Value Added Tax (VAT) and its Impact on Revenue Generation in India

By | October 23, 2017
Value Added Tax

Last Updated :

INTRODUCTION

Indirect tax system plays an important role in the economic development of a country by influencing the rate of production and consumption. The Government of India has after committing to the World Trade Organization (WTO) regime, decided to modernize and streamline its indirect taxation, in the light of the experience of other WTO member countries. Value Added Tax (VAT) means the tax which is payable only on value-added. It is multi-point tax system but without the effect of double taxation.

Value is added to the products, which an organization buys from other organizations such as raw materials, partly finished goods etc. After buying the organization applies its own labor and machine to manufacture the final products. VAT is a tax, which is imposed at every stage of production ie., from production level to retail level. Under VAT tax is calculated on value Added where value added is the difference between sales value and purchase value.

The VAT as a system of tax, conceptually, has been of great interest among the early writers in public finance. In this research, project researcher tries to explain the concept of VAT, their procedures, challenges among the Indian environment and opportunities, which are available under this regime. Initially, all states were to move to VAT system by 2000, but administrative problems and concern over the revenue implications of the change delayed the scheduled implementation. It was postponed five times before implementation. In fact, the introduction of a full-fledged VAT in India seems to present numerous administrative and constitutional difficulties, including the vexed question of Union-State relations.

In addition to this, implementing VAT in India in context of economic reforms has paradoxical dimensions. On one hand, economic reforms have led to more decentralization of expenditure responsibilities which in turn demands more decentralization of revenue raising powers if fiscal accountability is to be maintained. But on the other hand, the process of implementation of VAT can lead not only to revenue loss for the states but can also steal away the autonomy of the state indicating more centralization. Thus, the need is to develop such a “Federal Friendly Model” of VAT (along with a suitable compensation package) that can be implemented in India without compromising federal principles.

Definition – Value Added Tax

Value added tax in simple terms could be defined “as a tax on the value addition at different stages of manufacturing and distribution of goods and services”. It is a form of indirect tax in the nature of a multi-point sales tax with a set-off or credit for tax paid on purchases/services. Each transaction of goods sold in the course of business is taxed, thus providing revenue to the government on value addition at each stage.

Objectives of value added taxes

The primary objective is in the forefront of the evolution of value added tax Law, the State must ensure that barriers to inter-state trade should be eliminated in order to create a unified national market. It will agree that the VAT process must be simple, transparent, and consistent in structure and approach[1].

METHOD OF COMPUTING VAT

Value added tax is levied in principle on the value of goods and services produced. Value added tax for a given period is equivalent to all income- wages and salaries, rent, interest, and profit generated in the production of the aggregate output. A VAT never differs from a general tax on incomes of firms rather than individuals who ultimately receive income are responsible for paying the tax to the government. There are three methods for computing an individual firm which includes the addition, the creditor invoice and subtraction method. The first method-addition presents computing the VAT base is to sum the firm’s payments of wages, salaries, interest, rent, and profits.

These payments represent the firms’ contribution to the value of the economy’s output in the period or value added. The base multiplied by the tax rate indicates the amount owed the government in value added taxes[2]. The second method of subtraction method computes each firms value added as sales less purchases of raw material inputs from other businesses. The third method of credit or invoice computes the tax by applying the tax rate to sales and then subtracting taxes paid on the purchase of components. The computation of VAT in European countries is usually computed by the credit method.

The term VAT has been described as some special rate for some goods and services. Various categories of economic activity have been exempted in European countries to simplify the administrative procedure, the banking and the financial institutions offer services to which the value added concept is generally difficult to apply and are exempted from tax which includes governmental and educational services, medicine, transportation, communication products, and services.

In developing countries, considered necessities of life are taxed at lower rate than the base rate while the luxury items are taxed at higher than basic rates[3].

EFFECTS ON THE INDIAN SOCIETY

The Value added is the value that a producer (whether manufacturer, distributor, advertising agent, farmer etc.) adds to his raw materials, or purchases before selling the new or improved product or service. That is the inputs ( the raw materials, transport, rent, advertising and so on are brought, people are paid wages to work on these inputs and when final goods and services are sold some profit is left. As the term indicates, it is a tax imposed on value addition of the goods in a chain of the transaction from production, distribution, and retail.

