What's VAT? A primer

As far back as November 1999, at a conference of state chief ministers and finance ministers, a timeframe for ushering in the Value Added Tax (VAT) regime was agreed upon and a definite date, April 1 last year (2002), was set. However, by January 2002 it had become clear that the programme could not be pushed through as most of the states were unprepared. It was therefore, postponed by a year. This time around, it was decided to stick to the timetable for the introduction of the VAT regimen. It is political will rather than appreciation of the much-hyped superiority of the VAT regime that will determine the pace from now on. ET.com makes an attempt to understand the proposed legislation and its implication in a broad perspective. What is Value Added Tax? VAT is a sales tax collected by the government of destination state (i.e. the state in which the final consumer is located) on consumer expenditure. The only difference between VAT and sales tax is that it is collected in stages (instalments) rather than at one point (first/last) from the transactions involving sale of goods. The mechanism of VAT is such that, for goods that are imported and consumed in a particular state, the first seller pays the first point tax, and subsequent seller pay tax only on the value addition done by them â€“ leading to a total tax burden exactly equal to the last point tax. In case of any inter-state sale, the local tax already levied on purchases is refunded or adjusted (technically called set-off) against his Inter state Liability. Also, manufacturers are allowed to get set-off or adjustment from his sales tax liability on his sales up to the extent of local tax charged on purchases. Similarities to the present system Under the present system, an inter-state seller is allowed to purchase his inventory, without payment of tax, against statutory forms. Under the VAT system, he has to purchase, after paying local tax, but this tax paid on purchases is fully set off from his central sales tax Liability. In case his CST liability is less than the local tax already paid, the net can be adjusted against his other VAT liability or can be claimed as Refund. Similar is the case of manufacturers. Rather than purchasing without payment of tax against statutory forms, local tax is levied on purchases, and an equal amount is allowed to be set off against the sales tax liability on finished goods. Therefore, changeover to VAT in our case is change in local sales tax collection procedure only. From the point of view of the seller, the present arrangement of not subjecting certain transactions to tax (Like RD Sale, sale of raw material to manufacturer, sale to inter-state seller etc.) will change to subject all transactions to tax, but refund/adjust the tax so levied to the purchasing dealer . In other words, from the point of view of the purchaser, he will not be able to purchase tax free against forms , but can purchase tax paid and take set-off . Although it does not make any difference to the tax-payer, but the beauty of this system is that since all Local sales are subject to tax, there are no local statutory forms. In the present system, many traders dealing in goods that are distributed from a particular state are facing problem of double taxation because of withdrawal of footnote facility. VAT solves their problem too. The entire local sales tax levied on the purchases of an inter-state seller is allowed to be set off against the central liability. Hence, no double taxation. In VAT, like in present system, no local sales tax/VAT is levied on inter-state sales or exports. Similarly, in case of inter-state purchase or Imports, no set off is given because no local tax has been paid on such transactions. Manufacturers of exempted goods are presently not allowed to purchase their raw materials against forms. Similar would be the case under VAT. They will not be allowed to take tax credit for goods purchased for use in manufacture of exempted commodities. Differences as compared to the present system In VAT, all local sales will attract VAT liability. There would be no difference whether one is selling to another dealer or to the consumer. The same tax, equal to the rate of tax applied on the sale price, is to be charged. In the present system, whatever tax charged is to be paid to the department, however, under VAT, from this tax charged from the customer, he deducts the tax already paid on the purchases, and pays the rest to the Department. Present system does not allow capital goods, such as machinery, to be purchased against local forms. However in VAT, tax paid even on machinery is allowed to be set off. Method of computing VAT A bill or Invoice issued during a transaction of purchase or sale separately mentions the value of the goods and the tax. The purchasing dealer, on the strength of such invoice, can deduct (or take credit of) the tax paid by him on his purchases, from the tax liability on his sale made during the quarter. However, he does not have to wait for his sale to materialize, to get the credit. He can avail the tax credit as soon as and in the same quarter in which he makes the purchase and take the goods in his inventory, irrespective of the fact that he may be selling it later in the next quarter or even next year. VAT payable by a dealer in any quarter can be calculated by the formula: VAT = Tax liability â€“ Input tax credit For example, if a dealer makes a sale of item X at Rs.1200 + 120 (10% tax) and purchase of some other item Y for Rs.2000 + 100 (5% tax) in the same quarter, Net tax to be paid by him in the said quarter would be Rs.120 (Liability) â€“ Rs.100 (Credit) = Rs.20. This is irrespective of the opening stock or closing stock held by him. You can carry forward the net credit in your favour to the next quarter. If there is a net credit (overall) in your favour at the end of the year (this may happen for exporters), you can claim refund. What returns are to be filed, book-keeping and statutory forms? There would be a single-page return form common for local & central acts. The return would be required to be filed quarterly, as is being done today. It is proposed that following documents/annexure will be required to be filed with return: 1. Proof of payment/C portion challans. 2. Dealer-wise statement of Central RD sales, against C/D/F/H Forms. 3. Dealer-wise statement of purchases made during the quarter, for which tax credit has been availed. 4.Pre-utilisation account of C/E/F/H Forms with the last quarter return. The present system requires the dealers to maintain account of sale and purchases. Calculation of VAT also requires maintenance of such accounts only and nothing more. As discussed earlier there are no local statutory forms under VAT. However, the central statutory forms shall remain as it is. What happens to the Central Sales Tax Act? The CST Act will be amended; the tax rate for sale against C form shall attract tax at 2 per cent as against 4 per cent. The Central Statutory forms, Form C, D, F, H etc. shall continue to remain applicable. However, in future, the tax rate for sale against C form shall be gradually reduced from present to 0 per cent .Once it becomes zero, the Central Sales tax revenue of all the States will become negligible and automatically, the Sales Tax will get levied only by the Destination State. This is what that is being called as Abolition of Central Sales Tax . What is Input Tax Credit? All the things you buy locally will carry a VAT charge (i.e. Local tax would have been levied on it), but if you are a Registered Dealer, you can normally claim a credit for the VAT charged on most business purchases. This is your Input Tax. Input Tax is the tax (Local only) you have paid to your supplier on all your purchases made during the quarter under consideration. Input tax Credit is the Input tax you have paid to your supplier on your Creditable purchases made during the quarter under consideration. Purchases on which Input Tax Credit is available To claim the Input Tax credit, you should intend to use the purchased goods for either of the following: 1. Sale or resale 2.Use as i) Raw material, or ii) Capital Goods in manufacturing or processing of goods 3. Packing of goods. Further, a) Finished goods in which the inputs (or purchased goods) are used should not be exempt and the finished goods should be intended for sale or re-sale; b) Tax Invoice in Original, issued by the supplier is available with you; and c) The supplier (from whom you have purchased the goods) should be a registered dealer. The purchases made during the quarter which satisfy the above conditions are called creditable purchases.

What's VAT? A primer

ET.com makes an attempt to understand the proposed legislation and its implication in a broad perspective.

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