Commerce Subject: Indirect Tax Lesson: VAT: An Introduction Lesson Developer: Ms. Sonia Kaushik College/Dept: Bharti College University of Delhi

Transcription

1 Commerce Subject: Indirect Tax Lesson: VAT: An Introduction Lesson Developer: Ms. Sonia Kaushik College/Dept: Bharti College University of Delhi

2 Table of Contents: 1: Learning Outcomes 2: Introduction 3: Operation of Vat 3.1: Stages of VAT 3.2: Stages of Tax Collection 3.3: White Paper 3.4: Difference between Old VAT and New VAT System 4: CENVAT & Introduction of VAT in India 4.1: Preparatory Steps Suggested by Committee for the Introduction of VAT 5: Other Concepts 6: CST and VAT 6.1: Rate of CST 6.2: Objective of CST 7: Input Tax Credit 7.1: Non-Creditable or Non-Vatable Goods 7.2: Eligible Purchase for Input Tax Credit 7.3: Negative Purposes 8: Input Tax Credit 8.1: Carry Over of Tax Credit 8.2: Input Credit on Stock Transfer to Other States 8.3 Treatment of Input Tax in Case of Export Sales 8.4: Refund to Exporters within Three Months 8.5: Exemption or Refund to SEZ and EOU Units 8.6: Imports and VAT 8.7: Input Tax Credit on Capital Goods 8.8 Input Purchased from Other States 9: CENVAT Credit of Excise and Service Tax 9.1: Goods and Services Tax 10: Goods Covered Under VAT & Rates of VAT 10.1: Exempted Goods 10.2: VAT Rates 11: Variants of VAT 11.1: Why Consumption Variant is More Popular? 12: Modes of VAT 13: Merits and Demerits of VAT Summary Exercises Glossary References

3 1. Learning Outcomes: After you have read this lesson, you should be able to: understand the concept of VAT, identify situations where input tax credit is available, differentiate between CST and VAT, appreciate the role of VAT, apply the knowledge of VAT. 2. Introduction: VAT is a broad base tax levied at multiple stages with tax on outputs reduced by tax on inputs. VAT is collected at each stage where any value addition in the product is being made. VAT was first introduced in France in 1954, in Brazil & Denmark in 1967 and then in many European countries in 1970s and subsequently introduced in more than 130 countries. In India VAT has been introduced by most of the states and union territories with effect from 1 st April, 2015, though the concept has already been introduced in Excise in 1986 and in Service Tax in Adjustment of Excise Duty and Service Tax is also allowed as per applicable laws. In India, it is still not properly implemented. It is a state subject. It is not uniform in all the states. Even as on date it is not adjustable against service tax. So, as of now, it is not replacing the other Indirect Taxes and it is just a substitution for the earlier Sales Tax System. Value Addition 1: Did You Know? What is Tax? Tax is an amount charged by the Government for providing various benefits and amenities like defense, education, medical benefits, etc. Tax is the major source of revenue for the government. Two Types of Taxation: It includes Direct Taxation and Indirect Taxation. While Income Tax and Wealth Tax are the main examples of Direct Taxation, VAT, Excise Duty, Custom Duties, etc. are the main examples of Indirect Taxation. 3. Operation of VAT: The operation of VAT can be appreciated from the following illustration: Illustration 1: A is a trader selling raw materials to a manufacturer of finished products. He is an importer of

4 stock and purchases some material from local market as well. He sells the entire product to B. Rate of VAT is assumed to be per cent Ad Volorem. Solution 1: VAT can be calculated as under: Amount Sl.No. Particulars (Rs.) (i) Cost of Imported Materials for A (from other State) 10,000 (A will deposit Rs.1250 duty on the above. Since, this is not a 1,250 State VAT it will form cost of the input) (ii) Cost of Local Materials for A 20,000 (VAT charges by local suppliers Rs.2,500. Since the credit of this would be available, it will not be included in cost of input) Money spent on Expenditure (such as for storage, transport, (iii) interest, etc.) 8,750 Incurred and profit earned by A [Interest is assumed to be a manufacturing expense] (iv) Sales 40,000 (v) VAT on the (Approx.) 5,000 (vi) Invoice Value Charges by A to the Manufacturer, B 45,000 I. A s Liability for VAT Particulars Rs. Rs. Tax on the Sales Price 5000 Less : Set-off of VAT Paid on Purchases On Imported Goods Nil On Local Goods 2,500 2,500 Net Tax Payable 2,500 In the above illustration ( as well as in illustrations that follow ) it is assumed that set off of VAT paid on imported goods from outside countries or other States is not allowed. As B is a manufacturer of finished products manufactured from the raw materials purchased from A and other materials purchased from other suppliers. His liability would be as under: Particulars Rs. (i) Cost of Raw Materials for B 40,000 (VAT Recovered by A Rs.5,000) Cost of Other Materials for B

5 Local Purchases 20,000 (VAT Charged on the amount above Rs.2,500) Inter-State Purchases* 10,400 (CST paid Rs.400) Manufacturing and Other Expenses Incurred and Profit Earned by B 29,600 Sale Price of Finished Product 1,00,000 VAT on the Above +12,500 Invoice Value Charged by B to the Wholesaler, C 1,12,500 VAT Liability of B Tax on the Sales Price Less : Set off of VAT on Purchases 12,500 To A 5,000 To Other Suppliers 2,50 0 (-)7,500 Net Tax Payable 5,000 In VAT credit/set off of tax paid on inter-state purchases (inputs) is not allowed. C sells these goods to the retailer after packing the same. The following would be the position of C: Particulars Rs. Cost of Goods for C 1,00,000 (VAT Recovered by B Rs.12,500) Expenses Incurred on Packing Material 2,000 (VAT charged on the above Rs.250) Expenses Incurred and Profit Earned by C 18,000 Sales 1,20,000 VAT on the Above 15,000 Invoice Value Charged by C to D, a Retailer 1,35,000 Particulars Rs. Liability for VAT for C 15,000 Tax on the Sales Price Less : Set Off of VAT Paid

