INPUT TAX CREDIT, COMPOSITION SCHEME &

PROCEDURES

CHAPTER OUTLINE

SI. No. Synopsis

1. Input Tax Credit
2. Eligible and Ineligible Purchases
3. Carry forward, refund and exemption of VAT credit
4. Tax Rates & Penal Provisions
5. Registration under VAT
6. Composition Scheme
7. Records
8. VAT Invoice

9. Tax Payer’s Identification Number

10. Returns
11. Assessment
12. Audit
13. VAT and Sales Tax Incentives
 1. Input Tax Credit
As discussed earlier, the seller can take credit for the tax suffered on his purchases.

The setting off of tax paid on purchases (input tax) against the tax payable on sale of goods
(output tax) is known as input tax credit.

In regard the scope of input tax credit, the following may be noted: input tax credit on raw
materials, consumables etc.

i) Input tax credit shall be allowed to a registered dealer on intra-state purchases. Credit
can be claimed irrespective of whether the goods are subsequently used for the purpose of
inter-state or intrastate sales. The only criterion for set off is that tax should have been paid
on purchases within the State.

For example, Mr. X of Mumbai purchased materials from Mr. Y of Pune. The transaction
suffered tax of Rs. 10.000. Being an intra-state purchase, i.e. within the State of Maharashtra,
input tax credit is allowed. Subsequently, Mr. X sold part of the materials to Mr. C of Chennai.
This subsequent sale, though interstate, does not prevent Mr. X from availing the input tax
credit.

ii) It is not necessary that the goods purchased should have been utilized or sold. Credit can
be availed once the tax is actually paid even on the unsold goods.

iii) In most of the States, it has been provided that credit can be claimed only if purchases are
utilized for manufacture of taxable goods, i.e. goods on which VAT is collectible. In case only a
portion of the purchases are utilized for the above mentioned purpose, input tax credit can
be claimed only to the extent of such portion.
Input tax credit on capital goods
Capital goods include plant and machinery, furniture, fixture, electrical installations, vehicles
etc. (other than raw material) purchased by the registered dealer or manufactured by the
registered dealer himself.

i) Input tax paid on purchase of capital goods and also on the raw materials used for
manufacturing the capital goods is eligible for input tax credit.

ii) Input tax credit on capital goods can also be availed by manufacturers and traders unless it
is specifically excluded through the negative list. Items specified in the negative list are not
eligible for credit.

iii) The available credit has to be adjusted over a maximum of 36 equal monthly installments.

iv) However, the various states have an option to reduce the number of installments.

v) In case the capital asset is sold within 36 months, the proportionate credit will be
withdrawn.

Procedural requirements for claiming set off in case of capital goods

Bifurcate the purchases into capital goods eligible for set off and capital goods not eligible for
set off. Then, ensure whether the tax invoice is there for the capital goods eligible for set off
(If, invoice is not available then set off cannot be made).

Additional Points

1. Where the purchased goods are partially used for the purpose of taxable goods and
partially for exempted goods, input tax credit is allowed only to the extent of purchases used
for the purpose of taxable goods and the balance credit is to be reversed.

2. Under VAT laws, zero percent is also a rate of tax and hence credit is available even if the
final product is zero-rated. However, if goods are exempt from VAT, no such credit can be
availed.
Exercise
Pi. Ankith Engn. Corpn purchased goods for Rs. 2,00,000 in the month of June 2016. The sales
for the month is Rs. 5,00,000. The input tax rate and output tax rate are 4% and 12.5%
respectively. Calculate the amount of VAT credit available for setoff.

[Ans: Rs. 2,00,000 x 4% = Rs. 8,000]

Input tax credit on stock transfer

Stock transfer to branches or on consignment basis does not amount to sale. Therefore, it is
not subject to VAT or CST. However, if goods are sent outside the state on stock transfer or
consignment basis, credit or set-off of tax paid on inputs purchased within the state is
available only to the extent of tax paid in excess of 2%, as 2% is retained by the State
Government.

