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VAT: WHITE PAPER

1.Design of State-Level VAT:

1.1
As already mentioned, the design of State-Level VAT has been worked out by the Empowered committee through several rounds of discussions and striking a general balance between the common points of convergence regarding VAT and flexibility for the local characteristics of the states. Since the state level tax is centred on the basis of ‘set-off’ for the tax paid earlier, the needed common points of convergence also relate to this concept of set-off/input tax credit, it’s coverage and related issues as elaborated below.

1.2 Concept of VAT and Set-off/Input Tax Credit:
The essence of VAT is in providing set-off for the tax paid earlier, and this is given effect through the concept of input tax credit/rebate. This input tax credit in relation to any period means setting off the amount of input tax by a registered dealer against the amount of his output tax. The Value Added Tax (VAT) is based on the value addition to the goods, and the related VAT liability of the dealer is calculated by deducting input tax credit from tax collected on sales during the payment period (say a month).
If for example, input worth Rs.1, 00,000/- is purchased and sales are worth Rs.2, 00,000/- in a month, and input tax rate and output tax rate are 4% and 10% respectively, then input tax credit /set-off and calculation of VAT will be as shown below.

a.
Input purchased within the month: Rs.1, 00,000
  b. Output sold in the month: Rs.2.00, 000
  c. Input tax paid: Rs.4, 000/-
  d. Output tax payable: Rs.20, 000/-
  e. VAT payable during the month after set-off/input tax credit [(d)-(c)]:     Rs.16, 000/-

1.3
Coverage of Set-off/Input Tax Credit:


This input tax credit will be given for both manufacturers and traders for purchase of input / supplies meant for both sale within the state as well as to other states, irrespective of when these will be utilised/sold. This also reduces immediate tax liability.
Even for stock transfer /consignment sale of goods out of the state, input tax paid in excess of 4% will be eligible for tax credit.

1.4 Carrying over of Tax Credit:

If the credit exceeds the tax payable on sales in a month, the excess credit will be carried over to the end of next financial year. If there excess unadjusted input tax credit at the end of second year, then the same will be eligible for refund.
Input tax credit on capital goods will also be available for traders and manufacturers. Tax credit on capital goods may be adjusted over a maximum of 36 equal monthly instalments .The states may at their option reduce this number of instalments.
There will be a negative list for capital goods (On the basis of principles already decided by the Empowered committee) not eligible for input tax credit.

1.5 Treatment of Exports, etc:

For all exports made out of the country, tax paid within the state will be refunded in full, and this refund will be made within three months. Units located in SEZ and EOU will be granted either exemption from payment of input tax or refund of the input tax within three months.

1.6 Inputs procured from Other States:
Tax paid on inputs procured from other States through inter-State sale and stock transfer will not be eligible for credit. However, a decision has been taken for duly phasing out of inter state sale tax or Central sales tax. As a preparation for that, a comprehensive inter state tax information exchange system is also being set up.

1.7 Treatment of Opening Stock:

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. Resellers 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 available over a period of 6 months after an interval of 3 months needed for verification.

1.8 Compulsory Issue of Tax invoice, Cash memo or Bill:

This entire design of VAT with input tax credit is crucially based on documentation of tax invoice, cash memo or bill. Every registered dealer, having turn over of sales above an amount specified, shall issue to the purchaser serially numbered tax invoice with the prescribed particulars. This tax invoice will be signed and dated by the dealer or his regular employee, showing the required particulars. The dealer shall keep a counterfoil or duplicate of such tax duly signed and dated. Failure to comply with the above will attract penalty.

1.8 Compulsory Issue of Tax invoice, Cash memo or Bill:

This entire design of VAT with input tax credit is crucially based on documentation of tax invoice, cash memo or bill. Every registered dealer, having turn over of sales above an amount specified, shall issue to the purchaser serially numbered tax invoice with the prescribed particulars. This tax invoice will be signed and dated by the dealer or his regular employee, showing the required particulars. The dealer shall keep a counterfoil or duplicate of such tax duly signed and dated. Failure to comply with the above will attract penalty.

1.9 Registration, Small Dealers and Composition Scheme:

Registration of dealers with gross annual turnover above Rs. 5 lakh will be compulsory. There will be provision for voluntary registration. All existing dealers will be automatically registered under the VAT Act. A new dealer will be allowed 30 days time from the date of liability to get registered.
Small dealers with gross annual turnover not exceeding Rs. 5 lakh (or such limit as may be fixed by the States) will not be liable to pay VAT. States will have flexibility to fix threshold limit within Rs.5 lakh.
Small dealers with gross annual turnover not exceeding Rs.50 lakh who are other wise liable to pay VAT, shall however have the option for a composition scheme with payment of tax at a half percentage of gross turnover. The dealers opting for this composition scheme will not be entitled to input tax.
Registered VAT dealers whose turnover is above Rs. 50 Lakh should collect and pay VAT as per the rules.

1.10 Tax Payer’s Identification Number (TIN):

The Tax Payer’s Identification Number will consist of 11 digit numerals throughout the country. First two characters will represent the State Code as used by the Union Ministry of Home Affairs. The next nine characters may be different in different States.

