Critical Analysis of Value Added Tax With Special Reference To India

CRITICAL ANALYSIS OF VALUE ADDED
TAX WITH SPECIAL REFERENCE TO INDIA
SUBMITTED BY:
VIKRANT SINGH
MBA (G),SEM-IV
Enrollment no-A700
UNDER GUIDENCE OF:

--------------------------
Designation
ABS, Lucknow
DISSERTATION REPORT IN PARTIAL FULFILLMENT OF THE AWARD OF FULL TIME

MASTERS IN BUSINESS ADMINISTRATION (2009-11))
AMITY BUSINESS SCHOOL
AMITY UNIVERSITY UTTAR PRADESH LUCKNOW
1
PREFACE
As a part of our course curriculum I had to make a dissertation report on any topic to get
the right exposure to the practical aspects of business management.
Today VAT is widely applied in the European countries. However, now a number of
countries across the globe have adopted this tax system. VAT has gained so much
popularity that today it is considered as the only good sales tax. VAT is a general
tax that applies, in principle to all commercial activities involving the production
and distribution of goods and the provision of services.
I got an opportunity to work upon this topic. Where I work on the project entitled
“Critical Analysis of VAT”. Value added taxation avoids the cascade effect of
sales tax by taxing only the value added at each stage of production. Value added
taxation has been gaining favor over traditional sales taxes worldwide.
2
ACKNOWLEDGEMENT
In preparing this dissertation report a considerable amount of thinking and informational

inputs from various sources were involved. I express my deep sense of gratitude to
--------------------,my faculity guide for his excellent spirit, effective guidance,
encouragement and constant criticism, which gave me the confidence to complete the
term paper effectively. In spite of having a very busy schedule, he made sure in every
way that I acquire the best possible exposure and knowledge during my preparation of
research report under his guidance. He gave all the time and attention, which I needed to
complete my research and compile my term paper in as much orderly way as possible.
I am also thankful to all those people, who are directly or indirectly
associated with the timely completion my term paper, without which I otherwise would
not have able to complete my dissertation report.
Vikrant Singh
MBA(G) IV Sem.
(2008-2010)
3
Declaration
I HEREBY STATE THAT THIS PROJECT, SUBMITTED IN PARTIAL

FULFILLMENT FOR THE REQUIREMENTS OF MBA(G) PROGRAM OF
THE AMITY UNIVERSITY, LUCKNOW IS AN ORIGINAL RESEARCH
WORK CARRIED OUT BY ME UNDER THE GUIDANCE AND
SUPERVISION OF Mr. AURNOB ROY, AMITY BUSINESS SCHOOL
,LUCKNOW AND THE THESIS OR ANY PART HAS NOT BEEN
PREVIOUSLY SUBMITTED
Signature Signature
Name_______________ Name_____________
(Student) (Faculty
Guide)
4
Table of contents
CHAPTER I: INTRODUCTION
1.1. Background
1.2. Significance of the study
1.3. Scope and objectives
1.4. Limitations
CHAPTER II: PROFILE OF THE COMPANY

2.1. VAT
2.11. INTRODUCTION
2.12. COMPARISION WITH SALES TAX
2.13. PRINCIPLE OF VAT
2.14. BASIS FOR VAT
2.15. EXAMPLE OF VAT
2.16. VAT IN GLOBAL SCENARIO CONFERENCE
2.17. VAT AND INFLATION
2.18. SALIENT FEATURES OF VAT
2.19. VAT REGISTERED
2.20. ADVANTAGES AND DISADVANTAGES OF VAT
2.21.METHODS OF COLLECTING AND CHARGING VAT
2.22. CONSTITUTIONAL FRAMEWORK WHICH DEALS WITH THE
LEVY OF SALES TAX
2.23. WHO IS THE DEALER?
2.24. RELEVENT COMPONENTS FOR CALCULATING VAT
2.25. LIMITATIONS TO VAT
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2.26. CRITICISM
CHAPTER III: RESEARCH METHODOLOGY

3.1. Sources of data
Primary data
Secondary data
3.2. Statistical Tools
CHAPTER IV: ANALYSIS OF DATA
4.1. VAT: GLOBAL SCENARIO

4.11. Value Added Tax (VAT) in European Union Countries
4.12. Taxation in the United States
4.13. Value Added Tax (VAT) in Italy
4.14. Value Added Tax (VAT) in France
4.15. Value Added Tax (VAT) in Ireland
4.16. Value Added Tax (VAT) in Nigeria
4.17. Value Added Tax (VAT) in China
4.18. Value Added Tax (VAT) in UK
4.19. Value Added Tax (VAT) in Mexico
4.10. Value Added Tax (VAT) in Canada
4.21. Value Added Tax (VAT) in Germany
4.22. Value Added Taxes (VAT) India
CHAPTER IV: SUMMARY AND CONCLUSION
CHAPTER V: SUGGESTIONS AND RECCOMENDATIONS
BIBILIOGRAPHY
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CHAPTER I: INTRODUCTION
1.1. Background
1.4. Limitations
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1.1. Background
VAT has gained so much popularity that today it is considered as the only good sales tax.
VAT is a general tax that applies, in principle to all commercial activities involving the
production and distribution of goods and the provision of services. VAT is assessed and
collected on the value added to goods in each business transaction. Under this concept
the Government is paid tax on the gross margin of each transaction. VAT has many
positive gains to offer to Indian tax structure. For instance, it will eliminate the cascading
effect (tax on tax) of multi point taxation associated with the existing sales tax regime. A
uniform VAT rate will also eliminate competition among the states to offer tax
concessions to attract investment. More specifically, in context of economic reforms in
India it will make sales between states totally free thereby making India a common,
integrated market. Each producer will have a big common market before him. In fact in
recent literature (Bird 2000) VAT is considered as the most desirable form of tax from an
international perspective especially after global integration of the markets. But it is to be
noted that VAT has repercussions for the sensitive Center state relations.
VAT proposes to replace the sales tax that has conventionally been considered the best
form of ‘regional’ taxation. The traditional literature on taxation favours sales tax as best
source of revenue for sub national governments (for instance, Musgrave 1983) In fact in
India it is the only major revenue source for intermediate level of governments since low
per capita income and unemployment render income tax inadequate as a revenue source.
VAT thus poses serious problem for the finance of regional governments in India. Such
problems become more evident when the context of ongoing economic reforms is also
taken into account. In fact implementing VAT in India in context of economic reforms
has paradoxical dimensions for Indian federalism. On one hand economic reforms have
led to more decentralization of expenditure responsibilities which in turn demands more
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decentralization of revenue raising power if fiscal accountability is to be maintained. But
on the other hand implementation of VAT (to make India a single integrated market) will
lead not only to revenue loss for the states but also will steal away the states’ autonomy
indicating more centralization.
After economic reforms of 1991 expenditure responsibilities of the states vis a’ vis center
have increased. Thus to support and sustain economic reforms, it becomes essential to
devolve power for revenues to the sub central levels if adequate fiscal accountability and
much desired "Wicksellian connection" (Breton, 1996) is to be maintained. However, the
proposed implementation of VAT (also to support economic reforms) can do exactly the
opposite ie. loss of revenue to the states. Thus while objective behind introduction of
VAT is to eliminate much of the complexity and associated compliance costs of the
current system and also to increase India’s competitiveness in the international market
yet at the same time it poses serious problem for the finance of regional
governments.Thus the challenge in implementation of VAT in context of economic
reforms is to reconcile the opposing forces; one forcing toward centralization and other
towards decentralization. The need is to work out a variant of VAT that is acceptable to
states.
I consider in this dissertation report how emerging countries may in practice best design
and develop VAT, given the complex economic and political environments they face.
After an overview of what VAT system look like around the world, I discussed the
Indian perspective towards VAT and the principal objectives that India wants to achieve
through
VAT. In last, I conclude by considering the broader context within which VAT and
development issues must be designed and implemented.
9
My aim is to set out some of the basic issues facing VAT issues in emerging countries
and to outline some key elements that should be considered in designing the best feasible
VAT structure for any particular country at a particular time.
Value-added tax (VAT) now dominates tax systems around the world.
 Should every country have a VAT?
 Is the current VAT always as good as it could be in economic, equity, and

administrative terms?
 In developing and transitional countries the answers to such questions are critical
to stability, growth, and development. But can VAT be better designed and better
administered?
These are the key questions that must be answered in designing and implementing VAT.
But different tax designs may better suit different countries facing different
circumstances. These are the few questions which I am trying to cover up in this study.
2.3 LIMITATIONS OF THE STUDY
1. The study is based on secondary data available from monthly fact sheets,
websites and other books, as primary data was not accessible.
2. It is difficult to cover all the features of VAT in different countries
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3. The analysis and conclusion made by me as per my limited understanding and
there may be something variation in the actual situation.
4. The time period was limited.
CHAPTER II: PROFILE OF THE COMPANY
2.1. VALUE
ADDED
TAX
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2.11. INTRODUCTION
Value added tax or VAT is an indirect tax, which is imposed on goods and services at
each stage of production, starting from raw materials to final product. VAT is levied on
the value additions at different stages of production. VAT is widely applied in the
European countries. However, now a number of countries across the globe have adopted
this tax system.
VAT was first introduced in France as taxe sur la valeur ajoutee or TVA. In 1954, the
French economist, Maurice Laure, the joint director of the French tax authority, the
Direction generale des impost, initiated the concept of VAT, which came into effect on
April 10, 1954. Initially introduced for large businesses of France, with the passage of
time, VAT was employed for all business sectors of the country. In France, value added
tax is considered to be one of the major sources state finance.
Value added tax, also known as goods and services tax or GST proves to be beneficial for
the government. Through implementation of this tax system, government can raise
revenues invisibly, where the tax is not shown on the bill paid by the buyer. VAT is
different from sales tax in various aspects. While sales tax is to be paid on the total value
of the goods and services, VAT is levied on every exchange of the product, so that
consumers do not have to carry the total cost of tax. However, VAT is generally not
applied on export goods to avoid double taxation on the final product. However, if VAT
is charged on export goods, the tax amount is usually refunded to the tax payer.
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Value added tax can also be recovered. The individual consumers cannot recover VAT
on purchases made by them. However, businesses can recover VAT on the services and
materials, which are bought by them in order to continue the supply of the products and
services.
VAT was introduced to arrest the increasing smuggling and cheating, which were
resultants of high sales tax and tariffs. Initiated in France, VAT is used as an instrument
of taxation in all the member states of the European Union. Different VAT rates are
employed in different member states of EU. The minimum VAT rate for the EU
members is 15%. However, the reduced rate of VAT can be as low as 0%. The rate is
determined by the VAT authorities of different countries.
There are also some countries, where VAT has been introduced to replace sales tax. India
is one such country, where the system of VAT has been adopted for replacing the sales
taxation system.
The value added tax serves as the solution for different problems related to the sales tax
system. Unlike sales tax, in VAT, there is provision for input tax credit or ITC. Due to
the simplicity of the VAT system, the entire taxation system on consumer products and
services has become easier.
In some countries like India, the system of VAT has been designed to change the
existing system of sales taxation. Value added tax is different from the conventional
system of sales tax, because VAT is charged at every stage of value addition -
whereas sales tax is imposed on final value of transaction only.
The value added tax system allows for input tax credit, or ITC, on the amount of tax
levied at the preceding stage of the value addition chain. The allowance for ITC is
normally appropriated from the value added tax liability imposed on the following
stage of the sale of the product.
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2.12. COMPARISION WITH SALES TAX
Value added taxation avoids the cascade effect of sales tax by taxing only the value
added at each stage of production. Value added taxation has been gaining favor over
traditional sales taxes worldwide. In principle, value added taxes apply to all commercial
activities involving the production and distribution of goods and the provision of
services. VAT is assessed and collected on the value added to goods in each business
transaction. Under this concept the government is paid tax on the gross margin of each
transaction.
In many developing countries such as India, sales tax/VAT are a key revenue source as
high unemployment and low per capita income render other income sources inadequate.
However, there is strong opposition to this by many sub-national governments as it leads
to an overall reduction in the revenue they collect as well as a loss of some autonomy.
Sales taxes are normally charged only on final sales to consumers: because of
reimbursement, VAT has the same overall economic effect on final prices. The main
difference is the extra accounting required by those in the middle of the supply chain; this
disadvantage of VAT is balanced by application of the same tax to each member of the
production chain regardless of its position in it and the position of its customers, reducing
the effort required to check and certify their status. When the VAT system has few, if
any, exemptions such as with GST in New Zealand, payment of VAT is even simpler.
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A general economic idea is that if sales taxes exceed 10%, people start engaging in
widespread tax evading activity (like buying over the Internet, pretending to be a
business, buying at wholesale, buying products through an employer etc.) On the other
hand, total VAT rates can rise above 10% without widespread evasion because of the
novel collection mechanism. However, because of its particular mechanism of collection,
VAT becomes quite easily the target of specific frauds like carousel fraud, which can be
very expensive in terms of loss of tax incomes for states.
2.13. PRINCIPLE OF VAT
The standard way to implement a VAT is to say a business owes some percentage on the
price of the product minus all taxes previously paid on the good. If VAT rates were 10%,
an orange juice maker would pay 10% of the £5 per litre price (£0.50) minus taxes
previously paid by the orange farmer (maybe £0.20). In this example, the orange juice
maker would have a £0.30 tax liability. Each business has a strong incentive for its
suppliers to pay their taxes, allowing VAT rates to be higher with less tax evasion than a
retail sales tax. Behind this simple principle are the variations in its implementations, as
discussed in the next section.
2.14. BASIS FOR VAT
By the method of collection, VAT can be accounts-based or invoice-based[2]. Under the