6 To B 12,500 To Other Suppliers 250 (-)12,750 Net Tax Payable 2,250 Finally, when D sells the goods to the consumers, the position of D would be as under : Particulars Rs. (i) Cost of Goods for D 1,20,000 (VAT Recovered by C Rs.15,000) (ii) Expenses Incurred and Profit Earned by D 20,000 (iii) Sale Price of Goods 1,40,000 (iv) VAT on the Above 17,500 (v) Invoice Value Charged by D to the Consumers 1,57,500 (vi) Liability for VAT of D Tax on the Sales 17,500 Less : Set-off of VAT Paid to C 15,000 Net Tax Payable 2,500 Total Recovery: It must be clear from the above illustrations that at the successive stages through which the raw materials and other goods pass till they are sold to the ultimate consumers, VAT would be collected as under: Particulars Rs. Paid by Suppliers Selling Raw Materials to A 2,500 Net Tax Paid by A on his Sales to B 2,500 Paid by Suppliers Selling Other Materials to B 2,500 Net Tax Paid by B 5,000 Paid by Suppliers Selling Packing Materials to C 250 Net Tax Paid by C 2,250 Net Tax Paid by D 2,500 Total Recovery of Revenue 17,500 Now, if tax was leviable under a Sales Tax Law, at the last, where the finished product is sold to consumers, the Tax Authorities in the above case would have recovered the entire Tax of

7 Rs.17,500 from D at per cent on his Sales Price of Rs.1,40,000 and all earlier stages are to be exempted. 3.1: Stages of VAT: Based on discussion in the preceding pages in can be concluded that VAT is a Multi-Stage Tax and it has following stages: 1. Manufacturer to Distributor 2. Distributor to Wholesaler 3. Wholesaler to Retailer 4. Retailer to Consumer Figure 1: Stages of VAT Manufacturer Distributor Wholesaler Retailer Can It Be Said That the Whole Burden of VAT is on Consumer? Yes, as he does not get any credit. He is the last person in the VAT Chain. But, in VAT he is free from cascading effect. So in spite of burden, he is a beneficiary Stage of Tax Collection: Earlier India was having Single Point Taxation System either at first stage or at last stage. But there were certain merit and demerit of first and last stage collection. Demerits of First Stage Sales Tax Collection Demerits of taxing the Goods at Last Stage

8 1. Sales tax is collected at the first stage, therefore, the rate has to be higher. Imagine that the Government wants to collect a tax of Rs 5 on an item of Rs 100. But, if tax is to be levied at the First Stage say at Wholesalers Stage than, the rate has to be higher to achieve the result as the price shall be low. Say the Wholesale Price of the same item is Rs 50 at Wholesale Stage than obviously the Tax Rate shall be around 10% to achieve the same result. And higher Tax Rate always prompts a businessman for Tax Evasion. 1. Since. tax was being charged on the MRP, even if rate is low, tax appeared to be heavy so prompting the business man to evade taxes. 2. Difficult to track goods as the tax was only at the Last Stage and after this stage the goods reach the hands of the customer. 3. It is quite common to purchase goods at Last Stage by customers in cash. Thus, Tax Evasion becomes easier and it resulted in generation of more and more Black Money. 2. If somehow, goods escaped taxation at First Stage, then, they shall not be taxed at all. Because all systems shall be at First Stage only. 3. Higher chances of goods being underpriced to avoid taxation burden at First Stage. According to Kelkar Committee Each State levies multiple taxes on the same item in different names or at different stages e.g. Entry Tax, Luxury Tax, Sales Tax, Purchase Tax, Turnover Tax, Works Contract Tax, Special Tax, etc. It was suggested that all should be covered in one tax only i.e. State VAT White Paper: Earlier when India tried to introduce VAT, it faced opposition from trader community. Many times its implementation was postponed. An Empowered Committee of State Finance Ministers was formed, who met regularly and finally a White Paper on State Level VAT was introduced on This White Paper on State Level VAT was presented in three parts: Part I: In this part, the justification of VAT was mentioned. Part II: It contained the main design of State Level VAT. While doing so, it recognized that VAT is a State Level Subject and Various State Governments shall have reasonable freedom to do

9 variations depending upon facts and circumstances applicable to that particular State. Part III: It discussed the other issued for effective implementation of VAT. The White Paper also specified that registration under the State VAT shall not be compulsory up to Rs. 5 lacs. The limit was raised to 10 lacs by Empowered Committee of State Finance Ministers Difference between Old System & New System: Old Tax System Tax was levied at the Single Stage First or Last. Computation was complex. New Tax System Multi Stage Taxation It is comparatively transparent and easier. Lot of forms were being used for Purchased Goods without Taxes. Like in Delhi ST 1 was being used for this purpose. Dealers were required to provide a lot of information to authorities and were also required to file Return and Challan separately. New System has done away with these forms. Under VAT the returns and Challans are filed together in a simple format after selfassessment done by the dealer himself. Large number of forms Tax was imposed on goods only. Assessment of assessee was done by the department. Simpler penalties Very few forms Tax is imposed on goods as well as services. Self-assessment is done by the dealers. Stricter penalties Value Addition 2: Did You Know? What is Cascading Effect?

