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Implementation of Value Added Tax In India: Advantages And Disadvantages

Value-added tax, popularly known as VAT, belongs to the family of sales taxes. A general sales tax and turnover tax can be compared with value-added tax. A general sales tax is a tax on sales transactions but it is applied at only one stage of business activity right from the manufacturer to the retailer. A turnover tax is imposed at each sale transaction. Consequently, a turnover tax tends to increase the final sale value to the consumer cumulatively.

VAT is a tax not on the total value of the good being sold, but only on the value added to it by the last seller. The seller is liable to pay a tax on the net value added by him in the process of production, i.e. gross value minus the value of inputs or commodities purchased from other firms. The basic difference between VAT and a sales tax is that the tax liability under VAT is split up into stages.

VAT is distinguished from turnover tax where each transaction is taxed on its gross value, in contrast to tax on net value added as in VAT. A VAT can be designed to have different forms, exemptions, and rates. The popularity of VAT with authorities is mainly due to its administrative advantages. It is much easier to assess tax liability of a firm by using the credit method.

There is also a greater scope for cross-checking of returns submitted by firms hence it helps in checking tax evasion. A general VAT is supposed to be neutral to the resource allocation forms of production and business organization. In contrast, a turnover tax encourages vertical integration of production so as to avoid the intermediary sales and taxes, and to acquire a competitive advantage over others. It is argued that VAT avoids cost-cascading effect. A conventional sales tax leads to compounding of tax liability, while VAT does not. The use of VAT helps a country in encouraging its exports. In order to get a competitive edge over others, a country may refund the taxes paid on the export goods.

VAT’s applicability has serious limitations especially for underdeveloped countries. VAT is a complicated system and needs honest and efficient government machinery to do cross checking and link up various production activities and the resulting tax liability of each firm. It is, therefore, necessary that the country adopting should also be sufficiently advanced in its financial and economic structure and the firms should be in the habit of keeping proper accounts. The system is highly uneconomical; especially for the smaller firms it requires them to maintain elaborate and costly accounts.

The Indirect Taxation Enquiry Committee in its report in 1977 examined the feasibility of VAT system. It came to the conclusions that under our administrative and other circumstances, we should be cautious in adopting this tax form. It recommended its adoption, on an experimental basis, in a phased manner, to a limited number of manufacturing industries. VAT has been introduced by all States/UTs by now.

Uttar Pradesh is the latest which has introduced VAT on January 1, 2008. To avoid double taxation and tax cascading and have a simple and progressive taxation system for goods as well as services, it is proposed to introduce a combined national level goods and services tax (GST) which is now implemented. This is similar in concept to state VAT for goods. It provides for input tax credit at every stage for tax already paid till the previous transaction. This will also attempt to provide a rational system by subsuming several State and Central level indirect taxes on goods and services.

Silent Features of VAT:

  1. Rate of Tax VAT proposes to impose two types of rate of tax mainly:
    I) 4% on declared goods or the goods commonly used.
    II) 10-12% on goods called Revenue Neutral Rates (RNR). There would be no fall in such remaining goods.
    III) Two special rates will be imposed1% on silver or gold and 20% on liquor. Tax on petrol, diesel or aviation turbine fuel are proposed to be kept out from the VAT system as they would be continued to be taxed, as presently applicable by the CST Act.
  2. Uniform Rates in the VAT system, certain commodities are exempted from tax. The taxable commodities are listed in the respective schedule with the rates. VAT proposes to keep these rates uniform in all the states so the goods sold or purchased across the country would suffer the same tax rate. Discretion has been given to the states when it comes to finalizing the RNR along with the restrictions. This rate must not be less than 10%. This will ensure by doing this that there will be level playing fields to avoid the trade diversion in connection with the different states, particularly in neighbouring states.
  3. No concession to new industries Tax Concessions to new industries is done away with in the new VAT system. This was done as it creates discrepancy in investment decision. Under the new VAT system, the tax would be fair and equitable to all.
  4. Adjustment of the tax paid on the goods purchased from the tax payable on the goods of sale. All the tax, paid on the goods purchased within the state, would be adjusted against the tax, payable on the sale, whether within the state or in the course of interstate. In case of export, the tax, paid on purchase outside India, would be refunded. In case of branch transfer or consignment of sale outside the state, no refund would be provided.
  5. Collection of tax by seller/dealer at each stage. The seller/dealer would collect the tax on the full price of the goods sold and shows separately in the sell invoice issued by him.
  6. VAT is not cascading or additive though the tax on the goods sold is collected at each stage; it is not cascading or additive because the net effect would be as follows: the tax, previously paid on the sale of goods, would be fully adjusted. It will be like levying tax on goods, sold in the last state or at retail stage.