Example:
Where tax paid on inputs is 4%, then the available input credit shall be 2% (i.e., 4% - 2%)
However, full input tax credit shall be available if stock transfer is to another branch in the
same state.
Eligible and Ineligible Purchases for availing Input Tax Credit

Eligible Purchases Ineligible purchases

Input credit can be claimed In the following cases, input tax credit cannot be
only if the purchases are for availed:
any of the following purposes: a) purchases from unregistered dealers;
a) for sale/resale-both intra- b) purchases from registered dealers who opt for the
state and inter-state composition scheme;
b) to be used as containers/ c) purchase of goods as notified by the respective
packing materials, raw State Governments;
materials or consumable d) purchase of goods where the invoice is not available
stores required for with the claimant or where available, the amount of
manufacturing of taxable tax has not been shown separately;
goods or for packing of such e) where there is evidence that the invoice has not
manufactured goods intended been issued by the seller from whom the goods are
for intra-state or inter-state purported to have been purchased;
and export sales f) purchase of goods which are being utilized in the
c) used in the execution of a manufacture of exempted goods or purchase of
work contract; goods when the sales are exempt;
d) used as capital goods required g) goods in stock which have suffered tax under an
for the manufacture or resale earlier Act but are covered under exempted items
of taxable goods; and under VAT;
e) for making zero rated sales. h) goods purchased from other states or imported
from outside country (high sea sales);
i) goods purchased for personal use/consumption or
provided free of charge as gift; and
j) purchase of goods like motor vehicles, toilet
articles, furniture etc. which are not used in relation
to production of goods or held for sale/resale.
3. Carry forward, refund and exemption of VAT credit

i) The process of availing input tax credit is as follows:

a) The tax credit shall first be adjusted against the VAT liability;

b) The excess, if any, after setting off VAT may be adjusted against the Central Sales Tax
(CST) for the said period;

c) If there is excess credit even after adjusting VAT and CST, it shall be carried forward
till the end of the next year;

d) In case there is any unadjusted input tax credit at the end of the second year, the
same shall become eligible for refund. Here again, some States have decided to grant a
refund at the end of the first year itself.

It may be noted that, only when input tax credit is availed, it will not be included in cost. In
all other cases, it has to be included in the cost. Correspondingly, if VAT paid on capital
goods is availed as input tax credit, depreciation be claimed on the value excluding VAT.

Eg: In case of purchase from outside the state (Inter-State), say Mumbai dealer, from Tamil
Nadu, for Rs. 52,000, which includes CST of Rs. 1,000, the cost of purchase in this case,
would be Rs. 52,000 only, as CST credit of Rs. 1,000 will not be available for Input Tax credit.

ii) Refund may be granted if goods are exported out of the country. Such refund is to be
granted within 3 months from the end of the period in which the export transaction took
place. However, the refund can also be adjusted while making domestic sales.

iii) Similarly, units located in Special Economic Zone (SEZ) and Export Oriented Units (EOU)
are exempt from paying input tax. Even if such tax has been paid, a refund shall be granted
within 3 months. However, the respective State Governments may opt to reduce the time
frame of 3 months.

iv) In some states, reimbursement of tax is made available to specialized agencies of the
UNO, Consulates and Embassies of any other country located in such states, subject to
fulfillment of conditions.

v) Refund of SAD (Special Additional Duty charged not exceeding 4% in case of import in lieu
of VAT) can be claimed by a trader if he charges VAT on his sales and shall not allow buyer to
take credit on such purchases.
Illustration
P2. Swathi Enterprises provides the following details for the month of April, 2016:
Intra-State Sales - Rs. 12,00,000;
Inter-State Sales - Rs. 6,00,000;
Intra-State Purchases - Rs. 4,80,000.
The input tax rate and output tax rates are 12.5% and 4% respectively. CST rate is 2%.
a) Compute the VAT eligible for carry forward for the next month.
b) In case the CST payable is Rs. 10,000 would your answer be
different.