A full-fledged VAT, in essence, an ad valorem tax on domestic final consumption levied at all stages of production and final point of sale. At each stage, the tax is confined only to value added. So, Vat is a tax not on the total value of the goods being sold but only on the value added to it by the seller. The seller is therefore liable to pay tax not on its gross value but on the net value, the gross value minus the value of the input. It is a multi-stage tax is being collected in installment. Therefore, VAT may be called as modified multipoint sales tax. In this calculation starts from Rs.10/- from a trader to retailer ends in Rs. 19/- showing a difference of Rs.9 the additional value being extra charged till it reaches the consumers by the retailers.

The importance of value added tax in India and other countries are due to the following accounting standards which include:

  1. Simple tax structure and transparency;
  2. Neutrality of tax with respect to behavior of consumer and of producer;
  3. Transparency of tax amount in cost of goods and zero rating of tax on exports are easily identifiable.
  4. Ability to provide same revenue to the Government with lower rates of tax.

Over the last few years, many attempts have been made to implement value added tax in India. Initially, all states were to move to value added tax system by 2000, but administrative problems and concern over the revenue implications of the change delayed the scheduled implementation. It has been postponed many times in the five years and was finally applicable in 2005.

IMPORTANCE OF VALUE ADDED TAX IN INDIA  

If a well-administered system comes in, it will not only close options for traders and business men to evade paying their taxes, but also make sure they will be compelled to keep proper records of sales and purchases. At the macro level, two issues make the production of VAT critical for India. Industry watchers believe that the value added tax system, if enforced properly, will help in addressing issues like fiscal deposits problems in India and create a high price market for the public[4].

Summarization of the current advantages of value added taxes

  1. Covering all the states in India,
  2. It leads to revenue security for the government,
  3. Selection of rates varies state to state due to diversified markets.

Disadvantages of the value added taxes at present:

  1. VAT is recognized as an integral activity,
  2. VAT is difficult to operate from the position of both administration and business,
  3. Leads to business inflation,
  4. It has been identified that value added tax favors capital-intensive firms that can meet the global challenges.

ARTICLES–SPOTTING VAT STATUS IN INDIA

  1. Times of India, 2010 Mumbai: This is a piece of news to go nuts about. The prices of dry fruits, including cashew nuts, almonds, and dates, will go up by 20% to 25% in the state after the government decided to increase the value added tax on dry fruits by 8.5% from the current 4%. Once this 12.5% value added tax is levied on the nuts, prices will also soar for ayurvedic medicines, for which dry fruits are used as ingredients. The State’s decision came in on March 31, after the presentation of the budget.
  1. Hindustan Times, 2009 New Delhi: More than 400 petrol dealers here remained closed on Monday in protest against the increase in the value added tax on diesel in the capital; Dealers argued that the increase in Value added tax from 12.5 to 20%, has made diesel costlier by Rs. 3.50 in Delhi, as compared with Haryana leading to a loss of almost 30 to 35% of business for petrol dealers. The worst affected were the 150 odd petrol pumps that are located on the borders of Haryana and Uttar Pradesh.
  1. Express line, 2007, Jammu: With the VAT Bandh again, the medicine and chemist shops closing down from Monday till Friday. Though no prior notice has been given to the government, the chemists and druggist say that the closure has been forced, since the government is not responding and the State government has not issued any such prior notice so far regarding tax charges.

The articles in the newspaper, show how society is affected by the imposition of value added tax in India. The common people who are the daily earners are the most sufferers. Sometimes, such impositions anger burst out into the form of strike, hartal, and bandh affecting peace and harmony of the society. The common people are the most sufferers as they remain entangled in meeting essential commodities for their living which include rent tax, food tax, education tax, loan tax, medicine tax, entertainment tax, fare tax etc To maintain these standards the people sometimes engage themselves in activities leading to theft, fraud, cheating, and embezzlement in the environment.

EFFECTS OF VALUE ADDED TAXES ON SOCIETY

One of the important components of tax reforms initiated since liberalization is the introduction of value added tax. VAT is a multidimensional based system of taxation, with tax being imposed on value addition at each stage of a transaction in the supply chain. After independence, India embarked on rapid development to eradicate the extreme poverty that has affected the transaction in the supply chain. After independence, India embarked on rapid development to eradicate the extreme poverty that has affected the economy.