Advantages of VAT:

  1. Simplification: Under the CST Act, there are 8 types of tax rates1%, 2%, 4%, 8%, 10%, 12%, 20% and 25%. However, under the present VAT system, there would only be 2 types of taxes 4% on declared goods and 10-12% on RNR. This will eliminate any disputes that relate to rates of tax and classification of goods as this is the most usual cause of litigation. It also helps to determine the relevant stage of the tax. This is necessary as the CST Act stipulates that the tax levies at the first stage or the last stage differ. Consequently, the question of which stage of tax it falls under becomes another reason for litigation. Under the VAT system, tax would be levied at each stage of the goods of sale or purchase.
  2. Adjustment of tax paid on purchased goods: Under the present system, the tax paid on the manufactured goods would be adjusted against the tax payable on the manufactured goods. Such adjustment is conditional as such goods must either be manufactured or sold. VAT is free from such conditions.
  3. Adjustment of the purchased goods would depend on the amount of tax that is payable: VAT would not have such restrictions. CST would not have the provisions on refund or carry over upon such goods except in case of export goods or goods, manufactured out of the country or sale to registered dealer. Similarly, on interstate sale on tax-paid goods, no refund would be admissible.
  4. Transparency: The tax that is levied at the first stage on the goods or sale or purchase is not transparent. This is because the amount of tax, which the goods have suffered, is not known at the subsequent stage. In the VAT system, the amount of tax would be known at each and every stage of goods of sale or purchase.
  5. Fair and Equitable: VAT introduces the uniform tax rates across the state so that unfair advantages cannot be taken while levying the tax.
  6. Procedure of simplification: Procedures, relating to filing of returns, payment of tax, furnishing declaration and assessment are simplified under the VAT system so as to minimize any interface between the tax payer and the tax collector.
  7. Minimize the Discretion: VAT system proposes to minimize the discretion with the assessing officer so that every person is treated alike. For example, there would be no discretion involved in the imposition of penalty, late filing of returns, non-filing of returns and late payment of tax or nonpayment of tax or in case of tax evasion. Such system would be free from all these harassment
  8. Computerization: VAT proposes computerization which would focus on the tax evaders by generating Exception Report. In a large number of cases, no processing or scrutiny of returns would be required as it would free the tax compliant dealers from all the harassment which is so much a part of assessment. The management information system, which would form a part of integral computerization, would make the tax department more efficient and responsive.

Disadvantages of VAT:

  1. Discouraging Spending: Opponents of the income tax sometimes point out that taxing income has the perverse effect of dissuading people from earning it. If the country started to tax spending, it could create an incentive to spend less and save more, because savings would be tax free. This could have a recessionary effect on the economy if spending declines significantly.

  2. Repressiveness: Proponents of a progressive tax system in which the more you make, the more you pay, are opposed to the VAT because it is inherently regressive. Generally speaking, the poorer a person is, the more likely they are to spend, rather than save, their money. This means that a higher proportion of a low-earning person’s income would be subject to VAT than that of a high-earner’s income.
  3. Determining VAT Policy: One of the ways to mitigate the regressive nature of the VAT is to tweak the items that are subject to it. For example, excluding energy or rent from the VAT could lessen its impact on poorer people. To this end, Ireland excludes food, medicine and children’s clothing from its VAT. Of course, determining which items are subject to VAT and which aren’t can become a complicated process that is prone to political wrangling.
  4. The Double Whammy: By itself, a VAT doesn’t necessarily increase or decrease government tax revenue. Depending on how it’s implemented, it could have any of these effects. However, when VATS came into vogue in Europe, they were added to existing income taxes. This greatly increased both the income tax burden and the level of spending in most European countries. If a VAT is instituted without the abolition of the income tax, it could have the same impact here.

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