By – Vinay Kumar Shraff,

B.Com(H), FCA, AICWA, ACS, ADV. Dip in Mgt. Acct. – CIMA(London)

VAT – Concept & Implications

Value Added Taxation as the name suggests is a tax on value addition. In its purest
form, VAT is a tax that is levied on the value added along different stages of
production and distribution of a commodity or service. However India has a federal
structure and some taxes can only be levied by states while others by Centre. Power
to tax domestic production, known as Cenvat or Central Excise Duty & inter state
sales, known as Central Sales Tax is vested with the Centre & power of taxing intra
state sales, known as local sales tax vests with the states. The local sales tax forms the
main source of revenues for states, comprising about 60 to 70 percent of the total tax
revenue of the states.

From an administrative viewpoint, the VAT is levied more easily at the national level
because of the phenomenon of interstate trade that complicates matters at the state
level. However, given that sales taxes constitute the most important source of the
states’ revenue, divesting them of the power of sales taxation would grievously erode
their fiscal autonomy.

Alternatively, the Centre could vacate the domestic trade tax (i.e. Central Sales Tax &
Excise) field and leave it to the states to operate a destination based VAT in a
harmonized way. That option also does not seem to be feasible, as it would have very
serious negative repercussions of the Centre’s revenue and its capacity to undertake
regional distribution, unless there is a major compensating shift in its powers and
functions. Further, the centre has already advanced in the use of the VAT principle in
its excise taxation.

Hence the VAT system which is being implemented in India can be called dual VAT
system as the Central VAT (or CENVAT) on domestic production will continue to be
levied by Centre & local sales tax currently being levied in India will be replaced by
State VAT. Which means a manufacturer will pay both Central Excise duty as well as
local VAT for sale of his product within the jurisdiction of a particular state & a
wholeseller & retailer will pay only local VAT for sale within the jurisdiction of a
particular state. Now the question arises as to what will happen to Central Sales Tax.
CST will be eliminated in a phased manner over a period of three years.

The objective of this write up is to discuss about the State VAT which is going to be
implemented in India with effect from 1st April, 2005 replacing the local sales tax.
The concept of VAT is not align to Indian trade & industry as the concept of VAT was
introduced at manufacturing level way back in 1986 known as MODVAT or Modified
Value Added Tax. It was termed as MODVAT as the concept of VAT as was prevalent
in Europe was modified to restrict it only to manufacturing stage in India .
 Before we go on discuss State VAT, it is essential to discuss in brief the concept of
VAT through following illustration:-

Illustration

Let us assume Selling price of a product is Rs.100/- & tax rate is 10%. ‘A’ supplies
the product to ‘B’ at Rs. 110/-, which includes tax of Rs. 10/-. ‘B’ supplies the same to
‘C’ at Rs. 150/-, the value added is only Rs. 50/- hence under the VAT scheme, the tax
would be payable only on Rs. 50/- by ‘B’. However under the present scheme of State
VAT taxation being implemented in India & as is prevalent in European countries, ‘B’
would pay tax on Rs. 150/- but he will get credit of tax on his purchase. Which means
in the above example he will get a tax credit of Rs. 10/- while he will pay tax of Rs.
15/-, which effectively means he pays tax of Rs. 5/- only. This system of tax credit
gives greater control over series of transactions to taxing authority.

What will be the mechanism of availing input tax credit?

Tax credit will be allowed to a registered dealer, manufacturer as well as works contractor
for tax paid on all his purchase of goods in the normal course of business for resale or for
manufacture of taxable goods or for use as containers or packing material or for
execution of works contract.

Input tax credit will also be allowed to a manufacturer on Capital Goods used in the
manufacturing and processing of taxable goods. However input tax credit as admissible
shall commence from the date of commercial production and shall be adjusted against tax
payable on output over a period of three years.

However it is to be noted that only goods purchased from VAT registered dealers within
the jurisdiction of a particular state will be eligible for input tax credit. Input tax credit
will not be eligible on inter state purchases which means input tax credit will not be
allowed against Central Sales Tax .

There may be situation where purchases are partially used for sale in respect of exempt
goods and partially for sale in respect of taxable goods. In such a situation input tax credit
will be allowed proportionately to the extent inputs and capital goods have been used
towards taxable sale. However if the purchases are made with the intention of using them
towards taxable sale & accordingly input tax credit is availed but subsequently the
purchases are utilised towards exempt transactions then proportionate tax credit availed
shall be reversed.

Is there any requirement of a one to one correlation between input tax and output
tax?

There is no need for a one to one correlation between input tax and output tax which
means input tax credit will not be required to be adjusted against output tax on a bill to
bill basis.
What record will be required to be maintained for availing input tax credit?

Tax credit will be allowed only against the tax invoice containing the following
particulars on the original as well as copies thereof –

a) the word ‘tax invoice’ in bold letter at the top or any prominent place;
b) the name, address and registration certificate number of the selling registered
dealer;
c) the name, address and registration certificate number of the purchasing dealer;
d) an individual serialised number and the date on which tax invoice is issued;
e) description, quantity, volume and value of goods sold and amount of tax charged
thereon indicated separately;
f) signature of the selling dealer or his servant, manager or agent, duly authorised by
him;
g) the name and address of the printer, and first and last serial number of tax
invoices printed and supplied by him to the dealer.
Further every registered dealer will be required to maintain a true and up to date account
of the value of goods purchased or manufactured or sold by him in stock and in addition
he will have to keep such registers and accounts and in such form as may be prescribed
by respective VAT legislation of a particular state.