invoice method of collection, each seller charges VAT rate on his output and passes the
buyer a special invoice that indicates the amount of tax charged. Buyers who are subject
to VAT on their own sales, use these invoices to obtain a credit (reduction) towards their
own VAT liability. The difference in tax shown on invoices passed and invoices received
is then paid to the government (or a refund is claimed, in the case of negative liability).
Under the accounts based method, no such specific invoices are used. Instead, the tax is
calculated on the value added, measured as a difference between revenues and allowable
15
purchases. Most countries today use the invoice method, the only exception being Japan,
which uses the accounts method.
By the timing of collection[3], VAT (as well as accounting in general) can be either
accrual or cash based. Cash basis accounting is a very simple form of accounting. When
a payment is received for the sale of goods or services, a deposit is made, and the revenue
is recorded as of the date of the receipt of funds — no matter when the sale had been
made. Checks are written when funds are available to pay bills, and the expense is
recorded as of the check date — regardless of when the expense had been incurred. The
primary focus is on the amount of cash in the bank, and the secondary focus is on making
sure all bills are paid. Little effort is made to match revenues to the time period in which
they are earned, or to match expenses to the time period in which they are incurred.
Accrual basis accounting matches revenues to the time period in which they are earned
and matches expenses to the time period in which they are incurred. While it is more
complex than cash basis accounting, it provides much more information about your
business. The accrual basis allows you to track receivables (amounts due from customers
on credit sales) and payables (amounts due to vendors on credit purchases). The accrual
basis allows you to match revenues to the expenses incurred in earning them, giving you
more meaningful financial reports.
2.15. EXAMPLE OF VAT
Consider the manufacture and sale of any item, which in this case we will call a widget.
Without any tax
• A widget manufacturer spends £1.00 on raw materials and uses them to make a
widget.
• The widget is sold wholesale to a widget retailer for £1.20, leaving a profit of
£0.20.
• The widget retailer then sells the widget to a widget consumer for £1.50, making
a profit of £0.30.
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With a North American (Canadian provincial and U.S. state) sales tax
With a 10% sales tax:
• The manufacturer pays $1.00 for the raw materials, certifying it is not a final
consumer.
• The manufacturer charges the retailer $1.20, checking that the retailer is not a
consumer, leaving the same profit of $0.20.
• The retailer charges the consumer $1.65 ($1.50 + $1.50x10%) and pays the
government $0.15, leaving the profit of $0.30.
So the consumer has paid 10% ($0.15) extra, compared to the no taxation scheme, and
the government has collected this amount in taxation. The retailers have not lost anything
directly to the tax, and retailers have the extra paperwork to do so that they correctly pass
on to the government the sales tax they collect. Suppliers and manufacturers have the
administrative burden of supplying correct certifications, and checking that their
customers (retailers) aren't consumers.
With a value added tax
With a 10% VAT:
• The manufacturer pays $1.10 ($1 + $1x10%) for the raw materials, and the seller
of the raw materials pays the government $0.10.
• The manufacturer charges the retailer $1.32 ($1.20 + $1.20x10%) and pays the
government $0.02 ($0.12 minus $0.10), leaving the same profit of $0.20.
• The retailer charges the consumer $1.65 ($1.50 + $1.50x10%) and pays the
government $0.03 ($0.15 minus $0.12), leaving the profit of $0.30 (1.65-
1.32-.03).
So the consumer has paid 10% ($0.15) extra, compared to the no taxation scheme, and
the government has collected this amount in taxation. The businesses have not lost
anything directly to the tax. They do not need to request certifications from purchasers
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who are not end users, but they do have the extra accounting to do so that they correctly
pass on to the government the difference between what they collect in VAT (output
VAT, an 11th of their income) and what they spend in VAT (input VAT, an 11th of their
expenditure).
Note that in each case the VAT paid is equal to 10% of the profit, or 'value added'.
The advantage of the VAT system over the sales tax system is that businesses cannot
hide consumption (such as wasted materials) by certifying it is not a consumer.
Limitations to example and VAT
In the above example, we assumed that the same number of widgets were made and
sold both before and after the introduction of the tax. This is not true in real life.
The fundamentals of supply and demand suggest that any tax raises the cost of
transaction for someone, whether it is the seller or purchaser. In raising the cost, either
the demand curve shifts leftward, or the supply curve shifts upward. The two are
functionally equivalent. Consequently, the quantity of a good purchased decreases,
and/or the price for which it is sold increases.
This shift in supply and demand is not incorporated into the above example, for
simplicity and because these effects are different for every type of good. The above
example assumes the tax is non-distortionary.
A VAT, like most taxes, distorts what would have happened without it. Because the price
for someone rises, the quantity of goods traded decreases. Correspondingly, some people
are worse off by more than the government is made better off by tax income . That is,
more is lost due to supply and demand shifts than is gained in tax. This is known as a
deadweight loss. The income lost by the economy is greater than the government's
income; the tax is inefficient. The entire amount of the government's income (the tax
revenue) may not be a deadweight drag, if the tax revenue is used for productive
spending or has positive externalities - in other words, governments may do more than
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simply consume the tax income. While distortions occur, consumption taxes like VAT
are often considered superior because they distort incentives to invest, save and work less
than most other types of taxation - in other words, a VAT discourages consumption
rather than production.
2.16. VAT IN GLOBAL SCENARIO CONFERENCE
On March 15-16 in Rome, Italy the International Tax Dialogue - a joint initiative of IMF,
the OECD, THE World Bank with the UN as an active observer convened the first global
tax conference to examine the experience of countries adopting value added tax (VAT).
The summit simply stated that VAT is a general consumption tax assessed on value
added on goods and services as they pass through supply chain. The conference was
opened by Italian minister of Economy and Finance, Domenico Siniscalo and drew
participants from more than 85 countries as well as representatives from International
and regional tax organizations.
The discussion examined policy and administrative challenges of using VAT system. The
discussion included tax treatment in financial services, operation of VAT in small island
economies, application of VAT to the public sector and electronic commerce as well as
compliance and audit issues and growing incidence of tax evasion.
Italian minister of economy and Finance, Mr. Domenico Siniscalo emphasized the
opportunity to analyze the pros and cons of VAT, a tax that is now largely applied at
global level and a considerable source of tax yield. He noted the coverage of taxable
base, which is necessary to ensure effectiveness and neutrality of tax. The risks in
applying different taxes rates are market distortions and increase in both administrative
19
and compliance costs, which would be borne by administration and traders. He added
increasing tax fraud and evasion and measures for checking them.
Mr. Danny Leipziger, vice president of world bank's poverty reduction and Economic
management Network, stressed that "In just 50 years, value added tax have become a
major source of revenue in many countries. VAT constitutes a larger portion of revenues
both in developed as well as developing nations. Tax performance directly hits the ability
to meet the millennium targets. It is there fore a key policy area for all concerned with
revenue mobilization".
Mrs. Teresa Ter Minassian, Director of International Monetary Fund's Fiscal Affairs
Department stressed the importance of VAT for emerging market and Developing
countries." VAT has proved itself a powerful tool in modernizing and strengthening
domestic systems, enabling these countries to better meet the challenges of financing
poverty reduction and further trade liberalization. Bringing together for the first time the
world's leading experts and practitioners in the art of VAT, this conference is a unique
opportunity for sharing experience on this key aspect of the world's tax system"
Mr. Donald Johnston, the secretary general of the OECD chaired the high level opening
panel. He commented that the spread of new information technologies and closer global
economic integration significantly increases the risks of double taxation (or double non-
taxation) arising from interaction of different VAT systems around the world. He added,"
Perhaps the time has come to have model VAT convention, just as we have model
income tax convention". He noted that VAT systems in many OECD countries are being
systematically attacked by tax fraudsters, hence we need better international cooperation
to tackle such behavior.
EU commissioner Laszlo Kovacs noting the European commissions satisfaction at being

able to support this international event, stressed that "the commission will continue to
pursue its objectives for VAT reform which include the simplification and modernization
of the EU's VAT system. The system must not create obstacles for business and within
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the EU the process of tax reform must take full account of the policy objectives of the
Lisbon agenda. The economic environment within which the tax systems operate has
changed immeasurably in recent years and failure to recognize this will leave business
with undue compliance burdens. Inefficiency within the system also adds to the operating
costs of administrations and is a distraction from the need to combat systematic tax
fraud.Cooperation between tax administrations is an important component in tackling this
common concern".
2.17. VAT AND INFLATION
A global voice in concerned countries introducing value-added tax is that the

introduction of the tax would set in motion a spiral in which tax, prices and wages would
feed on each other -- that is, VAT would be inflationary was heard.
The introduction of VAT, or any tax for that matter, can never, by itself, lead to a
sustained increase in the rate of change in the price level.
Such a change in the inflation rate can be produced by an expansionary monetary policy
under circumstances. If, however, the term is interpreted as an increase in the price level
(or a one-period increase in the inflation rate), then whether VAT is inflationary in this
sense would depend on a number of factors. Presently inflation among nations is seen
mainly rising oil prices in international market.
After VAT was first introduced, a survey was conducted by Alan S Tait on its impact in
several countries on the basis of International Monetary Fund data, which shows that
VAT is never introduced in isolation.
There are a number of variables influencing price change, and therefore, it is difficult to
empirically assess the effect of VAT on prices. The impact of VAT on prices, therefore,
cannot be strictly segregated from the general trend in inflation.
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First, the taxes that have been replaced are also relevant. They could be a wholesale sales
tax of the cascading type, a simpler VAT, a multistage ring system, a cascade production
tax and so on.
Second, the design to yield equal or higher revenue also makes a difference.
Third, other concurrent changes such as rise in oil or steel prices in international and
internal markets, increase in utility rates, changes in wage levels, administrative changes
such as tighter monetary policy, price control, monitoring of prices and so on, make due
impact on the price rise.
It is seen that the net price effect of VAT would be nil if the VAT is an equal-yield tax.
There would not be any effect on the overall price change although there may be changes
in relative prices.
The tax being revenue neutral, the aggregate demand is unchanged and so there would be
no impact on the aggregate price level. The economists all over the world have viewed
that VAT is not inflationary.
Thus, this brings us to conclude that the potentially inflationary effect can be constrained
by government policies to inform the public and traders about the expected effect of
VAT on prices, the use of price controls, monitoring of prices, offsetting adjustment in
other taxes and generous provisions to ensure full credit for previously paid taxes on
inputs. Moreover a mechanized form of Government can give it a better shape through
administration.
2.18. SALIENT FEATURES OF VAT
a. Rate of Tax VAT proposes to impose two types of rate of tax mainly:
o 4% on declared goods or the goods commonly used.
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o 10-12% on goods called Revenue Neutral Rates (RNR). There would be
no fall in such remaining goods.
o Two special rates will be imposed-- 1% on silver or gold and 20% on
liquor. Tax on petrol, diesel or aviation turbine fuel are proposed to be
kept out from the VAT system as they would be continued to be taxed, as
presently applicable by the CST Act.
b. Uniform Rates in the VAT system, certain commodities are exempted from tax.
The taxable commodities are listed in the respective schedule with the rates. VAT
proposes to keep these rates uniform in all the states so the goods sold or
purchased across the country would suffer the same tax rate. Discretion has been
given to the states when it comes to finalizing the RNR along with the
restrictions. This rate must not be less than 10%. This will ensure By doing this
that there will be level playing fields to avoid the trade diversion in connection
with the different states, particularly in neighbouring states
c. No concession to new industries Tax Concessions to new industries is done away
with in the new VAT system. This was done as it creates discrepancy in
investment decision. Under the new VAT system, the tax would be fair and
equitable to all.
d. Adjustment of the tax paid on the goods purchased from the tax payable on the
goods of sale All the tax, paid on the goods purchased within the state, would be
adjusted against the tax, payable on the sale, whether within the state or in the
course of interstate. In case of export, the tax, paid on purchase outside India,
would be refunded. In case of the branch transfer or consignment of sale outside
the state, no refund would be provided.
e. Collection of tax by seller/dealer at each stage. The seller/dealer would collect the
tax on the full price of the goods sold and shows separately in the sell invoice
issued by him
VAT is not cascading or additive though the tax on the goods sold is collected at each
stage, it is not cascading or additive because the net effect would be as follows: - the tax,
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previously paid on the sale of goods, would be fully adjusted. It will be like levying tax
on goods, sold in the last state or at retail stage.
2.19. VAT REGISTERED
VAT registered means registered for VAT purposes, i.e. entered into an official VAT
payers register of a country. Both natural persons and legal entities can be VAT
registered. Countries that use VAT have established different thresholds for remuneration
derived by natural persons/legal entities during a calendar year (or a different period), by
exceeding which the VAT registration is compulsory. Natural persons/legal entities that
are VAT registered are obliged to calculate VAT on certain goods/services that they
supply and pay VAT into a particular state budget. VAT registered persons/entities are
entitled to a VAT deduction under legislative regulations of a particular country. The
introduction of a VAT can reduce the cash economy because businesses that wish to buy
and sell with other VAT registered businesses must themselves be VAT registered.
2.20. ADVANTAGES AND DISADVANTAGES OF VAT
Advantages Of VAT
1. Simplification Under the CST Act, there are 8 types of tax rates- 1%, 2%, 4%,
8%, 10%, 12%, 20% and 25%. However, under the present VAT system, there
would only be 2 types of taxes 4% on declared goods and 10-12% on RNR. This
will eliminate any disputes that relate to rates of tax and classification of goods as
this is the most usual cause of litigation. It also helps to determine the relevant
stage of the tax. This is necessary as the CST Act stipulates that the tax levies at
the first stage or the last stage differ. Consequently, the question of which stage of
tax it falls under becomes another reason for litigation. Under the VAT system,
tax would be levied at each stage of the goods of sale or purchase.
2. Adjustment of tax paid on purchased goods Under the present system, the tax
paid on the manufactured goods would be adjusted against the tax payable on the
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manufactured goods. Such adjustment is conditional as such goods must either be
manufactured or sold. VAT is free from such conditions.
3. Further such adjustment of the purchased goods would depend on the amount of
tax that is payable. VAT would not have such restrictions. CST would not have
the provisions on refund or carry over upon such goods except in case of export
goods or goods, manufactured out of the country or sale to registered dealer.
Similarly, on interstate sale on tax-paid goods, no refund would be admissible.
4. Transparency The tax that is levied at the first stage on the goods or sale or
purchase is not transparent. This is because the amount of tax, which the goods
have suffered, is not known at the subsequent stage. In the VAT system, the
amount of tax would be known at each and every stage of goods of sale or
purchase.
5. Fair and Equitable VAT introduces the uniform tax rates across the state so that
unfair advantages cannot be taken while levying the tax.
6. Procedure of simplification Procedures, relating to filing of returns, payment of
tax, furnishing declaration and assessment are simplified under the VAT system
so as to minimize any interface between the tax payer and the tax collector.
7. Minimize the Discretion the VAT system proposes to minimize the discretion
with the assessing officer so that every person is treated alike. For example, there
would be no discretion involved in the imposition of penalty, late filing of
returns, non-filing of returns, late payment of tax or non payment of tax or in case
of tax evasion. Such system would be free from all these harassment
8. Computerization the VAT proposes computerization which would focus on the
tax evaders by generating Exception Report. In a large number of cases, no
processing or scrutiny of returns would be required as it would free the tax
compliant dealers from all the harassment which is so much a part of assessment.
The management information system, which would form a part of integral
computerization, would make the tax department more efficient and responsive.
Disadvantages of VAT:
25
1. Provide a large tax cut for the wealthiest citizens.
2. Have very little positive impact on the economy. Many argue that taxes do not
influence investment decisions and that even if there were an unlocking effect.
3. Increase the budget deficit. If a capital gains tax cut reduces revenues and increases the
budget deficit, then savings and investment might actually fall after the tax cut. That
would only worsen reported capital shortage.
2.21.METHODS OF COLLECTING AND CHARGING VAT
Generally, there are 2 methods that are followed while charging and collecting the VAT:
1. Invoice or tax credit method The tax is collected and charged separately on the
basis of the tax that is paid on the purchase and the tax that is payable on the sale,
shown separately in the invoice. Therefore, the difference between the tax paid on
purchase and the tax payable on sale as per the invoice is the VAT.
2. Subtraction Method Under this method, the tax is collected and charged on the
aggregate value of the tax payable on sale and purchase by applying the rate of
tax, applicable to the goods. Therefore, the difference between the sale price and
purchase price would be VAT. It means VAT is the tax which consumers
ultimately face. It is collected at each stage. The tax earlier paid can be allowed as
set off or credit. Therefore, it is called as Last Point Tax .
2.22. CONSTITUTIONAL FRAMEWORK WHICH DEALS WITH