1.11 Return:

Under VAT, simplified form of returns will be notified. Returns are to be filed monthly/quarterly as specified in the State Acts/Rules, and will be accompanied with payment challans. Every returns furnished by dealers will be scrutinised expeditiously within prescribed time limit from the date of filing the return. If any technical mistake is detected on scrutiny, the dealer will be required to pay the deficit appropriately.

1.12 Procedure of Self-Assessment of VAT Liability:

The basic simplification in VAT is that liability will be self assessed by the dealers themselves in terms of submission or returns upon setting off the tax credit. Return forms as well as other procedures will be simple in all states. There will no longer be compulsory assessment at the end of each year as exists now. If no specific notice is issued proposing departmental audit of the books of accounts of the dealer within the time limit specified in the Act, the dealer will be deemed to have been self-assessed on the basis of returns submitted by him. Because of the importance of the concept of self-assessment in VAT, provision for ‘self-assessment’ will be stated in the VAT bills of the states.

1.13 Audit:

Correctness of self-assessment will be checked through system of departmental Audit. A certain percentage of dealers will be taken up for audit every year on a scientific basis. If however, evasion is detected on audit, the concerned dealer may be taken up for audits for previous years. This audit wing will remain delinked from tax collection wing to remove any bias. The audit team will conduct its work in a time bound manner and audit will be completed within six months.
Simultaneously, a cross checking, computerised system is being worked out on the basis of coordination between the tax authorities of the State Governments and the authorities of Central Excise and Income Tax to compare constantly the tax returns and set-off documents of VAT system of the state and those of Central Excise and Income Tax. This comprehensive cross checking system will help to reduce tax evasion and also lead to significant growth of tax revenue. At the same time, by protecting transparently the interests of tax complying dealers against the unfair practice of tax – evaders, the system will also bring in more equal competition in the sphere of trade and industry.

1.14 Declaration Form:

There will be no need for any provision for concessional sale under the VAT Act since the provision for set-off makes the input zero-rated. Hence, there will be no need for declaration form, which will be a further relief for dealers.

1.15 Incentives:

Under the VAT system, the existing incentive schemes may be continued in the manner deemed appropriate by the State after ensuring the VAT chain is not affected.

1.16 Other Taxes:

As mentioned earlier, all other existing taxes such as turn over tax, Surcharge, Additional Surcharge and Special addition tax (SAT) would be abolished. There will not be any reference to these taxes in the VAT bills. The states that have already introduced entry tax and intend to continue with this tax should make it vatable. Entry tax will need to be abolished. However his will not apply to entry tax that may be levied in lieu of octroi.

1.17 Penal Provisions:

Penal provisions in the VAT bill should not be more stringent than in the existing Sales Tax Act.

1.18
In general all the goods, including declared goods will be covered under VAT and will get the benefit of input tax credit.
The only few goods which will be outside VAT will be liquor, lottery tickets, petrol, diesel, aviation turbine fuel and other motor spirit since their prices are not fully market determined. These will continue to be taxed under the Sales Tax Act or any other State Act or even by making special provisions in the VAT Act itself and with uniform floor rates decided by the Empowered committee.

1.19 VAT Rates and Classification of Commodities:

Under the VAT system covering about 550 goods, there will be only two basic VAT rates of 4% and 12.5%, plus a specific category of tax-exempted goods and a special VAT rate of 1% only for gold and silver ornaments etc. Thus the multiplicity of rates in the existing structure will be done away with under the Vat system. Under exempted categories, there will be about 46 commodities comprising of natural and unprocessed products in unorganised sector, items which are legally barred from taxation and items which have social implications. Included in this exempted category is a set of maximum of 10 commodities flexibly chosen by individual states from a list of goods (Finalised by the Empowered committee), which are of local social importance for the individual states without having any inter-state implications. The rest of the commodities in the list will be common for all the states. Under 4%VAT rate category, there will be largest number of goods (about 270), common for all the states comprising of items of basic necessities such as medicines and drugs, all agricultural and industrial inputs, capital goods and declared goods. The schedule of commodities will be attached to the VAT bill of every state. The remaining commodities common for all the states will fall under the general VAT rate of 12.5%. In terms of decision of the Empowered committee, VAT on AED items relating to sugar, textile and tobacco, because of initial organisational difficulties, will not be imposed for one year after the introduction of VAT, and till then the existing arrangement will continue. The position will be reviewed after one year.

1.20 Effects of the VAT System:

The Empowered Committee has carefully worked out this design of State-level VAT after repeated interactions with the States and others concerned and striking a federal balance between the needed convergence and federal flexibility as well as ground level reality. If now all the components of the VAT are taken together, then it will be seen that the total effect of this VAT system will be to rationalise the tax burden and bring down, in general, the price level. This will also stop unhealthy tax-rate war and trade diversion among the states, which had adversely affected interests of all the states in the past. Moreover this VAT design will also significantly bring in simplicity and transparency in the tax structure, thereby improving tax compliance and eventually also the revenue growth, as mentioned in the beginning.

