Basic Concept of VAT

Can you tell me basic concept of VAT ?

VAT works on the principle that when raw material passes through various manufacturing stages and manufactured product passes through various distribution stages, tax should be levied on the ‘Value Added’ at each stage and not on the gross sales price. This ensures that same commodity does not get taxed again and again and there is no cascading effect. In simple terms, ‘value added’ means difference between selling price and purchase price. VAT avoids cascading effect of a tax.

Basically, VAT is multi-point tax, with provision for granting set off (credit) of the tax paid at the earlier stage. Thus, tax burden is passed on when goods are sold. This process continues till goods are finally consumed. Hence, VAT is termed as ‘consumption type’ tax. VAT works on the principle of ‘tax credit system’.

What is meaning of ‘cascading effect of tax ?

Generally, any tax is related to selling price of product. In modern production technology, raw material passes through various stages and processes till it reaches the ultimate stage e.g., steel ingots are made in a steel mill. These are rolled into plates by a re-rolling unit, while third manufacturer makes furniture from these plates. Thus, output of the first manufacturer becomes input for second manufacturer, who carries out further processing and supply it to third manufacturer. This process continues till a final product emerges. This product then goes to distributor/wholesaler, who sells it to retailer and then it reaches the ultimate consumer. If a tax is based on selling price of a product, the tax burden goes on increasing as raw material and final product passes from one stage to other.

For example, let us assume that tax on a product is 10% of selling price. Manufacturer ‘A’ supplies his output to ‘B’ at Rs. 100. Thus, ‘B’ gets the material at Rs. 110, inclusive of tax @ 10%. He carries out further processing and sells his output to ‘C’ at Rs. 150. While calculating his cost, ‘B’ has considered his purchase cost of materials as Rs. 110 and added Rs. 40 as his conversion charges. While selling product to C, B will charge tax again @ 10%. Thus C will get the item at Rs. 165 (150+10% tax). In fact, ‘value added’ by B is only Rs. 40 (150–110), tax on which would have been only Rs. 4, while the tax paid was Rs. 15. As stages of production and/or sales continue, each subsequent purchaser has to pay tax again and again on the material which has already suffered tax. Tax is also paid on tax. This is called cascading effect.

How VAT avoids cascading effect of tax ?

System of VAT works on tax credit method. In Tax Credit Method  of VAT, the tax is levied on full sale price, but credit is given of tax paid on purchases. Thus, effectively, tax is levied only on ‘Value Added’. Most of the countries have adopted 'tax credit' method for implementation of VAT.

The aforesaid illustration will work out as follows under VAT system.

‘B’ will purchase goods from ‘A’ @ Rs. 110, which is inclusive of duty of Rs. 10. Since ‘B’ is going to get credit of duty of Rs. 10, he will not consider this amount for his costing. He will charge conversion charges of Rs. 40.00 and sell his goods at Rs. 140. He will charge 10% tax and raise invoice of Rs. 154.00 to ‘C’. (140 plus tax @ 10%). In the Invoice prepared by ‘B’, the duty shown will be Rs. 14. However, ‘B’ will get credit of Rs. 10 paid on the raw material purchased by him from ‘A’. Thus, effective duty paid by ‘B’ will be only Rs. 4. ‘C’ will get the goods at Rs. 154 and not at Rs. 165 which he would have got in absence of VAT. Thus, in effect, ‘B’ has to pay duty only on value added by him.

Illustration of tax credit method to avoid cascading effect – Following example will illustrate the tax credit method of VAT. 

Note - 'B' is purchasing goods from 'A'. In second case, his purchase price is Rs 100/- as he is entitled to VAT credit of Rs 10/- i.e. tax paid on purchases. His invoice shows tax paid as Rs 14. However, since he has got credit of Rs 10/-, effectively is paying only Rs 4/- as tax, which is 10% of Rs 40/-, i.e. 10% of  'value added'  by him.

What is Consumption Types of ‘VAT’?

In Consumption Type VAT, ‘Value Added’ is considered by deducting all purchases, raw materials and capital items.  Consumption type VAT is popular and it is adopted by most of the countries for following reasons : (a) Administration control is easy due to ‘credit method’ that can be adopted (b) It makes no distinction between capital intensive and labour intensive activities (c) Tax avoidance by classifying capital goods purchases as revenue purchases is avoided. (d) It is in harmony with the 'destination principle' (e) It simplifies tax administration as there is no need to distinguish between purchase of capital goods and consumption goods.