10 In very simple terms, it means tax on tax. For example, in earlier system, tax was being levied on input as well as on output. Then, in a way it was also taxing the sales tax. This is called cascading effect. For example, suppose A sells goods to B for 10,000 which are subject to 10% Sales Tax. Effective Billing shall be of Rs 11,000. Now suppose B sells goods to C for Rs 15,000 after keeping a profit margin of 4,000. Then, Tax will be at 10% of Rs 15,000 i.e. 1,500. Now if we observe closely, we can see that tax is not only being levied on Rs 10,000 again, but, also on Rs 1,000 of Sales Tax. So, this is taxation on taxation. Vat has avoided it. Now, as credit of earlier tax shall be available, the dealer shall sell the goods at Rs 14,000. Still with a margin of profit of Rs 4,000. Tax shall be Rs 1,400. But, after credit of Rs 1,000 the effective payment of VAT shall be Rs 400 only. It is 10% of Value Addition of Rs 4,000. Thus we can see that in the old system, double taxation was there. First input was being taxed and then output was being taxed. This is also called cascading effect. But this system resulted in lower tax collection to the Government. 4. CENVAT & Introduction of VAT in India: In India, Excise Duty and Service Tax are being levied through Central Acts while Sales Tax (VAT) is still being governed by State Level VAT Provisions. CENVAT is applicable on Excise and Service Tax but still VAT is outside its purview. On March 1, 1986, MODVAT was introduced to provide credit for Excise Duties paid on inputs. Initially, it was for very few commodities. Over the time it was extended, and later Central VAT (CENVAT) Scheme was introduced in the budget of With implementation of The Finance Act, 2004, the Duties of Excise paid on inputs / capital goods and Service Tax paid on input services could be adjusted against a manufacturer s Excise Duty Liability or a service provider s Service Tax Liability. Need for Similar Provisions in Sales Tax Area: To materialize this concept, the then Union Finance Minister, called a meeting of the State Finance Ministers in May A Committee was formed with these Ministers to examine all aspects of Sales Tax Reform, including the introduction of VAT. The Committee suggested various reforms including the following: 1. To adopt four General Floor Rates (0,4,8,12) and two Special Floor Rates (1 and 20) in place of existing multiple. 2. Limiting the levels of Exemption to its Minimum.

11 3. To Prepare a list of Exempt Goods and fix a target date beyond which no State/Union Territory should exempt goods other than those mentioned in the list, and 4. Doing away with Sales Tax Incentives for industrialization. INTERACTIVE Preparatory Steps Suggested by the Committee for Introduction of VAT: Figure 2: Introduction of Vat For implementing the above decisions, an Empowered Committee of State Finance Ministers was set up. 5. Other Important Concepts: a. Discontinuance of Central Sales Tax: After the introduction of VAT System at State Level, phasing out the CST was proposed. But, after elimination of CST, States will stand to lose large revenue on account of its discontinuance, a mechanism is being thought of for compensating the States for such loss of revenue. b. Stock Transfer: Inter-State Stock Transfer is not considered as a sale. Hence, not subject to taxation in most of the VAT Systems. c. Tax paid on inputs used in manufacturing which are subsequently transferred or tax paid on goods purchased, which are subsequently transferred, is generally eligible for input credit after a retention of 2% by the concerned State Government. d. Compensation of Losses: A few State Governments fear loss of revenue due to introduction of VAT. As a solution to this, Central Government agreed to compensate 100% of such loss in First Year, 75% in 2 nd year and 50% of such loss in the 3 rd year.

12 INTERACTIVE 2 6. Central Sales Tax (CST) & Value Added Tax (VAT): Central Sales Tax is charged by the seller of goods when he makes an Inter-State Sale i.e. sale to dealer / consumer in the other States. In this case, goods move from one State to another State. On the other hand, VAT is charged by the seller of the goods, when he makes an Intra- State Sale i.e. sales made to a dealer or a consumer within the same State. CST is levied by the Central Government. But, it is collected and retained by the State Government, from where the movement of goods originally started. VAT is levied by the respective State Governments and it is collected and retained by the same State Government. Goods purchased from other States are subject to CST. Such CST is not eligible for Input Tax Credit as CST has been received by other State from where the movement of goods actually started. Hence, CST paid on purchases from other States is not eligible for Input Tax Credit or are called Non-Vatable. For example: A of Jaipur sold goods to B of Delhi. In this case, CST shall be charged by A (dealer of Jaipur) and shall be paid by B (inter-state purchaser). Now, suppose B of Delhi sells these goods to C of Delhi, then, in this case, B shall charge Delhi VAT from C. But B shall not be entitled to Input Tax Credit of the amount he paid as CST to A. A selling dealer is entitled to Input Tax Credit on the purchase made within the State for making sale of such goods to other State. In the above example, C of Delhi sells goods to D of Rohtak. Here, C shall deposit CST to Government. He shall be entitled to Input Credit of the amount he paid to B Rate of CST: Situation 1: If goods are sold to the Registered Dealer against Form C. It is Local VAT Rate or 2% whichever is less. Situation 2: Other cases i.e. Sale to Unregistered Dealer or Non-receipt of Form CST = Local VAT Rate. Example 1: Local VAT Rate Sale to Registered Dealer Sale to Any Other Person 1% 1% 1%

13 2% 2% 2% 4% 2% 4% 12.5% 2% 12.5% 6.2. Objective of CST: Central Sales Tax was introduced in 1956 through Central Sales Tax Act Prior to levy of CST, State Governments use to charge Sales Tax even in case of Inter-State Sales and there was multiple taxation on the basis of Nexus Theory e.g. If seller was in Punjab and buyer was in U.P., both of the States collected Sales Tax because of nexus i.e. connection of the Sales Transaction with each of the state. In order to check the problem of multiple taxation, Central Sales Tax Act was enacted (to pass a law) in In case of Inter State Sale, Central Sales Tax was levied and it was to be collected by the State Government from where the sales have taken place. It is collected by the State Government on behalf of the Central Government but as per provisions of Central Sales Tax Act, the Tax so collected shall be retained by the respective State Government. As the purpose of levying of CST was not to collect Central Sales Tax by the Central Government rather the purpose was to check multiple taxation. Value Addition 3: Did You Know? Service Tax, VAT or CST? Click the link below to know the difference between service tax, VAT and CST. Source: 7. Input Tax Credit: It means simply, in a particular period, say a month, the Output Tax is reduced by the amount of Input Tax paid. Input Tax Credit is available for the whole VAT paid within state on purchases of Taxable Goods. A Dealer cannot claim the Input Tax Credit if the purchase of goods and capital goods are not meant for business. Figure 3: Types of Goods

