CHAPTER II

" VALUE ADDED TAX–

A CONCEPTUAL FRAMEWORK
 

2.1 MEANING OF VAT 

2.2 ORIGIN 

2.3 VALUE ADDED TAXES (VAT) IN INDIA 

2.4 TAX REFORMS 

2.5 INTRODUCTION OF MODVAT 

2.6 INTRODUCTION OF MODVAT 

2.7 OPERATIONAL DEFINITIONS OF VAT 

2.8 SALIENT FEATURES OF VAT 

2.9 SIGNIFICANCE OF VAT IN TAXATION REGIME 

2.10 SHORT COMINGS OF VAT 

2.11 OPPOSITION TO VAT IN INDIA 

2.12 VAT AND CST DISTINGUISHED 

2.13 LEVY OF VAT 

2.14 METHODS OF COMPUTATION OF VAT 

2.15 VAT IN DIFFERENT COUNTRIES 

2.16 TRENDS IN EXPENDITURE 

2.17 VAT FRAUDS 

2.18 VAT AUDIT 

 
 Chapter–II
VAT-A CONCEPTUAL FRAMEWORK

2.1  MEANING OF VAT 
VAT is defined by the Ministry of Finance as a tax on sale of a commodity at every
point in a series of sales by the registered dealers with the provision of credit of input
tax paid at the previous point of purchases thereon. Such credit would be available
regardless of whether the goods are sold to another dealer or to a customer.1

2.2  ORIGIN 
The origin of value added tax (VAT) can be traced as far back as the writings of
F. Von Siemens, who proposed it in 1918. VAT was first introduced in France in
1954. Initially VAT was applied only to transactions entered into by manufacturers
and wholesalers. Finally, in accordance with the sixth Directive of the European
Economic Commission (of May 17, 1977), the French law amended on December 29,
1978 and the scope of the tax was expanded to include services under VAT. The tax
base was broadened to include agriculture in its ambit in 1984.

Development of VAT in other countries has been gradual. Until the sixties
many countries did not adopt it. The subsequent switch over to VAT by Latin
American, Asian and African countries has brought the figure now to more than 150
countries. The Government of India had set up an Indirect Taxes Enquiry Committee
way back in 1976, under the Chairman of Shri. L.K. Jha, who strongly recommended,
the adoption of VAT in India. This committee recommended adoption of MANVAT,
a VAT at the manufacturing level. As a result of the MODVAT scheme was
introduced with effect from May 1, 1986. Initially it covered selected items in only 37
Chapters. Textile sector was brought under MODVAT in 1996 and the tobacco sector
in 2000. MODVAT was extended from March 1, 1994. MODVAT was renamed as
CENVAT (Central value Added Tax) with effect from April 1, 2000. All inputs used
directly or indirectly (except HSD, LDO and Petrol) are eligible for CENVAT.

                                                            
1
Dr. Avadhesh Ojha Satyadev Purohit Reena Garg, “VAT in India A Global View Law & Procedure”, The Tax
Publishers, Jodhpur -2006.P.10.

54
 During Post liberalization, it is said that Value Added Tax in India is one of
the most important constituent of tax reforms. VAT can also be referred to as a multi
point destination based system of taxation, such that tax is charged at every step of
transaction in the supply chain. VAT is actually a State subject in India, acquired from
Entry 54 of the State list, for which States are sovereign in making decisions. With the
help of tax department in their respective States, the governments ensure the levy of
VAT. The Central government is instrumental in guiding the State government with
respect to execution of tax.

The department of revenue under the Ministry of Finance is given the power
to have control with respect to direct and indirect taxes, through two statutory boards,
i.e. Central Board of Direct Taxes (CBDT) and the Central Board of Central Excise
and Customs (CBEC).The sales tax division of department of revenue is responsible
for levying VAT. India had a problem of double taxation. Goods were taxed before
the manufacturing process as an input and once again after manufacturing. To avoid
such double taxation, which had a negative impact on the economy, VAT was
introduced.