Ans: a) Computation of VAT eligible for carry forward

Particulars Notes Rs. Rs.
A Intra state purchases during the month 4.80.000
B Input tax paid @ 12.5% (Input tax) A  12.5% 60,000
C Intra state sales during the month 12.00.000
D Tax @ 4% on sales of goods C  4% 48,000
E Net VAT liability during the month D - B, if positive Nil
F Input credit after set-off B-D 12,000
G Inter-state sales 6.00.000
H CST liability to be paid on inter-state sales G  2% 12,000
I Credit to be carried forward F-H Nil

c) In case, if the CST liability is Rs. 10,000, then the credit to be carried forward will be Rs. 2,000
(12000-10000)
4. Tax Rates & Penal Provisions
The different rates of tax are summarized as below:
651

1 Rate of tax Goods falling under the category

There are about 50 commodities falling under this category, out of

which only 10 are decided by the States. The remaining are common
Exempted category to all States. It consists mostly of natural, unprocessed products in
the unorganized sector, items which are legally barred from taxation
and items which have social implications.
Eg: Vegetables
Petrol, and fruits,
diesel, aviation Earthern
turbine pots,
fuel, Electricity,
motor spirits, Kumkum,
liquor etc.etc.
whose
prices are not fully market determined, fall under this category.
Non-VAT goods
However, the States may or may not levy tax on them. If tax is levied,
it cannot exceed 20%.

1% VAT Applicable for precious stones, bullion, gold and silver ornaments etc.

Large numbers of goods, common to all States fall under this

category. It consists of basic necessities such as medicines and drugs,
4% VAT
agricultural and industrial inputs, capital goods etc.

Subsequently, this rate has been increased by some States.

Other commodities, which are common for all states and do not fall
12.5% VAT under any of the above categories fall under this category.

Subsequently, this rate has been increased by some States.

Penal Provisions

Since VAT is a State subject, the penal provisions vary from State to State. In general, they are
more stringent when compared to the earlier Sales Tax Law.

Illustration

P3. Mr. Krishnakanth, a dealer in consumer goods presents the details for the month of
October, 2016 which are as follows:
Amounts in Rs.

Opening Closing
S. No. Particulars Purchases Sales
Stock
Stock
1
Exempted Goods 1,50,000 3,00,000 4,00,000 50,000

2. 4% Goods (Excluding VAT) 3,75,000 5,00,000 9,00,000 25,000

3. 12.5% Goods (Excluding VAT) 60,000 3,00,000 4,00,000 40,000

The opening balance of VAT input tax credit is Rs. 2,500.

Calculate the Gross Turnover, Taxable Turnover, Input Tax Credit, VAT liability.

Ans: Computation of Gross Turnover, Taxable Turnover, Input Tax Credit and VAT liability

Input Tax Taxable VAT

Particulars Purchases Gross Turnover
Credit Turnover liability
Exempted
3,00,000 Nil 4.00,000 Nil Nil
Goods
4%-Goods 5,00,000 20,000 9,00,000 9,00,000 36,000

12.5% Goods 3,00,000 37,500 4,00,000 4.00.000 50,000

Total 11.00.000 57.500 17.00.000 13.00.000 86.000

Computation of VAT liability after set-off

Particulars Ref. Rs. 653

Opening credit 2,500

Add: Input Tax Credit 57,500

Total Input Tax Credit available for set-off A 60,000

VAT liability on sales B 86,000

VAT liability after set-off B-A 26.000

Registration under VAT

Registration is a process of obtaining certificate of registration (RC) from the VAT authorities of
respective states.

The White Paper provides that application for registration to the VAT Commissioner is
compulsory when the annual turnover exceeds Rs. 5 lakhs. However, the Empowered
Committee of State Finance Ministers subsequently allowed the States to increase the
threshold limit to Rs. 10 lakhs with the condition that the concerned State would bear the
revenue loss on account of increase in the threshold limit. It is not compulsory for dealers who
do not fall under the above category to register under VAT.

A dealer should file an application in specified form along with the fee to the registering
authority with a sufficiently stamped self addressed envelope along with necessary documents.

