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Corruption in VAT is the most taxing issue
May, 29th 2014

The new government at the Centre raises afresh the prospect of the introduction of the Goods and Services Tax (GST) that is expected to make India a common market. But ahead of that, it is important that the government address the issue of the rampant corruption in the administration of the value-added tax (VAT), which will, together with service tax, be subsumed in GST.

Although corruption is prevalent in all the arms of administration in India, its existence in the administration of VAT is mind-boggling. This is mainly because concomitant reforms in administration were not followed through when VAT was adopted by the states between 2003 and 2008. Most states instead of overhauling their local tax administrations, merely effected some patchwork changes that were tacked on to the old sales tax set-up.

VAT was an important tax reform because it removed the cascading effect of multi-point sales tax through the mechanism of credit set-offs - in other words, VAT does not increase the price of the commodity more than the amount of tax. Also, due to the credit mechanism, this tax reduces transaction costs for large corporations as well as small dealers, and has provided the business community an opportunity to improve their operations and to gain a competitive advantage in a global economy.

However, the increasing magnitude of corruption in state VAT administrations is mainly on account of the existing organisation for tax administration and related procedures.

For instance, in most states, the existing organisation for VAT is based on geographic zones. Accordingly, the state is divided into wards or circles, which are primarily activity units. This traditional design maintains close proximity between the taxpayer and tax administrator. The excessive direct contract between taxpayers and tax officers is not very healthy for smooth tax administration. It would make better sense to re-organise the tax department on the basis of functions. For example, the work related to revenue receipts should be a separate cell, as should the follow-up action against defaulters, which is an important component of VAT management. In this set-up, special attention needs to be paid to the role of delinquents. A separate wing is needed to handle such dealers - to contact them on the phone, send them reminders and personally meet them. Similarly, it is important to have an audit wing with auditors who are specially trained to examine the accounts of the dealers. These auditors should have experience in the verification and enforcement branch, and should be responsible for the fieldwork of audit and assessment. Each auditor has to be given a specific audit assignment. Most states lack such audit wings.

Also, the existing system of VAT does not give due importance to a client services department, which would help increase voluntary compliance and reduce the interaction of the dealers with the department.

On similar lines, it is important to reorganise the tax department by setting up a separate wing for the registration of dealers to enable them to have online or on-the-spot registration. Many states have refurbished their VAT departments to give them a new look, but the facility of online or spot registration, related procedures and the amount of information sought does not match the requirements of a modern-day VAT administration.

A cursory look at the procedures related to registration, payment of tax, auditing and so on indicates that most of the states have prescribed procedures that call for direct personal contact and interaction between taxpayer and administrators. This gives the taxpayer the opportunity to collude with the tax official to reduce his tax liability. Given that the same processes are used even though the introduction of VAT expanded the number of registered dealers, the magnitude of corruption in the VAT administration has inevitably grown exponentially.

It is imperative, therefore, to re-engineer the tax administration on a functional basis and to rationalise the procedures by adopting information technology. The eSeva Kendras in Andhra Pradesh provide a good example of how this can be done through the use state-of-the-art technologies, as do the client services provided by the GST administration in Canada. The significance of this reform will be felt much more when GST is introduced and the department has to manage a large number of dealers operating in the system. Streamlining the system will have huge implications for India as it seeks to integrate with the global economy.

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