The Hindu Business Line : VAT — on slippery track still

The States are poised to undertake the most important tax reform attempted in the country. But the VAT regime will succeed only if they legislate to get the necessary administrative machinery moving.

THE near decade-long efforts to introduce the value-added tax (VAT) regime, which began with a meeting of chief ministers convened in 1995 by then Finance Minister, Dr Manmohan Singh, appeared to be succeeding in most respects at the Empowered Committee of State Finance Ministers held on June 18, 2004, with all except one State agreeing to its introduction from April 1, 2005.

The Empowered Committee issued a white paper on "State-level Value Added Tax" on January 17, outlining the modalities for introducing VAT.

However, this steady progress that was marked by political consensus has been disturbed by two recent events. A meeting of Chief Ministers, Finance Ministers and Commercial Tax Ministers of six BJP-ruled States on March 19 has thrown a spanner in the works by seeking to defer the implementation of VAT and set a new date that is agreed to by all States.

Mr Yashwant Sinha, former Finance Minister, explained: "The legislative preparations in various States are at different stages and it seems unlikely that VAT can be introduced in the entire country. Piece-meal introduction of the new tax will be undesirable, particularly to States such as Uttar Pradesh and Tamil Nadu do not implement it."

Having described VAT as a progressive system, the BJP spokesperson argued that it was not clear whether the necessary information systems and procedures had been fully created so that tax-payers could easily obtain exemptions and set-offs.

The difficulties likely to be experienced by the States due to the simultaneous existence of State VAT and Central Sales Tax, during the phasing-in years have led to the demand for a detailed roadmap for phasing out Central Sales Tax and a clear policy for compensating the States for monetary losses arising due to the abolition of sales tax.

The CPI(M) for its part has come up with a different kind of jab on the cheeks of VAT advocates. Dr Ashok Mitra, a former Finance Minister of West Bengal, has filed a writ petition questioning the legality of the VAT regime.

The crux of Dr Mitra's argument is that the State governments do not have the power to impose VAT and that it cannot be introduced without amending the Constitution. This petition is likely to come up for hearing at the Calcutta High Court on March 30.

These unexpected developments have made the road to VAT implementation a slippery one. Deadlines for VAT implementation have been set four times in the last six years.

On November 6, 1999, the Conference of Chief Ministers set an April 1, 2001 deadline for VAT implementation and reiterated it in June 2000. This was followed by the setting-up of an Empowered Committee of State Finance Ministers, in July 2000 to work out the modalities. As the issues were complex and a consensus on a common VAT design difficult to achieve, the deadline was deferred to July 2001, then to April 2002, and then again to January 2002, and further on to April 2003.

A conference of Chief Ministers, presided over by the Prime Minister, held on October 18, 2002, reiterated the Empowered Committee decision that all States and Union Territories should introduce VAT from April 2003.

In a meeting on February 8, 2003, the Empowered Committee of State Finance Ministers, restated that all State legislation on VAT contain a minimum set of common features to avoid the cascading effect of taxes and increase revenues as the coverage expands to value addition at all stages of sale in the production and distribution chain.

But some States had apprehensions of losing revenue and expressed the need for compensation. The Finance Ministry had to then step in to speed up the proposed tax reform.

In his 2003 Budget speech, Mr Jaswant Singh, Minister for Finance and Company Affairs, stated: "In view of the apprehensions expressed by a large number of States about possible revenue loss in the initial years of introducing VAT, the Central Government has agreed to compensate 100 per cent of the loss in the first year, 75 per cent in second and 50 per cent in the third. This loss will be computed on the basis of an agreed formula.

The Government of India considers the introduction of VAT at the State level to be a historic reform of our domestic trade tax system.

It will assist the States to transit successfully from the erstwhile sales tax system to a modern domestic system, which at present is in use in over 120 countries."

With only 16 States ready with the VAT legislation, it was felt that a partial introduction would do more harm than good. As a result, VAT was not introduced from April 1, 2003.

But the Empowered Committee of State Finance Ministers, headed by Mr Ashim Das Gupta (West Bengal), continued to evolve the minimum set of common features for the new VAT regime, and finalise modalities for its implementation.

After a meeting in June 2004 when the Finance Minister, Mr P. Chidambaram, promised compensation, the Committee came up with a white paper on the main design of VAT.

At the same time, the Committee noted that "VAT is a State subject and therefore States will have the freedom to appropriate variations consistent with the basic design agreed upon" and that there was need for "striking a federal balance between the common points of converging with regard to VAT and flexibility for the local characteristics of the States".

In his Budget speech Mr Chidambaram reiterated the Centre's decision to compensate the States according to the agreed formula in the event of revenue loss to them and stated: "In a remarkable display of the spirit of cooperative federalism, the States are poised to undertake the most important tax reform ever attempted in this country. All States have agreed to introduce VAT with effect from April 1, 2005. VAT is a modern, simple and transparent tax system that will replace the existing sales tax and eliminate the cascading effect of sales tax.

"It is in force in more than 130 countries, from Sri Lanka to China. India has VAT at the Central level (CENVAT), but only for goods. In the medium to long term, it is my goal that the entire production-distribution chain be covered by a national VAT, or even better, a goods and services tax, encompassing both the Centre and the States.

"The Empowered Committee of State Finance Ministers, with the solid support of the Chief Ministers, has laboured through the last seven years to arrive at a framework acceptable to all States. I take this opportunity to pay tribute to the Empowered Committee, and wish the States success on the introduction and implementation of VAT."

Mr Chidambaram provided more than encouraging words with a firm allocation of funds to back his assurance of compensation. Budget 2005-06 carries the provision of Rs 5,000 crore for Grants to the States under Demand 42 of the Union Finance Ministry.

It appears that the Centre in its concern for fiscal health of the States has become a facilitator of fiscal reforms in the States.

The introduction of the VAT regime will, therefore, depend on the efforts of the States to enact the necessary legislation and to get the administrative machinery ready for not only introducing VAT but also tiding over the initial problems of implementing the reform.

(To be concluded)

(The author, a former IAS officer, is vice-chairman and honorary director, Indian Institute of Economics, Hyderabad.)

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