The Hindu Business Line : It's time to uncork VAT

VALUE added tax (VAT) is a multistage tax, levied on value added at different stages of production and distribution of a commodity or the supply of a service. Since it is a tax on both goods and services, it is also known as a goods and services tax.

However, India would currently maintain a distinction between the taxes on goods and the taxes on services and the integration of these taxes into one all-India VAT is sometime away.

However, there has been a slow but sure move towards this goal, in terms of the recent proposals in Budget 2004 on integration of input credits across goods and services.

The impending introduction of VAT at the State level, in lieu of the sales tax, with effect from April 1, 2005, is a very major development. It needs to be mentioned here that India will adopt a dual VAT system, that is, a Central and a State VAT.

Thus, manufactured goods will continue to be subjected to both Cenvat and the State VAT. The central sales tax (CST), which is the tax on the inter-State sales of goods, is intended to be slowly phased out.

Impact of VAT

Since the VAT that is intended to be introduced in the States with effect from April 1, 2005, is fundamentally different from the current sales tax, the impact of its introduction will be significant and varied across industry sectors.

The parameters of VAT, as they are known at present, are such that the implications could be significant and adverse for companies with an all-India presence with extended supply chains, starting from procurement and manufacture through distribution.

Typically, companies with pan India distribution structures, such as in the FMCG and pharma sectors, would be impacted.

However, it is not only industry that is affected by the introduction of the VAT.

There are implications for both Central and State governments as well, which are as follows:

Industry: The substantive ones are:

Supply chain modifications,

Product pricing,

Distribution channel dynamics/dealer and distributor management; and

Market share and comparative competitiveness among players.

The procedural ones include:

Admissibility to input-tax credits on transition to VAT;

Other transitional issues;

Documentation and record keeping; and

Modifications in ERP and other IT systems.

Central Government: The implications include budgeting for possible loss of revenue and financing/funding the compensation payable to States; loss of revenue at the Central level as a result of phasing out of CST and additional excise duty; impact on Cenvat and the Central service tax; possible impact with regard to the large-scale computerisation initiatives at the State level.

State governments: Stakeholders' acceptability; transitional issues for trade and industry; revenue considerations arising from possible loss of revenue; mindset change at all levels of the bureaucracy; staff capacity building; large-scale computerisation; procedural issues relating to return filing, validation of input credits; and other documentation and record keeping.

Implementation

Clearly, the switchover to VAT is a mammoth exercise and there are major implementation issues. To successfully implement VAT,

States must realise that the two focus areas of training and re-orientation of staff, as well as computerisation of the sales tax department must be addressed. The training effort is a huge one consisting of a mass rollout of knowledge on VAT, with all its attendant details.

As regards computerisation, it is a truism that computerisation is critical for a successful transition from sales tax to VAT.

Indeed, VAT, by its very nature, will extend throughout the supply chain, thereby resulting in massive incremental registration requirements. Moreover, the tax places considerable emphasis on documentation.

Hence, the imperative of computerisation.

If one were to assess the state of readiness on this critical dimension, many States are lagging behind, although there is now a realisation to push ahead quickly.

Clearly, successful VAT implementation will largely depend on a broad and deep computerisation in the States, ahead of the switch over from sales tax to VAT. Significant financial resources are required to be committed to this key task.

The business case for a VAT has long been made. The present sales tax is an anachronism and must be discontinued. VAT provides a level playing-field and is a transparent, modern, user-friendly and relatively simple to administer tax.

VAT is simply an idea whose time has come and it is now only a question of time before its introduction.

(The author is executive director, PricewaterhouseCoopers.)