The Hindu Business Line : How to unlock the VAT idea

THOUGH the integration of service sector taxation is ideal in a comprehensive value-added tax (VAT) regime, any plan to implement VAT should not be delayed as a result of such an ambitious goal. If the Central Government is really keen to go ahead with the implementation of State-level VAT at an early date and considering the complexities in the immediate integration of taxation of service sector, the better course of action would be to:

Implement VAT at the State level from April 1, 2005, after addressing the concerns of the trade and industry;

Set the timeframe for phase out of the Central sales tax (CST) levy;

Continue with the levy of service tax for one more year under the present dispensation with facility of set off of Excise duty paid on goods used in the execution of services;

Draft a comprehensive service tax legislation and put in place the new Act from 2005.

Provide modalities for set off of service tax paid against Excise duty and State VAT.

It should be borne in mind that the transition to VAT is a process and not a one-shot affair. Considering the complexities, such as denial of input tax credit on inter-State purchase, disallowance of input tax credit with reference to stock transfer, and so on, the VAT legislation proposed is only a VAT-enabled Sales Tax Act. Over a period of 2-3 years, CST may be phased out and the levy of service tax may be integrated.

Compensation to the States

This is another contentious issue. The formula announced by the previous Government to compensate the loss on transition to VAT at 100 per cent in the first year, 75 per cent in the second, and 50 per cent in the third was not acceptable to most of the State Governments who had demanded full compensation for all the years. The issue of compensation on phasing out of CST was not taken into consideration at all.

While much has been written about the issue of quantification of the possible revenue loss to States on transition to VAT, one possible solution to reduce revenue loss to the States is suggested.

A new slab rate of tax of 8 per cent and to fix the revenue neutral rate in the 10-12 per cent band, as may be decided by the respective States. This will be beneficial to trade and industry and also to the consumers.

It is to be appreciated that the rate of tax on most of the goods, particularly in the northern States, had been in the 8-10 per cent band. In the proposed VAT rate structure, the goods in the 8-10 per cent band have moved either to the 4 per cent or 12.5 per cent slab.

The 8 per cent slab will help the States partly overcome the possible revenue loss and will also be a disincentive to tax evasion in case the goods had moved to the 12.5 per cent slab. Fixing the VAT rate of tax on drugs and medicines in the 8 per cent slab will not meet with much opposition as these goods are subject to 8 per cent tax in most of the States.

As revenue becomes buoyant the rate structure can be revised to have fewer rates.

Diehard VAT protagonists and economists will scoff at the suggestion for addition of one more rate of tax, as multiplicity of rates of tax is not a VAT virtue. It must be appreciated that it took the Centre four years to align and rationalise the Central Excise rates. Should the States be expected to align the rates at one go? Preferably, they should be allowed a 2-3-year timeframe to align the rates of tax into a three-rate structure.

(The author a Madurai-based chartered accountant.)