14 Vatable Goods(ITC Allowed) Rate of VAT(0%, 1%, 4%, 12.5%) Goods Taxable Goods Non-Taxable Goods Non-Vatable Goods(ITC not Allowed) Exempted Goods Rate of VAT Special Composition Rate of VAT 7.1. Non- Creditable/Non-Vatable Goods: No VAT Credit is allowed in case of some of the commodities because those commodities are either not meant for resale or these are allowed to be sold only once and such goods are called Non-Creditable or Non-Vatable Goods and the list of such goods differs from State to State and some of such items are as given below: a. Commercial Vehicles, Two and Three Wheelers, Spare Parts for Repairs, Maintenance, Tyres and Tube thereof; b. Fuels like Petrol, Diesel, Kerosene, LPG, CNG, PNG and Coal; c. Food for human consumption; d. Beverages for human consumption; e. Air Conditioners, Air Conditioning Plants or units other than those used for manufacturing purposes; Air Coolers, Fans and Air Circulators; f. Goods for personal consumption or for gifts. INTERACTIVE Eligible Purchases for Input Tax Credit: To be eligible for the credit purchases should be for any of the following purposes:

15 1. For Sale / Resale within the State; 2. For sale to other parts of India in the course of Inter-State Trade or Commerce; 3. For being used in execution of a Works Contract; 4. To be used as Capital Goods required for the purpose of manufacture of Taxable Goods; 5. To be used as a. Raw Materials; b. Capital Goods; c. Consumable Stores; d. Packing Materials / Containers and goods so manufactured by the use of above items are sold in the course of export out of the territory of India. 6. For making Zero Rated Sale like Sale to exporters or Sale to SEZ or to International Organisations; 7. To be used as Containers or Packing Material, Raw Material, Consumable Stores, Manufacture of Taxable Goods or in the packing of such Manufactured Goods (intended for Local or Inter-State Sale). Value Addition 4: Did You Know? What is SEZ? Special Economic Zone means a specific area which has been declared to be SEZ by the Government and the persons having their units in the SEZ shall be required to export the goods manufactured by them and there will not be any Output Tax. The persons selling goods or providing services in the SEZ shall not charge any Tax from the buyers in the SEZ but the seller shall be allowed Tax Credit as a Special Rate. Common Goods Used for Taxable Goods and Tax Free Goods: In this situation, input tax credit shall be allowed proportionate to the extent the purchases are used for specified purposes Negative Purposes: Situations Where Credit Not Available: 1. Goods purchased from Unregistered Dealers; 2. Goods purchased from other States / Countries (known as High Seas Purchases) and sold in Home State; 3. Goods purchased from other State and sold to some other State; 4. Purchase of goods used in manufacture of Exempted Goods; 5. Purchase of goods where invoice is not available; 6. When goods have been purchased from dealer who does not have invoices showing amounts of tax charged separately by the Selling Dealer; 7. Purchase of Non-Creditable Goods as may be specified by State Government; 8. Purchase of goods from a Dealer who has opted for Composition Scheme; 9. Purchase of goods for personal use/consumption;

16 10. Purchase of goods for being provided free of charge as gifts/samples; 11. Goods purchased are destroyed by fire or are stolen or lost; 12. Goods received on Consignment Sale or on stock transfer from other States; 13. Goods purchased and returned back within the specified period. No Credit on Certain Purchases: In following cases, Input Tax Credit is not available: a. Purchase of Automobiles; b. Fuel. However, some States are allowing Input Credit for the same. Difference between Zero Rated Sales and Exempted Sales Zero Rated Sales Exempted Sales 0% NIL Input Tax Credit can be availed No Input Tax Credit Refund available No Refund at all Dealer in the VAT Chain Dealer is out of VAT Chain 8. Input Tax Credit: Input Tax Credit is allowed in the same month without waiting for the item being utilized or being sold Carry Over of Tax Credit: It is allowed when Input Tax paid is more than Output Tax Payable. First, the excess amount shall be adjusted against CST, but if balance is still there, than, it shall be carried forward to subsequent month(s). Balance amount is refunded at the end of FY. In few States it is allowed after Second Year. Question 1: A purchases goods from B for Rs 1,12,500 which includes 12.5%. A sells 30% of goods to C in the same State by adding 20% profit on cost. Balance 70% of goods are sold to D of another State. The profit charged in this case is 25% on cost. VAT charged is 12.5% and CST charged is 2%. Compute the Input Tax Credit and its set off allowed to A Input Credit on Stock Transfer to Other States: Stock transfer to branches or on consignment basis does not amount to sale. Therefore, it is not subject to VAT or CST. However, if goods are sent outside a State on stock transfer /

17 Consignment Basis, Credit (Set Off) of Tax paid on inputs purchased within the state is available after retention by State Government of 2%. Means if LOCAL VAT is 12.5%, 10.5% credit is allowed. Full credit allowed for transfers within the same State. The above can be achieved by reducing the credit figure by 2% of cost of goods transferred. For example, if goods worth Rs 2,25,000 is purchased including Local VAT of 12.5%, then Vat Credit available is Rs 25,000. Now, further suppose 10% of goods are transferred to other State by stock transfer. Then, credit of Rs 25,000 shall be reduced by: 2,00,000 X 10% X 2% = Rs 400/- Now Credit Available for Set Off is Rs 25,000 (-) Rs 400 = Rs 24,600. We can also understand the above concept using another method: 100% of goods of Rs 2,00,000 subject to VAT of 12.5% = 25,000 Now on 90% of goods, VAT credit allowed is 12.5% = 200,000 X 90% X 12.5% = 22,500 And on balance of 10% of goods, VAT credit 10.5% = 2,00,000 X 10% X 10.5% = 2100 Total Credit Allowed = 24,600. Question 2: A of Delhi purchased goods from B of Delhi amounting to Rs 4,50,000 (inclusive of VAT of 12.5%). A sold it in the following manner: 1) 40% within Delhi with 30% profit on cost. 2) 25% goods sold to other State with 40% profit on cost. CST Rate is 2%. 3) 15% goods are transferred to other Branch in some other State. 4) 20% goods are transferred to other Branch within the same State. Compute the Input Tax Credit, it s Set Off and Carry Forward to next month Treatment of Input Tax in Case of Export Sales: Export Sales are Zero Rated (i.e. no VAT or CST is payable in case of Exports) and thereby exporters are either granted refund of Input Taxes paid by them on purchases they made from the same State or they can adjust such Input Tax while making the Domestic Sales Refund to Exporters within Three Months: As per white paper refund is granted for the input tax paid if goods are exported to other country. As per the guidelines of white paper the refund is to be granted within a period of 3 months from the end of the period in which the transaction for export took place.