What is meaning of ‘Value added’?

 In the above illustration, the ‘value’ of inputs is Rs 110, while ‘value’ of output is Rs 150. Thus, the manufacturer has made ‘value addition’ of Rs 40 to the product. Simply put, ‘value added’ is the difference between selling price and the purchase price.

In the aforesaid example, the tax revenue which was earlier Rs 25 came down to Rs 14. As the number of stages increase, the revenue will further reduce. How this will be beneficial to Government ?

It is obvious that tax revenue will go down in VAT system, if same rate of tax is maintained. Hence, VAT rate will have to be suitably increased to ensure that tax revenue does not reduce. This rate is termed as ‘Revenue Neutral rate’ (RNR). It is the VAT rate at which tax revenue remains same despite giving credit of duty paid on inputs.

RNR should be lower than present sales tax rate – Presently,  sales tax is levied by most State Governments at the first stage i.e. wholesale stage and no tax is levied at subsequent stage. However, in VAT system, tax will be collected at consumption stage, i.e. last stage. Thus, if today, sales tax rate is 15% on wholesale price of Rs 100, under VAT system, tax will be collected at consumption stage i.e. on retail price of (say) Rs 125. Thus, RNR will be lower than present sales tax rate of State Governments. It has been decided to levy sales tax at RNR of 12.5% for most of commodities.

Disadvantages of Cascading effect of taxes

A tax purely based on selling price of a product has cascading effect, which has the following disadvantages :

Computation of exact tax content difficult - It becomes very difficult to know the real tax content in the price of a product, as a product passes through various stages and tax is levied at each stage. This is particularly important for granting Export incentives or for fixing regulatory prices.

Varying Tax Burden - Tax burden on any commodity will vary widely depending on the number of stages through which it passes in the chain from first producer to the ultimate consumer.

Discourages Ancillarisation - Ancillarisation means getting most of the parts/components manufactured from outside and making final assembly. It is common for large manufacturers (like automobile, machinery etc.) to get the parts manufactured from outside and make final assembly in his plant. If a component is purchased from outside, tax is payable. However, if the same component is manufactured inside the factory, no tax would be payable. Thus, manufacturers are tempted to manufacture parts themselves instead of developing ancillary units for supply of the same. This is against the national policy, because it discourages growth of Small Scale Industry and increases concentration of economic power.

Increases cost of production - If a manufacturer decides to reduce ancillarisation, it increases cost of production and waste of scarce national resources, as the large manufacturer may not be in a position to fully utilise the production capacity of the machinery.

Concessions on basis of END use is not possible - Same article may be used for various purposes e.g. Copper may be used for utensils, electric cables or air conditioners. Government would naturally like to vary tax burden depending on use. However, this is not possible as when Copper is cleared from factory, its final use cannot be known.

Exports cannot be made tax free – Though final products which are exported, are exempt from tax, there is no mechanism to grant rebate of tax paid at the earlier stages on the inputs. - - It may be noted that as per WTO (World Trade Organisation) stipulations, exports can be made free of domestic taxes, but export incentives as such cannot be given.

Disadvantages of single point tax

Most of States have introduced single point sales tax to avoid cascading effect and also for convenience of collection. Sales Tax is usually collected at the first stage, i.e. at the manufacturing stage or on first sale after goods are imported from out of the country or are brought from out of the State. There is no tax at subsequent sales. The system of collecting tax only at first stage has following disadvantages -

What are advantage of VAT over conventional system of taxation ?

Advantages of VAT are as follows :

The disadvantage is that paper work required increases considerably and it is not as simple as a single point sales tax.

Destination principle - The advantage of ‘consumption type’ VAT is that tax burden is only at the last i.e. consumption stage. This is useful for taxation structure based on 'destination principle'. At all the earlier stages of production, there is no tax burden in view of the credit obtained when the inputs are used for production of final product. Thus, it becomes easier to give concessions to goods used by common man or goods used for manufacture of capital goods or exported goods and charge heavy duty on luxury goods.

What are advantages of State Level VAT ?