2.3  VALUE ADDED TAXES (VAT) IN INDIA 
VAT is the indirect tax on the consumption of the goods, paid by its original
producers upon the change in goods or upon the transfer of the goods to its ultimate
consumers. It is based on the value of the goods, added by the transferor. It is the tax
in relation to the difference of the value added by the transferor and not just a profit.
All over the world, VAT is payable on the goods and services as they form a part of
national GDP. It means every seller of goods and service providers charge the taxes
after availing the input tax credit. It is the form of collecting sales tax under which tax
is collected in each stage on the value added to the goods. In practice, the dealer
charges the tax on the full price of the goods, sold to the consumer and at every end of
the tax period reduces the tax collected on sales and tax charged to him by the dealers
from whom he purchased the goods and deposited such amount of tax in government
treasury.

55
2.4  TAX REFORMS 
The reform process began with the Wanchoo Direct Taxes Enquiry Committee Report
of 1971,2 and gained impetus during the government headed by V.P. Singh
(December 1989–November 1990) who cut the top marginal rate for individuals to 50
per cent and overhauled indirect taxes by introducing MODVAT (modified value
added tax). Subsequently, the then finance minister Dr. Manmohan Singh took on the
mantle of tax reforms in 1991. Government since then has shown continued
commitment to the reform process, which is evident from the fact that many of the
recommendations of various committees have been or are being implemented.

The report published by the Tax Reforms Committee headed by Raja J.

Chelliah (1993)3 is widely acclaimed as the most comprehensive and analytical
treatment of Indian tax policy and reform issues, since independence. This was
followed by other reports, noteworthy of which are the Shome Committee report
(2001),4 which largely updated the Chelliah Committee’s recommendations, and the
Kelkar Task Force reports5. The underlying mandate of all these reports was to
simplify the tax system. All of them focus on the need to improve tax administration
and reduce exemptions. Quite a few of which are Kelkar Committee
recommendations such as e-filing, setting up of large taxpayer units and submission
of annual information reports by third parties have been implemented and the fruits
thereof are seen with increased revenue collections.

The implementation of VAT encountered with several postponements of the

cut-off date. The Government, the Empowered Committee and the Chief Ministers
conference decided to switch over to VAT after overcoming several hurdles. For its
implementation, the Finance Ministry resorted to a constitutional amendment to allow
States to tax services as recommended by the G.C. Srivastava Committee6. Earlier

                                                            
2
Wanchoo Direct Taxes Enquiry Committee Report of 1971.
3
Raja J. Chelliah, Report of Tax Reforms Committee- II, 1993
4
Parthasarathy Shome, Report of Advisory Group on Tax Planning & Tax Administration for the Tenth Plan, Govt. of
India, May 2001
5
Vijay L. Kelkar, Report of the Task Force on Indirect taxes, Ministry of Finance & Company Affairs, Govt. of India,
December 26, 2002
6
G.C. G.C. Srivastava, IAS Secretary committee report on finance commission 2004

56
 G.C. Srivastava Committee on service tax had recommended either bringing services
in the concurrent list or allowing States to tax services on the lines of the Central
Sales Tax Act. Before the amendment, the power to levy tax on services is not
mentioned either in the Union List or State List contained in the Schedule VII of the
Constitution. With the then constitutional framework the only option is to invoke
entry 97 of the Union List which has been vested with residuary powers to levy any
tax not mentioned in the State List or the Concurrent List. The Central Government
had invoked the entry 97 and taxed various services. Entry 97 which reads as ‘Any
other matter not enumerated in List II or List III including any tax not mentioned in
either of those lists.’

The Tax Information Network (TIN) is new unique registration number that is
used for identification of dealers registered under VAT. It consists of 11 digit
numerals and will be unique throughout the country. First two characters will
represent the State Code as used by the Union Ministry of Home Affairs. The set-up
of the next nine characters may, however, be different indifferent States. TIN is being
used for identification of dealers in the same way like PAN is used for identification
of assesses under Income Tax Act. All the dealers seeking for new registration under
VAT or Central Sales Tax will be allotted new TIN as registration number. Every
State Commercial Tax Department has made provisions and has issued new TIN to
their existing dealers replacing old registration/CST number.