18 8.5. Exemption or Refund to SEZ and EOU Units: SEZ and EOU are either exempted from the payment of Input Tax or Input Tax is refunded to them after 3 months. The State Government has the power to reduce the time period of 3 months. Question 3: A of Delhi purchased goods from B of Delhi for Rs 22,50,000 which includes VAT 12.5%. A sold goods to the following parties: 1. 90% of the goods sold to C of Delhi by charging 30% on cost. 2. 3% goods are sold to D of Ambala by charging 20% on cost. CST 2%. 3. 2% goods sold to E of New York by charging 10% profit on cost. No tax charged. 4. 5% goods to F of Jalandhar Branch. Compute the Input Tax Credit and Set Off allowed and the VAT & CST payable Imports and VAT: Presently States do not have powers to levy a tax on imports. It is also essential to bring imports into the VAT Chain. This will need a Constitutional Amendment. Because of the availability of Set-Off, not only cascading effect would be reduced but tax compliance would also improve. The Empowered Committee is discussing this issue with the Government of India Input Tax Credit on Capital Goods: It may be capital items like Plant & Machinery, furniture etc. Similarly material, etc. may be purchased to construct a building. Normally, to avoid cascading effect, tax paid on capital inputs is allowed as deduction. White Paper: Earlier this set off was allowed only in case of manufacturers. But as per White Paper, Input Tax Credit on capital goods will also be available for traders and manufacturers. Tax Credit on capital goods is not available in lump sum. It may be adjusted over a maximum of 36 equal monthly installments. The State has the power to reduce the number of installments. In Maharashtra, set off is allowed in one slot. As per White Paper, there is a Negative List for capital goods, which is not eligible for Input Tax Credit. For example, Motor Vehicles, Elevators, Electronic items like AC s, Computers, entertainment items like Television, DVD Players, Cameras, etc. This List may vary in each State.

19 Procedural Requirements: 1. Proper Tax Invoice should be there to prove the amount of capital asset and tax paid thereon. 2. Where it is allowed in installments, it should be claimed accordingly. 3. Where prior permission is required, it should be taken. 4. In some cases, State VAT Law specifies, if the vendor has not deposited the VAT, the purchaser is not entitled to claim its set off. At the most, it can be claimed to the extent of VAT deposited in the chain earlier. Thus, buyer should be cautious enough to purchase goods from a person of repute because if after his payment of VAT, the seller does not deposit it in Government Treasury, he will not be entitled to set off Input Purchased from Other States: Tax paid on inputs procured from other states through inter-state sale and stock transfer will not be eligible for credit. Question 4: Determine how much Input Tax Credit shall be available to the Dealer A in Delhi in respect of the following purchases: 1. Inter-State Purchases : Rs 3,06,000 (CST included Rs 6000); 2. Local Purchases from within the same State : Rs 4,50, % included); 3. Goods purchased from an Unregistered Dealer : Rs 70,000; 4. Goods purchased from a Dealer (Mr B) who has opted for Composition Scheme: Rs 60,000. Mr B has paid a Tax of 1% on it; 5. Local Purchases from within the same State: Rs 2,08,000 (VAT 4%); 6. Local Purchases from within the same State: Rs 50,000. (VAT is not separately charged); 7. Capital Goods purchased which includes Delhi VAT of Rs 3,60,000. As per Law, assume the credit is allowed in 36 equal monthly installments; 8. Goods 72,800 (including 4% local VAT). Goods used in manufacture of Exempted Goods; 9. Goods Imported from Japan : Rs 5,00, CENVAT Credit of Excise and Service Tax: CENVAT means Central Value Addition Tax. Excise Duty and Service Tax are levied by Central Government, whereas VAT is levied by the State Government. Hence, the manufacturer / assessee is allowed CENVAT credit of Excise and Service Tax on input goods / input services while making the payment of Central Excise and Duty and Service Tax. The above mentioned credit is allowed only when buyer is also a manufacturer. On the other hand, under VAT, the credit is allowed to manufacturer and trader.

20 9.1. Goods and Service Tax: Goods and Service Tax is India s most ambitious Indirect Tax Reform aimed at attaining a comprehensive and harmonized Tax Structure. The then Finance Minister, Mr. P. Chidambaram, in Union Budget , has proposed the roll out of GST. Aims of GST: 1. To remove the multiplicity of taxes; 2. To eliminate the cascading effect of Tax on Tax; 3. To make the prices of Indian products competitive; 4. To provide benefit to end consumers. After introduction of GST, set off shall be available regarding all major types of Indirect Taxes like Excise Duty, Service Tax and VAT. The model of GST is dual in nature because Central and State, both governments can collect Tax to raise revenues to fulfill their requirements. It will subsume most of the Indirect Taxes being levied in India. Value Addition 5: Know More Working of CENVAT Click on the link below to know the working of CENVAT. Source: Goods Covered Under VAT & Rates of VAT: Two major classifications are: Taxable Goods and Exempted Goods. Taxable Goods can be further divided into two parts: a) VAT able goods i.e. goods for which Input Tax Credit shall be allowed; b) Non-vatable goods i.e. goods for which Input Tax Credit shall not be allowed Exempted Goods: The Empowered Committee has listed about 50 commodities consisting of a) Natural & unprocessed products; b) Items which are legally barred from taxation; and c) Items which have social implication Some of the items are:

