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

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.

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)

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 Name_______________ (Student) Guide) Signature Name_____________ (Faculty

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

2.26. CRITICISM

CHAPTER III:

RESEARCH METHODOLOGY
Primary data Secondary data

3.1. Sources of 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: CHAPTER V:

SUMMARY AND CONCLUSION SUGGESTIONS AND RECCOMENDATIONS

BIBILIOGRAPHY

CHAPTER I: INTRODUCTION
1.1. Background 1.2. Significance of the study 1.3. Scope and objectives 1.4. Limitations

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 8

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 Indias 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. 1.2. Significance of the study 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.

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.

1.3. Scope and objectives 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

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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 (1.651.32-.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 nontaxation) 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. 21

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. 22

10-12% on goods called Revenue Neutral Rates (RNR). There would be no fall in such remaining goods. 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:

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1.

Provide

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:

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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 nonresident 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 endconsumers 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.

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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.

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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

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 taxfree.

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 nonneutralities 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 Tax cut fully offset by a reduction in government Consumption (1 per cent of GDP) (a) (b) (c) Reduction of labour, corporate and VAT2 Reduction of labour and corporate taxes only2 Reduction of labour taxes only2 0.54 0.54 0.65 0.57 0.81 0.97 1.28 1.88 1.24 Employment Investment

Tax shift from labour to consumption (1 per cent of GDP) (d) Tax shift from labour to VAT without compensating transfer recipients3 (e) Tax shift from labour to VAT with compensating transfer recipients4 0.37 0.48 0.32 0.66 0.82 0.73

VAT Rates In Non-EU Countries

42

Country Argentina Australia Bulgaria Canada China, People's Republic of2 Croatia Dominican Republic Ecuador Iceland India Israel Malaysia Mexico New Zealand Norway Philippines Romania Russia Serbia Singapore South Africa Sri Lanka Switzerland

Rate Standard 21% 10% 20% 7% or 15% 17% 22% 6% 11% 24.5% 12.5% 16.5% 5% 15% 12.5% 25% 10% 19% 18% 18% 5% 14% 15% 6.5% Reduced 10.5% or 0% 4.5% 6% or 3% 12% or 0% 14% 4%, 1%, or 0% 0% 11% or 7% 9% 10% or 0% 8% or 0% 7% or 4% 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 nonluxury 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 Exportation of goods Edible vegetable and grain duplicates 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% Rate 0 13%

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

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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.

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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

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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

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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,

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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

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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

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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%.

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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 selfassessments, 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

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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.

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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 Selle r Buyer Price (Excludin g Tax) A B 100 4% CST 12.5 B C 114 % VAT Tax Rate

Invoice value (InclTax ) 104 4

Tax Payabl e

Tax Credi t

Net TaxOutflo w

4.00

128.25

14.25

0*

14.25

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12.5 C D 124 % VAT Consume r 12.5 134 % VAT VAT CST 16.75 4.00 150.75 16.75 15.50 1.25 139.50 15.50 14.25 1.25

Total to Govt.

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

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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 90s) 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 Indias 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.

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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

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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 Indias 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 subnational 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 Indias 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

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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 subnational 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

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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 Brazils 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 Brazils 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 Qubec in Canada, the state of Michigan in USA and Brazilian states are the only examples (of subnational vat) so far. Michigans 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

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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

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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 Indias 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 exporters 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 wont 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 `in 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 `empower' States to levy sales tax/value-added tax (VAT) of up to four per cent on these

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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 `entry 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 `appropriate' 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

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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.

V
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

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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

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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, con- sumption taxes in the OECD countrieswere either single-stage taxes-levied on retail or wholesale exchange, or they were multistage, '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

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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 retail 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.

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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

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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.

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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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