Preparing for VAT

The decision of the State governments to move over to a value- added tax (VAT) from April 2002 has the appearance of taking the country one step closer to a full-fledged VAT in both the States and the Centre, but actually what is emerging is a hybrid system that falls between many stools.

A beginning was made at the Centre we began with the modified value-added tax (MODVAT) - now the Central VAT or CENVAT - which is applicable only at the manufacturing stage. Services - some but not all - are covered by the service tax. In the States a State VAT will replace the existing sales tax, and presumably cover only manufactured goods. In addition, there will be the Central sales tax (CST) on inter-State sales which will continue. So what is emerging is a ``Dual VAT'' except that two important issues - taxation of inter-State sales and taxation of services - are yet to be addressed.

VAT has many advantages, on that there can be little dispute. Its transparent nature and the fact that it does away with the cascading effect of most indirect taxes makes it attractive for both businesses and governments. But the State governments will have to do a considerable amount of preparatory work if they are to realise all the benefits of a VAT and contain the dislocation that could arise from this major shift from the existing regime of sales taxes. Unfortunately, as the Centre's experience, first with MODVAT and more recently with the CENVAT, has shown false claims and poor administration combine to make revenue buoyancy more a dream and less a reality. Indeed, the widespread abuse of MODVAT and CENVAT has been seen as a major reason for the limited growth of excise revenue in recent years.

While a number of State governments have decided to introduce VAT at the retail stage from April next, the Special Category States and the three new States created last year will have to make the change only by April 2003. One distinctive aspect of the State VAT will be that it will apply only to sales within each State. Inter-state trade will continue to attract levy of the CST. While there is a proposal to lower the rate of CST, unless cross-border trade too is brought under a VAT, the new system will remain a limited switch-over.

However, the larger challenges lie in introducing a universal system in which evasion can be prevented. For this to happen computerisation is essential and businesses trading in commodities that attract VAT should be on the records of the tax administrators. The State governments have achieved varying levels of computerisation and it is only now that they have decided to provide businesses with permanent account numbers (PANs), as in income tax administration.

The apprehensions about what will happen to their main source of revenue have made a number of State governments ask for compensation in case they experience a fall in collections. In the short-term, a revenue decline is possible, although in the long-term a VAT regime should make revenue more and not less buoyant.

The Centre has said it will prepare a compensation formula to assist those States that may witness a decline in revenue during the transition. However, what parameters the Centre will use and under what system it will transfer funds are yet to be outlined. Then there is the issue of integrating services into the VAT system. The States on their part are keen that they and not the Centre should have the power to tax services.

The new State VAT will start off with a big advantage since it will be a system that the States themselves have decided to introduce and it is not one imposed on them by the Centre. But mere ``ownership'' of a programme is not enough to guarantee success. All the States are yet to introduce the minimum sales tax rates they agreed on more than a year ago and likewise do away with tax concessions for investment which had encouraged an unhealthy competition among themselves. Although the guilty have been identified as a few Union Territories and the smaller States, some of the larger entities in the North and South have used this as an excuse to back down from their commitments.

The conference of State governments has, in consultation with the Centre, now proposed a vary drastic course of action. States that do not adhere to the guidelines on minimum sales tax rates and concessions for investment will be denied all Central assistance. Is this the right way to go about enforcement is a question that has to be asked.

CRR

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