21 1. Books, Periodicals and Journals including Maps, Charts and Globes; 2. Blood; 3. Fresh Vegetables and Fruits; 4. Earthern Pot; 5. Electrical Energy; 6. Fresh Plants, Saplings and Fresh Flowers; 7. Kum Kum, Bindi, Sindur, Bangles except made of Precious Metals; 8. Curd, Lassi, Butter Milk; 9. Betel Leaves. Coverage of Goods: Generally all goods are covered by VAT System including the Declared Goods. Outside VAT, goods includes goods like Liquor, Lottery Tickets, Petrol, Diesel, Aviation Fuel and other Motor Spirit, etc. as their prices are usually not determined by the market. These will be governed by the special provisions in the VAT or continue to be taxed under any other State Act VAT Rates: VAT system is applicable on about 550 goods and normally two Basic Rates of 4% & 12.5% of VAT is applicable plus a specific category of Tax Exempted Goods and a Special VAT Rate of 1% only for Gold and Silver Ornaments. Thus, there are four rates for VAT as per White Paper plus special 20% rate: % - Other than discussed below; 2. 4% - Items as medicines and drugs, agricultural and Industrial Inputs, Few Capital Goods and Declared Goods [e.g. Coal, cotton yarn, oil seeds, pulses, sugar, iron and steel, LPG for domestic use, etc.]; 3. Exempted Goods; 4. 1% for Gold and Silver Ornaments, Precious Stones and Bullion; 5. Special 20% Rate: Applicable on Petrol, Diesel, Aviation Turbine Fuel, Other Motor Spirit, Liquor and Lottery Tickets, etc. 11. Variants of VAT: Figure 4: Variants of VAT

22 Gross Product Variant: In this variant, VAT is payable on sales and deduction is allowed for VAT paid on inputs only (excluding VAT paid on Capital Inputs). As credit is not allowed for VAT on capital goods, VAT paid for acquiring capital assets shall form part of cost of asset for computing depreciation. For example, an asset is purchased for Rs 3,00,000 and VAT 12.5%. Then, total cost is 337,500. If we assume life of 10 years then depreciation shall be Rs 33,750/-. In a way, capital goods are being taxed twice. It results in delaying the modernization and up gradation. INTERACTIVE 4 Income Variant: In this variant of VAT, VAT is payable on sales and VAT deductions are allowed for purchases of raw materials and components as well as proportionate VAT on depreciation on capital goods. As VAT Credit is being allowed through depreciation amount, VAT amount paid on capital goods does not form part of cost of asset. Thus, depreciation shall not be computed on VAT component. For example, in the above case, depreciation shall be Rs 30,000 p.a. (Rs 3,00,000 / 10 years of life). So, VAT deduction shall be allowed to the extent of 12.5% of Rs 30,000 i.e.3,750. Difficulty arises in selecting the method of depreciation. Consumption Variant: Under this variant, deduction is allowed for all business purchases including capital assets. It

23 does not distinguish between capital and current expenditures. Here, Tax on capital goods is also set off against VAT Liability. It results in easy administration as it does not differentiate between capital goods and consumption goods. Normally VAT deduction is allowed in 24 or 36 installments (depending upon the law in each state). As VAT deduction is being allowed for VAT paid on capital goods, VAT does not form part of cost of asset and is not considered for computing depreciation. Thus, in the above case, in Consumption Variant also, the depreciation comes to Rs 30,000 p.a. But further, say, the VAT is allowed to be deducted in 36 installments or say in 3 years then, deduction allowed for VAT shall be Rs 37,500 /36 = pm or 12,500 p.a. Note for Students: Unless the practical question talks about the number of installments allowed, we deduct the whole VAT on capital goods using Consumption Variant. As an option we can assume 36 installments and RESOLVE the question with second assumption also Why Consumption Variant is more Popular? Consumption variant is popular due to following reasons: Firstly, investment decisions are not affected by it because the tax on capital goods is also set off against the VAT Liability. Hence, the system is Tax Neutral in respect of techniques of production (labour or capital intensive). Secondly, it s a convenient method from the point of administrative expediency as it simplifies tax administration by obviating the need to distinguish between purchases of capital goods and consumption goods. Because of above mentioned reasons, Consumption Variant Method is quite popular and being followed in most of the countries. Also, most VAT countries include many services in the Tax Base. As the business gets set-off for the tax on services, it does not cause any cascading effect. Value Addition 6: Illustration Three Gross Product Variant of VAT Exercise : A submits the following information: Purchase of Raw Material and Component Rs 8,00,000 4% VAT on Above Purchases Rs 32,000 Purchase of Capital Goods -Machinery (life 10 years ) Rs 6,00, % VAT on Above Machine Rs 75,000 Direct and Indirect Expenses Rs 5,00,000 Profit 30% on total

24 cost VAT Payable on Sales 12.5% Compute a) The selling price of the product; b) Cost to consumer (including VAT); c) VAT payable to Government in all three variants i.e. Gross Product Variant, Income Variant and Consumption Variant. (assume 36 installments in consumption variant) Solution: Gross Product Variant Computation of Cost: Raw Material Cost Rs 8,00,000 Direct and Indirect Expenses Rs 5,00,000 Depreciation on Machine Rs 67, Total Cost 13,67,500 Add: 30% 4,10, Sale Price 17,77,750 Add: 12.5% 2,22, Cost to Consumer 19,99, VAT Collected from Consumer = Rs. 2,22,219 Less: Paid on Inputs ( Rs 32,000) ,219 Income Variant: In this Variant, as VAT deduction is allowed proportionately on Depreciation Portion, VAT paid on Capital Goods does not form part of cost of asset for computing depreciation. Hence, in this case, depreciation shall be computed on Rs 6,00,000. It means depreciation for machine of life of 10 years is Rs 60,000. Computation of Cost: Raw Material Cost Rs 8,00,000 Direct and Indirect Expenses Rs 5,00,000 Depreciation on Machine Rs 60, Total Cost 13,60, % 4,08,000

