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Published by: Kirti Srivastava on Jul 31, 2011
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07/31/2011

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Basics Of Value Added Tax

What is VAT? • It is nothing but Sales Tax. • It is a multi-point sales tax. • It is collected on value addition only at each stage. • Tax paid by the dealer is deducted from the tax payable collected at every point of sale and the tax already paid. How is VAT different from the current Sales Tax? Current Position Tax levied at the stage of the first sale (only for cotton, leather and natural gas at the final stage). Under VAT

Tax levied and collected at every point of sale.Tax levied and collected at every point of sale. Tax collected at every point of sale and the Successive sales (resales) of goods on tax already paid by the dealer at the time of which tax is already paid do not attract purchase of goods will be deducted from tax. the amount of tax paid at the next sale. Dealers reselling goods on which tax has Dealers reselling tax-paid goods will have already been paid do not collect any tax to collect VAT and file returns and pay VAT on resale and file nill returns. at every stage of sale (value addition). The manufacturer will pay VAT on the On 19 goods used as raw materials there goods purchased as raw materials but the is no input tax credit on the tax paid on VAT paid on raw materials will be deducted such goods and 2% tax is levied on other on the sale of goods manufactured. Thus goods used as raw materials for duplication of tax burden on raw materials manufacture. will be avoided. Computation of tax liability is complex. It is transparent and easier. Sales Tax is not levied at the time of VAT dispenses with such forms and sets purchases against statutory forms but off all tax paid at the time of purchase from there is misuse of such forms resulting in the amount of tax payable on sale. tax evasion. Returns and chalans are filed separately The return and the chalan will be filed and in returns the dealers have to give together in a simple format after selfnumerous details. Scrutiny of returns is assessment done by the dealer himself also difficult. which will be subject to scrutiny. Huge number of forms required in At the most a few forms required. procedure. Only two rates. Six taxation rates. Tax only on goods. Tax on goods and services both. Assessment done by the department. Self-assessments by dealers. Penal provisions for defaulters and Penalties will be stricter. evaders of tax not very strict.

Why VAT? • More equitable – tax burden is shared by all dealers. • More transparent – easy procedures and only two rates, broadly speaking.

Rs. the excess credit will be carried forward to the next month. Credit for input taxation . If the tax credit exceeds the tax collected during a month on sale within the state. 150 Rs. Better Compliance . five lacs and twenty-five lacs may opt for a simple composition tax at a nominal rate in place of VAT. Credit will be given within the same month for entire VAT paid within the state on purchase of inputs and goods. 100 paid on the purchase by the dealer Net VAT paid by the dealer on value addition after resale Total tax at 10% on the last sale price of RS. Input credit excludes purchases: from unregistered dealers from other states/countries of goods used in manufacture of exempted goods of capital goods goods used as fuel in power generation of goods to be dispatched as branch transfers outside States of goods used in manufacture of goods to be dispatched outside any state as branch transfer/consignments and in cases where the dealer does not have invoices showing amounts of tax charged separately by the selling dealer. Rs. • Dealers having annual turnovers between Rs. 5. 150. Rs. 15(output tax). How to pay VAT? VAT will be paid along with monthly returns. five lacs may register voluntarily. What types of input tax are eligible for VAT credit? Input tax credit is given for entire VAT paid within the state on purchases of taxable goods meant for resale/manufacture of taxable goods. Purchase Price Tax paid on purchase Sale Price Tax payable on sale price Input tax credit VAT payable Total tax collection by govt. Credit thus accumulated over any month will be utilized to deduct from the tax collected by the dealer during that month. 10. 5. 15. Example: (Rate of tax assumed at 10%).100. How to calculate VAT? VAT is calculated by deducting tax credit from tax collected during the payment period. Rs. Rs.through self-policing. Rs.cost efficiency. Who pays VAT? • All dealers registered under VAT. Prevents cascading effect – through input rebate. -------Rs. . Avoids distortions in trade and economy – uniform tax rates.• • • • • Simpler. • Dealers with turnovers less than Rs. 10(input tax).easy computation and easy compliance. Rs. Which goods will be taxable under VAT? All goods except those specifically exempt. 10. five lacs shall register for VAT. On the sale price of Rs. • All dealers with an annual turnover of more than Rs.