The advantages are as follows, as enumerated in para 2.20 of White Paper on State-Level VAT  –

CENVAT in Central Excise

Government had set up ‘Indirect Taxation Enquiry Committee’ in 1976 under chairmanship of Shri L K Jha. On the basis of recommendations of the Committee, VAT was introduced in 1986 in India in respect of Central Excise by way of Modvat (Modified Value Added Tax). It was termed as ‘modified’ as firstly, it is restricted to only Central Excise Duties and secondly, it is restricted only upto manufacturing stage and not beyond. Initially, Modvat was extended to inputs, and restricted to goods falling under 37 chapters of Central Excise Tariff. Coverage of Modvat was gradually increased and more and more chapters were added. Modvat was extended to capital goods in 1994. Modvat was renamed as Cenvat (Central Value Added Tax) w.e.f. 1-4-2000. Presently, Cenvat provisions are extended to all manufactured final products except matches. All inputs (except HSD, LDO and petrol) are eligible. Inputs may be used directly or indirectly. It may be present in the final product or may not be present in final product.

State Sales Tax VAT

Sales Tax is a State subject. Over the period, many distortions had come in taxation due to unhealthy competition among States by giving sales tax incentives and ‘tax rate war’ started to attract more revenue to State. Many steps were taken to remove the distortions and rationalise tax structure since 1999. It was decided to introduce uniform State Level VAT.

Introduction of VAT is difficult in India as sales tax is a State Subject and sales tax on sale within the State can be levied only by respective State Government. Even in respect of Central Sales Tax (CST), though the tax is levied under Central Act, the CST is collected in the State from which goods are sold, i.e. originating State and CST so collected is retained by that State only. The CST amount never goes to Union Government.

After lot of persuasion by Central Government, all States ultimately agreed to introduce State Level sales tax VAT at the conference of Chief Ministers all States at Delhi in November, 1999. A high power committee consisting of senior representatives of all 29 States was constituted under Chairmanship of Dr. Asim Dasgupta, Finance Minister, West Bengal. It was decided to introduce Sales tax VAT w.e.f. 1-4-2002. It was delayed on several occasions and finally, all State Governments (except UP, Tamil Nadu and few other States)  introduced State Sales Tax VAT w.e.f. 1-4-2005.

States ruled by BJP like Gujarat, Chhatisgarh, Jharkhand, Madhya Pradesh and Rajasthan had not introduced VAT. They have introduced Vat w.e.f. 1-4-2006. Tamilnadu has announced that it introduce Vat on 1-1-2007.

Uttar Pradesh and Uttaranchal also have not introduced VAT till April 2007. It is hoped that they will introduce VAT in due course.

A white paper indicating policy of State Level VAT was released on 17-1-2005. he discussions in following paragraphs is based on the White Paper which is a policy document. It is not binding on State Governments and each State will deviate from the policies as indicated in White Paper.

Will there be model law for all States ?

Though model law draft has been prepared, each State has made changes as per their needs. Though basic concepts are same in VAT Acts of all States, provisions in respect of credit allowable, credit of tax on capital goods, credit when goods are sold inter-state are not uniform. Even definitions of terms like ‘business’, ‘sale’, ‘sale price’, ‘goods’, ‘dealer’, ‘turnover’, ‘input tax’ etc. are not uniform.

Schedules indicating tax rates on various articles will also not be uniform, though broadly, it is expected to be same.

Please explain highlights of the State Sales Tax Vat.

The highlights are as follows - 

Tax Credit - Manufacturer will be entitled to credit of tax paid on inputs used by him in manufacture. A trader (dealer) will be entitled to get credit of tax on goods which he has purchased for re-sale [para 2.3 of White Paper on State-Level VAT).

Input Tax Credit - Credit will be available of tax paid on inputs purchased within the State. Credit will not be available of certain goods purchased like petroleum products, liquor, petrol, diesel, motor spirit (position of furnace oil is not clear].

No credit is available in case of inter-state purchases.

Credit of tax paid on capital goods - Credit will be available of tax paid on capital goods purchased within the State. Credit will be available only in respect of capital goods used in manufacture or processing. The credit will be spread over three financial years and not in first year itself. There will be a negative list of capital goods [para 2.4 of White Paper on State-Level VAT)

Instant credit – Credit will be available as soon as inputs are purchased. It is not necessary to wait till these are utilised or sold [para 2.3 of White Paper on State-Level VAT).

No credit of CST paid - Credit of Central Sales Tax (CST) paid on inputs and capital goods purchased from other States will not be available. [para 2.6 of White Paper on State-Level VAT). This appears to be discriminatory and violative of Articles 303 and 304(a) of Constitution, as discussed later.