2.4.1  Major  Recommendations  of  the  Indirect  Taxation  Enquiry 

  Committee (ITEC), 1978 

There have been a number of important committees and commissions which have
examined excise taxation in India. All of them have emphasized the need to improve
long-term productivity in revenue and overall growth in the economy, removal of
cascading. Through tax rebate on inputs, reduction in the number of rates, exemptions
and incentives and overall simplification in the tax laws making compliance and tax
administration easier. Indirect Taxation Enquiry Committee, (ITEC) popularly known
as the Jha Committee, recommendations.

The ITEC was constituted under the chairmanship of Shri L K Jha in 1977,
after two decades a comprehensive report on taxation in India was brought out by
John Mathai Commission during 1953–54.The ITEC submitted its Interim Report in

57
 1977, followed by the Final Report in 1978. The major objectives before the
committee in reforming the structure of excise duties were:

• To achieve a determine degree of progression; and

• To avoid cascading and distortions (GOI, 1978: pp.305).

The committee was in favor of replacement of the existing systems of excises, sales
tax, octroi and certain other indirect taxes by a comprehensive VAT in the long-term.

This Committee was of the view that VAT system should be introduced at the
manufacturing stage only, initially and named it MANVAT or manufacturing VAT.
The extractions of VAT to wholesale and retail stager were not considered to be
prudent. The Committee stated “the right course of action, in our view, is not to
pursue the theoretically best solution, namely, one integrated system based on the
VAT principle, but to adopt the second best solution of MANVAT combined with a
reformed system of sales taxation”.

This Committee commissioned a study of the implications of applying

MANVAT to the automobile industry, and came to the conclusion that significant
quantitative benefits would flow from adoption of VAT at the manufacturing stage,
despite higher compliance and administrative costs and concluded that the relative
price distortions in MANVAT because inputs are freed from taxation. John F Due,
stated “one of the most exhaustive studies of indirect taxation ever made in the
country”7. Its most significant recommendation was the introduction of a system of
MANVAT, under which input taxes could be partly refunded.

2.5  INTRODUCTION OF MODVAT 
Based on the recommendations of the committee MANVAT in the name of
MODVAT or a Modified Value-Added Tax was introduced to minimize the
cascading effects of excise taxation. Under this scheme, a manufacturer or an
intermediate manufacturer can take credit for excise duty paid on raw materials and
components used by him in his manufacture. MODVAT thus, helps to avoid double
taxation on inputs as well as on finished goods.

                                                            
7
Purohit Mahesh C and Purohit Vishnu Kanta, Commodity Taxes in India Directions for Reforms, Gayatri
Publications, New Delhi, 1995, pp.3

58
2.5.1  Major Recommendations of Tax Reforms Committee (TRC), 1991–1993 

In pursuance of its commitment to reform the tax system, the Government of India
constituted the ‘Tax Reforms Committee’ on 29th August, 1991 under the
chairmanship of Professor Raja J Chelliah as part of the overall structural reforms
related to liberalization of the Indian economy. It submitted its Interim Report in
December 1991 followed by Final Report, Part–I in August 1992 and Final Report,
Part–II in January 1993. The recommendation of this committee is as follows:

The Committee emerged with contour of an ideal tax system with respect to
indirect taxes, and the extent to which the ideals have to be compromised for reasons
of practical difficulties and administrative limitations. As far as indirect taxes are
concerned, the Committee felt that it should “cover as many transactions as possible
and should be broadly neutral in relation to production and consumption; departures
from neutrality must be deliberate and for achieving a few major objectives”. Hence,
the taxes levied must have only a few rates and very few exemptions. The basic
indirect tax at the Central level should be broadly neutral and in course of time cover
commodities as well as services.