Industrial incentives in the form of exemption and deferment of sales tax may have to be continued under VAT as they are commitments made by the government. • 4% tax on essential goods.What to expect under VAT? As per the Recommendations of the VAT Advisory Committee number of tax rates should not exceed two. What are RBI’s qualitative and quantitative instruments of credit control? . • Continues for certain commodities as Govt. may decide. • Tax exemptions on food grains. What will happen to the Sales Tax Act? • Continues for the pending assessments. What will happen to the Central Sales Tax? In an ideal VAT regime there is no room for CST. appeals and recoveries. capital goods and industrial inputs. the GOI is contemplating certain amendments in the CST. fruits and processed milk. vegetables. The units may get certain options. declared goods. To begin with. What else will VAT cover? The GOI is contemplating to empower states to collect VAT on considerable number of services as well as on goods on which AED (additional excise duty) is levied. • All other goods to be taxed on the basis of revenue neutrality. What will be the status of the industries enjoying sales tax exemption and deferment? The matter is under consideration of the government. • Current system to continue for diesel and petrol. • Special rate of 1% on gold and silver and articles thereof.

Bank Rate Policy: The bank rate is the Official interest rate at which RBI rediscounts the approved bills held by commercial banks. 2. inflation and money supply. 4.e. 3. If RBI wishes to control credit and discourage credit it would increase CRR & SLR. banking system of the country) to not to lend to particular groups/ persons. Open Market Operations: OMO The Open market Operations refer to direct sales and purchase of securities and bills in the open market by Reserve bank of India. 3. the current SLR is 25%.) . Regulation of monetary growth and maintenance of price stability Ensuring adequate expansion of credit Assist economic growth Encourage flow of credit into priority and neglected sectors Strengthening of the banking system of the country The quantitative or general measures influence the total volume of the credit while the qualitative measures influence the selective or particular use of credit. Each scheduled bank needs to send a weekly report to RBI which shows its assets and liabilities. RBI will increase the Bank Rate. The current Cash reserve Ratio is 6%. approved govt. Current Bank Rate is 6%. 2. securities etc. The aim is to control volume of credit. Cash Reserve Ratio: Cash reserve ratio refers to that portion of total deposits in commercial Bank which it has to keep with RBI as cash reserves. . For example each bank has to get a license from RBI to do banking business in India and this license is always subject to cancellation by RBI provided the bank does not fulfill the requirements stipulated by RBI. The banking regulation act 1949 says that the Reserve Bank of India can ask any particular bank (or even all the banks i. Statutory Liquidity Ratio: It refers to that portion of deposits with the banks which it has to keep with itself as liquid assets(Gold. For controlling the credit. Apart from this RBI is armed with weapons to control the money market in India. The quantitative measures of credit control are : 1. 4. 5.The government through the reserve bank of India employs the monetary policy as an instrument of achieving the objectives of general economic policy. Reserve Bank of India has the power to influence the volume of credit created by banks in India. The main objectives of the monetary policy are as follows: 1.

for credit demanded beyond a limit. and are typically used to exchange fixed-rate interest payments for floating-rate payments on dates specified by the two parties. 5. Direct Action: This step is taken by the RBI against banks that don’t fulfill conditions and requirements. guidelines. 4. 3. Since the exchange of payment takes place in two different currencies. Rationing of credit: The RBI controls the Credit granted / allocated by commercial banks. written statements. Currency Swaps A currency swap is an agreement between two parties to exchange the principal loan amount and interest applicable on it in one currency with the principal and interest payments on an equal loan in another currency. 6. Moral Suasion: psychological means and informal means of selective credit control. which could range up to ten years. Some of them are 1. warnings etc. the two parties swap the principal amount specified in the contract. a common maturity period and the interest and exchange rates determined at the commencement of the contract. 2. the prevailing spot rate is used to calculate the payment amount. Guidelines: RBI issues oral. Currency Swap. RBI may refuse to rediscount their papers or may give excess credits or charge a penal rate of interest over and above the Bank rate. Consumer Credit Regulation: This refers to issuing rules regarding down payments and maximum maturities of installment credit for purchase of goods. How Does a Currency Swap Work? A currency swap agreement specifies the principal amount to be swapped. Margin requirements: This refers to difference between the securities offered and and amount borrowed by the banks. . to the banks. This financial instrument is used to hedge interest rate risks. appeals. The two parties would continue to exchange the interest payment at the predetermined rate until the maturity period is reached. These contracts are valid for a specific period.Qualitative measures: Qualitative credit is used by the RBI for selective purposes. On the date of maturity.

