The value added tax (VAT) regime was supposed to have been imposed on April 1, 2003. Fierce opposition from the trader lobbies and several state governments stalled the move and the introduction of VAT was postponed.

The Haryana was the only state to go ahead with the imposition of VAT in 2003 and in a year''s time the state government''s tax collections had shot up by 30 per cent. This has opened the eyes of other state governments to the fact that if they wish to boost their revenues, then VAT is an idea whose time has come.

On Friday, June 18, finance minister P Chidambaran convened a meeting of the state finance ministers to discuss the implementation of VAT. The position now is that almost all the states have agreed to implement VAT , effective April 1 2005.

The unique feature of the VAT system, which is in use in several developed countries, is that it ushers a ''win-win-win'' situation for all the concerned parties. In other words, it is beneficial to the consumer, the businessman and the government.

The principle under which VAT works is that tax is only paid for the ''value -added'' component of a taxable product or service. To illustrate, let us consider an example, say, of a textile processor. If he buys raw material, i.e cloth from the market, for Rs10,000 and under the present taxation system, if he has to pay a tax of 10 per cent, his cost of raw material becomes Rs11,000.

The raw material is then processed into finished goods, which now has a higher market value of, lets say, Rs20,000. On the sale of these finished goods worth Rs20,000, once again a tax of 10 per cent is levied, bringing the total selling price to Rs22,000, of which the total tax component is Rs3,000 (Rs1,000 initially and Rs2,000 in the second stage). Here the tax on the raw material is collected twice and is unfair to the consumer.

VAT attempts to eliminate this anomaly. In the example above, under VAT, tax in the second phase will be levied only on the value-added portion. Thus a tax of 10 per cent will be levied on Rs9,000, which is the value-added portion and the total amount of tax collected will be Rs1,900 as against Rs3,000, which was being collected under the earlier system.

Apart from the taxpayer, the textile processor also stands to benefit as the cost of the final product comes down which should lead to a spurt in demand and increased sales from which the government would get more revenues due to the increased sales. More importantly, the VAT regime will bring about better tax compliance, as the textile processor will have to show proof of having paid the Rs1000 tax he pays for the raw material in order to get credit for the tax paid. Thus, non-cash transactions will be eliminated, and this will widen the tax net.

The various state governments'' reluctance to switch over to VAT was stemmed by the fear of loss of revenues. Under the earlier system, which has been in force since the days of the princely states, state governments were virtually free to slap any sort of tax like entry tax, purchase tax ,etc, to increase their revenues. While this may have brought them revenues, these taxes are also dampeners to free and unrestricted interstate sales. VAT ensures similar tax levies for all the states and smoother flow of interstate trade.

The proposed tax regime also envisages phasing out of the central sales tax (CST) which, will now be ''co-terminus'' with the implementation of VAT. This implies that CST will be phased out by the time VAT is implemented. Indications are that the CST rate would initially be brought down from four per cent to two per cent before being eliminated.

Asim Dasgupta, chairman of the ''empowered committee of state finance ministers on VAT'', which has drawn up the model VAT bill told reporters after Friday''s meeting that state governments would be given some "flexibilities" in dealing with goods of local importance.

On the issue of compensation to states for losses, if any, on the implementation of VAT, Dasgupta said that the finance minister has assured the states that any losses on account of implementation of VAT or phase out of CST would be compensated. "These are positive announcements from the centre, whose support is needed by us for implementing VAT. The principle, quantum and the period of compensation would be decided by the finance ministry in consultation with the empowered committee by September," he said.

Dasgupta went on to add that the empowered committee argued before the finance minister that "the right to taxation of services should be given to the states" and that they should also be allowed to collect and appropriate service tax on "major services" to bolster their revenue base.

Dasgupta said the finance minister has assured the states that a fresh review of the draft services taxation bill would be taken up. "He has promised to consult the states and asked all of them to give their views in writing on this matter," he said.

Come April 2005, we can expect the prices of onions and potatoes to fall.