Transitional Credit of stock as on 1-4-2005 - Input tax as already paid on goods lying in stock as on 1-4-2005 (which are purchased on or after 1-4-2004) will be available to dealer. Detailed stock statement will have to be submitted to sales tax authorities.. This credit will be available over a period of six months after an interval of 3 months need for verification  [para 2.7 of White Paper on State-Level VAT).

Very few sales tax forms – Most of present sales tax forms will disappear. [para 2.14 of White Paper on State-Level VAT) However, forms relating to EOU/SEZ may continue. Forms under CST Act will continue.

What will be tax rates ?

Ideally, VAT should have only one rate. Though this is not possible, it is certain that there should be minimum varieties of rates.  Broadly, following VAT rates are proposed [para 2.18 and 2.19 of White Paper on State-Level VAT)-

Is there any concession for small dealers ?

Floor rate of exemption – VAT tax will be payable only by those dealers whose turnover exceeds Rs five lakhs per annum. They can register on optional basis. Dealers having turnover exceeding 5 lakhs should register within 30 days from date of liability to get registered  [para 2.9 of White Paper on State-Level VAT)

Composition scheme for dealers with turnover upto Rs 50 lakhs - Small dealers having gross turnover exceeding Rs five lakhs but less than Rs 50 lakhs have option of composition scheme. They will have to pay a small percentage of gross turnover. They will not be entitled to any input tax credit. [para 2.9 of White Paper on State-Level VAT) The percentage has not been announced, but earlier, it was announced as 1%.

The scheme is optional. They can opt to pay normal VAT tax and avail credit of input tax.

What about turnover Tax, surcharge, additional tax etc. imposed by State Governments ?

Those taxes on sale will go. However, Octroi and Entry tax (which is in lieu of octroi) will continue. Other type of Entry Tax will either be discontinued or will be made Vatable [para 2.16 of White Paper on State-Level VAT) .

When the input credit will not be available ?

Credit of tax paid on inputs will be denied in following situations -

No credit if final product is exempt - Credit of tax paid on inputs is available only if tax is paid on final products. Thus, when final product is exempt from tax, credit will not be availed. If availed, it will have to be reversed on pro-rata basis.

No of credit if output goods are transferred to another State - If the final products are transferred to another State as stock transfer or branch transfer, input credit availed will have to be reversed on pro-rata basis, which is in excess of 4%. In other words, in case of goods sent on stock transfer/branch transfer out of State, 4% tax on inputs will become payable [It is not clear what will be the policy after CST is reduced to 2% or when CST is reduced to zero].

No input credit in certain cases - In following cases, the dealer is not entitled to input credit - (a) Inputs used in exempted final products (b) Final product not sold but given as free sample (c) Inputs lost/damaged/stolen before use. If credit was availed, it will have to be reversed.

Zero rated sale - Certain sales are ‘zero rated’ i.e. tax is not payable on final product in certain specified circumstances. In such cases, credit will be available on the inputs i.e. credit will not have to be reversed. Distinction between ‘zero rated sale’ and ‘exempt sale’ is that in case of ‘zero rated sale’, credit is available on tax paid on inputs, while in case of exempt goods, credit of tax paid on inputs is not available.

As per para 2.5 of White Paper on State-Level VAT, export sales are zero rated, i.e. though sales tax is not payable on export sales, credit will be available of tax paid on inputs. In respect of sale to EOU/SEZ, there will be either exemption of input tax or tax paid will be refunded to them within three months.

If supplies to EOU/SEZ are exempt from sales tax, then the question will arise whether these are ‘zero rated’ or ‘exempt goods’.

One to one correlation not required - The total input credit available can be utilised for payment of tax on any output. It is not necessary to establish one to one correlation. However, if part of inputs are used in exempted final products, proportionate input credit will have to be reversed.

What are the procedural provisions ?

General procedural provisions are as follows -

Tax Identification Number - A system of audit checks will have to be established to keep check on bogus invoices. One essential requirement is to give TIN (Tax Identification Number) to all registered dealers, so that a check is maintained that (a) The tax as shown in the invoice has indeed been paid (b) There is no double credit on basis of same invoice. TIN will have to be indicated on each invoice issued. It will be a 11 digit numerical code. First two digits will indicate State Code [para 2.10 of White Paper on State-Level VAT) .