THE LEVY OF SALES TAX:
26
The states are empowered to impose sale tax on the goods that are subject to purchase or
sale by enacting laws. The Parliament has enacted the CST Act and the states are in the
process of enacting laws. The sale of goods or purchase includes:
a. the sale of goods, defined under the Sale of Goods Act.

b. transfer of goods used as otherwise in pursuance of the contract.
c. transfer of goods used otherwise in Works Contracts.
d. delivery of goods in pursuance to Hire Purchase Agreement or on installment.
e. transfer of right to use to goods on lease or otherwise.
f. supply of food by the club or body to its members.
g. supply of food articles or drinks for consumption.
The transaction referred above from (c) to (g) are considered to be deemed sale and
power can be exercised to impose tax on such sale by the states. States are also
empowered to provide levy, creating a liability to pay tax and other payment assessment
and certain procedural formalities like maintenance of accounts, records, appeals and
issue of declaration of Tax Invoice, Input Tax Credit, etc.
To determine the cost of tax on certain commodities, the VAT law maybe classified as
prescribed goods and classified goods and computation of tax on the turnover of sale and
the taxable turnover and assessment. Under VAT laws, tax is imposed on the sale or
purchase of the goods. The states levy the rate of tax at the point of levy upon such
goods. They are also empowered to prescribe modes and manners of set-off.
LEVIES OF TAX UNDER THE VAT
1. Sale Tax or Output Tax including Deemed Sale within the state. It covers all
kinds of transfer of goods, under the Sale of Goods Act including deemed sale
that is transfer of goods by way of Works Contract delivery of goods on the basis
of a hire purchase agreement or installment, etc.
2. Purchase Tax, including Deemed Purchase within the state. The tax paid on
purchase of goods in certain circumstances.
27
3. Composition tax, that is in lieu of tax by way of lump sum tax. This means the
amount paid by the dealers like retailers whose turnover is below the specified
limit of the taxable turnover that is allowed to pay the amount at his option.
2.23. WHO IS THE DEALER?
Section 2(10) of the VAT Act, 2003 defines the term dealer. Dealer means the person,
who is engaged in the activities in connection with or consequent to or incidental to trade
or commerce. It also means the person, who supplies, distributes, sells or buys any goods
against the valuable consideration or otherwise. He can be the merchandise agent, factor,
broker, auctioneer or executes Works Contracts, transfer the goods by way of lease,
delivers the goods on Hire-Purchase Agreement or installment or supplies goods or
distributes them by way of or as part of the service. He can be a casual dealer or his agent
or non-resident dealer or sub-agent. The dealer also means the local branch of any firm
company, any association, body of individual, situated outside the state whether
incorporated or not.
Agriculturist or educational institutions will not be deemed to be dealers.
Any dealer, registered under the earlier law or whose turnover exceeds the prescribed
limits subject to tax; or any merchandise agent like factor, broker, auctioneer, etc, or non-
resident dealer, are also liable to pay CST. Any dealer registered himself under voluntary
registration under Section 25 or any successors to the business to which the predecessors
are also liable to tax under section 60.
Any dealer whose turnover exceeds the specified limit as prescribed by the state is liable
to pay tax. The turnover will be considered on the total turnover of sale and purchase. It
will be levied in the event of any sale or purchase.
Special Additional Tax (SAT)
SAT refers to the Special Additional Tax. It may either be independent of VAT or in
addition to VAT. It maybe levied at the first stage or at any stage as may be notified in
28
the state. The SAT will be levied on the sale of prescribed goods such as liquor, petrol,
aviation turbine fuel, diesel, raw opium, tendoo leaves, natural gas. The rate on SAT
would be levied as prescribed in respect of the relevant schedules or notifications. SAT
will be payable along with the ordinary sales tax that is payable under the Act. This is
done by furnishing returns within the prescribed time and in the stipulated form.
2.24. RELEVENT COMPONENTS FOR CALCULATING VAT:
• Sale or purchase price of the goods

• Turnover of sale or purchase including the taxable turnover
• Output Tax
• Input Tax
• Input Tax paid on purchase on which the credit or set off claim
• Net tax payable
Imposition and rate of VAT

This is the single most important section in any VAT related Act. The goods that come
within the purview of the VAT and those that fall outside it have been restated by the
Sixth VAT Directive. This schedules states the applicability of the tax on the supply and
exchange of goods, as well as the rates of exchange.
VAT rates also vary widely across the EU VAT area. While there are parts of Europe
where 25% VAT is applied to goods, there are also areas where as low as 0% VAT is
levied on certain commodities in some countries. However, irrespective of these
extremities, the general VAT rate remains at around 15%.
Taxable Persons and Registration
29
This schedule defines the persons to be taxed. Being an indirect tax, it is important for
the law to ascertain the payee on whom the tax is levied. It includes persons as well as
business organizations.
Scope of VAT on Taxable Supplies

Supply is generally defined by the Treasury order of the respective country. Associated
schedules also go on to ascertain and fix the Time and Place of supply. Reverse charge
on supplies received from abroad, depending on the place and time of the supplier and/ or
the recipient of the service.
Scope of VAT on acquisitions of belongings of other member states This schedule is

particularly applicable to the member countries of the EU. The formation of a common
currency has drastically refashioned the taxation system in the whole of Europe. All
member countries of the Euro are bound to be a part of the EU VAT area. The levying
authority and the collecting authority as well as the rates of taxation are determined by
the Euro Council.
In most EU states, and particularly the UK, this clause also includes the acquisition from
member states. The meaning of acquisition is defined by an additional schedule of the
VAT Act. The Time and Place of acquisition is also covered and defined by the Act.
Acquisitions from persons belonging to another member state, is another schedule which
is also particularly applicable to EU. However, it can be well applied to other economic
blocs as well, like the Nordic countries and Latin America, of course with specific
modifications.
Input Tax and Output Tax

Two kinds of VAT are levied in Europe. First, there is the output tax, which is paid by
the customer on the exchange directly. Then, there is the 'input tax', paid by one business
to another for supplies. The Sixth VAT Act of the EU Council states that the Input VAT
cannot be recovered if it is attributed to exempt supplies.
30
Payment by reference to accounting periods and credit for input tax against output
tax.
The input tax of the business houses is calculated to be recovered by the output tax. The
government pays off the excess if it fails to be recovered, of course with clear accordance
to the statutes and the clauses lay down by the VAT Act of that particular country.
Payments on account of VAT

The customer, moreover, can avail a discount in tax on the basis of previously taxed
input and labor at the exempt stage, resulting in a lowered effective rate than the headline
rate.
VAT Acts also cover the following key areas:
• General provisions relating to imported goods

• Application of customs enactments
• Free Zone Regulations
• Place and Time of acquisition and Supply
• Value of supply of goods or services
• Value of imported goods
• Goods imported for private purposes
• Invoices provided by recipients of goods or services
2.25. LIMITATIONS TO VAT
It is important to note that quantity demanded for a good being taxed does not decrease,
is not valid in real world circumstances.
The fundamentals of supply and demand suggest that any tax raises the cost of
transaction for someone be it the seller or purchaser. In raising their cost, either the
demand curve shifts leftward, or the supply curves shifts rightward. The two are
functionally equivalent. Consequently, the quantity of a good purchased, and/or the price
for which it is sold decrease. The example fails to recognize this, as it is different for
31
every good. In sum, in understanding the above examples, one must realize they assume
the tax is non-distortionary.
VAT, (as well as any other tax) distort what would have happened without it. Because
the price for someone rises, not all the goods that would have been traded were there no
tax are traded. Correspondingly, some people are more worse off than the government is
made better off by tax income. In other words, a deadweight loss is created. The income
lost by those being taxed is greater than the government's income; the tax is inefficient.
2.26. CRITICISM
The "value-added tax" has been criticized as the burden of it relies on personal end-
consumers of products. Like all consumption taxes, it is a regressive tax. (The poor pay
more, as a percentage of their income, than the rich.) Defenders claim that excising
taxation through income is an arbitrary standard, and that the value-added tax is in fact a
proportional tax in that people with higher income pay more at the same rate that they
consume more. The effective progressiveness or regressiveness of a VAT system can
also be affected when different classes of goods are taxed at different rates. To maintain
the progressive nature of total taxes on individuals, countries implementing VAT have
reduced income tax on lower income-earners, as well as instituted direct transfer
payments to lower-income groups, resulting in lower tax burdens on the poor.[4]
Revenues from a value added tax are frequently lower than expected because they are
difficult and costly to administer and collect. In many countries, however, where
collection of personal income taxes and corporate profit taxes has been historically weak,
VAT collection has been more successful than other types of taxes. VAT has become
more important in many jurisdictions as tariff levels have fallen worldwide due to trade
liberalization, as VAT has essentially replaced lost tariff revenues. Whether the costs and
distortions of value added taxes are lower than the economic inefficiencies and
enforcement issues (e.g. smuggling) from high import tariffs is debated, but theory
suggests value added taxes are far more efficient.
32
Certain industries (small-scale services, for example) tend to have more VAT avoidance,
particularly where cash transactions predominate, and VAT may be criticized for
encouraging this. From the perspective of government, however, VAT may be preferable
because it captures at least some of the value-added. For example, a carpenter may offer
to provide services for cash (i.e. without a receipt, and without VAT) to a homeowner,
who usually cannot claim input VAT back. The homeowner will hence bear lower costs
and the carpenter may be able to avoid other taxes (profit or payroll taxes). The
government, however, may still receive VAT for various other inputs (lumber, paint,
gasoline, tools, etc) sold to the carpenter, who would be unable to reclaim the VAT on
these inputs. While the total tax receipts may be lower compared to full compliance, it
may not be lower than under other feasible taxation systems.
Because exports are generally zero-rated (and VAT refunded or offset against other
taxes), this is often where VAT fraud occurs. In Europe, the main source of problems is
called carousel fraud. Large quantities of valuable goods (often microchips or mobile
phones) are transported from one member state to another. During these transactions,
some companies owe VAT, others acquire a right to reclaim VAT. The first companies,
called 'missing traders' go bankrupt without paying. The second group of companies can
'pump' money straight out of the national treasuries.[citation needed]
This kind of fraud
originated in the 1970s in the Benelux-countries. Today, the British treasury is a large
victim.[5] There are also similar fraud possibilities inside a country. To avoid this, in some
countries like Sweden, the major owner of a limited company is personally responsible
for taxes. This is circumvented by having an unemployed person without assets as the
formal owner.
33
CHAPTER III: RESEARCH METHODOLOGY
In this chapter we will present how we will conduct our research in order to collect
primary data and reach the objective of the dissertation. We will also be
discussing which different types of methodologies that were used.
3.1. Research design
34
It is a descriptive research study.As the facts which were gathered and analysed here are
already gathered in different researchs.I only collected the important one which are
related to my study from various sources and reached on a particular solution.
3.2. Sources of data
Primary data:
I searched the matter from my perspective, which gave me right and justified
conclusion.As far as my topic is concerned it was not possible at all for me to find out the
primary data through survey.
Secondary data:
Secondary data can be classified into three different subgroups: documentary, multiple
source, and survey. Documentary second hand data comes in both written and non
written form. It is the data that can be collected from sources such as journals, databases,
transcripts etc. This form of data is dependent on the access the researcher has to it.
Survey based secondary data is the data that is collected through the survey and is
available as data table forms. Multiple source secondary data is data that has been
compiled into documentary or survey form.
3.3. Analytical Tools :
Here I collected application of VAT in different countries. It gives useful insight of my