Money Market in India The money market is the market in which short term funds are borrowed and lent. The lending money market institutions are      Government of India and other sovereign bodies Banks and Development Financial Institutions PSUs [Public Sector Undertakings] Private sector organizations The Government /Quasi government owned non-corporate entities. State governments and other statutory bodies. based on the prevailing economic scenario. This leads to a huge downturn in the value of the domestic currency. Companies having fixed rate liabilities can capitalize on floating-rate swaps and vise versa.The equivalent amount of the loan value in another currency is calculated by using the net present value (NPV). Instruments that are issued by the Development Financial Institutions [DFI] and banks carry the highest credit ratings amongst non-government issuers mainly due to their connection with the Indian Government. Instruments of money market . Speculators can benefit from a favorable change in interest rates. Limitations of Currency Swaps • • • The drawbacks of currency swaps are: Exposed to credit risk as either one or both the parties could default on interest and principal payments. This implies that the exchange of the principal amount is carried out at market rates during the inception and maturity periods of the agreement. Vulnerable to the central government’s intervention in the exchange markets. Large numbers of instruments that are trade in the money market are issued by Government of India. Benefits of Currency Swaps The benefits of currency swaps are: • • • • • Help portfolio managers regulate their exposure to interest rates. Reduce uncertainty associated with future cash flows as it enables companies to modify their debt conditions. Reduce costs and risks associated with currency exchange. This happens when the government of a country acquires huge foreign debts to temporarily support a declining currency.

5. Existing mainly as a refuge for low rated corporate. Interest rates are market determined. If the period is greater than one day and up to 14 days it is called Notice money. Call Money Call or notice money is an amount borrowed or lent on demand for a very short period.Allowed in 1989. in nature. it is auctioned on every alternate Wednesday. These are generally sold on discount basis. o o o 14-day T-bill: maturity is in 14 days. RBI issues treasury bills [T-bills] at a prefixed day and for a fixed amount. A CD is a negotiable promissory note. The call market enables the banks and institutions to even out their day-to-day deficits and surpluses of money. A CD is issued at a discount to the face value. the discount rate being negotiated between the issuer and the investor. CDs were one of RBI’s measures to deregulate the cost of funds for banks and FIs. 100 crores. otherwise the amount is known as Call money. No collateral security is needed to cover these transactions. These instruments are normally issued in the multiples of five crores for 30/45/60/90/120/180/270/364 days. Co-operative banks. Inter-Corporate Deposits An Inter-Corporate Deposit or ICD is an unsecured loan extended by one corporate to another. 4. 364-day T-bill: maturity is 64 days. it is auctioned on every Friday of every week and the notified amount for auction is Rs. which is not a reporting week and the notified amount for auction is Rs. 91-day T-bill: maturity is in 91 days. 500 crores. 2. 182-day T-bill: maturity is in 182 days. Commercial Papers Commercial papers [CPs] are negotiable short-term unsecured promissory notes with fixed maturities. it is auctioned on every alternate Wednesday which is a reporting week and the notified amount for the auction is Rs. it is auctioned on every Friday of every week and the notified amount for auction is Rs. 100 crores. commercial banks and primary dealers are allowed to borrow and lend in this market for adjusting their cash reserve requirements. There are 4 types of treasury bills. 100 crores. Treasury Bills These are the lowest risk category instruments for the short term. both borrowers and lenders are required to have current accounts with Reserve Bank of India. Certificates of Deposits After treasury bills. This is a completely inter-bank market. In view of the short tenure of these transactions. . the next lowest risk category investment option is certificate of deposit (CD) issued by banks and Financial Institution (FI). the maturity most quoted in the market is for 90 days. Although RBI allows CDs up to one-year maturity. secure and short term. issued by well-rated organizations. of up to a year. Organizations can issue CPs either directly or through banks or merchant banks [called as dealers]. this market allows funds surplus corporate to lend to other corporate. o 3.1.