It is to be noted that in case a dealer does not register himself under the VAT Act, he cannot
avail input tax credit and this would consequently increase his cost, thereby reducing his profit.
To demonstrate, Mr. S purchases goods for Rs. 60,000 (including VAT of Rs. 10,000). He sells
the goods to Mr. T for Rs. 70.000. In case Mr. S is a registered dealer, he can avail credit of Rs.
10,000. Therefore, profit would be Rs. 20,000 (70,000 - 50,000), whereas if Mr. S does not avail
the credit, the cost to him would be Rs. 60,000 thereby reducing the profit to Rs. 10,000 (Rs.
70,000 - Rs. 60,000).
The following are the provisions relating to registration of a dealer under the VAT Act. For
this purpose, a “dealer” means any person, who consequent to, or in connection with, or
incidental to, or in the course of his business, buys or sells goods for a consideration or
otherwise.

Voluntary registration: Even if a dealer is not required to register under the VAT Act, he
may voluntarily register, if he so desires and shall be registered if the Commissioner is
satisfied that the business of the applicant requires registration. The Commissioner has the
right to impose any terms and conditions that deem fit. Advantage: Buyer from such dealer
will get input tax credit on the purchases.

Compulsory registration: An assessee failing to register under the VAT Act, may be
compulsorily registered by the Commissioner. Further, failure to register shall attract default
penalty and forfeiture of right to set off input tax credit prior to the period of compulsory
registration.

Based on turnover Based on transaction

Registration is compulsory if the The following dealers shall be compulsorily
Turnover is >5 lakhs/10 lakhs. registered:
The registration is to be made i) Dealers purchasing goods from other states;
within 30 days of crossing the limit. ii) Dealers selling goods to other states;
iii) Dealers exporting and importing goods from
a country outside India;
Cancellation of Registration: Registration may be cancelled on:
iv) Dealers are liable to pay tax at 20% on goods

i) Transfer of business to a new location;like

or liquor, petrol, diesel etc.
ii) Annual turnover of the manufacturer/trader dealing in designated goods falls below the
specified amount; or
iii) Discontinuance or disposal of the business; or
iv) Dealer has become insolvent; or
v) Change in the constitution of the business.
Composition Scheme Conditions & Eligibility

Small dealers who are liable to pay VAT but whose gross turnover does not exceed Rs. 50
lakhs in the preceding financial year, may opt for the composition scheme.

Under this scheme, tax shall be payable as a small percentage of the gross turnover. This
provision is made available to relieve the small dealers from the burden of complying with the
several procedures. The fixing of composite rates of tax is left to the discretion of the
respective States.

However, the following are not eligible for the composition scheme:
i) a manufacturer/dealer who sells goods to other States;

ii) a dealer who sells goods in the course of import into or export out of the territory of India;

iii) a dealer who transfers goods outside the State otherwise than by way of sale (like stock
transferring for the execution of a works contract);
iv) a manufacturer/dealer who purchases goods from other states; and

v) a dealer, who wants to issue VAT invoice.

The option of exercising the composition scheme is given to the dealer. The dealer shall
exercise the option in writing to the Commissioner for a year or part of the year in which he
registers under the Act.

It is to be noted that on the day of exercising the option, the dealer should not possess any
stock of goods which were purchased from outside the State and shall not use such goods
after the date of exercising the option. Further, he cannot claim credit on inventory held by
him on the date of exercising the option.
Advantages
a) The biggest advantage of this scheme is that it saves the cost of labour and efforts of
maintaining records. Only the purchase, sale and inventory records are to be maintained.
b) Also, there is a simple return form to cover a longer return period.
c) Generally, a small tax is payable (as low as 0.25%)

Disadvantages
a) The major disadvantage of the scheme is the ineligibility of the dealer to avail input tax
credit. Further, they cannot pass on the credit to other dealers. Hence VAT chain is broken
resulting in cascading effect of taxes.

b) Dealers who wish to avail input tax credit may not prefer purchasing from composition
dealers.

Illustration:
XYZ Ltd. give the following details for the month of March, 2017:

Particulars Purchases (Rs.) Sales (Rs.)

