NDIA has often been described as a country with a large market. In reality, the lack of a uniform tax rate and inter-state barriers have broken up this market and fragmented our trade and commerce. What could have been substantial gains arising out of the liberalisation process are being frittered away. It has also abetted diversion of trade from one state to another, fuelled unhealthy competition and encouraged tax evasion. The absence of a uniform tax rate has also prevented investments based on the large size of the Indian market. State-specific units have been set up, which may not be competitive because of their sub-optimal size. The distortions are harming the competitiveness of the Indian economy at a juncture when we need to catch up on so many missed windows of opportunities.
Indirect tax reforms were clearly an integral part of the liberalisation process started in 1991. In the years since then India has been attempting a tax structure which is simple, moderate, rational and easy to administer and comply with. The Raja Chelliah Committee spoke of uniform tax rates way back in 1992. An attempt to unify sales tax rates in the states with effect from January, 2000, was made by the Standing Committee of State Finance Ministers when minimum floor rates were announced. This, however, did not specify a ceiling and added to the complexity. Multiple rates across the states continue to proliferate.
The negative effect of the present “origin-based CST” can be understood by the following example: 1. Importer of raw material in state A pays CST in state B.
2. Converts into a new product in state A and resells that end product in another state (C) by paying CST in the home state (A).
3. With the addition of transport, loading, unloading and other incidental charges, the cost of end product rises sharply. The cascading effect is quite visible. The complexities in the sales tax structure at the state level can be addressed after the implementation of the VAT (value-added tax) system. A dual VAT would, among other things, remove the cascading impact of taxes.
The experience of the countries which have adopted a VAT system has been that it results in a simpler system, brings transparency and encourages voluntary compliance besides garnering revenue to the exchequer.
The ground reality is that the issue of VAT’s implementation beginning on April 1, 2003, is still in the air. States are concerned about the revenue losses in the wake of this transition. Some states have already adopted measures for new taxes such as entry tax to recoup any anticipated fall in revenues. There is no place, however, for such taxes under the VAT set-up. These measures will end up hurting the very basis of VAT, a tax regime meant for simplifying taxes.
The switchover from the present tax system to VAT would ensure that the following objectives are achieved:
- increase the competitiveness of Indian industry by removing the multiplying effect of the various taxes and levies.
- help removal of barriers to inter-state trade and commerce and facilitate
creation of a unified national market.
- ensure simplicity and transparency in the system.
- ensuring revenue neutrality in the long run so that the states are comfortable with the shift to new system.
- The mechanism should be self-regulated.
At the central level, the initiative has been to lower the tariff walls of both excise and customs, rid the system of the complexities, reduce the number of rates, correct anomalies and bring down the interface with the government.
The introduction of a single rate of excise, i.e. Cenvat of 16 per cent, was a major step and brought in some rationalisation in the tax structure. Attempts have also been made in states to bring down the number of sales tax rates. Still, under the current dispensations in various states, “special” rates like 2%, 3%, 3.5%, 4%, 8%, 10%, 12% and up to 72% prevail.
After the implementation of Cenvat for Central excise, we are on the threshold of the introduction of the VAT system at the state level. Under the VAT regime, formal assessment is not framed. The returns filed are accepted as such subject to certain conditions. The system is quite transparent.
Implementation of VAT with effect from April 1, 2003, calls for thorough preparation at the state level. The primary focus should be to design a tax structure that is simple, has low rates and rests on a broad base. The first task is to design legislation and notify the Act in the coming Assembly sessions. Secondly, the states must issue the rules at the earliest. The finalisation of the VAT Act and rules well in advance is crucial to give industry time, say two to three months, to adjust to the new regime.
