The value-added tax (VAT) regime replaced sales tax with the key objective of eliminating the cascading effect of commodity taxes. It was believed that VAT would help widen the tax net, lead to revenue buoyancy and deter tax evasion.
In theory, a comprehensive VAT should have covered both goods and services. VAT should therefore have replaced excise duty, sales tax, entry tax, octroi and service tax, creating a single tax on all value addition. However, in India, VAT has replaced only sales tax. Three years out, what was the thought behind the implementation and how well has it worked out?
The VAT structure designed by the empowered committee did away with the multiple rates in the old sales tax regime and broadly divided the rate structure into two categories, i.e. 4% or 12.5%. The idea behind requiring the states to have uniformity of rates was to achieve three objectives. One, to eliminate tax competition between states; two, to simplify the tax regime; and third, to have a system of moderate tax rates and curb instances of extremely high taxation on some commodities.
This has worked very well over the past three years, considering the magnitude of the task before the empowered committee. There have certainly been some ambiguity and disputes on some items, as to whether they featured in the 4% schedule or suffered a rate of tax of 12.5%. However, it is difficult to see how this could have been totally eliminated.
Additionally, we have a system under the Constitution where each state has sovereignty with respect to trade taxation. Fundamentally, that would inevitably lead to discrepancies between state laws in terms of items in the 4% list, procedures, etc. Therefore, the experience with uniformity of rates has gone extremely well, considering the difficulty of the task.
However, this uniformity is now showing signs of strain. Gujarat has recently moved away from the basic rate structure and introduced the concept of additional VAT, resulting in VAT of 5% and 15% on certain specified goods. Similarly, some states have introduced tax exemptions/deferrals in order to attract new investment. It is difficult to see what the solution could be to this gradual drift away from the original concept of a uniform VAT across the states. As long as the states have the Constitutional power to amend/enact a law for taxing sales of goods, a gradually growing number of discrepancies between the state VAT Acts are bound to emerge.
A second point in the unfinished agenda of VAT reform concerns double taxation. There is a large area of double taxation that is emerging between VAT and service tax. For example, licensing of patents, trademarks and other transactions with respect to intellectual property rights potentially attract both VAT and service tax. Similarly, a software services contract can be taxed both under service tax as an information technology software service and under VAT as a works contract. This is an area which requires urgent attention.
A third area concerns inter-state sales. Inter-state sales are subject to CST, which is not creditable to the purchaser. It was recognised by the empowered committee that this was a significant flaw in the VAT regime that was introduced in 2005. Over the past two years, the CST rate has been reduced to 2%. It therefore looks likely that CST will be phased out entirely within 1-2 years. However, there is little clarity on what will replace CST. Clearly, CST needs to be replaced by some other tax. If it is simply done away with and inter-state transactions do not suffer tax, a large majority of sales will be structured as inter-state sales.
Discussion is currently veering around a tax levied by the destination state, creditable to the purchaser, but which is collected by the selling state. If this is implemented, it would indeed complete a long-awaited step in making the VAT system efficient and transparent.
CST at concessional rate against Form C is allowed only on select transactions between registered dealers. Considering that no credit of CST is available, the government should consider allowing such concessional duty on all business-to-business transactions. This would result in all banks, service providers, schools, hospitals, and similar organisations being able to issue Form C and avail a lower rate of tax for their purchases.
In summary, there is lot that has been done with the introduction of VAT. It has brought about an enormous improvement in the system of trade taxation in India. However, if the government can keep up the momentum and address the issues mentioned here, industry and trade would truly be thankful.