2.5.2  Recommendations of the Final Report (Part–I) of TRC, 19928 

The Committee submitted the following suggestions to transform the then existing
mixed system of MODVAT and excise on a gross value basis into a VAT at the
manufacturing level:

• Extension of excise to cover manufactured goods which were exempted, and

some selected services mentioned in the Interim Report;
• Reduction in the level of unduly high rates on some commodities;
• Gradual reduction in the number of rates to three between 10 and 20 percent;
• Extension of MODVAT credit to inputs;
• Extension of MODVAT credit for machinery not fully at the time of purchase,
but in installments during a subsequent period of years as laid down in the
law; and
• Extension of VAT to the important services used by the productive enterprises

                                                            
8
Raja J. Chelliah, Recommendations of the Final Report of Tax Reforms Committee (Part-I), 1992

59
2.5.3  Recommendations of the Final Report (Part–II) of TRC, 19939 

Part–II of the TRC Final Report deals mainly with the restructuring of the import
duties in India. The Committee emphasized the need to have a simple, broad–based
and neutral tax system with moderate rates. It is against this background that the
Committee had designed a three rate MODVAT regime at the manufacturing level at
10, 15 and 20 percent, with sumptuary excise on non–essential commodities at 30, 40,
or 50 percent. It stressed on widening of tax base by bringing the exempted goods into
the ambit of tax.

2.5.4  Review of Chelliah’s (TRC) Recommendations on VAT 

The report of the tax reforms committee (1991, 1992 and 1993) paved the way for
far–reaching reforms that were undertaken in the field of central excise during the
nineties. According to Acharya, “Taken together, these three volumes of the Chelliah
committee report (GOI, 1991–93) constitute the finest treatment of tax policy and
reform issues in India in the past 30 years”10. As a follow-up on the recommendations
made by the TRC, the rates and number of levies of central excise were drastically
reduced, the coverage of MODVAT was extended, specific duties were replaced by
advalorem, a number of exemptions were abolished and rationalized, service taxation
was introduced in a limited way and several steps were taken to modernize the
indirect tax system of the country.

2.6  FISCAL REFORMS IN INDIA 
Ever since the introduction of new economic policies of liberalization, privatization
and globalization in India in early 1990s, the debate regarding the restructuring of
Indian fiscal system had also has been initiated. Though the Modified Value Added
Tax (MODVAT) was introduced in the Central Excise in 1987, a comprehensive
VAT system was put in place in the early 1990s. Rationalization of Income Tax, both
personal income and corporate income; downsizing the public sector through reducing
subsidies and various expenditure cuts were also initiated by the Union government
during the period. In the reform decade of 1990s, financial transfers (in real terms)

                                                            
9
Raja J. Chelliah, Recommendations of the Final Report of Tax Reforms Committee (Part-II), 1993
10
Review of Chelliah’s (TRC) Recommendations on VAT

60
 from Union government to State governments declined, the debt burden of the State
governments grew, the committed expenditures of the States increased substantially
(particularly after the implementation of fifth pay commission awards for government
employers) contrasting with their inelastic revenue sources. These features of fiscal
crisis at the level of State governments show the need for reforming State fiscal
system. The major aspect of the State fiscal reform was the introduction of State level
VAT from April 1, 2005 in majority of States and Union Territories in India.

2.6.1  Reasons for Implementing State level VAT in India 

The States have the exclusive power to levy tax on intra-State trade (General Sales
Tax). The Union government levies the Central Sales Tax (CST) at the rate of 4% on
inter-State trade that can be collected and retained by the exporting State. The power
to levy sales tax, by several States allowed indulging in providing sales tax
concessions and in competitively reducing the sales tax rates to attract investments.
This resulted in undesirable offshoots for large federal economy. Firstly, some States
had failed to realize that the tax concessions could not be a permanent feature to
attract investment and failed to create infrastructure facilities, to attract and sustain
investments. Secondly, the investments should flow to regions that could help to reap
the economies of scale in production with the help of infrastructure facilities and
location. The sales tax concessions devoid of this economic rationale had induced
mal-allocation of investment and increased overall cost of production in the economy.
Thirdly, the tax competition between States prevented from exploiting full tax
potentials. Fourthly, the differential tax policies had not helped in creating a single
common market in India. The sales tax system in India has only resulted in creation of
a heterogeneous tax system, isolated regional markets and mal-allocation of
productive resources across States.