project report.
Documentary observation:
Books, annual report, website, published and unpublished materials.
35
CHAPTER IV: ANALYSIS OF DATA
36
4.1. VAT:
GLOBAL
SCENARIO
4.11. VAT IN EUROPEAN UNION COUNTRIES
The tax-to-GDP ratio rose steadily in most EU countries up to the late 1990s due to a
sustained expansion of public sector commitments to welfare provision. Since the late
1990s, many EU countries have cut tax rates. The tax burden in the EU area remains
much higher still now.
37
Consumption taxes account for a large share of total tax revenues
Effective tax rates on consumption in the EU area are, on average, higher than in most
other OECD countries. This not only reflects a higher tax to GDP ratio but also a tax mix
relying heavily on consumption taxes. In fact, consumption-based taxes accounted for 30
per cent of total tax revenues in the EU area in 1998 in comparison to 19 and 16 per cent
in Japan and the United States respectively. VAT playing a dominant role accounting for
about 60 per cent of total tax revenues on goods and services in the EU area.
The heavy reliance on consumption taxes has several advantages
(i) consumption taxes are relatively neutral towards saving and investment decisions;
(ii) they do not discriminate between imports and locally-produced goods and do not
affect external competitiveness (as long as they are based on the destination principle);
and
(iii) they provide a symmetric treatment of labour, transfer and capital income
Free movement of goods, people and capital within the EU area, combined with the
advent of the single currency has affected the design of national tax systems. Thus, EU
countries' experience in reforming their tax system may provide useful insights for other
countries and regions where international integration is deepening.
EU tax systems
The tax burden in the EU area is much higher than in most other OECD countries.
Defined as the tax-to-GDP ratio, it stood at 40 per cent in 1998, some 11 and 12
percentage points higher than in the United States and Japan, respectively. The tax mix is
also different. Most EU countries rely heavily on social security contributions,
38
consumption and environmentally related taxes. On the other hand, corporate income and
property taxes account for a much lower share of total tax revenues than in Japan and the
United States -- the United Kingdom and France being the main exception to
Shifting the tax burden from labour to capital in EU
The average effective tax rate on labor in the EU area appears to be about 15 percentage
points higher than in the United States and Japan While the calculation of average
effective tax rates suffer from methodological problems and does not take into account
any shifting of tax incidence. There is little doubt that tax in the EU area concentrates
heavily on the labour markets. Labour income is most heavily taxed in Austria, Belgium,
France, Italy and the Nordic countries while the United Kingdom, Ireland, and Portugal
stand out for taxing labour income at an average effective rate broadly equal to that of the
United States and Japan. Since the mid 1990s, many EU countries have introduced
measures to lower the tax burden on labour, typically by reducing payroll taxes to boost
the demand for labour, and foster work incentives. Several countries have recently
shifted the tax burden away from labour intensive activities in order to give a further
boost to the demand for labour.
Some EU countries have recently lowered the generous tax allowances granted through
the corporate income tax for the depreciation of equipment investment, thus rebalancing
the relative cost of labour and capital.
Lowering indirect taxes on labour intensive activities :
The European Council adopted in 1999 an EC directive granting an option to those EU

countries who wish to do so to apply a reduced VAT rate to certain labour intensive
services, for the period 2000-02. The objective is to stimulate demand for these services,
and thus employment, and to bring part of the informal economy back to the surface.
39
Activities targeted are: (i) small repairs to bicycles, footwear, leather articles, clothing
and household linens; (ii) renovation and repairs to private housing; (iii) Window
washing and cleaning of private homes; (iv) home health care; (v) hairdressing. Nine
countries have seized this opportunity: Belgium, Greece, Spain, France, Italy,
Luxembourg, the Netherlands, Portugal, and the United Kingdom (for the Isle of Man
only).
Variations in consumption tax rates and exemptions across countries may distort
International competition.International differences in VAT rates do not seem to affect
consumption choices greatly, although they can have a significant impact on cross-border
shopping in boundary areas and on a few goods and services. In fact, while
harmonization efforts in the 1980s and early 1990s were reflected in a lower dispersion
of VAT rates, the 10 per cent range in standard VAT rates across EU countries has
persisted since 1993, suggesting that there is no clear spontaneous trend towards
harmonization. Since the application of reduced or super-reduced rates is not
homogeneous across EU countries, bilateral variations for some products are much
higher. The tourism industry where price competition is important provides an example.
VAT rates range between 3 and 25 per cent within the EU area. The dispersion of excise
duties is even larger and induces not only cross-border shopping but also smuggling.
Some EU countries can maintain lower indirect tax rates, thus attracting consumers from
neighboring countries. This serves to raise their tax revenues at the expense of
neighboring countries.
CHANGES IN EU TAX SYSTEM
First, if an EU customer buys and downloads software from an EU online retailer, then
VAT is imposed. In contrast if the retailer is based outside EU, The transaction is tax-
free.
40
Secondly - Services sold to a customer outside the EU area are subject to VAT.
To remove discriminatory factors on services delivered online, the Commission proposed

a directive in June 2000 requiring non-EU e-commerce providers to register in at least
one EU country when offering services to private consumers and charge the VAT
according to the rules of that country on all online sales.
To ensure that the compliance burden is eliminated where it would reduce the incentive
to carry on business activity and to permit tax administrations to focus resources where
the return is likely to be high, the proposed directive introduces thresholds of online
sales. In addition, the Swedish authorities, during their Presidency of the Council of the
European Union in 2001, have proposed to require vendors to charge VAT at the rate
applicable to the customer's country of residence.
This would reduce the competitiveness bias against high VAT countries and the non-
neutralities between electronic and traditional commerce. However, despite broad
support of most EU countries, there is currently no agreed approach to tackling VAT on
e-commerce while any decision at the EU level requires unanimity.
In any case, in absence of an enhanced international co-operation among tax

administrations, fair and effective taxation of e-commerce transactions would rely on
voluntary compliance by companies based outside the EU area. Given the complexity of
existing VAT rules and the lack of effective enforcement, it may be faster and cheaper
for traders to opt for non-compliance. However, private purchasers often prefer to deal
with entities that have established a degree of credibility and trust, including the
compliance with tax rules.
Effect of Tax reform In EU
Shifting from wage to a consumption tax is considered as an advantage because it

broadens the tax base insofar as consumption out of other income would also be taxed.
41
Simulations performed by the European Commission show that a cut in labour taxes by 1
per cent of GDP, coupled with an increase in VAT, would increase employment by
almost 0.7 per cent in the long-run if transfer recipients were not compensated for their
real income loss -- though this could induce some undesirable distributional effects. If the
loss in purchasing power for transfer recipients were fully compensated.
Long-run effects of a tax reform in the EU area
GDP Employment Investment

Tax cut fully offset by a reduction in
government
Consumption (1 per cent of GDP)
Reduction of labour,
(a) 0.54 0.54 1.28
corporate and VAT2
Reduction of labour and
(b) 0.65 0.57 1.88
corporate taxes only2
Reduction of labour taxes
(c) 0.81 0.97 1.24
only2
Tax shift from labour to
consumption
(1 per cent of GDP)
(d) Tax shift from labour to VAT
without compensating transfer 0.66 0.82 0.73
recipients3
(e) Tax shift from labour to VAT
with compensating transfer 0.37 0.48 0.32
recipients4
VAT Rates In Non-EU Countries
42
Rate
Country
Standard Reduced
Argentina 21% 10.5% or 0%
Australia 10% -
Bulgaria 20% -
Canada 7% or 15% 4.5%
China, People's Republic of2 17% 6% or 3%
Croatia 22% -
Dominican Republic 6% 12% or 0%
Ecuador 11% -
Iceland 24.5% 14%
India 12.5% 4%, 1%, or 0%
Israel 16.5% -
Malaysia 5% -
Mexico 15% 0%
New Zealand 12.5% -
Norway 25% 11% or 7%
Philippines 10% -
Romania 19% 9%
Russia 18% 10% or 0%
Serbia 18% 8% or 0%
Singapore 5% -
South Africa 14% 7% or 4%
Sri Lanka 15% -
Switzerland 6.5% 3.6% or 2.4%
4.12. Taxation in the United States
43
Tax system in US is considered to be a complex system which may involve payments to
at least four different levels of government:
Local government, possibly including one or more of municipal, township, district and
county governments Regional entities such as school, utility and transit districts
State Government
Federal Government
US tax consists of a coordinated pair of taxes, one levied on business and other on
individual's business tax component of US tax is a subtraction method value added tax of
consumption type.
Value-added tax need of the hour: - US
Recently President Bush's tax commission has rejected the idea of a national sales tax
and has expressed misgivings over European-style consumption taxes, drawing
complaints of timidity from critics who want the panel to eliminate the income tax.
"Apparently they have dismissed out of hand the prospect of fundamental reform," said
Leo Linbeck, the chairman and chief executive of Americans for Fair Taxation, a group
advocating a federal retail sales tax.
"That's disappointing to me, as you might expect."
The President's Advisory Panel on Federal Tax Reform wrapping up its work on
recommendations for making the federal tax system fairer, simpler and better for
economic growth.
Replacing income taxes with a national retail sales tax expressing concerns about high
tax rates and rampant tax evasion problem can be solved.
44
Planners are checking for the possibility of recommending a value-added tax - a tax used
widely in Europe that imposes a tax on increased value of a product at each stage of
production and passed on to consumers.
The changes they have recommended, which leave the income-tax system in place, have
made some reform advocates believe that the panel will not embrace fundamental
change.
4.13. Value Added Tax (VAT) in Italy
Value Added Tax or VAT as it is popularly called is an indirect tax that is levied on
business transactions. VAT is applicable on all business deals that include the transfer of
services and goods. VAT is imposed on the additional value resulting out of such a
business transaction. It is also known as Goods and Services Tax or GST. VAT is paid by
the final consumer. Goods that are exported are usually exempted from VAT in order to
avert double taxation. Even if VAT is charged it is subject to refund.
Value Added Tax was introduced by Maurice Laure, a well known French economist,in
1954. At that point of time it was known as taxe sur la valeur ajoutee. He was also one of
the Directors of the French tax authority. Initially VAT was meant for big businesses but
gradually it was applied to every sphere of business. The European Union Value Added
Tax or EU VAT is applicable for all the countries that are part of the European Union.
The VAT rates differ in each of the member countries of the European Union. It is fixed
at a minimum standard rate of 15%. In some countries, however, the VAT rates are as
low as 5% and levied on specific commodities like power and domestic fuel. The
maximum VAT imposed in any of the European Union countries is 25%.
45
In Italy, the Value Added Tax imposed on various business transactions and purchases is
20%. Value added tax charged on basic products is levied at a reduced rates of 4% and
10%. Even services, imports and assets come under the domain of value added tax in
Italy. VAT returns are submitted on a monthly basis. They can also be made once in
every quarter. At the end of the financial year, an annual VAT return is to submitted on
the 15th of March.
Since VAT is also applied to one's assets, the tax rates are fixed in between 4%-8% of the
total asset value. Apart from the VAT, the Inheritance tax is also in place in Italy after its
re introduction in 2007.
The Value Added Tax system in Italy is in line with the European Union Value Added
Tax rules and regulations. According to it, the VAT is paid by the final consumer only.
At the production and distribution level, the suppliers of various services and goods
deduct the input VAT. The tax is levied on any and every service or article that forms a
part of a business transaction in Italy.
4.14. Value Added Tax (VAT) in France
The system of value added tax was formulated by a French economist in the year 1954.
The version of VAT that is used in France is called taxe sur la valeur ajoutee or TVA.
It was put into effect for the first time on April 10, 1954 by Maurice Laure, the then joint
director of tax authority of France. The value added tax system has been a great success
in France since the very beginning. In the later years, VAT was imposed on all other
business activities in the French economy. At present, the value added tax contributes
substantial share of the state finance in France. The revenues collected from VAT make
up 45% of the French state revenues.
46
More on VAT in French Economy
In France, the value added tax is imposed on all types of general consumption. VAT is
popular for two reasons. The first reason is that it is imposed at each stage of value
addition. Unlike sales tax, there is no scope of cascading in the value added tax.
The VAT system is also helpful in avoiding the incidence of double taxation. Another
major advantage of value added tax is that under this system all traders are dealt equally.
It also involves minimum distortionary effects on economic activities.
Current Issues on Value Added Tax in France