25 Sale Price 17,68, % 2,21, Cost to Consumer 19,89, VAT Collected from Consumer = Rs 2,21,000 Less: Paid On Inputs (Rs 32,000) (60,0000 X Less: VAT on Depreciation (7,500) 12.5%) VAT Payable 1,81, Consumption Variant: In this case also, VAT on capital goods is deductible, though in this case, it is allowed usually in 24 to 36 installments, VAT is not considered for computing depreciation on the cost of the asset. So, in this case also the depreciation shall be Rs 60,000 p.a. It means our computation shall be same upto Cost to consumer and VAT collected from consumer. In the end the VAT payable shall be calculated as follows: VAT Collected from Consumer = Rs 2,21,000 Less: Paid on Inputs ( Rs 32,000) Less: VAT on Capital Goods VAT Payable 1,64, Question 5: A submits the following information: (25,000) (Rs 75,000 / 3 Years) Purchase of Raw Material and Component Rs 12,00,000 4% VAT on Above Purchases Rs 48,000 Purchase of Capital Goods Being Machinery (life 10 years ) Rs 24,00, % VAT on Above Machine Rs 3,00,000 Direct and Indirect Expenses Rs 6,00,000 Profit 20% on total cost

26 VAT Payable on Sales 12.5% Compute a. The selling price of the product; b. Cost to consumer (including VAT); c. VAT payable to Government in all three variants i.e. Gross Product Variant, Income Variant and Consumption Variant. (Assume 36 installments in Consumption Variant) 12. Modes of VAT: Figure 5: Modes of VAT a. Addition Method: As VAT is a tax on the value added, this method is based on the addition of all elements of cost, i.e. 1. Wages & Salaries; 2. Power and Electricity; 3. Rent; 4. Depreciation on Capital Goods; 5. Manufacturing Expenses; 6. Trading Expenses; 7. Marketing Expenses; 8. Interest on Capital (assume it is relating working capital); 9. Profit Element; It is also known as Income approach. Here, VAT is computed on total value addition done by a particular person in the chain of

27 Distribution System. The main drawback of this system is that it does not require matching of invoices in order to check Tax Evasion. Where it can be used? Addition Method can be used mainly when all details are clearly available for the additions to be made. Question 6: A purchases raw material for Rs 2,00,000 (excluding VAT of Rs 8,000) and incurred the following manufacturing and trading expenses: 1 )Direct and Indirect Manufacturing Expenses Excluding Dep. Rs 1,00,000 2 )Dep. on Assets used for Manufacturing Activities Rs 20,000 3 )Trading Expenses Rs 15,000 4 )Rent and Interest Rs 33,000 5 )Profit Rs 12,000 VAT Payable = 4% on sales. Calculate the VAT payable using the Addition Method. Solution 6: Total Value Addition done (Addition Method) = 1,00, , , , ,000 = 1,80,000 VAT = 4% on Rs 1,80,000 = Rs 7,200 b. Subtraction Method: This method is also known as Product Approach. In this method, the difference between outputs and inputs is the value added. Again, it has two variants: 1. Direct Subtraction Method 2. Intermediate Subtraction Method Direct Subtraction Method: In this method, tax is levied on the difference between the aggregate tax-exclusive value of

28 sales and aggregate tax-exclusive value of purchases. Intermediate Subtraction Method: In this method, tax is levied on the difference between the aggregate tax inclusive value of sales and aggregate tax inclusive value of purchases. Above methods are not practically workable as the margin of dealer get disclosed. Disadvantages of Addition & Subtraction Method: It s not workable in the case of a manufacturer when the rate of tax is different in respect of inputs and outputs. The subtraction method of computing VAT is normally applied where: a. The tax is not charged separately, and b. The same rate of tax is attracted on all, including consumables and services, added at all stages of production / distribution c. Tax Credit Method (Also known as Invoice Method or Voucher Method) Tax = Difference between Output of Tax and Input of Tax Advantages of Tax Credit Method = Advantages of Vat System Question 7: An item purchased for Rs 4500 including 12.5% VAT is sold for Rs 5625 (including VAT of Rs 12.5%). Compute VAT liability using Subtraction Method & Tax Credit Method. Solution 7: AS PER DIRECT SUBTRACTION METHOD: Firstly, the difference between values will be calculated (exclusive of Taxes). Sales = Rs 5,000; Purchase = Rs 4,000 Difference & VAT Payable = [5,000 minus 4,000] X 12.5% = 125 AS PER INTERMEDIATE SUBTRACTION METHOD: The difference between values will be determined (inclusive of Taxes).

