The International Monetary Fund, in its semi-annual World Economic Outlook released on April 9, expressed its concern over India's large fiscal deficit at 10 per cent of the GDP.

Further any globally accepted tax administrative system, will only help India integrate better in the World Trade Organisation regime.

Retail community protests

Small businessmen and traders are likely to be badly hit by the new system as many of them have used loopholes in the current system to avoid paying taxes.

A section of the retail community went on strike last week stating that some anomalies linked to the proposed VAT system have not been addressed.

A high-power committee, including senior state finance ministers, had pointed out the anomaly to the government last year. "However, the Centre continues to ignore the suggestions and this makes our situation only more difficult," a member of the retailers' association in Mumbai says.

Sources in the sales tax department say that some issues will need to be ironed out in coming months. "The government is looking at the whole issue through a single dimension (of collecting revenues). The retail community will be hit by the multipoint VAT system. This is a complex system and may create more confusion," he said.

No extra paperwork for retailers

There are, however, sections of the VAT system which ensure lesser paperwork for the retail community. There will be no local statutory forms under VAT. The existing sales tax system requires dealers to maintain an account of sales and purchases, and the VAT system also requires maintenance of only such accounts.

Further, the Central Sales Tax Act would be amended and there would be a single-page return form common for local and central Acts. The return would be required to be filed quarterly, as is being done currently.

Some states against VAT

The state government concerns may be seen as political lobbying.

Since large sections of the trading community have protested against VAT, both the Bharatiya Janata Party and the Congress have not made any categorical statements for or against VAT. Instead they have tried to befriend the trading community.

The BJP has always been seen as supportive of the cause of the trading community at large. The ruling government has very effectively pushed the onus of responsibility onto the state governments (as it is a state-related issue). Further, each party sings a different tune in different states.

VAT would mean higher revenues to the financially hit states in the country.

It would also mean less tax evasion and more earning for the states. But, no political party can afford to ignore the agitating trading community, which becomes a vexed issue for the political parties.

Part II: Who benefits from VAT?

Part III: VAT deadline may extend to July

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