The state was given an interventionist role for achieving optimum growth and to quickly accomplish an economic transition from an underdeveloped to a developed country. This required the government to collect the surplus funds were available and to mobilize them for rapid development which is included by the name of direct and indirect taxes. In India, income tax, corporation tax, wealth tax are examples of direct taxes whereas, customs, excise and sales taxes are examples of indirect taxes.

Thus, those who are considered to be too poor to pay direct taxes because their incomes are low are also forced to pay taxes. The idea is that at each stage of production and distribution, there is value addition and a part of that should be given to the government for social development.

The rates of taxes charged differ from area to area as per policy. With the upcoming of the Mall system and International services in India like VLCC, Mc Donalds, Sub Foodways etc. charge a hefty amount from the public in the namesake charging as per government order. The medium and lower class people that are not aware of these accounting techniques face difficulties in the ascertainment of rates for a good or service. In order to maintain a better value added tax system in India, it is necessary to maintain a dual process of maintaining invoices, bills by the seller and the purchaser.

“VAT is already levied differentially on food and drink; more VAT is charged to drink coffee on the premises than to take it away”, writes Sheron, an adviser to the Commons health select committee’s inquiry into alcohol earlier this year. “If this policy was applied to alcohol but was reversed – say, for example, reducing the VAT for on-sales from 20 to 12% – it would be possible to increase the rate of duty to compensate for this without increasing the price of alcohol in pubs.”

INDIAN POSITION

India is a federal state. Thus, the powers of taxation are divided between the Centre and State. In India’s indirect Tax system, the Central government has the authority to impose excise duties on production or manufacture while the States are assigned the power to levy sales tax. In addition, States are empowered tax on many other goods and services in the form of entry tax, octroi, entertainment tax, electricity duty, motor vehicles tax. Inside newspapers, we read about the high prices charged for products and services like airfares, food products, petrol, entertainment etc. is affecting people in a positive way leading to contribution for nation and humanity. The quotation of famous personalities which show the impact of value added tax in India Chidambaram to State Governments:

“on behalf of the Centre, I promise to fully cooperate with you, compensate you and help in building a computer network system and resolve all problems” (Ramesh Chandra Secretary of the Federal Panel)

“Value added tax will be launched tomorrow (April 1) and there is absolutely no question of deferring it.” (World Bank Country director Michael Carter)

“A comprehensive value added tax widens tax net, as it makes tax evasion difficult going by the experience of other countries, value added tax has proved beneficial and leads to remove buoyancy”.

These comments by renowned personalities help in understanding the technicalities of the accounting and taxations.

THREATS UNDER VAT THAT IS RECOGNIZED AS PER INDIAN PERSPECTIVE

The Indian consumer is more burdened with financial crunch and price inflation. The poor are the most sufferers and their purchasing power is low. They have to earn hard to live a standard life, at one’s blood and sweat. The concept of small and working family has emerged in the cities, towns and even in villages where both the partners are working to support themselves and their family. In the rural areas, the men move out to cities in search of employment and the females look after the activities of the household. In such a situation the imposition of a heavy tax is feasible or the tax rates should be subsidized to avoid criminal activities such as murder, theft, fraud, embezzlement in the society.

It is not only the consumer who are hit hard by the value added tax charges but the intermediaries involved in the chain, from producer to retailers have to pay taxes to the government and meet the legal and accounting standards to present a fair picture of their businesses[5].

From the consumer’s end:

  1. Incorrect usage of non-VAT memos,
  2. Use of fake bills to counter purchases made from unregistered dealers or dealers,
    3. Adjustment of inter-state with purchases made local.

From the seller’s end:

  1. Unauthentic bills,
  2. Classification of goods for applicability of special additional tax,
  3. Classification of goods to identify,
  4. Underpricing of goods sold.

The general public is affected by tax rates simultaneously, as rich class people are only able to bear the burden.

Issues concerning the effects of VAT

The consequences of adopting VAT or any tax change have effects on inflation, income distribution, resource allocation, economic growth and nations balance of payment depends upon the specific forms of tax and the accompanying circumstances. Many believe tax to be a regressive tax. The objective is to encourage the economy’s potential for and achieve economic growth. VAT as a direct tax tends to increase the nation’s exports than imports. The VAT is also considered advantageous to the balance of trades.