Thus, State level computer network with check based on TIN will be established. Otherwise, misuse will be rampant.

Invoice based credit - Tax credit will be given on basis of document, which will be a ‘Tax Invoice’, cash memo or bill. Such invoice can be issued only by a registered dealer, who is liable to pay sales tax. The invoice should be serially numbered and duly signed, containing prescribed details. The tax payable should be shown separately in the Invoice. The dealer should keep counterfoil/duplicate of such invoice duly signed and dated  [para 2.8 of White Paper on State-Level VAT)

In case of manufacturer, Invoice issued under Central Excise Rules should serve purpose of VAT also, if the invoice contains required particulars.

Debit note and credit note - If sale price is increased/reduced subsequent to sale, the transaction will be recorded through proper debit/credit note. The buyer will adjust the input credit available to him accordingly.

What are provisions of assessment ?

Dealer is required to assess his tax and pay himself. It will be basically self assessment. There will be no compulsory assessment at end of the year. If notice is not issued within prescribed time, dealer will be deemed to have been self assessed [para 2.12 of White Paper on State-Level VAT)

Returns will be filed monthly/quarterly, as prescribed, along with challans. Returns will be scrutinised and if there is technical mistake, it will have to be rectified by dealer [para 2.11 of White Paper on State-Level VAT)

There will be audit wing in department and certain percentage of dealers will be taken up for audit every year on scientific basis. The audit wing will be independent of tax collection wing, to remove bias. There will be cross verification with Central Excise and Income Tax also. [para 2.13 of White Paper on State-Level VAT)

What are other provisions of State VAT ?

The other provisions are as follows -

Refund of input tax – Entire input tax will be refundable within three months, when final product is exported. In respect of sale to EOU/SEZ, there will be either exemption of input tax or tax paid will be refunded within three months  [para 2.5 of White Paper on State-Level VAT).

If tax credit exceeds tax payable on sales, the excess credit will be carried to end of next financial year. Excess unadjusted credit at end of second year will be eligible for refund [para 2.4 of White Paper on State-Level VAT)

This will delay refund, as next year, department will take view that first balance credit should be utilised and then current year’s credit should be utilised. This will be unfair.

Check posts and transit passes - Government can set up check posts. The invoice will have to be produced at the check posts. System, of transit pass may be introduced. This is bound to increase harassment of transporters and is bound to increase corruption to unprecedented level.

Exemptions and incentives to new industries already granted to continue - All State Governments were offering sales tax incentives to new industries set up in the State. The incentives were broadly of three types - (a) Exemption - Don’t charge tax and don’t pay (b) Deferral - Charge sales tax in invoice but pay after long period of (say) 12 to 18 years (c) Remission - Charge in the invoice but retain and do not pay to Government. - - State Governments have stopped giving incentives to new industries after January, 2000. However, there are commitments in respect of industries set up prior to January, 2000. State Governments to continue with the incentives which were already granted [para 2.15 of White Paper on State-Level VAT).  [Some States may allow industries under exemption scheme to convert to deferral scheme so that such industries can pass on benefit of VAT to their buyers].

Entry tax/Octroi will continue - There is no proposal to extend VAT to entry tax (in lieu of octroi) or Octroi levied by local authorities. These will continue.

Provisions relating to CST

What are the provisions relating to CST ?

Presently, CST will continue, though it is proposed to be phased out in due course. The provisions in respect of Central Sales Tax are summarised below –

In that case, this appears to be a Local VAT and not National VAT. Is it so ?

Unfortunately, the way sales tax VAT is proposed to be implemented by States, it is only local (i.e. State) VAT and not national VAT. This is because –

(a)   If goods are purchased from another State, credit (set off) of CST paid in other State will not be granted by the State where the goods are consumed/used/sold.

(b)   If goods are sent to another State on stock transfer basis, only restricted input credit will be given

Obviously, this is against basic concept of VAT. As discussed later, these provisions appear to be violative of Articles 303 and 304(a) of Constitution of India.. Thus, the State Level VAT as proposed to be implemented, is a truncated version of VAT. It can at the most be termed as ‘Local Sales Tax VAT’ and not ‘National Sales Tax VAT’.

Constitutional Issues arising out of discrimination

Provision of not granting credit of CST seems discriminatory. Will it stand scrutiny of law ?