The standard rate of value added tax in France is 19.6 percent; while the reduced rate
being 5.5 percent or 2.1 percent. The President of France, Nicolas Sarkozy, is hopeful
about raising the issue of VAT rate cut at the upcoming meeting of the European
Council. The demand of France to cut the value added tax rate allover in Europe aims to
check the hike in fuel prices in the global market. The French president has also put
stress on the fact that the call for cut in VAT on fuel needs to be strictly European.
4.15. Value Added Tax (VAT) in Ireland
In Ireland the general rate of value added taxation is 21% but there are also other rates of
13.5% and 4.8%. In Ireland value added taxes are imposed on the assets owned by
various entities as well as the different services that are provided throughout Ireland.
Value added taxes are also imposed on all goods that are imported into Ireland.
There are a number of regulations that are applicable for registering with the value added
tax authorities in Ireland. As far as services are concerned the minimum required amount
of turnover is thirty five thousand Euros and for goods the amount is seventy thousand
Euros. The returns of value added taxes are filed once at a time in a space of two months.
However, under certain circumstances the returns could be filed in one occasion in a
year.
47
Value added tax in Ireland may be called a retail sales tax. In case of the luxury items
bought in Ireland the tax paid is 21%. However, the tax rate that is imposed on the non-
luxury products is 12.5%. People, who are from countries that are non members of the
European Union are allowed to claim certain amounts of the value added taxes paid by
them upon purchasing goods while staying in the country. This plan allows the costs of
goods to be brought down by 17.36%.
The reduction is not applicable for services like meals and bills of hotels for example.
Rather goods that are bought in the country and exported outside the European Union
within a period of three months come under the purview of the value added taxes in
Ireland. The visitors have to provide various papers that show that the goods have been
merchandised. An example of such documentation would be the invoice bearing the
stamp of the Ireland customs department.
There are certain value added tax outlets in Ireland that deal with the visitors. They
provide offers known as Cashback whereby tourists gather the tax rebates when they are
about to leave Ireland. There are other ways of collecting the tax rebates like filling up
forms when the purchase is being made.
As per the value added tax rules that are in operation in Ireland taxes are imposed on the
disposal of the taxable interest in a particular property. By disposal is meant selling off or
leasing for a period of ten years or more. There are certain conditions that need to be
fulfilled so that the value added taxes may be imposed on the property. One of the main
conditions in this case is that the period of lease has to be at least ten years and the
property has to be redevelope3d after the 31st of October, 1972.
there are certain rates that are applicable in these. In cases where the disposer of the
property has held an interest in the property for a decade or more the rate of value added
tax imposed is 13.5%. The rate of value added taxes imposed on the short term leases is
21% on rents in cases where exemptions have been made. The rate of value added taxes
imposed on construction activities are 13.5% and in case of fittings the rate of value
added taxes to be paid is 21%.
48
4.16. Value Added Tax (VAT) in Nigeria
The value added taxes in Nigeria were created as replacements or substitutions for the
sales taxes that were in operation before. They were imposed on all goods that were
manufactured in the country as well as goods that had been made outside the country and
were selling there. As per the VAT Decree No. 102 made on the 24th of August, 1993 in
Abuja by the President and Commander-in-Chief of Nigeria, General I. Babangida
certain goods and services have been exempted from the purview of value added
taxation. As per the specifications laid down in the above mentioned decree goods such
as all exported goods, medical and pharmaceutical products, products meant for kids,
basic food items, commercial vehicles and their spare parts, books and other educational
materials, fertilizer, farming machines, agricultural products, farming transportation
equipments and veterinary medicines and magazines and newspapers.
As per the above mentioned decree a number of services have been declared exempted
from value added taxation in Nigeria. These services are all the services that are
exported, medical services, plays and performances that are run by educational
institutions for educational purposes and services that are provided by community banks,
mortgage organizations and people's banks. In Nigeria the companies or business
organizations that function on a no profit making basis are required to pay value added
taxes.
The Nigerian Federal Government enacted the VAT Amendment Act in 2007. This act
empowered the Federal Government to fix the rate of value added taxes to be imposed in
Nigeria. The rate was increased to 10%. However, discussions regarding the possibility
of a 50% reductions in the rate are on. In Nigeria value added taxes are also imposed on
sale of land, as well as check transactions. The number of payments to be made is 12 and
the amount of time is 160 hours.
The value added taxes are one of the major sources of financing in a number of
49
economically developing countries across the world. The situation is similar in Nigeria as
well. During 1994 the revenues earned from value added taxes in Nigeria exceeded the
projections. They contributed 4% of the total revenue raised by the Federal Government
in that year. In 1995 the rate of contribution was 5.39%. However, there have been some
teething issues as far as value added taxes in Nigeria are concerned.
The members of the organized private sector in Nigeria have been voicing their
reservations regarding the value added taxes that are taking a toll on the prices of their
products as well as the operational prices of their products. The way the Nigerian Federal
Government has looked after issues related to value added taxes in has attracted a certain
degree of criticism. Their management of the expenditure of the revenues generated from
the value added taxes has faced some flak as well. The fact that no research was
conducted into the possible effects of the value added taxes before they were put to work
has only compounded the problems. All in all the situation of the value added taxes in
Nigeria is far from desirable.
4.17. Value Added Tax (VAT) in China
Value Added Tax (VAT) was implemented in China in 1984. Initially, the tax was levied
on 24 specified items. The need for constructing a socialist market economy system in
China resulted in the proclamation of 'The Provisional Regulation of the People's
Republic of China on Value Added Tax' on January 1, 1994.
Value Added Tax in China is one of the important sources of fiscal revenues for the
government, especially the central government. The implementation of VAT is done by
the State Administration of Taxation while the customs collects the import VAT.
50
The revenue earned from VAT is divided between the central (75%) and local
government (25%).
The list of VAT taxable items and the rates in China can be understood from the
following:
Coverage of Collection Rate

Exportation of goods 0
Edible vegetable and grain duplicates 13%
Agriculture, forestry, aquatic products, products of animal husbandry
Book, magazines, newspapers
Tap water, cooling, heating, hot air supplying, gas, hot water, natural gas,
liquefied petroleum gas, coal/charcoal products for household use
Selected non-metal mineral products, Selected metal mineral products, coal
Chemical fertilizers, feeds, agricultural machinery, agricultural chemicals,

plastic converting film for farming
Crude oil, mine salt and other goods and services not listed above 17%
VAT in China is payable by individuals as well as enterprises who are associated with
selling merchandise, providing services related to processing, repairing and assembling
and import of goods. VAT Taxpayers in China are categorized into two sections, normal
taxpayer and small taxpayer, depending on the turnover of the goods and services on sale
and the accounting system condition.
The amount of VAT payable by the normal taxpayer can be calculated by the following:
Output tax payable for the current period – Input tax payable for the current period = Tax
payable
51
The amount of VAT payable by the small taxpayer is as follows:
Sales amount x Applicable rate = Tax payable
(The applicable rate is 4% for commercial sectors and 6% for others)
Certain items and services are exempted from VAT. These include the following:
• Instruments and equipment imported for direct use in scientific research, experiment
and education
• the agricultural production materials as ruled, the self-produced primary agricultural

products sold by Agricultural producing units and individuals
• Imported materials and equipment granted, gifted by foreign governments or

international organizations
• Contraceptive medicines and devices
• Articles imported directly by organizations for the disabled for exclusive use by the
disabled
• Materials imported directly to support the poverty relief and charity cause donated
freely by overseas natural persons, legal persons and other organizations
• The taxable services provided by individual disabled laborers
• Antique books purchased from the public
Certain reforms have been implemented in particular areas of China in 2004 with regard
to the VAT.
4.18. Value Added Tax (VAT) in UK
52
Value added tax in UK has been imposed on the final consumption of particular goods as
well as services in the national market. At the same time, VAT in the UK is levied at
various production phases. This tax is also imposed on the distribution phases of the
products. According to this rule, almost all the goods and services in the United Kingdom
are charged with Value Added Tax. Recently, the VAT rules have been revised in the
United Kingdom. The government has decided to collect VAT at a standard rate of
17.5%. The VAT registration threshold has also been raised from £64,000 to £67,000.
These new rules and regulations have been implemented from April 2008.
Further, these rules have made it mandatory for the companies to register for value added
tax if the company's taxable supplies have crossed the maximum limit of VAT threshold.
Again, if any company has found that its taxable supplies is under the UK VAT
threshold, but is expected to cross the same within a month, the company has to register
itself for the value added tax.
There are instances where the businessmen have registered themselves for VAT although
the business turnover has been well under the threshold. This is done because registering
for VAT provides a number of additional benefits.
The businesses have to pay this tax for every kind of purchase as well as sell of products
or services. Taxes that are paid for purchasing products or services are known as input
tax and the taxes paid for selling products and services are termed as output tax.
There are certain situations when a VAT registered business' output is higher than the
input tax.
In these conditions the difference between the two is paid to the customs and excise. In
certain situations the businesses receive less VAT than it pays. This extra amount is paid
back to the businesses by the C&E.
53
4.19. Value Added Tax (VAT) in Mexico
In Mexico value added taxes are imposed on the sale of goods as well as services. The
general rate of value added taxation in Mexico is 15%. The same rate is also applicable
as far as importing of goods and services are concerned. However the rates of value
added taxes in Mexico is lower in the areas that are located on the international border of
Mexico.
In these areas the rate of the value added taxes is 10%. however, certain commodities are
excluded from the value added taxes in Mexico. For example, the non residential real
estate properties are subjected to the value added taxes but the land upon which the
particular property has been constructed is exempted from taxation.
The value added taxes in Mexico are part of the Federal Tax Structure of Mexico. It may
also be regarded as one of the principal taxes in Mexico. The various items that are
exempted from value added taxes in Mexico are sales of land, financial services, books,
medical services, credit instruments like equity shares, education, residential
construction, rental expenses of residential properties and raw materials for residential
construction. However there is an exemption made in case of the medical services. The
interest that is earned by the credit card providers in case of medical services is subjected
to value added taxes.
The taxes that are paid by the business organizations when they buy goods are normally
adjusted against the tax that they pay when they sell any goods or services. The tax on
sales is applicable for all the customers as well. In case there is an excess amount of
credit it may be paid back by the tax authorities to the concerned business organization.
There are a lot of transactions that are exempted from value added taxes in Mexico.
However the money that is paid on buying raw materials, services and supplies may be
recovered by through either direct refund or by adjusting the amount against the value
added tax the particular individual is supposed to pay. The categories that are included in
54
this list are rentals, export of goods. sale of specific basic foodstuffs, export of services,
agricultural goods, sales to maquilodras, who are in-bond assembly plants of Mexico,
agricultural services and sales to companies that deal exclusively in the export of goods.
There are also certain other minor transactions that are included in this list.
4.10. Value Added Tax (VAT) in Canada
Value added tax in Canada is known as Goods and Services Tax. The goods and services
tax was introduced in Canada on the 1st of January 1991. It was introduced by Brian
Mulroney, who was the Prime Minister at that time and Michael Wilson, who was the
finance minister. The goods and services tax in Canada replaced the manufacturers' sales
taxes. The main purpose behind introducing the goods and services tax was that the
manufacturers' sales tax was having a negative impact on the export prospects of the
manufacturing sector in Canada. The manufacturers' sales tax was hidden and the rate of
taxation was 13%. The goods and services tax could be called a multi-level tax.
The introductory rate of the value added taxes in Canada was 7%. At present the rate is
5%. In Canada the value added taxes are taken along with the sales taxes that are
applicable for the particular provinces.
The only exception to this is the province of Alberta. There are no sales taxes at the
provincial level in Alberta. In provinces like New Brunswick, Nova Scotia and
Newfoundland a Harmonized Sales Tax is charged.
The Harmonized Sales Tax is a combination of goods and services tax and the provincial
sales tax. The rate of the goods and services tax is 5% and the provincial sales tax rate is
8%. This means that the total harmonized sales tax collected in the three above
mentioned provinces is 13%.
There are certain items that are regarded as being zero rated under the value added
taxation system in Canada. The items are basic groceries, outbound transportation,
prescription drugs, medical devices and inward transportation. The export of certain
55
goods and services are also regarded as being zero rated. The value added taxes of
Canada have helped in the increase of the efficiency of the Canadian economy.
4.21. Value Added Tax (VAT) in Germany
The value added tax in Germany is levied on the production of goods and services in the
country. All business entities are subject to the payment of tax on performing production
processes in Germany. The current rate of VAT in Germany is 19%, enforced from 1st
January, 2007. In Germany, a reduced tax of 7% is collected from the sale of particular
items such as foods, magazines and books. The rate of VAT is set according to the
parameters of the European Union Value Added Tax system. The value added tax in
Germany effectively earns high revenue for the country in the form of income through
taxation.
VAT is generally known as Umsatzsteuer in Germany. Formerly, the value added tax
was referred to as the Mehrwertsteuer. This term is still prevalent in some parts of the
country.
Procedure of Taxation
The business entities in Germany add VAT prior to the pricing of the product and
services. The gross price of goods in Germany includes the 19% VAT charges. The
business enterprises submit the reports of taxation monthly and are required to pay the
taxes on a monthly, quarterly or yearly basis. The reports also comprise of computation
of tax for the ensuing quarter. The period of tax payments is dependent on the annual
turnover of the company. The amount for tax is paid in advance to the tax office. Most of
the large scale producers are required to submit their advance on a monthly basis.
Returns on VAT
The value added taxes payable by the business entities in Germany include the taxes paid
by the companies on purchase of goods and services. This is balanced through returns on
VAT. This is known as input VAT or Vorsteuerabzug in Germany. In most occasions,
56
the business entities pay more tax than what they receive. In later stages the authorities
return the excess tax paid as soon as the computations are complete. This situation is
frequent in the start-up phase where the company's expenditure is more than its income
from sale.
Exemptions from the Tax

Some of the goods and services are exempted from payment of the value added tax in
Germany. Some of these are listed below:
 Letting real estate for a long-term period

 Overseas export items
 Honorary or voluntary services
 Services provided by certain professional groups such as doctors
 Cultural services provided by public theatres, museums and zoos to the public
 Institutions providing value added services such as general education or vocational
training
 Financial services (e.g. granting loans)
No VAT is charged on intra-community shipments such as a sale of goods to another

commercial organization among the members of the European Union. However, the
recipient entrepreneur is subject to acquisition tax that is payable to the authorities. This
is similar to the input VAT and is refundable.
Provisions for small and medium sized companies