29 VAT payable is calculated on the amount = (Rs 5,625 Less 4,500) = Rs 1,125 So, VAT included in this amount = 1125 X 12.5 / = 125 AS PER TAX CREDIT METHOD VAT Payable = Rs 625 [Tax on Sales] less Rs 500 [Tax on Purchases] = Merits and Demerits of VAT: Justification/ Merits / Need / Features of VAT: 1. It provides full set off for input tax as well as tax on previous purchases; 2. Even credit allowed on VAT paid on capital items (may be in 36 or similar number of installments); 3. It abolishes the burden of several other taxes such as turnover tax, surcharge on sales tax, additional surcharge, special addition tax, etc. 4. CST is being phased out, so overall tax burden will rationalize and prices, in general, will fall; 5. VAT has replaced the existing system of inspection by a built in self-assessment by traders and manufacturers; 6. The tax structure has become simple and more transparent. Now, with only two tax rates, even a non-educated trader can understand the tax being charged from him by the wholesaler and the tax he is going to charge from the customer. Everything is transparently available on the invoice (bill) itself. This transparency enables the State Governments to know as to what is the exact amount of tax at each stage. Thus, it is a great aid to the Government while taking decisions with regard to rate of tax etc. 7. It will lead to improvement in tax compliance; 8. Government can expect increase in tax collection as more and more people will avoid dealing in cash either due to fear of being caught or due to attraction of simplicity, lower rate of taxation and other benefits being offered by VAT system. If tax is evaded at one stage; 9. Also, it is a stable source of revenue for the Government. As the collection is based on sales rather than income. People do purchase various products even on credit or on installments, even if there income is relatively low in a particular period; 10. It is in a way of charging tax in installments; 11. Unlike turnover tax, it taxes the input only once; 12. It is a justified approach as all dealers share the tax burden; 13. Easy procedures; 14. Only two tax rates;

30 15. Easy computation; 16. Lower taxation, lower cost, more competitiveness in business & exports; 17. Avoid distortions in trade and economy due to uniform tax rates (uniformity in the system); 18. Easy to understand; 19. Helps reducing tax evasion. There is a system of self-policing. It induces businesses to demand invoice from their suppliers so that they can get credit of tax against purchases made by them. If tax is evaded at one stage, full tax shall be realized at next stage. Therefore, evasion can occur when all companies in a production and distribution chain act in collusion to conceal their sale. To obtain tax credit invoice issued by one dealer is maintained by other to claim credit. It works like self-policing. 20. Certainty: The VAT system is simply based on transactions. No dispute regarding taxable stage of sale, no dispute regarding classification of goods for taxation at a particular rate & minimum requirement of declaration forms. Not much complicated definitions of sales, sales price, turnover etc. The tax is also broad based and applicable to all sales in business leaving little room for different interpretations. 21. Broader Base: Almost all sales are covered; 22. Neutrality: In the present VAT system, how much value is being added at what stage is of no consequence. It does not restrict the number of times an item is being sold in the distribution process. So specialization progresses in this system. No body tries to do all the steps to avoid tax burdens. Now, decisions regarding business depend on free play of market forces and competition rather than tax considerations. 23. As no item shall be mentioned on his certificate of registration, he can purchase any item of his choice which he wants to deal. Dealers are allowed to purchase any item they require as raw material for the purpose of manufacturing or for packing. 24. Abolition of Statutory Forms: There are no forms under VAT. Therefore, all problems related to forms automatically get resolved. Dealer will not have to make visits to department to get these forms issued. Similarly, there will be saving to the department both in terms of cost and in terms of time. Assessing officers will be saving lot of time which otherwise was being wasted in issuance of statutory forms, and now this can be utilized for other useful purposes including monitoring of tax collection and better administration. 25. Minimum Exemptions: The system will be more effective because of minimum exemptions. 26. Removal of limitations connected with first point or last point taxation; 27. Consignments are also being taxed at 2%: Though its nominal, but this is an additional revenue for state governments; 28. VAT acts are designed in such a way that high value tax payers should not be spared and on the contrary small dealers should be hassle free from compliance procedure. 29. Better Accounting Systems: Since the tax paid on an earlier stage is to be received back, the system will promote better accounting policies. 30. No Effect on Retail Price: System of VAT has always been criticized as tax is payable on the final sale price, the VAT usually increases the prices of the goods. However, VAT does not have any inflationary impact as it merely replaces the existing equal sales tax. Rather the tax impact on raw material is being eliminated by this VAT system. Therefore, VAT is not inflationary.

31 Value Addition 7: Quiz Multiple Choice Questions Click on the link below to take a quiz on the concept of VAT. Source: INTERACTIVE 5 Demerits of VAT System: 1. Extends through the production and distribution chain right up to the retail stage; 2. Extends to goods only. Services out of it. Proper credit could not be taken. Services are covered by Central Government and VAT is governed by states Government. 3. Due to pressure from various parts of the Industry, a lot of items are outside the purview of VAT; 4. Option to go up and down the rates of VAT of 4% and 12.5% (1% for Gold etc) is not available; % rate is too high; 6. Proper clarity is not there as to classification of various items. E.g paper is there in 4%. But it is not clear whether it includes tissue paper, toilet paper, gift-wrap, writing paper, drawing paper, etc; 7. VAT on MRP at first point for example, on drugs in West Bengal and Maharashtra is not good. It defeats the concept. Plus it shifts VAT collection from consumption states to producing states; 8. To achieve proper results, there should be just one rate and all commodities should be covered. By having different rates, composition schemes, exemptions etc, the proper result cannot be achieved; 9. As VAT is different in each State, still purchases from within the state and purchases from outside the state are not at PAR; 10. For smaller firms, the accounting and related expenses have increased. Now, they have to maintain proper records and invoices to claim credit. Returns etc have to be filed; 11. VAT is a type of Consumption Tax. Poor people spend most part of their income as compared to rich. So in a way it collects more tax from the poor. Thus while income tax is a progressive system of taxation, VAT is a regressive system of taxation. Though this limitation is to some extent solved by giving exemptions on various essential products and fixing lower rates of tax on other essential goods. 13. VAT increases administration cost of the states as well as now they have to deal with many dealers. Investment in stock will increase. As one has to pay tax at the time of purchase, he will have to carry tax paid stock. Thus, working capital requirement and interest burden shall increase. 14. VAT credit is not available if no tax is payable on final product being exempt or taxable at lower rate. 15. No credit for inter-state purchases. It is against the spirit of VAT. 16. Composition scheme will obstruct the flow of audit trail and this scheme can be mis-utilized by dishonest dealers. 17. Audit by department may be biased in few cases and can cause hardship. It is better to depend more on external audits.