Really, that is a major issue.

Article 303 of Constitution of India provides as follows, ‘Neither Parliament nor the legislature of State shall have power to make any law giving any preference to one State over another, or making any discrimination between one State and another’. As per Article 304(a), State Government can impose tax on goods imported from other States, but cannot discriminate between goods imported from other States and goods manufactured within the State.

As per White Paper of Stale level VAT, sales tax credit will be available if inputs and capital goods are purchased within the State, but not when goods are purchased from out of State. This appears to be clearly discriminatory.

Kelkar Committee in para 7.2 of its final report submitted in December 2002, has also expressed apprehensions about legal implications of Article 304(a) in State Level VAT. The Kelkar Committee has expressed apprehension that investment decisions will tend towards States where the market within the State is larger than outside.

Why State Governments are not agreeing to give credit of CST ?

The State Governments are of the view that they cannot give input credit of CST as the tax is paid in other State and they cannot give credit of an amount which they did not even receive.

VAT is only simple way of taxing value added, credit is only notional - Fallacy of the argument of States is that, as explained earlier, the so called input credit is only a simple way of paying tax on ‘Value Added’. Other method of implementation of VAT is ‘subtraction method’, where purchase price is deducted from sale price and VAT tax is paid on net amount. This method is highly cumbersome and practically impossible when various inputs are used to manufacture numerous outputs. Thus, ‘input tax credit’ is not ‘credit’ in true sense of the term, but an easy and simple way to ensure that tax is paid only on ‘value added’ at each stage.

Only Marginal difference possible - States forget that if inter-state sales are zero-rated, in case of goods brought from other States and consumed within the State, States will be getting full revenue of tax without allowing any set off. Thus, net effect on the tax revenue of State will be marginal.

Producing and Consuming States will benefit in different ways – ‘Producing State’ means those States who produce more than they consume. ‘Consuming States’ are those which consume more that they produce. In case of ‘Producing States’, goods sent outside the State for consumption outside the State will be more that goods brought into the State for consumption.

The ‘Producing State’ does not get tax revenue in respect of goods produced in the State, but consumed outside the State. Since VAT is a consumption based tax, theoretically, ‘Consuming States’ will be benefited in the VAT tax regime while ‘Producing States’ will suffer loss of revenue.

The ‘Consuming States’ are mainly BIMARU States i.e. Bihar, Madhya Pradesh, Rajasthan and Uttar Pradesh. ‘Producing States’ are developed States like Maharashtra, Gujarat, Tamilnadu, Punjab, Haryana, Andhra Pradesh, Delhi and Karnataka.

In consumption type of VAT, it is true that ‘Producing States’ are at a loss. However, isn’t it true that there is more employment generation and wealth generation in a ‘Producing State’ ? If so, it will lead to more economic activities, more employment and more consumption. More consumption will lead to more taxes, isn’t it ?

Tax concession is available only if raw material is purchased locally. Will it not discourage inter-state purchases ?

Giving credit only for locally purchased goods appears to be discriminatory and it appears that this will discourage inter-state purchases.

In State of UP v. Laxmi Paper Mart AIR 1997 SC 950 = (1997) 2 SCC 697 = 1997 AIR SCW 865 = 105 STC 1 (SC), levy of differential sales tax on exercise books made from paper purchased within the State and made from paper purchased from out of State and sold within the State was held to be discriminatory and offending Article 301. - similar case in * Andhra Steel Corporation v. CCT (1990) 78 STC 243 (SC) = (1990) Supp SCC 617.

In Loharn Steel Industries Ltd. v. State of AP AIR 1997 SC 1694 = 1997 AIR SCW 817 = 105 STC 30 (SC), sales tax payable on finished product was exempt if raw material was purchased within the State. This was held discriminatory.

Validity of the provision may be open to question in Court of Law.

If goods sent on stock transfer basis, credit will be granted only in excess of 4% tax paid on inputs. Thus, indirectly, tax will be levied on stock transfers. Is it permissible ?

As per Article 286, State Government cannot impose tax on sale or purchase during imports or exports; or tax on sale outside the State. It means that State Government can impose sales tax only on sale within the State.

State Level VAT provides that if goods are stock transferred to another State, input credit of tax will be restricted. Credit will be allowable only to the extent of tax paid on inputs in excess of 4%.