Coinciding with the introduction of the new economic policy in the early
1990s, the States had realized the need for a harmonious sub-national sales tax system
in India, and it was felt that the ultimate form of harmonized sales tax system could be
the State Level VAT with zero rating tax on exports, that is, with zero CST and
reimbursement of State Level VAT. As an intermediate step, Uniform Floor Sales Tax
Rates (UFSTR) was introduced in 2001. Further, the sales tax-related industrial
incentives were also discontinued from January 1, 2000. This was considered as a

61
 forerunner for the introduction to State Level VAT. The States initially introduced
truncated version of UFSTR, signaling an ideal State VAT in India. The removal of
differential sales tax systems between States are for two economic reasons is:

• The cascading effect of the non-VAT sales tax systems, that is, the tax on tax,
is clearly inflationary. On the contrary, the state governments realized a
portion of the ultimate price of a commodity as sales tax, which was smaller
than the actual sales tax rate levied. Therefore, it was an opaque sales tax
system; in other words, the consumer did not know the portion of the price
paid which was collected as tax, and the government did not realize the
intended proportion of prices as tax.

• The first- point sales tax in a State on a commodity, then the value addition
made in the subsequent transactions were not taxed. To overcome these
shortcomings of the non-VAT sales tax regime, States had decided to
implement State Level VAT.

2.6.2  Implementation of State Level VAT 

The Empowered Committee of State Finance Ministers released ‘A White Paper on

State Level-Added Tax’ in January 2005. It stated that almost all the States excluding
Uttar Pradesh had consented to implement State Level VAT from April 1, 2005. But,
only 21 States introduced it. Uttar Pradesh, Uttranchal, Tamil Nadu and five BJP-
ruled States implemented later for various reasons. The White Paper states, “The VAT
will not only provide full set-off for input tax as well as tax on previous purchases,
but also abolish the burden of several of the existing taxes, such as turnover tax,
surcharge on sales tax, additional surcharge, special additional tax, etc., In addition,
Central Sales Tax is also going to be phased out”. It is expected the State Level VAT
will be self-policing, improve tax compliance and reduce prices and all these will
increase tax buoyancy. Although the tax rates are the same across states under State
Level VAT, there is some flexibility- states are allowed to decide ten items that could
be exempted from State Level VAT, and to incorporate slight changes in the tax laws
and administration.11

                                                            
11
R Srinivasan, “VAT- An Indian Experience”- Effects of State level VAT: A Conceptual Analysis, ICFAI Edited
book, 2006 p.12-14.

62
2.6.3  Nature of Indirect tax system in India 

The indirect taxes are commonly and collectively known as consumption taxes. The
nature of the taxes shown in the Table 2.1 below:

Table: 2.1

Nature of Indirect Tax

Tax Relevant Statute Taxable event

Customs Duty Customs Act,1962 These duties are imposed by

Customs Tariff Act,1975 Central Government on goods
imported into and Median rate
24.42%
Central Value Added Central Excise Act, 1944 A tax on the manufacture or
Tax(CENVAT) or Central Excise Tariff Act production of goods in India
popularly known as CENVAT Credit Rules, imposed by the Central
Excise duty 2004 Government Median rate 8.24%
Service Tax Finance Act,1994 A tax imposed by the Central
CENVAT Credit Rules, Government on the identified
2004 services rendered by persons
defined in the provisions
Median rate 10.3%
Central sales tax Central Sales Tax Act, A tax on the inter- State sales of
1956 goods, imposed by the
originating State Rate 2%
Research & Research & Development The Cess is imposed on the
development cess Cess Act, 1986 import of technology
Rate 5%
Value Added Tax VAT Acts of respective A tax on the Intra-State
State Governments sales/purchases of goods,
imposed by the States Rate
generally at 4% and 12.5%
Entry tax Specific provisions laid Entry tax is levied by the State
down by State Governments on entry of goods
Governments into the State and is payable by
the purchaser.
Local levies such as Specific provisions laid These could be imposed by
octroi or local area down by State municipal or local authorities.
taxes Governments

Source: Abhishek A.Rastogi ACA, “Taxmann’s Guide to Goods & Services Tax”, A comprehensive &
illustrated guide to Goods & Services Tax .Taxmannn Publications Pvt.Ltd. New Delhi -2010 P.6.