2.Steps Taken by the States:

2.1
It is now of significance to note that most of the states, after collective interaction in the Empowered Committee, have either already modified or agreed to modify their VAT bills by incorporating this common points of convergence including flexibility as mentioned in the VAT design above, and are also taking other preparatory steps towards introduction of VAT from April 1,2005.

2.2
As part of the preparatory steps, the states have started the process of preparing the draft of VAT rules, including Books of Accounts to be maintained. The objective will be to keep these as simple as possible so that it becomes easy for a small trader to comply with the requirements.

2.3
Moreover, the states have initiated, and in many cases also completed, steps for computerisation up to the levels of assessing officers and also at the check posts. This process will continue since this is extremely important for document-based verification and integration with Taxation Information Exchange System as well as with information of the Central Excise and Income Tax systems as indicated earlier.

2.4
It may be mentioned here that the Government of India is also releasing appropriate Central funds for VAT related computerisation in the North-Eastern states.

3.Releated Issues:
3.1 While the states have thus taken several steps towards introduction of VAT, certain supporting decisions were critically needed at the national level for more effective implementation of VAT from April 1,2005.

3.2
It needs to be carefully noted that although introduction of VAT may, after a few years, lead to revenue growth, there may be a loss of revenue in some states in the initial years of transition. It is with in view that the Government of India had agreed to compensate for 100% of the loss in the first year, 75% of loss in the second year and 50% of the loss in the third year of introduction of VAT, and the loss would be computed on the basis of an agreed formula. This position has not only been reaffirmed by the Union Finance Minister in his Budget Speech 2004-2005,but a concrete formula for this compensation has also now been worked out after interaction between the Union Finance Minister and the Empowered Committee.

3.3
As mentioned earlier, there is also a need, after introduction of VAT, for phasing out of Central Sales Tax (CST). However, the states are now collecting nearly Rs.15000 crore every year from CST.There is accordingly a need of compensation from the Government of India for the loss of revenue as CST is phased out. Moreover, while CST is phased out there is also critical need for putting in place a regulatory frame-work in terms of Taxation Information Exchange System to give a comprehensive picture of inter-state trade of all commodities. As already mentioned, this process of setting up of Taxation Information Exchange System has already been started by the Empowered Committee and is expected to be completed within one year. The Empowered Committee will review the position regarding CST during 2005-2006 and suitable decision on the phasing out of CST will be taken.

3.4
It is also essential to bring imports in to the VAT chain. Because of the set-off, this will not result in any tax cascading effect, but will only improve tax compliance. A proposal for VAT on imports, including the collection mechanism with adequate safeguards for the protection of interest of land-locked states, is being discussed with the Government of India.

3.5
Similarly discussion between the Empowered committee and the Government of India is going on for an early decision on the question of collection and appropriation of service tax by Central and the States.
If decision on VAT on imports and service tax are taken expeditiously at the national level, then these two important spheres of taxation can be integrated, along with the AED items as mentioned earlier, in to the VAT system of the states from the second year of introduction of VAT.

3.6 It may be noted that this VAT design has been worked out carefully by the Empowered committee to strike a balance not only between the common points of convergence and federal flexibility, but also a balance between what can be done to begin with and what should be incorporated subsequently for further perfection of the VAT system.

3.7
For successful implementation of State-level VAT, close interaction within trade and industry is especially important. The Empowered Committee has therefore also set-up a consultative committee with one representative from each of the national level trade organisations and national level chambers of commerce and industry. This committee has already started interacting with the Empowered Committee. This process of interaction will continue regularly to discuss issues and sort out problems of implementation of VAT. Such consultative committees will also be set up at the level of each state, and interaction with the State Government will take place in a similarly regular manner.


3.8
In the course of discussion with representatives of trade and industry, reference has often been made to the earlier VAT bills of some of the states. It should be clearly noted, as already mentioned before, that all the states have agreed to amend their earlier VAT bills so as to conform broadly to the common design as elaborated in this White Paper. This process of amendment has also started. The point of reference on VAT should therefore be this design of VAT as explained in this white paper. It should also be mentioned that there are some important points on the ground level implementation of VAT, which have been raised by the representatives of trade and industry. Many of the points will be taken care of in the Vat rules of the state, with changes wherever necessary.


3.9
Finally, a comprehensive campaign on State-Level VAT will be launched to communicate in simple and transparent manner the benefit of VAT for common people, traders, industrialists and also the State Governments. This campaign will then be launched first at the national level on the basis of necessary coordination between the States and Centre. This will then be simultaneously followed up at the level of every State and also in districts of the states. This campaign will be based on written materials as well as publicity through all media. The purpose of this campaign will be a two-way interaction between the Government and the trade and industry as well as the common people.


There is now only looking forward to the introduction of State-level VAT by all the states and Union Territories from April 1,2005. We seek cooperation of all sections of the people in the country.

There is now only looking forward to the introduction of State-level VAT by all the states and Union Territories from April 1,2005. We seek cooperation of all sections of the people in the country.

 


 
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