In case of ‘stock transfer’ or ‘branch transfer’ to another State, goods will be sold outside the State. Hence, it is not ‘sale within the State’.

Restricting set off (or credit) on inputs used in goods which are stock transferred amounts to taxing inter-state transaction by back door. It is indirectly taxing a sale outside the State. It can be argued that what cannot be done directly can also not be done indirectly, as effect in both cases is same.

What is the ideal solution to get over the constitutional issues arising out of discrimination ?

The correct solution is ‘zero rating’ of goods sold on branch transfer.

‘Zero rating’ means tax is not levied on final product but input credit is still allowable. In case of ‘exempt final products’, input credit is not allowable, while in case of ‘zero rated final products’, input credit is allowable even if no tax is payable on final product.

Presently, State-Level VAT provides for ‘zero rating’ in case of exported goods. This should be extended to inter-state transfers/sale also. Though the white paper is not clear on this issue, it seems that inter-state sale will be 'zero rated' from 1-4-2010.

Amendment of Constitution is another alternative - If State VAT Act provisions are held constitutionally invalid, one alternative is to amend Constitution to validate such taxation. If such a thing is proposed, Article 1(1) of Constitution will also need amendment. The Article presently reads ‘India, that is Bharat, shall be a Union of States’. It will have to be amended to read, ‘India, that is Bharat, shall be a Union of heterogeneous, incompatible and corrupt States’.

The word ‘corrupt’ will have to be added as provision of check posts and transit passes is bound to lead to corruption at unprecedented levels.

It is unfortunate that Europe was able to introduce VAT, though it consists of different sovereign countries, while we are not able to introduce VAT though we claim to be ‘one nation’.

Accounts, Records and Returns

Input Records required

Detailed and elaborate records of input credits and output tax is essential in VAT system.

Records of Purchases of Inputs - Credit of tax paid on inputs can be availed only if original tax invoice (VAT Invoice) is available. Assessee should maintain proper ‘Purchase Register’, recording receipts of all tax invoices. These should be serially numbered for purpose of checking and cross reference. The record should indicate break-up of tax paid at different rates, so that tax paid at different rates on inputs can be calculated. Suggested columns of the record are -

* Sr No. (Control No.) * Supplier’s Invoice No. /Debit Note No. * Date of Invoice/Debit Note * Name of Supplier * TIN No. of supplier * Description of goods * Quantity * Net purchase price * Excise duty paid (If same record is to be used for Cenvat credit also) * VAT tax @ 1% * VAT tax @ 4% * VAT Tax @ 12.5% * Tax not eligible for VAT credit * Purchases from URD (Unregistered Dealers)  * tax on URD purchases * Gross purchase price * Remarks

Purchases from unregistered dealer - If purchases from unregistered dealers are few, the same may be included in main Purchase register itself. In such cases, if tax rates on URD purchases is varying, tax payable on URD purchases at different rates will have to be worked out. If URD purchases are numerous, it may be advisable to maintain separate records of URD purchases, so that calculations at different rates will be convenient. In such case, register similar to aforesaid purchase register may be used for URD purchases also.

Monthly totals - Monthly totals of credits availed should be taken.

Record of debit notes - If Debit Note is issued by supplier, additional input credit of tax paid by supplier on increased price will be available. This should be entered in the Cenvat Credit record. While entering debit note, cross reference to original invoice should be given.

Quantity record of inputs - Stock record of all inputs is required to be maintained. The record should be for each type of input individually. One or more pages may be reserved for each type of input. The suggested format is -

# Description of input # Unit of measurement (At the top of each page)

Columns on each page will be - * Date * Opening stock * Sr No. of receipt (Control No. as per Records of input credit) * Quantity received * Date of issue * Quantity issued (for manufacture or sale) * Closing Stock * Remarks

Opening stock - Credit will be available for tax paid on inputs lying in stock as on 31-3-2005. Tax paid on capital goods lying in stock as on 31-3-2005 will not be available. It is necessary to carry out detailed inventory as on 31-3-2005. The record may be prepared in following format -

* Sr No. * Supplier’s Invoice No. * Date of Invoice * Name of Supplier * ST Regn No. of supplier * Description of goods * Quantity * Net purchase price * Tax eligible for input credit * Tax not eligible for VAT credit * Gross purchase price * Remarks

The tax paid on inputs lying in stock will be available as per provisions of State VAT tax law.