Intra-State 8,00,000 (12.5%) 6,00,000 (4%)

Inter-State 5,00,000 (CST - 2%) 9,00,000 (CST - 2%)

Out of Rs. 8 lakhs Intra state purchases, Rs. 75,000 were from unregistered dealer; Rs. 50,000
from registered dealers who opt for composite scheme; Rs. 25,000 worth goods used in
manufacturing of taxable goods intended for exports.

Compute the VAT Credit available for set off and carry forward purposes.
 Ans: Computation of eligible purchases for computation of VAT credit

Particulars Rs. Remarks

Intra-State purchases
 From unregistered dealer 75.000 Ineligible purchase
 From registered dealer who opts for composite 50.000 Ineligible purchase
scheme 25.000 Eligible purchase

 Goods used in manufacturing of taxable goods

6,50,000
intended for exports Eligible purchase
5,00,000 Ineligible Purchase
 Others ( 8,00,000 - 75,000 - 50,000 - 25,000)
Inter-State purchases

Total amount of eligible purchases is Rs.6,75,000. Computation of VAT credit eligible for set-off
& carry forward

Particulars Notes Rs. Rs.

A Eligible purchases 6.75.000

B Input tax paid @ 12.5% (Input tax) A  12.5% 84,375
C Intra-state sales during the month 6.00.000
D Tax @ 4% on sales of goods C  4% 24,000
E Net VAT liability during the month D - B, if positive Nil
F Input credit after set-off B –D 60,375
G Inter-state sales 9.00.000
H CST liability to be paid on G  2%
inter-state sales 18,000
I Credit to be carried forward F-H 42.375
Records
The following are the records to be maintained under the VAT Law and failure to comply invites
penalty:
i) purchase and sale records including a separate record of any exempted sale; and
ii) VAT account.

Some of these records have to be produced to the officer from time to time. These include:
a) copies of all invoices issued (including details of tax charged), in serial number and copies
of all debit and credit notes issued, in chronological order;
b) all purchase invoices (including details of tax paid), copies of customs entries and receipt
for payment of customs, and debit and credit notes received to be filed in chronological order
either by date of receipt or under each suppliers name;
c) details of output and input taxes in each period and a net total of the tax payable or excess
credit carried forward, as the case may be at the end of each month;
d) details of goods manufactured and delivered from the factory of the taxable person;

e) details of each supply of goods from the business premises, unless such details are
available at the time of supply of invoice issued at or before, that time.

Declaration Forms
In VAT system, there are no concession sales. Hence most of the declaration forms are
abolished.

VAT Invoice
Invoice is a document which contains a list of goods sold, with the price, tax charged and other
details as may be prescribed under the Act. The following provisions are mandatory and failure
to comply attracts penalty:
i) Every registered dealer whose gross turnover exceeds the specified amount shall issue to
the purchaser a serially numbered tax invoice with the prescribed particulars;
ii) The tax invoice shall be dated and signed by the dealer or his regular employee. A
counterfoil or duplicate copy of such invoice shall be maintained by the dealer.

Importance of VAT invoice

VAT invoices play a vital role since, without the invoices, credit cannot be availed. In case any
original invoice is lost or misplaced, a duplicate authenticated copy must be obtained from
the issuing dealer.

A VAT invoice:
i) promotes assurance of invoices and helps in determining the input tax credit;
ii) facilitates multi-point taxation and prevents cascading effect of taxes; and

iii) assists in effective audit and investigation and checks evasion of tax.

Contents of a VAT invoice

Generally, a VAT invoice should contain the following critical details:
i) name, address and registration number of the seller;
ii) name, address and registration number (not mandatory in all States) of the purchaser;

iii) pre-printed/self generated serial number;

iv) date of issue;

v) description, quantity and value of goods sold; and

vi) signature of the seller or his regular authorized employee/representative.

In case the registered dealer is a seller other than a seller who opted for the composition
scheme, the following additional details are to be provided in the invoice:
i) the words “tax invoice” in a prominent place; and

ii) rate and amount of tax charged to the customer.