VALUE ADDED TAXES CAN BE ACCOUNT BASED

By the method of collection, value added tax can be account-based. Under the accounting method of collection, each seller charges value added tax rate on his output and passes the buyer a special invoice that indicates the amount of tax charged. Buyers who are subject to value added tax on their own sale, consider the tax on the purchase invoices as input tax and can deduct the sum from their own value added tax liability. Cash basis accounting is a very simple form of accounting.

When a payment is received for the sale of goods or services, a deposit is made, and the revenue is recorded. as of the date of the receipt of funds no matter when the sale had been made “Question: A is a trader selling raw materials to a manufacturer of finished products. He imports his stock in trade, as well as purchase the same in the local markets. If the rate of VAT is assumed to be 12.50% would pay tax as under.*”

FINANCIAL IMPACT OF VALUE ADDED TAX ON DIFFERENT SECTORS- DISCUSSION

Standard value added tax rate in India

In India, the standard rate is 14%, while the reduced rates are 4, 1 and 0. Presently, there are two basic rates of VAT in India namely 4 and 12.5% effective from 1st April 2005. Apart from this, there is an exempt category and a special rate of 1% for a few selected items. In the exempt category, items of basic necessities and goods of local importance have been put up[6]. The value added tax is charged differently in the products/manufacturing and service industry.

The examples will provide the clear picture of VAT charges in India.

The value added tax is charged differently in the products/manufacturing and service industry. The examples will provide the clear picture of VAT charges in India. Here, the Figure 3 presents how service industry charges VAT are affecting the ignorant customers and ultimately society. The issue is that common man is unaware of the financial terminologies and calculations. In the case of the production industries, the process starts from the purchase of raw material, manufacturing and finally selling.

Manufacturer/Producer

The manufacturer would be required to purchase raw material after paying full tax on the rate applicable on such material. Unlike the present system wherein the manufacturer can purchase the goods at a concessional rate of tax against the declaration form no. which will be required to be issued by the manufacturer[7]. The input tax suffered by him would be adjusted off from the sale of the finished product. Here, the calculation made by the manufacturer as VAT is calculated by deducting tax credit from tax collected during the payment period.

Wholesaler

The wholesaler who purchases goods in large quantities from the producer or manufacturer has the responsibility, in turn, to charge VAT rate from the consumer for the price paid. The wholesaler sells the product at a lower price in comparison to the retail price to promote the sale of the bulk commodity.

Trader / Retailer

The trader would be required to collect tax on the sales made by him and the tax liability would be set off or adjusted from the purchase or input tax credit of the goods locally purchased by the consumers. The third intermediary in the supply chain has the most effective role of maintaining a good relationship with the customers[8]. They directly deal with the regular customers the prices charged by them includes retailer, government and producer share.

Consumers

The consumers, the ender user are overburdened with the high VAT paid by them due to product or service reaching to them is through the channel of intermediaries.

The common public is ignorant of the taxation techniques and finds it difficult to calculate the selling price of a commodity. It is required that the customers collect invoice at every purchase to maintain an authenticity in the system[9].  The government has imposed VAT laws in 2006 for every individual intermediary in the supply chain to pay indirect tax as per fixed in law.

For example, in the furniture industry (product/ manufacturing industry) at every purchase by the manufacturer from raw material procurement, cutting, designing and manufacturing tax is charged at each level.

  1. Raw material (wood) purchase (VAT charged),
  2. Manufacturing of furniture (VAT charged again),
  3. Selling price (VAT charged third time).

In the name of government law, to charge rate at every process. The price hike has emerged as a big issue in the Indian society, where people work hard to meet their daily requirements. They are charged thrice for a commodity at 12.5%.  In today’s scenario, the role of direct purchase and hyper marketing is growing in India.

The scope of direct sales through malls has emerged as a big market, leading to the elimination of intermediaries in the supply chain thus reducing the per value added services charged from the consumers. These markets are the solution to the traditional marketing system in India to overcome the hike in prices of the commodities and services. The traditional supply chain has been replaced by the new system of marketing through super bazaars, sub malls so that consumers have more choice to buy the varied products. The price charged by them not only included the VAT charge, but also service charge and showroom costs which add more cost to the product.