Record of credit notes received from suppler - If supplier issues a credit note, corresponding sales tax amount will have to be reduced. Hence, record of debit notes received from suppliers should be kept in following form -

* Sr No. * Supplier’s Credit Note No. * Date of Credit Note * Name of Supplier * TIN No. of supplier * Description of goods * Net amount of debit note * VAT tax @ 1% * VAT tax @ 4% * VAT Tax @ 12.5% * Tax not eligible for VAT credit * Gross Amount of Credit Note * Remarks

Record of capital goods - Credit is available on VAT tax paid on capital goods also. However, since the credit is available in stages, separate records are required. Suggested columns of the record are -

* Sr No. (Control No.) * Supplier’s Invoice No. /Debit Note No. * Date of Invoice/Debit Note * Name of Supplier * TIN No. of supplier * Description of goods * Quantity * Net purchase price * Excise duty paid (If same record is to be used for Cenvat credit also) * VAT tax @ 4% * VAT Tax @ 12.5% * Gross purchase price * Location of capital goods* Credit in first year * Credit in second year * Credit in third year * Remarks

Monthly totals - Monthly totals of credits availed should be taken.

Record of debit notes - If Debit Note is issued by supplier, additional credit of tax paid by supplier on capital goods will be available. This should be entered in the Cenvat Credit record. While entering debit note, cross reference to original invoice should be given. Alternatively, price of capital goods may be increased suitably.

Recording of credit notes - Credit note received from supplier will amount to reduction in the price of capital goods and corresponding reduction in tax paid on capital goods. It may be advisable to enter net price of capital goods after deducting the credit note, after making suitable remarks.

Record of Tax credit available

Monthly/quarterly totals of the following should be taken - (a) Input credit available (b) Credit available on capital goods (c) Credit notes from suppliers (c). Purchase tax paid on purchases from URD. - - Following record may be maintained on monthly basis -

* Month and year * Opening Balance * Credit of inputs * Credit of Capital Goods * Purchase tax on purchases from URD * Credit of inputs in opening stock * Total * Less Tax reduced by Credit Notes * Net credit available * Credit utilised during the month * Closing Balance (if any) * Remarks

These monthly/quarterly totals should tally with the monthly/quarterly return that is required to be submitted to VAT tax authorities.

Carry forward/refund of tax credit - If input tax credit cannot be utilised in a particular month/year, the credit can be carried forward and used in subsequent months/year. Refund of such excess credit is permitted only if goods were exported out of India.

Record of output tax

Record of output tax payable will be required in the form of Sale Register. The Sale Register should have following columns -

* Invoice/Debit Note No. * Date * Name of buyer * Buyer’s TIN No. * Description of Goods * Quantity * Sale within State @ 1% * Sale within State @ 4% * Sale within State @ 12.5% * VAT @ 1% * VAT @ 4% * VAT @ 12.5% * Sale Exempt from tax * Export Sale * Consignment Sale * Inter State Sale * CST @ 4% * Gross Sale Price * Remarks

 Credit Notes register - The dealer may issue debit/credit notes to his buyers. Debit Notes may be entered in the Sale Register itself, as value of sale will increase to that extent. Record of credit notes may be kept separately, as tax liability of dealer will reduce to the extent of tax on reduction in price given to buyer. The Credit Notes register may have following columns -

* Credit Note No. * Date * Name of buyer * Buyer’s TIN No. * Description of Goods * Net Sale within State @ 1% * Net Sale within State @ 4% * Net Sale within State @ 12.5% * VAT @ 1% * VAT @ 4% * VAT @ 12.5% * Sale Exempt from tax * Export Sale * Inter State Sale * CST @ 4% * Gross Sale Price * Remarks

Sale Account by retailers - Retail sellers are not entitled to any VAT credit. They cannot show VAT tax separately in the invoice. Mostly, they will be under composition scheme. They will maintain daily record of gross sales.

Payment of Tax and filing Returns

Every dealer is required to file returns on monthly/quarterly basis. If the aforesaid records are kept properly, filing the return will be very easy and mistakes will be minimum.

Net Tax payable - Net tax payable will have to be calculated as follows - (a) Output tax plus (b) Purchase tax on URD purchases plus (c) Reversal of Credit (On exempted goods, stock transfers, free samples, lost inputs) - Less - (d) Input tax credit available.  - - This net amount is required to be paid through prescribed challan on or before due date.