Tax Invoice cannot be issued by a dealer who has opted for composition scheme and for
inter-state sales.
Tax Payer’s Identification Number
The tax payer’s identification number (TIN) is a unique 11 digit code issued to identify a tax
payer. The first two characters represent the respective States code as used by Union Ministry
of Home Affairs and Government of India (Census Code). The other characters vary from State
to State and will include two check digits. TIN will facilitate computer applications and cross-
check information on tax payer compliance etc.

Returns
The procedures for filing returns under VAT have been designed in such a way so as to facilitate
efficient data processing. It also aims to encourage dealers to comply with filing of returns and
reduce the compliance costs for the assessee. In case of late filing, penalty shall be levied.
The periodicity (monthly/quarterly/annually) of filing these returns shall be decided by the
respective States. The returns shall also be accompanied by output VAT liability, value of input
tax credit and payment of VAT and other details as may be prescribed. The return should be
filed within prescribed time schedule. In case of any mistake, revised return may be filed. If on
scrutiny, any technical error is detected, the assessee shall be called to rectify the error and
pay the deficit of tax, if any.
Dealers who opted composition scheme are required to file a return on periodical basis as
stipulated under respective state VAT provisions.

Assessment
a) The VAT system largely subsists on the concept of self assessment. The VAT liability is
assessed by the dealer himself by way of submitting returns, setting off credit etc.
b) If no specific notice is issued within the prescribed time limit, the dealer will be deemed to
have been self-assessed.
c) In case doubt arises, the dealer may be called for scrutiny. Accordingly, dealers may be
asked to submit certain records and documents like list of purchases, sales etc. If on scrutiny, it
is found that dealer was dishonest, he will be penalized heavily.
System of cross checking
VAT system is laid on self assessment. Hence a system of cross checking is essential. Dealer
may be asked to submit list of sales or purchases above a certain monetary value or to give
dealer-wise list from whom or to whom the goods have been purchased/sold for values
exceeding a prescribed monetary ceiling.

This system is worked on the basis of co-ordination between authorities of State Government
and Central Excise and Income tax to compare the tax returns. This system helps to reduce tax
evasion and protects the dealers from the unfair practice of tax-evasion.

Audit
a) Since VAT is largely based on self-assessment, the accuracy of the self-assessment will be
checked through a system of Departmental Audit.
b) Here, a certain percentage of the dealers will be taken up for audit every year on a
scientific basis. If evasion is detected in audit, audit of previous periods may be taken up.
c) In case any discrepancy is noticed, the VAT authorities may appropriately scrutinize the
other records of the dealer.
d) Authorized officers would visit the business place of the assessee and examine his records
to verify the correctness of the returns filed with the Department. This work may be supervised
by higher officials in order to ensure that the independence of the authorized officers is not
affected.
e) Apart from the Departmental audit, the States may require an audit of accounts by a
Chartered Accountant. This doubly ensures that there is no tax evasion.
f) It is left to the discretion of the State to select the class of dealers who have to get their
books audited.
It might be useful if the medium and large scale dealers are assessed on a regular basis.
VAT and Sales Tax Incentives
Tax incentives are offered by State Governments with a view to promote industrial
development of the State. Incentives result in short term loss to the State Government but in
long term, generate higher revenue due to the overall development of the State. By and large,
the incentives are given in 3 modes:
A. Exemption from Tax - Eligible industry is not required to pay tax either on purchase of raw
materials or on sale of finished goods. Such exemption ceases on the expiry of the exemption
period or the exemption amount whichever occurs first. However, availing of exemption by the
eligible industry would result in VAT chain getting broken and hence, credit cannot be passed
on to the buyer.
B. Deferment of Tax Liability - Tax is collected from the buyers but payment is deferred for a
certain period. After the expiry of such period, payment is made in specified installments.
C. Remission of Tax - Eligible unit is allowed to collect tax from the buyer but is not required
to pay the same to the Government. Input credit paid on purchases made by the unit is also
refunded.