Central sales tax (CST) has proved be a bane for VAT’s implementation in a federal arrangement like India. CST is clearly a massive revenue generator for states. Yet it results in a cascading effect and is VAT-incompatible. To allay states’ apprehensions, Finance Minister Jaswant Singh has come out with a plan of phasing out CST instead of its outright abolition. How CST can be handled at the ground level in a VAT regime, more so in the absence of a clearing house mechanism among states, is a challenging task. It simply adds another layer of complication to the entire implementation process.
In case a clearing-house mechanism cannot be introduced, the solution will be to abolish CST from April 1. In its place a Central value added tax for inter-state sales, inter-state VAT or I-VAT, can be introduced.
While the Centre and states are busy grappling with the crucial issues of implementing VAT, the CII, Northern Region, has reviewed the process from a different perspective. The driving force behind this project is the underlying prerequisite that there must be uniformity among the VAT Acts of various states for a successful transition to VAT. A single VAT Act must be adopted throughout India. But alas! Sales tax being a state subject, drafting of VAT Acts is within the precincts and discretion of the respective state governments.
A comparison of the draft VAT Acts of the key north Indian states — Delhi, Punjab, Haryana, Rajasthan and UP — among each other has been made. Parallels have been drawn with the draft VAT Acts from other regions of India. For a “national” perspective, one representative state was chosen from each region of India, namely Gujarat (western region), Karnataka (southern region) and West Bengal (eastern region). All eight draft Acts were benchmarked on 26 crucial VAT provisions.
Results of this analysis only go to confirm some worst fears. The draft Acts come in all flavours, shapes and sizes. Not surprisingly, the variations stem from the respective state concerns and, to an extent, the state-specific legal jargon. However, greater the variance among the Acts of the states, larger will the chaos and bottlenecks.
A significant highlight is that draft VAT Acts of three northern states (Punjab, Delhi and Haryana) are in some aspects better than those of representative states from the west, south and east. The other two northern region states, Rajasthan and UP, need not go far to emulate! Rajasthan, a vocal champion of the VAT cause, needs to draft a simpler and more taxpayer-friendly Act.
The major challenge is to bring out harmony among the incongruous Acts, particularly where the inter-state trade is concerned. Sadly, we may have to contend with a fragmented marketplace, instead of providing cohesion, through the basic VAT philosophy, to move towards the common Indian market.
The Central government’s initiative of circulating the Model Value Added Sales Tax Bill, 2003, for the state governments is a positive step, but has not made an impact. The CII submitted an important set of recommendations to the empowered committee of the government on October 19 to iron out the discrepancies.
It is expected that a single/uniform rate across the country for all commodities in the present socio-economic environment may not be feasible. To begin with, the VAT rates could be a two-slab structure. Besides the exceptional rates of nil, 1% and 20% for specified items, there should be a 4% rate on items of mass consumption, i.e. merit goods as well as industrial inputs, and all other items should be at the Revenue Neutral Rate (RNR) which could be 10% or 12.5%. There is need for a cap of 12.5% on the RNR as any rate higher than this will provide incentive for tax evasion. The list of industrial inputs attracting 4% should be comprehensive and cover all items used by the industry.
The product classification and description of individual products should also be aligned with Central taxes and the International Convention of Harmonised System of Nomenclature (HSN). This would reduce litigation. The uniform classification across all the states and the Central taxes, like excise and Customs duty, will create the right environment for the growth of trade and industry.
Besides “pre-implementation” aspects, states have to prepare for the ground realities of implementation by undertaking the following activities in a time-bound manner:
- Training and orientation of officials. There should be accountability and reward for good performance.
- Computerisation as part of the strategy to minimise the interface with the taxpayer.
- Concurrently with the simplification of procedures, it is also important to design an efficient penalty and appeal system.
A lot of ground has yet to be covered to ensure smooth transition to a VAT regime in India. The northern region states of Delhi and Punjab have been quite proactive and made progress in the run-up to the current phase. Other states have to wake up to the gravity of the effort required to catch up and also to get ready for the implementation process.
The author is the President of Magnus Consultants and Chairman, CII, Northern Region.