These markets have emerged as a supermarket to the public as the role of direct selling is encouraged leading to mitigation of additional cost and risk in the process of transferring goods from one place to another (Government of India, 2005).

Stocks

A stock statement is required to be furnished as prescribed for the quarter ending and then monthly from January to March. Set-off of tax paid stocks would be given. Tax paid stocks as on march ending would be the basis for claiming set off under the new value added tax Act[10].

Export

Export would be zero-rated. Tax paid on raw material used in the manufacture of goods for export would be refunded by the State Government in cash \ adjustment. The exports would become more competitive in the world market as there would be no tax henceforth on the raw material used for the manufacture of goods for export[11].

PROBLEMS OF IMPLEMENTATION OF VALUE ADDED TAX IN INDIA

In this study, it is found that there are a number of problems to introduce Value Added Tax on commodities in different states in India, but in this paper, only major problems have been taken which are facing by different states for imposing of the VAT, as follows:

  • Billing: The main problem of the VAT is billing because billing is essential for traders to get the rebate on inputs. Without billing it is difficult to get a rebate on inputs. The billing of the commodities must be a separate entry of basic price and sales tax, so, therefore, traders get the rebates but it is very difficult for the traders to pass the separate entry of basic price and sales tax.
  • Lack of Uniformity: In India, there are a number of States which had already implemented VAT, but some States have not agreed to impose VAT in their state. In this situation, it is very difficult for inter-state transactions of the commodities, because of those states, which are not implementing, VAT in their state they prefer to buy goods from those States that are not implementing VAT.
  • Concession for New Industry: Central Government announced concession for new Industries, which are to be established in rural areas. After the establishment of industries in rural areas, the government does not give any concession for such an industries. Practically the government does not make any provision for the concession of such an industry. The government announced concession for new industries only in the air not in practice.
  • Number of Taxes imposed by the Government: The main problem of Value Added Tax are other taxes which are imposed by the State Government due to economic problems of the state. Although traders are ready to pay VAT they are having demand that government should remove other taxes i.e. Entry tax, Octroi, Toll tax, Local body tax etc.
  • Lack of infrastructure facilities: In VAT billing is essential for the traders but it is difficult to maintain the infrastructure, computers, etc. facilities for the same. In rural areas and even in urban areas do not have such sufficient infrastructure facilities because India is a developing country and have a scarcity of finance and technology etc.
  • Dealing in Variety of Goods: Most of the traders in India deals in a variety of goods in their shops. Different commodities have different VAT rates. In that situation it is very difficult for a traders to maintain billing on VAT on their goods, for example a trader deals consumables items, as well as durable items in their shop, a consumer purchase one item of both the Variety of both the items, have separate rate of VAT in that situation it is very difficult in billing of VAT.

EVALUATION OF VALUE ADDED TAX IN INDIA

Value Added Tax is a tax on consumption. It is a multi-point levy collected in installments at each stage of production and distribution. The final and total burden of this tax are borne by the domestic consumers of goods and services. Being a tax on domestic consumption on VAT is charged on goods exported from the country. Value Added Tax is levied on the sellers of goods and services based on value added by their respective units.

The base for VAT is determined by Value added at a particular stage of production or distributions. In other words, inputs of a firm are not taxed at each point the firm has reimbursed the tax which it has already paid at the time of purchasing the inputs, thus there is no cascading effect.

The indirect system plays an important role in the economic development of a country by influencing the rate of production and consumption. The Government of India has after committing to the World Trade Organisation (WTO) regime, decided to modernize and streamline its indirect taxation, in the light of the experience of other WTO member countries.

The government has availed of the services of the international management-consulting firm Authur Andersen for drafting of Rules, Procedures, and Forms for the introduction of the VAT. Value Added Tax is prevalent in over 120 countries. In India, the introduction of VAT would be a historic reform of the domestic trade tax system. It is expected to facilitate the State and Union Territories to transit successfully from the Sellers, while sales tax system to a modern domestic tax system.