Some of the small undertakings expecting an annual business turnover less than EUR
50,000 in the current year or with less than EUR 17,500 turnover in the previous
financial year are exempted from the payment of value added tax in Germany. However,
these small enterprises are not allowed to deduct the input tax through billing.
The small and medium sized companies in Germany can also opt for actual receipts
taxation or Istbesteuerung. This allows the companies to pay after they receive their
payments. This method is preferred by the small companies to the imputed tax payments
57
which may cause cash flow problems. The ceiling for actual receipts taxation in the
eastern states of Germany is EUR 500,000 till the end of 2009 while for the rest of the
country, the ceiling is EUR 250,000.
4.22. Value Added Taxes (VAT) India
In India, VAT replaced sales tax on 1 April 2005. Of the 28 Indian states, eight did not
introduce VAT. Haryana had already adopted it on 1 April 2004. Due to the federal
nature of the Indian constitution, the states do have the power to set their own VAT rate.
OECD (2008, 112-13) approvingly cites Chanchal Kumar Sharma (2005) to answer why
it has proved so difficult to implement a federal VAT in India. The book says:
"Although the implementation of broad-base federal VAT system has been considered as
the most desirable consumption tax for India since the early 1990s, such a reform would
involve serious problems for the finances of regional governments. In addition,
implementing VAT in India in context of current economic reforms would have
paradoxical dimensions for Indian federalism. On one hand economic reforms have led to
decentralization of expenditure responsibilities, which in turn demands more
decentralization of revenue raising power if fiscal accountability is to be maintained. On
the other hand, implementing VAT (to make India a single integrated market) would lead
58
to revenue losses for the States and reduce their autonomy indicating greater
centralization" (Sharma, 2005, as quoted in OECD, 2008, 112-13) [1]
Chanchal Kumar Sharma (2005:929) asserts: "political compulsions have led the
government to propose an imperfect model of VAT" 'Indian VAT system is imperfect' to
the extent it 'goes against the basic premise of VAT'. India seems to have an 'essenceless
VAT' because the very reasons for which VAT receives academic support have been
disregarded by the VAT-Indian Style, namely: removal of the distortions in movement of
goods across states; Uniformity in tax structure. Chanchal Kumar Sharma (2005:929)
clearly states, "Local or state level taxes like octroi, entry tax, lease tax, workers contract
tax, entertainment tax and luxury tax are not integrated into the new regime, which goes
against the basic premise of VAT, which is to have uniformity in the tax structure. The
fact that no tax credit will be allowed for inter-state trade seriously undermines the basic
benefit of enforcing a VAT system, namely the removal of the distortions in movement
of goods across the states."
"Even the most essential prerequisite for success of VAT i.e. elimination of [Central
sales tax (CST)] has been deferred. CST is levied on basis of origin and collected by the
exporting state; the consumers of the importing state bear its incidence. CST creates tax
barriers to integrate the Indian market and leads to cascading impact on cost of
production. Further, the denial of input tax credit on inter-state sales and inter state
transfers would affect free flow of goods." (Sharma,2005:922)
The greatest challenge in India, asserts Sharma (2005) is to design a sales tax system that
will provide autonomy to subnational levels to fix tax rate, without compromising
efficiency or creating enforcement problems.
The Andhra Pradesh experience
In the Indian state of Andhra Pradesh, the Andhra Pradesh Value Added Tax Act, 2005
came into force on 1 April 2005 and contains six schedules. Schedule I contains goods
generally exempted from tax. Schedule II deals with zero rated transactions like exports.
59
Schedule III contains goods taxable at 1%, namely jewelery made from bullion and
precious stones. Goods taxable at 4% are listed under Schedule IV. The majority of
foodgrains and goods of national importance, like iron and steel, are listed under this
head. Schedule V deals with Standard Rate Goods, taxable at 12.5%. All goods that are
not listed elsewhere in the Act fall under this head. The VI Schedule contains goods
taxed at special rates, such as some liquor and petroleum products.
The Act prescribes threshold limits for VAT registration - dealers with a taxable turnover
of over Rs.40.00 lacs, in a tax period of 12 months, are mandatorily registered as VAT
dealers. Dealers with a taxable turnover, in a tax period of 12 months, between Rs.5.00 to
40.00 lacs are registered as Turnover Tax (TOT) dealers. While the former category of
dealers are eligible for input tax credit, the latter category of dealers are not. A VAT
dealer pays tax at the rate specified in the Schedules. The sales of a TOT dealer are all
taxable at 1%. A VAT dealer has to file a monthly return disclosing purchases and sales.
A TOT dealer has to file a quarterly return disclosing only sale turnovers. While a VAT
dealer can buy goods for business from anywhere in the country, a TOT dealer is barred
from buying outside the State of A.P.
The Act appears to be the most liberal VAT law in India. It has simplified the registration
procedures and provides for across the board input tax credit (with a few exceptions) for
business transactions.[verification needed] A unique feature of registration in Andhra Pradesh is
the facility of voluntary VAT registration and input tax credit for start-ups.
The Act also provides for transitional relief (TR) for goods on hand as of 1 April 2005.
However, these goods ought to have been purchased from registered dealers between 1
April 2005 to 31 March 2006. This is a bold step compared to the 3 months TR provided
by several developed countries.
The act not only provides for tax refunds for exporters (refund of tax paid on inputs used
in the manufacture of goods exported) but also provides for refund of tax in cases where
the inputs are taxed at 12.5% and outputs are taxed at 4%.
60
The VAT Act in Andhra Pradesh is administered by the Commercial Taxes Department
(department to collect VAT and other taxes) using a networked software package called
VATIS. The personnel were trained prior to the Act coming into force. VATIS is used to
process documents and forms received and to generate registration certificates and tax
demand notices.
VAT, to be successful, relies on voluntary tax compliance. Since VAT believes in self-
assessments, dealers are required to maintain proper records, issue tax invoices, file
correct tax returns etc. The opposite seems to be happening in India. Businesses are still
run on traditional lines. Cash transactions are order of the day. The unorganised sector
dominates the market. The hope of higher tax compliance and lesser evasion is still a far
cry in Andhra Pradesh. This is reflected in the high percentage of return defaulters
(14%), credit returns (35%) and nil returns (20%). That is, roughly 70% of VAT dealers
are presently not paying any tax. Filing of credit returns is rampant among FMCG,
Consumer Durables, Drugs and Medicines and Fertilizers. The margins are low in this
sector (ranging between 2 to 5%). The value addition is not enough to yield revenue as of
now. Credits offered by manufacturers compound the problem. The question is, in a
typical purchases and sales scenario, can there be more output tax than input tax? When
purchases consistently exceed sales, can output tax exceed input tax? If a VAT dealer can
balance his/her purchases and sales, can there be a net tax to the State? Is there a
mathematical model or paradigm which can give value added tax and which can reduce
the percentage of credit returns? There are no ready answers for these queries. The only
remedy seems to be the restriction of input tax to the corresponding purchase value of
goods put to sales. In fact a two-tier system can be adopted to counter the credit returns -
allow full input tax to manufacturers and restrict input tax to the purchase value of goods
put to sale to traders. Restricting input tax to 4% in the case of inter state sales and in the
case of products taxable at 12.5% seems to be another solution.
Importance of VAT in India
India, particularly being a trading community, has always believed in accepting and
adopting loopholes in any system administered by State or Centre. If a well-administered
61
system comes in, it will not only close options for traders and businessmen to evade
paying their taxes, but also make sure that they'll be compelled to keep proper records of
sales and purchases.
Under the VAT system, no exemptions are given and a tax will be levied at every stage
of manufacture of a product. At every stage of value-addition, the tax that is levied on the
inputs can be claimed back from tax authorities.
At a macro level, two issues make the introduction of VAT critical for India
Industry watchers believe that the VAT system, if enforced properly, will form part of
the fiscal consolidation strategy for the country. It could, in fact, help address issues like
fiscal deficit problem. Also the revenues estimated to be collected can actually mean
lowering of fiscal deficit burden for the government.
International Monetary Fund (IMF), in the semi-annual World Economic Outlook

expressed its concern for India's large fiscal deficit - at 10 per cent of GDP.
Moreover any globally accepted tax administrative system would only help India
integrate better in the World Trade Organization regime.
Advantages of VAT
1. Coverage – If the tax is considered on a retail level, it offers all the economic
advantages of a tax of the entire retail price within its scope. The direct payment
of tax spreads out over a large number of firms instead of being concentrated only
on particular groups, such as wholesalers & retailers.
2. Revenue Security - Under VAT only buyers at the final stage have an interest in
undervaluing their purchases, as the deduction system ensures that buyers at
earlier stages are refunded the taxes on their purchases. Therefore, tax losses due
to undervaluation will be limited to the value added at the last stage.
Secondly, under VAT, if the payment of tax is avoided at one stage nothing will
be lost if it is picked up at later stage. Even if it is not picked up later, the
62
government will at least have collected the VAT paid at previous stages. Where
as if evasion takes place at the final/last stage the state will lose only tax on the
value added at that particular point.
3. Selectivity - VAT is selectively applied to specific goods & business entities. In

addition, VAT does not burden capital goods because of the consumption-type.
VAT gives full credit for tax included on purchases of capital goods.
4. Co-ordination of VAT with direct taxation - Most taxpayers cheat on sales not
to evade VAT but to evade their personal and corporate income taxes. Operation
of VAT resembles that of the income tax and an effective VAT greatly helps in
income tax administration and revenue collection.
Disadvantages of VAT
1. VAT is regressive
2. VAT is difficult to operate from position of both administration and business
3. VAT is inflationary
4. VAT favors capital intensive firms
Items covered under VAT
• All business transactions that are carried on within a State by

individuals/partnerships/ companies etc. will be covered under VAT.
• More than 550 items are covered under the new Indian VAT regime out of which
46 natural & unprocessed local products will be exempt from VAT
• Nearly 270 items including drugs and medicines, all industrial and agricultural
inputs, capital goods as well as declared goods would attract 4 % VAT in India.
63
• The remaining items would attract 12.5 % VAT. Precious metals such as gold and
bullion will be taxed at 1%.
• Petrol and diesel are kept out of the VAT regime in India.
Tax implication under Value Added Tax Act
Selling Invoice
Tax Tax Net
Selle Price Tax value
Buyer Payabl Credi TaxOutflo
r (Excludin Rate (InclTax
e t w
g Tax) )
4%
A B 100 104 4 0 4.00
CST
12.5
B C 114 % 128.25 14.25 0* 14.25
VAT
64
12.5
C D 124 % 139.50 15.50 14.25 1.25
VAT
12.5
Consume
D 134 % 150.75 16.75 15.50 1.25
r
VAT
VAT
Total to Govt. 16.75 4.00
CST
IMPLEMENTING VAT IN INDIA : IMPLICATIONS FOR

FEDERAL POLITY
Over the last few years, many attempts have been made to implement VAT in India.
Initially, all states were to move to VAT system by 2000, but administrative problems
and concern over the revenue implications of the change delayed the scheduled
implementation. It has been postponed for five times in past five years. In fact,
introduction of a full fledged VAT in India seem to present numerous administrative and
constitutional difficulties, including the vexed question of union-state relations. In
addition to this, implementing VAT in India in context of economic reforms has
paradoxical
dimensions. On one hand economic reforms have led to more decentralization of
expenditure responsibilities which in turn demands more decentralization of revenue
raising powers if fiscal accountability is to be maintained. But on the other hand the
process of implementation of VAT can lead not only to revenue loss for the states but can
65
also steal away the states’ autonomy indicating more centralization. Thus the need is to
develop such a ‘federal friendly model’ of VAT (along with a suitable compensation
package) that can be implemented in India without compromising federal principles.
Introduction
VAT has emerged as one of the most fundamental component of the ambitious agenda of
tax reforms since 1991. Initial renditions of VAT were evident in the report and
recommendations of the Tax Reforms Commission of 1992.Though the initial phase of
tax reforms can be said to be crisis driven in the sense that the economic reforms of
which it was a part was itself crisis driven, the present phase however intends to bring
about systemic improvements in tax structure. The reforms are aimed at attending to the
necessities of a market economy that India is committed to become. The agenda is to
make the tax system responsive to the requirements of the international competition. In
fact in the changing global economic scenario, economy can be kept competitive only by
making the tax system comprehensive, broad based, simple and transparent. The concept
of a broad based VAT (that theoretically became most favoured form of tax worldwide
during the 90’s) promises to achieve these goals in case of indirect taxation. But the
process of implementation of VAT is likely to face constraints in a federal country like
India since it entails revenue loss and loss of autonomy for the sub-central levels. The
aim of this paper is to explore these constraints and to give suggestions for making the
implementation of VAT more federal friendly.
Present heading is divided into five sections. Section I makes a case for adopting VAT
system in India and highlights its repercussions for the sensitive Center-State relations.
Section II demonstrates how three main variants of VAT interact with the constraints
imposed by India’s federal structure. Section III looks at various attempts in direction of
tax rationalization by the GOI that have done away with some of the constraints. The
attempts to deal with the major constraints of compensation have been separately dealt
with in section IV. The concluding section (Section V) draws attention towards certain
rethinking and prospects for federal polity.
66
I
Vat is a fiscal innovation that began tentatively with French sales tax reform of 1954-55
and spread quickly to cover 130 countries with in just about 50 years. VAT has gained so
much popularity that today it is considered as the only good sales tax. VAT is a general
tax that applies, in principle to all commercial activities involving the production and
distribution of goods and the provision of services. VAT is assessed and collected on the
value added to goods in each business transaction. Under this concept the Government is
paid tax on the gross margin of each transaction. VAT has many positive gains to offer to
Indian tax structure. For instance, it will eliminate the cascading effect (tax on tax) of
multi point taxation associated with the existing sales tax regime. A uniform VAT rate
will also eliminate competition among the states to offer tax concessions to attract
investment. More specifically, in context of economic reforms in India it will make sales
between states totally free thereby making India a common, integrated market. Each
producer will have a big common market before him. In fact in recent literature (Bird
2000) VAT is considered as the most desirable form of tax from an international
perspective especially after global integration of the markets. But it is to be noted that
VAT has repercussions for the sensitive Center state relations.
VAT proposes to replace the sales tax that has conventionally been considered the best
form of ‘regional’ taxation. The traditional literature on taxation favours sales tax as best
source of revenue for sub national governments (for instance, Musgrave 1983) In fact in
India it is the only
major revenue source for intermediate level of governments since low per capita income
and unemployment render income tax inadequate as a revenue source.
VAT thus poses serious problem for the finance of regional governments in India. Such
problems become more evident when the context of ongoing economic reforms is also
taken into account. In fact implementing VAT in India in context of economic reforms
has paradoxical dimensions for Indian federalism. On one hand economic reforms have
led to more decentralization of expenditure responsibilities which in turn demands more
67
decentralization of revenue raising power if fiscal accountability is to be maintained. But
on the other hand implementation of
VAT (to make India a single integrated market) will lead not only to revenue loss for the
states but also will steal away the states’ autonomy indicating more centralization.
After economic reforms of 1991 expenditure responsibilities of the states vis a’ vis center
have increased. Thus to support and sustain economic reforms, it becomes essential to
devolve power for revenues to the sub central levels if adequate fiscal accountability and
much desired "Wicksellian connection" (Breton, 1996) is to be maintained. However, the
proposed implementation of VAT (also to support economic reforms) can do exactly the
opposite ie. loss of revenue to the states. Thus while objective behind introduction of
VAT is to eliminate much of the complexity and associated compliance costs of the
current system and also to increase India’s competitiveness in the international market
yet at the same time it poses serious problem for the finance of regional
governments.Thus the challenge in implementation of VAT in context of economic
reforms is to reconcile the opposing forces; one forcing toward centralization and other
towards decentralization. The need is to work out a variant of VAT that is acceptable to
states.
II
A wide study of the experiences of different countries with VAT across the globe shows
that there can be different models of VAT depending upon the circumstances prevailing
in each country. Theoretically speaking VAT is mainly of two kinds viz national and sub-
national VAT
but there are some hybrid types as well. In this section the federal constraints in
implementing three models namely; (i) the national vat, (ii) sub-national vat; and, (iii)
dual vat have been discussed:
(i) The National Model:

