The proposed introduction of Value-Added Tax (VAT) from April 1, 2005, has the trading community in overdrive. Chartered accountants Sanjay Dhariwal and Anil Jogani demystify the new levy.

As the entire country gears up to adopt 'value added tax' (VAT) from April 2005, businesses across the country, irrespective of their size, must begin preparing for new ways of accounting that will be demanded of them. The Bangalore-based Tally Solutions, makers of India's bestselling accounting software, has seen VAT successfully implemented in over 80 countries across the world. The advantages of switching from the existing sales tax structure to VAT cannot be ignored, and it was just a matter of time before India joined the remaining 130 countries that are currently using VAT.

The VAT regime will, in the long run, benefit everybody. The benefits for the government are quite clear. To begin with, it is not possible under the present sales tax system to bring in transparency about incidence of tax or the quantum of tax payable on commodity. VAT encourages voluntary compliance and thereby simplifies assessment procedures.

Moreover, it eliminates disputes about tax liability of a transaction or rate of tax applicable, reducing compliance costs. VAT reduces the number of tax rates and tax concessions on different goods. It eliminates additional levies like resale tax, turnover tax, cess, additional tax and surcharge. VAT also seeks to prevent the problem of under-valuing and inflation, as all stages of production and distribution are subject to tax. It proposes to permit claims of credit for tax only on the receipt of an invoice.

VAT is a more transparent and accurate system of taxation. The existing sales tax structure automatically triggers double taxation, thereby cascading the tax burden. For example, before a commodity is produced, inputs are first taxed, the produced commodity is then taxed and finally, at the time of sale, the entire commodity is taxed once again. By taxing the commodity multiple times, the cost of the goods increases; at the end it is the consumer who pays for it all.

VAT is a multi-point sales tax, with a set-off for tax paid on purchases (inputs) and capital goods. What this means is that traders (any person who carries on the business of buying, selling, supplying or distributing goods directly or otherwise whether for cash, deferred payments, commission, remuneration or other valuable consideration) can actually deduct the amount of tax paid during purchase from the tax collected on sales, paying just the balance amount to the government.

EFFECTS OF VAT ON TRADERS
ADVANTAGES		DISADVANTAGES
	Dealers get input credit for taxes paid on purchases. Therefore, they will benefit by making purchases 'with a bill'		Record keeping, classification of goods and suppliers will become more complex. Automation of accounting procedures will be required.
	Dealers will benefit by stocking goods which have already incurred Value Added Tax rather than risk purchasing from unregistered dealers.		Every purchase made must be recorded. The current sales tax structure mandates the maintaining of sales records only.
	The tax net is broader, practically eliminating the unregistered dealer and providing a fair opportunity to genuine dealers.		The revenue neutral rate will be slightly higher than the present rate of tax.
	Dealers will benefit from disclosing their actual turnover, especially in retailing; the tax collected by the supplier will be available for claiming credit. For example, incidental charges cannot be disguised with the new regime.		VAT will be charged at the normal rate throughout the sales cycle. This will include the resale segment as well, which is currently either not taxed or taxed at a lower rate.
	Dealers will not be taxed multiple times.		The initial uncertainty of laws and procedures will cause confusion, as well as increase red tape and costs. But this is only temporary.
	Dealers will no longer require a Declaration Form, thereby reducing workload considerably.		In case of importing of goods from outside the state, the dealer will not be eligible for tax credits, raising the cost of inter-state purchases.
	Fewer tax rates means dealers will have less problems in the classification of goods.		Complications about credit for sales tax on goods bought prior to the VAT introduction date. All goods which were bought after April 1, 2004 and are still in stock on April 1, 2005 will be eligible. Tax credit will be available for six months after a three-month verification period.
	There will be a uniformity in taxes from state to state.		Services are not included in the VAT regime, so problems of reversal of credit of service tax paid will arise, especially in cases of outsourced manufacturing.
	Bottlenecks associated with tax assessments will be eliminated, as self-assessment is the basis of VAT.

Small dealers: Small dealers, whose annual gross turnover does not exceed Rs50 lakh, are liable to pay VAT on their purchases, but they can opt for the 'composition scheme' where they simply pay a flat 1 per cent on their turnover, irrespective of value added. Dealers opting for this composition scheme will not be entitled to input tax credit.

Very small dealers: Very small dealers are traders whose gross annual turnover does not exceed Rs5 lakh. They will not be liable to pay VAT. But states have the flexibility to fix the threshold limit for this category under Rs5 lakh, if they desire.

Case study: Karnataka
Assumptions:
a) Under the Value Added Tax Act, the revenue neutralised rate is 12.5 per cent.
b) Under the Karnataka Sales Tax Act, the general rate under Section 5(1) is 12 per cent
c) Sale from 'A' to 'B' is an interstate sale.
d) Sale from 'B' to 'C' is a first sale in the state of Karnataka.
e) Sale from 'C' to 'D' and 'D' to 'E' is a second sale.

The transaction chain under Sales Tax:
(assuming a profit of Rs10 during each transfer)

Tax implication under Karnataka Sales Tax Act:

Note: The tax rate above excludes additional tax and cess leviable under the KST Act, 1957. Note however, that RST may not be charged at all in some states, affecting the total tax amount.

The transaction chain under VAT:
(assuming that the same profit of Rs10 is retained during each transfer)

Tax implication under Value Added Tax Act:

*Note: Central sales tax (CST), once paid, cannot be claimed for credit. CST is assumed to remain the same, though it could to be reduced to 2 per cent when VAT is introduced, and then eventually phased out.

Net difference of tax payable by a consumer

In addition to reducing the tax burden on traders, VAT also helps create a homogenous tax structure and, therefore, a level marketplace. This is essential to India's plans of becoming a more active international player in world trade.

VAT can create a win-win situation for India, as it has in many countries across the world. Today, the technology exists to help organisations make a smooth transition to VAT, easing the burden of such a fundamental change in taxation. India is ready for VAT.