Will input tax credit be available in case of stock transfer ?

Input tax credit in respect of goods used for transfer of stock other than by way of sale
outside the jurisdiction of a particular state will not be allowed. However input tax credit
may be allowed on tax paid in excess of 4% on the raw materials used directly in the
manufacture of the finished products.

Can input tax credit be utilised against payment of Central Sales Tax?

It has already been stated above that input tax credit will not be allowed against inter state
purchases which means neither tax paid in one state will be allowed as tax credit in
another state nor tax credit will be allowed against Central Sales Tax. Now the question
arises as to whether input tax credit will be allowed on local purchases i.e. State VAT of a
particular state against Central Sales Tax. The answer is input tax credit will be allowed
against local purchases used in inter state sale. Moreover any input tax credit lying
unutilised at the end of a tax period, after paying his tax liability towards sale within the
jurisdiction of a particular state, will be allowed to be adjusted against tax liability, if any,
under the Central Sales Tax Act, 1956 at the option of the dealer, for the said tax period,
and only remaining amount of tax Central Sales Tax will be payable. Any amount of
credit remaining after such adjustment shall be carried forward to the next tax period.
Eligibility of tax credit on stock of goods as on the date of implementation of VAT
i.e. 1/4/2005

A dealer will be eligible for tax credit on stock of goods only for the stock purchased
since a date specified prior to 1/4/2005. The rate of tax applied shall be the rate of tax
under the VAT Act or the tax rate actually paid whichever is lower. Some of the States
have provided that the credit will be available only when the tax is charged in the
purchase bill. Andhra Pradesh has provided that tax credit will be available as per the
formula to be prescribed even if the tax is not specified in the purchase bill. The dealer
will be required to maintain the original invoice and such other records as may be
specified in the respective State VAT Acts. The dealer will be required to file a stock
statement within a short period of 7 days to 15 days after 01/04/05 of goods on which
input tax credit is claimed.

Exemptions

Concessions have been granted by the Government in the form of tax exemption for
specified periods. In some cases, tax exemption has been granted on sales as well as
purchase of raw materials/machinery by the units. All exempted units will switch over
to deferment of sales tax. The implication of conversion of concession to deferral are
a) The unit will get the benefit of input tax credit. If the concession had continued
input credit would not have been available.
b) The purchasing dealer will get input credit, which would not have been available,
if the concession had continued.
Zero Rating on Exports
Zero Rating means that the tax payable on sale of a commodity is fixed at 0%. Though
apparently, it looks similar to an exempt transaction, there is a significant difference
between the two. While in an exempt transaction, the tax paid on input lapses (or cannot
be set off), under the Zero rated sales, prior stage tax is set off against the 0% tax paid,
and effectively the entire tax paid on purchases is eligible for refund. Thus 'Zero Rating'
is advantageous to the dealer compared to 'exempting' of sale transactions. Generally
Export Sales are zero-rated and thereby, exporters are granted refund of taxes paid by
them on their inputs. Exporters gain significantly due to the 'Zero Rating' concept under
VAT.
Implications of VAT
Transition from sales tax to VAT will pose significant challenges for industry & trade.
Impact will be marginal for small/ medium scale units with localised presence but it
could be substantial for large organisations with all India presence. Some key issues
which requires attention on transition to VAT are:-

a) Inventory Management leading to 1.4.2005

The invoice and other records as have been specified in respective VAT Acts should be
maintained in accordance with the law. The inventory records shall be kept updated &
proper arrangements should be made for stock taking on 31.3.2005 so that statement of
stock can be filed with the 7 to 15 days as required in the respective VAT Acts. Further
purchase from exempted units & unregistered dealers should be looked into as the same
may not be eligible for tax credit.

b) Procurement

The issue of procuring the goods from within the State or outside the State is to be
addressed. Though commercial consideration as to the quality of the goods, the
dependability of the supplier, cost and other factors are relevant, the tax incidence is a
factor to be considered.

c) Pricing

Due to multi point levy under VAT, the price to the ultimate buyer may be higher in some
cases, than at present with the levy of tax on the value addition at each point of sale and
resale . The possibility of passing on the additional cost to the ultimate buyer depends on
the elasticity of supply and demand. If the price increase cannot be passed on to the
ultimate buyer the manufacturer or the trader will have to absorb the price increase
depending again upon supply/demand elasticity.

d) Distribution

Under VAT input tax credit of raw materials used in the manufacture of goods for stock
transfer will be restricted to that paid in excess of 4%, hence an economic analysis of
stock transfer to depots vs. direct inter state sale will have to be made.

e) Accounting / Software

The costing/ accounting software deed to be redesigned for valuation of stock, costing of
products, accounting for inputs & tax credits, adjustment of tax credit on sale etc.
Further it will be useful if software can be designed to generate a list of stock on which
input tax credit will be available on 1/4/2005.