The Tax Reform Committee (1992) chaired by Raja J. Challiah suggested the
conventional model of vat ( National VAT) for India. This was seen as an arrangement
68
that will reduce administrative and compliance costs. Conventionally, National VAT is
considered as an ideal form of VAT. It has been argued that VAT operates more
successfully as a national VAT (McLure 1993, Tait 1988). Norregaard (1997) states that
the requirements needed to operate VAT are generally best met by the central
government. For instance the extensive administrative capability required to manage vat
is at best a function of the central government. Similarly the need to make VAT neutral
with respect to the spatial allocation of production and consumption and the need to
exercise extensive border control between jurisdictions strengthens the belief that it is
appropriate to assign value added taxes to the central government. Tax Reforms
Committee (TRC) concluded that the ideal solution to India’s sales tax problems would
be a single VAT to replace not only the present federal sales tax (the Union excise) but
also the state sales taxes (which are, for the most part, imposed at the production level),
with the revenue being shared between the levels of government.
In fact, a single ‘National VAT’ is of distinct advantage even if all or some of the
proceeds of the tax are to be distributed to the states, either on the basis of estimated
consumption or on some formula basis. This approach of intergovernmental transfer may
be the best approach to finance sub-central levels of governments. While the total to be
transferred is fixed as designated share of VAT collections, the amount to be allocated to
each state is determined by a formula laid down by the central government. This model is
in operation in Germany. TRC thus recommended a “German solution.” But it is to be
kept in mind that even in Germany the federal issues were not easily resolved and the
formula of revenue sharing with sub-national levels could not be implemented without
considerable disagreement.
In Indian case, strong regional governments (in the era of coalition politics and
regionalization of national politics), will make it extremely difficult either to enforce a
centrally determined formula or even to arrive at a mutually agreed tax-sharing formula.
The regional governments may also oppose the said arrangement because they will not be
ready to lose control over jobs that will become inevitable under single administration of
national VAT. The governments will also grudge the loss of revenue due to loss of power
69
over sales tax, which is the only major source of revenue for sub-national governments.
(ii) The Sub-national Model:
It has been argued that the conventional/national model of vat is the most popular and
workable model. (supported by the fact that even some of the federal countries like
Argentina, Austria, Germany and Mexico have chosen to adopt national model despite
difficulties in resolving federal issues). However, in India where regional governments
are quite strong (especially after regionalization of national politics) consensus among
states is a precondition to introduce VAT and more so when it is apprehended that
implementation of vat in context of economic reforms can create problems for finances
of the regional governments in India.
This is the reason behind attempts in India to develop and implement a model of VAT
that will not compromise decentralization principles. In fact, Charles McLure (2000) and
Bird and Gendron (1998) discuss the problem of imposition of VAT at two levels of
government and that of application of VAT to interstate trade within the same country.
Richard M. Bird (1999, 2000) argues that the conventional model of tax assignment is no
longer viable because subnational governments are increasingly being asked to pick up a
larger portion of social expenditures on health and education. As a consequence the sub-
national VAT is being considered in context of countries like India with important
regional governments.
It has been argued that in India, sub-national vat would enable the regional governments
to deal with the new expenditure responsibilities shifted to them especially after 1991. It
is to be noted that Ip and Mintz (1992) in their subnational vat model recommended that
the Federal government should turn over all sales taxes to the provinces to reduce the
administrative and compliance costs of taxation and to give more revenue discretion to
provinces and hence make them more responsible for financing more of their own
spending on health or education. McLure (2000) also emphasizes the desirability of
permitting state governments to set their own VAT rates. But in case of India sub
70
national VAT would pose problem as to which state should receive revenues from VAT
on imports and which should bear the burden of VAT refunds on exports. The difficulties
associated with the levy of VAT at the sub-national level can be judged from the
experience of Brazil. According to Norregard, Brazil offers an example of VAT
assignment system that is generally believed to have had detrimental effects on economic
performance.
In fact international experience suggests that the developed and non federal countries
have a better record of smooth transition to VAT. When VAT is sought to be
implemented in a federal state, various problems prop up pertaining to federalism in
general and fiscal federalism in particular. Problems are more severe when the country
where VAT is sought to be implemented is a developing country in addition to being
federal.
The difficulties associated with the levy of VAT at subnational level can be appreciated
from the experience of Brazil (a developing federal economy). Shome and Spahn (1996)
Silvani and dos Santos (1996) Serra and Afonso (1999) and Versano(2000) have shown
in their studies that Brazil’s enthusiastic adoption of VAT at two levels had resulted in
complex administrative and technical problems that seemed insurmountable.[Silvani and
dos Santos (1996) have suggested a ‘German solution’ for Brazil]. Norregard (1997) also
affirms that Brazil’s VAT assignment system had detrimental effects on economic
performance. It is to be noted that subnational VAT arrangement is quite unpopular. Out
of 130 countries implementing vat, the province of Québec in Canada, the state of
Michigan in USA and Brazilian states are the only examples (of subnational vat) so far.
Michigan’s VAT being slated to be repealed by 2009 and Brazil being an unsuccessful
case Quebec is the only successful experience. Yet the illustrative effect of the Canadian
experience has contributed towards the emergence of interest in the theory of Subnational
VAT. This theory is based on the idea of extending the application of VAT to state or
provincial level of the government.
It is to be noted that in case of subnational vat system the most challenging issue is to
71
find a uniform solution to deal with cross border shopping problems associated with
taxing sales at the two levels of the government. In VAT arrangement that is envisaged
for India by the white paper, this significant issue of ‘how vat would be administered at
State borders’ has not been addressed. Even the most essential prerequisite for success of
VAT ie elimination of CST has been deferred. CST is levied on basis of origin and
collected by the exporting state; the consumers of the importing state bear its incidence.
CST creates tax barriers to integrate the Indian market and leads to cascading impact on
cost of production. Further, the denial of input tax credit on inter-state sales and inter
state transfers would affect free flow of goods.
According to the literature on Subnational VAT, it can be implemented on the basis of

either of the two principles (i) Origin principle and (ii) Destination principle
Conventional literature supports implementing a sub national VAT on origin principle.

Neumark (1963) states that the only way in which sub national units can effectively levy
a VAT was on origin basis. But to avoid any distortion they have to levy VAT at uniform
rates. This however involves a federal predicament because the above mentioned system
can work only if sub national governments give up their fiscal autonomy. Thus it defeats
the very purpose of the sub national VAT which is to preserve federal principle of sub
national autonomy. Moreover, if a nationally uniform VAT is administered by sub
national authorities and revenues shared on the basis of origin as in case of Russian
Federation, then the same distortions would be created as in the case of non-uniform
subnational origin based VATs (as revealed by Baer, Summers and Sunley 1996).
The theoretical debate about relevant merits and demerits of the two principles of origin
and destination, clearly converge in favour of the destination principle [Lockwood, de
Meza and Myles(1994,1995), Bovenberg (1994), Lopez-Garcia (1996) and Genser
(1996)]. The conditions needed to avoid distortions in efficiency if different jurisdictions
levy different rates under the origin principle seem unlikely to be satisfied in most federal
states. The destination principle on the other hand is not only considered compatible with
independent taxation of consumption but is also less likely to result in distortions (Keen
72
and Smith 1996). At present EU applies the destination principle using the ‘deferred
payment method’ (Cnossen and Shoup, 1987). This does not mean that the destination
principle solve all cross-border trading problems, it however helps to diminish the serious
ones. R.M. Bird have stated that no one has yet found any simple and uniform solution to
deal with all cross border shopping problems associated with taxing sales at the two
levels of government (Bird 1993).
In case of India there seems to be only one practical solution for inter- state taxation and
that is ‘zero rating of inter-state sales’. This option envisages reduction of rate of tax
under CST, initially to 2% and gradually to zero percent.
(iii) Dual VAT Model:
In the report on “Tax policy and tax administration for the Tenth Plan” (May 2001) Dr
Parthsarthy Shome recommended a national integrated Centre-State VAT in parallel or
dual format. Taxonomically Dual VAT is a type of Subnational VAT where each level
sets its own rates independently (thus retaining autonomy) but on similar bases. The base
for a sub-national VAT system is a well-designed and comprehensive national VAT. In
the dual VAT system, the only VAT rate set centrally is that of the central government
itself. According to Bird and Gendron (2000) in this system there is no need for any
‘central’ edict with respect to either the range or level of state taxes applied to interstate
trade since no such taxes are applied. Thus dual VAT approach obviously requires a
central VAT (although perhaps one that collects no revenue) and some degree of
information exchange and co-operation amongst tax authorities. It can be recalled that
way back in 1994 the Government of India appointed a study group to recommend
measures to harmonize and rationalize the domestic trade tax system in the country. The
study group made a thorough analysis of the distortions of the prevailing system of
taxation and recommended the gradual moving over to destination based, consumption
type value added taxes at the state level. At the central level, the study group
recommended complete switching over to the manufacturing stage VAT. At the state
level, the existing sales taxes were to be transformed into retail stage destination type
73
VAT. In other words development of dual VAT – a anufacturing stage VAT by the
centre and a consumption type destination based retailed stage VAT by the states was
suggested as a solution. NIPFP (1994) also recommended for a system of ‘independent
dual VATs’. State VATs were to be restricted to the retail stage, with the central VAT
being levied only on Bagchi (1997) suggested that the long-run solution should be a
concurrent or dual VAT with a nationally-determined base but independently-set federal
and state rates. The major constraint in case of India for applicability of a dual vat is that
the system works well when there is a high level of administrative cooperation. It is
difficult to expect this model to work as such in India because the extent of
improvements required to be made in India’s existing central government sales tax before
attempting any reform in subnational tax regimes will be enormous, if anything similar to
this solution is to be implemented. Even otherwise the quality of administration in India
to generate the required extent of mutual support among the two levels of the government
is quite low.
III
Though it has been observed that the TRC recommendation fell short of developing a
coordinated domestic trade tax system in the country (Rao, 2000) as it failed to make a
dent in the independent and overlapping commodity tax systems at the central and state
levels, yet some healthy changes have occurred in the tax structure since 1991. For
instance there has been a considerable simplification and rationalization of union excise
duties. Besides reduction in the number of rates, the tax has been progressively converted
from a specific into ad valorem levy in respect of majority of commodities. The facility
of providing credits on input taxes under the MODVAT too has been progressively
extended to a larger number of commodities, with the budget 2000 taking a quantum leap
by introducing CENVAT.
Another important change since 1991 is the introduction of a selective tax on services.
74
The constitution does not assign this tax base specifically either to the centre or states.
However, the central government by invoking residuary powers has introduced a tax on
services since 1994-95.( After 92nd Amendment service tax has been brought under
Union list of seventh schedule) Beginning with three services (telephones, non-life
insurance and stock brokerage), the base of the tax has been broadened to cover a large
number of services such as transporters, car rentals, air travel agents, architects, interior
designers, management consultants, chartered accountants, cost accountants, company
secretaries, credit rating agencies, market research agencies, underwriters, private
security/detectives, real estate agencies and mechanized slaughter houses. In budget
2004-05, 13 more services were brought under the net taking the total to 71.
Over the last few years, many attempts have been made to implement VAT in India.
Initially, all states were to move to a VAT by 2000, but administrative problems and
concern over the revenue implications of the change delayed the scheduled
implementation. Most states, however, began to implement some of the agreed
preliminary measures, such as the uniformity of “floor rates” on particular classes of
goods. Yet political compulsions impeded any further advancement in this direction and
the schedule for implementation of VAT has been repeatedly postponed for five times
since 1999, the year when all the state governments for the first time agreed that they
would introduce a VAT system to replace the sales tax structure.
IV
It can be argued that a major difficulty in evolving a destination based retail stage VAT
at the state level arises from the apprehensions expressed by a number of states about
possible revenue losses in the process of transition to VAT.
Thus the first hurdle is to compute the revenue loss incurred by the states on basis of an
agreed formula and then devise a plan for compensation to the states. In fact one major
reason for revenue loss is the fact that in order to stabilize VAT, elimination of CST will
become inevitable as the two cannot remain in tandem. Discussions between the states on
75
replacing their sales taxes by VATs in fact centered to a considerable extent on the issue
of what to do with the CST in order to deal with the inter state trade. Bagchi (1996)
suggested the CST be reduced to 2 percent, with the exporting state keeping half the
revenue and the remainder being pooled and distributed “on an equitable basis” basically
to finance a full rebate of the exporter’s tax by the importing states. In 1997 a committee
of state finance secretaries also recommended reduction of CST by 2 percent, with half
the revenues going to the exporting state and the other half pooled and shared on the
basis of consumption (Poddar 1999).
The CST is a major source of revenue for the states, thus the problems arising out of
eventual phasing out of the CST will be difficult to resolve. State governments are
demanding the right to retain and in fact widen the tax net by levying a range of taxes,
including entry tax. This would defeat the fundamental objective of imposing VAT,
namely, unifying and harmonizing the complex tax structure in the country. Thus the
compensation issue is directly related to the reluctance of the states to pursue tax
rationalization sincerely. ‘Revenue’ after all is what matters the most to the government.
As Keen and Smith (2000) have emphasized that the fate of any possible redesigns of
central-state or interstate taxation is likely to turn on who gains and who loses, and by
how much. It won’t be wrong to suggest that as a rule when fiscal circumstances permit
some compensatory transfers to be made to losers, as was done in Canada, the level of
acceptance of the rational tax system rises.
As a part of revenue compensation package the states were given the power to tax AED
goods (textiles, tobacco and sugar) in 2002-03 budget. Earlier, the states merely received
1.5% of the Central tax revenues distributed to them as suggested by Eleventh Finance
Commission, for giving up their right to levy sales tax on the three commodities. There
was no sales tax on sugar, tobacco and textile products. Instead, the Centre levied an
additional excise duty (AED) on these items ìn lieu of sales tax', the proceeds of which
were meant to be passed on to the States. What the 2003- 04 Budget did was to
èmpower' States to levy sales tax/value-added tax (VAT) of up to four per cent on these
76
products, even while the Centre will continue to impose the AED. Both the levies thus
now co-exist. The AED cannot go because states are given an additional 1.5 per cent of
the Centre's shareable tax revenues, which is their entitlement from the levy as per the
11th Finance Commission's award.
Service tax has also been used to address the compensation issue. In India, the states do
not have the power to levy tax on services. The states can levy sales taxation of only
goods. Taxation of services before 92nd Amendment Act, 2003 (passed on 7th January
2004) was not assigned to either the centre or the state, but the former levied taxes on
selected services based on its power to levy taxes on residual items under èntry 97' of
the Union List, which relates to taxes not mentioned in either the State or Concurrent
Lists. After 92nd amendment service tax has been brought explicitly under Union list of
seventh schedule. The central government has tried to use service tax to convince the
states to gradually eliminate the taxation on inter-state sales (CST) so that a levy of
destination based VAT becomes a reality. Thus 92nd Amendment seeks to allow States
to `collect' and àppropriate' taxes on services. Though power to `levy' these taxes, will
remain with the Centre yet the act has given sufficient powers to the State governments
to collect the proceeds. In the Budget 2003-04 the general service tax rate was increased
from 5 percent to 8 percent in order to allow the states to appropriate 3 percent of the
overall 8 percent service tax and leave the rest to the center. Budget 2004-05 increased
service tax to 10 percent. Thus now the overall position is that, even after States are
empowered to collect and appropriate revenues from three out of the overall ten per cent
service tax rate, they will still be entitled to 29.5 per cent of the Centre's balance seven
per cent collections under this head. For 2003-04, the Centre budgeted total revenues of
Rs 8,000 crore from service tax, of which Rs 2,360 crore or 29.5 per cent was devolved
to the States as per the 11th Finance Commission's formula.
It is due to such efforts in the past coupled with determination of the UPA government
and assurance for adequate compensation for revenue loss due to VAT ( if any) and
deferring the phasing out of central sales tax, that a consensus among the states seems to
be emerging with all agreeing to implement a state level VAT. In order to compensate
77
states for any loss of revenue while switching over to the new tax regime a three tier
package has been offered, that include 100% compensation for revenue loss in the first
year, 75% in the second and 50% in the third.
But the things cannot be taken for granted as the quantification of the loss on transition to
VAT will be contentious issue. It has been asserted that the loss on transition to VAT
may not be as high as is expected to be projected by the states. It is to be noted that
compensation of loss to states on transition to VAT will be on agreed basis and has yet
remained quite elusive.
Keeping in view the need for developing viable VAT model for Indian states on one hand
and uncertainty on account of past experiences of repeated postponements of deadlines
for implementing VAT, on the other, certain measures have been suggested by various
experts. M.G. Rao states “Simplification and rationalization of the state taxes into VAT
has to be calibrated carefully. Rate rationalization, systematic provision of tax credit on
inputs and those paid on previous stages, removal of competing tax incentives and
concessions, zero rating the tax on inter-state sales – all these have to be done in phases.
There is also an urgent need to create a proper management and information system and
to computerize tax returns”. [M. Govinda Rao (2000)] Here it would be important to
point out that implementation of VAT in Indonesia and Thailand is a success story. It can
be attributed to careful planning and the employment of a simple system of record
keeping, tax rates and tax administration leading to high compliance levels.
The greatest challenge in India is to design a sales tax system that will provide autonomy
to the subnational levels to fix tax rate in a common geographical space, without
compromising efficiency or creating enforcement problems. In fact, political
compulsions have led the government to propose an imperfect model of VAT that is a
unique hotch- potch. The VAT system rolled across India by the white paper on State
78
level VAT is not a true VAT. The rate structure as recommended by the empowered
committee of state finance ministers is complex. Though the white paper claims that CST
will be phased out, no exact time period has been mentioned. Local or state level taxes
like octroi, entry tax, lease tax, workers contract tax, entertainment tax and luxury tax are
not integrated into the new regime which goes against the basic premise of VAT which is
to have uniformity in the tax structure. The fact that no tax credit will be allowed for
inter-state trade seriously undermines the basic benefit of enforcing a vat system, namely
the removal of the distortions in movement of goods across the states.
On January 18th 2005 all national dailies quoted Mr P. Chidambaram as saying, “It is
our dream to move on to GST (Goods and Services Tax) in future….it will be a National
VAT and the State level VAT would be integrated into it.” Given the political realities
and constitutional problems, this wishful thinking is likely to remain a dream for ever.
This dream overlooks the fact India is a federal country with strong regional governments
(the fact that regional governments shars power at the center makes them more
powerful).
While devising a proper and feasible model of VAT for India it should be kept in mind
that one of the major lessons of the Canadian experience is simply that there is no need to
have single VAT system for whole country. Respecting the regional differences different
provinces can be allowed to adopt different variants of VAT. Canada has allowed five
different systems to operate in its ten provinces. This probably answers the often raised
question as to whether by amending the constitution a Central VAT ( the centre levying
the VAT and sharing it with states) or a Subnational VAT (VAT being completely in
state hands ) shall be followed.
Thus it is important not to try to formulate a universal and precise conceptual design
leading to elimination of the likelihood of evolution of a tax policy that will be able to
put up with the regional differences thereby allowing different systems to coexist within
same nation. The better part is that it is functioning well in a federal country like Canada.
This however does not mean that the system will necessarily work in India too. In fact
79
differences in political culture, may lead to certain difficulties in permissibility of such
solutions in India. This significant issue, therefore, calls for further study and
investigation in Indian context.
CHAPTER IV: SUMMARY AND CONCLUSION
In one the most large scale reforms of the country's public finances in over past 50 years,
India has finally agreed the launch of its much-delayed Value Added Tax (VAT) from
1st April 2005. At a rate of 12.5%, VAT will come in on April 1, 2005. The tax, agreed
after state finance ministers met in New Delhi, is designed to make accounting more
transparent, cut trade barriers and boost tax revenues.
The system had been postponed many times, mainly because of opposition from the
powerful trading lobby. Ashim Dasgupta, who heads a panel overseeing the
implementation of VAT, said: "We are very happy to announce that a broad consensus
among states was arrived at the meeting to introduce VAT on April 1, 2005." The
80
Congress-led new left-leaning United Progressive Alliance (UPA) government has made
implementing VAT one of its key priorities.
According to analysts VAT is essential in tackling the problem of tax evasion. In India,
all the state governments collect over Rs 85,000 crore (Rs 850 billion) by way of sales
tax and further over 20,000 crore (Rs 200 billion) by way of Central Sales Tax. This is
what officially comes mostly from petroleum, liquor, iron and steel and cement
companies. Rough estimates suggest that these industries account for over 50 per cent
sales tax for the states and the Centre. Majority of the officials in sales tax departments
believe that what they actually collect is less than 50 per cent of the revenue that should
otherwise accrue to them if all transactions are accounted for by the businessmen.
India has a large un-organised market, especially agro-based industries and here a large
number of transactions go unrecorded. The menace of stock transfers adds to the problem
of tax evasion. In India, introduction of VAT will only change the collection methods for
sales tax rather than reform the indirect tax system.
Governments rely increasingly on taxes on general consumption — and on value-added