SUGGESTIONS

To improve the existing weakness in VAT system some policy measures are suggested which are as follows:

  • Coordination reforms should be undertaken at the central, State, and local levels. A major objective should be the minimization of distortion and compliance cost. In fact, the sub-nation tax system should be revised so that the principles of a common market are not violated. Taxes on domestically traded goods and services should be coordinated in the spirit of cooperative federalism. Domestic and external trade taxes should also be coordinated to ensure the desired burdens of consumption taxes on the community are achieved.
  • Broadening the base of both central and state taxes and keeping the tax structure simple-within the administrative capacity of the governments is an important international lesson that should be incorporated in further reform. Phasing out an exemption for small-scale industry, maintain exemptions and concessions to industries in the services sector and minimize discretion and selectively in the tax policy and administration are all important not only for further soundness of the tax system but to enhance its acceptability and credibility[12].
  • Overall transparency of tax collection for the VAT regime has increased compared to the sales tax regime. So, VAT implementation should be more encouraged by providing the necessary administrative machinery for better functioning of this system.
  • VAT features are highly competent to allot a benefit to the government. So the channel of distribution and flow of VAT must be reformed.
  • The most important reform in the tax administration is making the transition to information- based tax administration, online filing of tax returns, compiling and matching information are key to administrative reform. Tax administrator should assist taxpayers in a timely fashion and help to reduce their compliance costs.

CONCLUSION

Value added tax would change the nature of trade in the coming years, but the medium level of trade would face problems as the companies would reduce the tier of marketing. Similarly, small retail dealers would be required to maintain more accounts or pay composition money which cannot be collected from the customers. The present provision of central sales tax and Value added tax cannot go together.

After the abolition of central sales tax, the direct marketing concept may gain ground and the necessity of having a warehouse, godowns etc. in all states may decrease or finish. Value-added tax in India has been introduced in modified variants over the past two decades. However, value-added tax in its original form is yet to be introduced in India, at Central or State level.

After the negative and positive impact on the Indian consumers, Value added tax has been identified as the real goal maker by the Indian government in the coming years to foster growth and prosperity in the country. The change in the standard of livings has increased the purchasing power of the high-class society but the medium and the poor class society has to work hard in order to achieve there living and meet extravagances.

– L. Sanmiha

Content Writer @ Legal Bites


References

[1] NCAER (2009). “Moving to Goods and Services Tax in India: Impact on India’s Growth and International Trade”, Thirteenth Finance Commission, Government of India.

[2]Purohit MC, Vishnu KP (2009). “Goods and Services Tax in India: Estimating Revenue Implications of the Proposed GST”, Thirteenth Finance Commission, Government of India.

[3] Rao MG (1998). “Model Statute for Value Added Sales Tax in India”, New Delhi. Business School, pp. 104-114.

[4] Shankar (2005). “Thirty Years of Tax Reform in India.” Economic and Political Weekly.

[5]Hossain SM (2003). “ Poverty and social impact analysis: A suggested framework.”IMF Working Paper, WP/03/195, October.

[6]Agha A, Haughton J (1996). Designing VAT system some efficiency consideration: The review of economics and statistics. MIT Press, 78(2): 303-308.

[7] Glen P, Jenkins HJ, Chun YK (2006). Is the value added tax naturally progressive? Queens Economics Department Working Paper, No. 1059.

[8]Ravi YK (2005). Value added taxes issues and concerns. The Institute of Chartered Accountants of India, pp. 1616-1618.

[9] Bibi S, Jean–Yves D (2004). “Poverty – Decreasing indirect tax reforms: Evidence from Tunisia.” CIRPEE Work. Pap., 04-03, Department of Economics, University, Laval.

[10] Mahesh CP (2001). National and sub-nationals of VAT’S – A road map for India. Jstor, Econ. Polit. Wkly, p. 757.

[11]Kavita R (2008). Goods and services tax for India, National Institute of Public Finance and Policy, New Delhi. Work. Pap., 57: 2-6.

[12] Government of India (2005). “A white paper on State level. Value added tax” Ministry of Finance, Empowered Committee of State Finance Ministers, January.

Author: Keshav

He is a scholar of Masters in Diplomacy, Law, and Business at Jindal School of International Affairs; a law graduate; an ardent and passionate writer; an enthusiastic learner; a liberal opinionist, a workaholic, a night owl, and a humble, witty character.

  • Shrikant M says:

    Nice Article. However, VAT has been already replaced with GST so we are waiting for the article from your side on the GST too….