(2) Capital Market. Types: There are two types of financing/capital markets: (1) Money Market. from a multitude of may be several hundreds or thousands. and therefore the risk inherent is high. 7. the rates in this market are higher than those in other markets. As the cost of funds for a corporate is much higher than a bank. These bills are called trade bills. Commercial Bills Bills of exchange are negotiable instruments drawn by the seller or drawer of the goods on the buyer or drawee of the good for the value of the goods delivered. underlying loans and passes the money to the holders of the PTCs. It is called reverse repo when viewed from the prospective of supplier of funds. If the bill is payable at a future date and the seller needs money during the currency of the bill then the seller may approach the bank for discounting the bill. Pass through Certificates This is an instrument with cash flows derived from the cash flow of another underlying instrument or loan. Legally speaking PTCs are promissory notes and hence tradable freely with no stamp duty payable on transfer. Under such an agreement the seller sells specified securities with an agreement to repurchase the same at a mutually decided future date and price. Capital Market: Definition: The means by which large amounts of money (capital) are raised by companies. These trade bills are called commercial bills when they are accepted by commercial banks. Ready Forward Contracts These are transactions in which two parties agree to sell and repurchase the same security. Such a transaction is called Repo when viewed from the prospective of the buyer of securities that is the party acquiring fund. 6.A better rated corporate can borrow from the banking system and lend in this market. Most PTCs have 2-3 year maturity because the issuance stamp duty rate makes shorter duration PTCs unviable. 8. This process is called securitization. which only receives money. Similarly. the buyer purchases the securities with an agreement to resell the same to the seller on an agreed date in future at a predetermined price. The issuer is a special purpose vehicle (SPV). governments and other organizations for long term use and the subsequent trade of the instruments issued in recognition of such capital. ICDs are unsecured. The ICD market is not well organized with very little information available about transaction details. .

(2) Capital Market: Capital market refers to a market where the financial institutions mobilize the savings of the people and lend them for long term. Institutional sources of Capital Market: There are a number of financial institutions which are directly involved with real investment in the economy. (iv) Federally sponsored credit agency securities. in other words. It mainly centers round its activities on the discount houses. . The main institutional sources of capital market are as follows: (i) Insurance Companies. (vi) Commercial banks bonds and commercial paper. Insurance companies are financial intermediaries. Capital Market. (iii) State and local government bonds. short dated bonds. the treasury bills.(1) Money Market: Money market is the market for very short term loans. deals in various credit instruments such as. (v) Finance company bonds. period for raising new capital in country. the commercial banks. refers to the long term borrowing and lending of capital funds. (ii) Corporation bonds. These institutions mobilize the saving from the people and channel funds for financing the development expenditure of the industry and government of a country. The money market. (viii) Corporate stock. They call money by providing protection from certain risks to individuals and firms. etc. The insurance companies invest the funds in long term investments primarily mortgage loans and corporate bonds. certificate of deposits. the bill of exchange. The financial institutions take maximum care in investing funds in those projects where there is high degree of security and the income is certain. Capital Market Instruments: The principal capital market instruments used for long term funds are: (i) Mortgages.

specialist finance institutions.. The accumulated saving is invested in mortgage loans. The investment trust mobilize saving and meet the growing. The income of the investment trust depends upon the dividend it receives from shares invested in various companies.(ii) Pension Funds. The stock exchange is a market in existing securities (shares. etc. (vi) Saving Banks. Stock exchange. These funds are now increasing utilized in the provision of long term loans for the industry and government. corporate bonds. The specialized finance corporations are being established to help and provide finance to the private industrial sector in the form of medium and long term loans or foreign currencies. The commercial banks are also now activity engaged in the provision of medium and long terms loans to the industrialists. purchase of buildings for the industry and houses for the people. agriculturists. (viii) Commercial banks. The holders of units can resell the units at the prevailing market value to the trust itself. (vii) Specialized Finance Corporation. etc. (ix) Stock Exchange. need of corporate sector. The stock exchange provides a place for those persons who wish to sell the shares and also wish to buy them. debentures and securities issued by the public authorities). (v) Unit Trust. The saving banks collect the savings of the people. (iv) Investment Trusts. The pension funds are provided by both employees and employers. The Unit Trust collects the small savings of the people by selling units of the trust. (iii) Building Societies. The building societies are now activity engaged in providing funds for the construction. thus helps in raising equity capital for the industry .

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