taxes (VAT), in particular — to raise revenue. The percentage of GDP revenue from
consumption taxes has doubled over the last thirty years, with VAT replacing not only
other consumption taxes but to a large extent also excise duties. By contrast, there is
no evidence of a significant overall shift from income taxes to consumption taxes. 1
Vat in its modern form was not born with the introduction, of general consumption taxes
in the 1960s. Until the late 1960s, indeed, consumption taxes in the OECD countries-
were either single-stage taxes-levied on retail or wholesale exchange, or they were multi-
stage, 'cascading' taxes levied whenever goods and services were sold. The only OECD
countries which already had a VAT system were France (introduced in part in 1954, fully
81
in 1968) and Finland (in 1964). Mexico, which became a member of the OECD in 1994,
introduced a VAT system in 1960.
Since then VAT has become the most popular form of tax on general consumption (for
governments, at least). There are two main reasons for its widespread adoption. The more
important is that under a VAT system tax is levied at-each stage and can be reclaimed in
the next link in the trading chain until the final consumer is reached; all traders are
treated on an equal footing. In general, VAT thus has little or no distortionary economic
effects.
Under a tax on retail sales, by contrast, the end-user of a product or a service has to be
identified, since that is the stage at which the tax has to be levied. Under a VAT system
with tax being levied at each stage, it is of course in the trader's own interest to reclaim it.
In this way the tax will automatically be paid by the final consumer.
Cascading taxes, on the other hand, cannot be reclaimed by the purchaser, so that the tax
component of the price of goods becomes larger and larger the more stages there are
between producer and consumer — with obvious distortionary effects as between highly
integrated enterprises and other enterprises.
Second, VAT is often considered more difficult to evade than taxes on wholesale or re-
tail sales. The invoice credit system used in nearly all countries leaves a trail of invoices
that may be followed by tax auditors. There is in general no common interest between
VAT-registered sellers and purchasers to evade tax. Instead, the purchaser has no interest
in bringing down the invoice price since he can reclaim a high volume of tax, although
the seller has an interest in a low invoice price to reduce his own tax liability. But no tax
system is foolproof: there are of course still risks of tax evasion.
82
CHAPTER V: RECOMMANDATION
VAT would change the nature of trade in the coming years, but the medium level of trade
that is C&F agents, distributors, stockiest etc. would face problems as the companies
would reduced the tier of marketing. Similarly small retail dealers would be required to
maintained more accounts or pay composition money which cannot be collected from
the customers. The present provision of CST and VAT can not go together. After the
abolition of CST the direct marketing concept may gain ground and the necessity of
83
having warehouse, godowns etc. in all states may decrease or finish. It would adversely
affect the trade and employment of the states. America which has similar federal and
state laws \ Constitution has not implemented VAT. It needs study as to why a develop
and advance economy like America has not adopted VAT.
BIBLIOGRAPHY
Books
1. Ahmed, Ehtisham and Nicholas Stern, 1991. The Theory and Practice of Tax
Reform in Developing Countries (Cambridge University Press).
2. Baer, K., V. P. Summers, and E.M. Sunley (1996) "A Destination VAT for CIS
Trade," MOCT- MOST, Economic Policy in Transitional Countries, 6: 87-106.
3. Bagchi, A. (1996) "Harmonizing Sales Taxes in a Federation – Case Studies:

India and Canada," Working Paper No. 9, National Institute for Public Finance
and Policy, New Delhi.
84
4. Bagchi, A. (1997) "Tax Assignment in the Indian Federation: A Critique,"
National Institute for Public Finance and Policy, New Delhi.
5.Bird, R.M. (1999) “Tax Policy and Tax Administration in Transitional

Countries,” in G. Lindencrona, S-O Lodin, and B. Wiman, eds., International
Studies in Taxation: Law and Economics (London: Kluwer Law International).
Articles
Economic Times- December 15, 2001
Indian Express-September 3, 2000
Websites
www.google.com
www.dogpile.com
www.j-info.com
www.marketingterms.com
www.internetworldstats.com
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CRITICAL ANALYSIS OF VALUE ADDED

TAX WITH SPECIAL REFERENCE TO INDIA

UNDER GUIDENCE OF:

DISSERTATION REPORT IN PARTIAL FULFILLMENT OF THE AWARD OF FULL TIME

AMITY BUSINESS SCHOOL

AMITY UNIVERSITY UTTAR PRADESH LUCKNOW

In preparing this dissertation report a considerable amount of thinking and informational

I HEREBY STATE THAT THIS PROJECT, SUBMITTED IN PARTIAL

CHAPTER II: PROFILE OF THE COMPANY

CHAPTER III: RESEARCH METHODOLOGY

CHAPTER IV: ANALYSIS OF DATA

4.1. VAT: GLOBAL SCENARIO

CHAPTER IV: SUMMARY AND CONCLUSION

CHAPTER V: SUGGESTIONS AND RECCOMENDATIONS

1.2. Significance of the study

1.3. Scope and objectives

 Should every country have a VAT?

 Is the current VAT always as good as it could be in economic, equity, and

2.3 LIMITATIONS OF THE STUDY

2. It is difficult to cover all the features of VAT in different countries

4. The time period was limited.

CHAPTER II: PROFILE OF THE COMPANY

2.13. PRINCIPLE OF VAT

2.14. BASIS FOR VAT

By the method of collection, VAT can be accounts-based or invoice-based[2]. Under the

2.15. EXAMPLE OF VAT

Without any tax

With a 10% sales tax:

With a value added tax

With a 10% VAT:

Limitations to example and VAT

2.16. VAT IN GLOBAL SCENARIO CONFERENCE

EU commissioner Laszlo Kovacs noting the European commissions satisfaction at being

2.17. VAT AND INFLATION

A global voice in concerned countries introducing value-added tax is that the

2.18. SALIENT FEATURES OF VAT

2.19. VAT REGISTERED

2.20. ADVANTAGES AND DISADVANTAGES OF VAT

2.21.METHODS OF COLLECTING AND CHARGING VAT

2.22. CONSTITUTIONAL FRAMEWORK WHICH DEALS WITH

a. the sale of goods, defined under the Sale of Goods Act.

LEVIES OF TAX UNDER THE VAT

2.23. WHO IS THE DEALER?

Agriculturist or educational institutions will not be deemed to be dealers.

Special Additional Tax (SAT)

2.24. RELEVENT COMPONENTS FOR CALCULATING VAT:

• Sale or purchase price of the goods

Imposition and rate of VAT

Taxable Persons and Registration

Scope of VAT on Taxable Supplies

Scope of VAT on acquisitions of belongings of other member states This schedule is

Input Tax and Output Tax

Payments on account of VAT

VAT Acts also cover the following key areas:

• General provisions relating to imported goods

2.25. LIMITATIONS TO VAT

3.1. Research design

3.2. Sources of data

3.3. Analytical Tools :

Here I collected application of VAT in different countries. It gives useful insight of my

Books, annual report, website, published and unpublished materials.

4.11. VAT IN EUROPEAN UNION COUNTRIES

The heavy reliance on consumption taxes has several advantages