63
2.6.4  Economics of indirect taxes  
A global review of indirect tax systems substantiates that VAT and GST are emerging
as taxes of the future. The review also gives an insight that the shift from direct to
indirect taxation is a not a myth but a reality. A system adopted by approximately 150
countries in less than 50 years indicates that the introduction of VAT/GST has spread
very widely and rapidly. It has become the most widespread general tax on
consumption, demonstrating its potential to raise tax revenue in a neutral and
transparent manner.

2.6.5  Economic growth and tax to GDP ratios 
Indian always had a greater reliance on indirect taxes than on direct taxes. This trend
has been recently reversed in India as compared to other countries where there is shift
towards a higher proportion of indirect taxes. In India, it has historically been easier to
tax the consumption of goods and services indirectly rather than to tax incomes. A
significant proportion of economic activity, primarily in the agricultural sector,
continues to take place outside of the direct tax system.

India seeks to increase an overall tax of GDP ratio and is focused to raise the
proportionate contribution of direct taxes to overall tax revenues. The Economic
Survey of India for 2008–09 depicts the Taxes to GDP ratios which is shown in the
Table 2.2 below:12

                                                            
12
Abhishek A.Rastogi ACA,Aditya kumar, “Taxmann’s Guide to Goods & Services Tax”, New Face of Indirect Taxes in
India.Taxmannn Publications Pvt.Ltd. New Delhi -2009, P.2-3.

64
 Table: 2.2
Share in Central Taxes

Statement: Share in Central Taxes Statement: Share in Central Taxes

(Amount in Crore) (Amount in Crore)
State 2008–09 2009–10 2010–11 Variation (Per cent) State 2008–09 2009–10 2010–11 Variation (Per cent)
(Accounts) (Revised (Budget (Accounts) (Revised (Budget
Col.3/ Col.4/ Col.3/ Col.4/
Estimates) Estimates) Estimates) Estimates)
Col.2 Col.3 Col.2 Col.3
1 2 3 4 5 6
I. Non- Special II. Special
Category Category
1. Andhra Pradesh 11.802 12,109 14,505 2.6 19.8 1. Arunachal 462 475 686 2.9 44.4
Pradesh
2. Bihar 17.693 18,154 23,600 2.6 30.0 2. Assam 5,190 5,547 7,595 6.9 36.9
3. Chhattisgarh 4,258 4,369 4,806 2.6 10.0 3. Himachal 837 859 1,635 2.6 90.2
Pradesh
4. Goa 415 427 557 2.7 30.4 4. Jammu and 2,053 1,880 2,911 –8.4 54.8
Kashmir(RE)
5. Gujarat 5,726 6,176 6,600 7.9 6.9 5. Manipur 581 596 944 2.6 58.4
6. Haryana 1,725 1,922 2,194 11.4 14.2 6. Meghalaya 595 636 854 6.9 34.3
7. Jharkhand 6,024 5,763 6,340 –4.3 10.0 7. Mizoram 383 393 563 2.6 43.1
8. Karnataka 7,154 7,000 9,060 –2.1 29.4 8. Nagaland 422 433 657 2.6 51.8
9. Kerala 4,276 4,387 4,826 2.6 10.0 9. Sikkim 379 374 500 –1.3 33.9
10. Madhya Pradesh 10,767 11,047 11,047 2.6 0 10. Tripura 687 734 1,069 6.9 45.7
11. Maharashtra 8,018 8,248 10,883 2.9 31.9 11. Uttarakhand 1,507 1,546 2,345 2.6 51.7
12. Orissa 8,280 8,496 10,004 2.6 17.8 All States 1,61,052 1,65,477 2,00,466 2.7 21.1
13. Punjab 2,084 2,527 2,908 21.3 15.0
14. Rajasthan 8,999 9,258 12,252 2.9 32.3
15. Tamil Nadu 8,511 8,758 10,402 2.9 18.8
16. Uttar Pradesh 30,906 31,712 35,517 2.6 12.0
17. West Bengal 11,322 11,650 15,206 2.9 30.5

Source: RBI Bulletin 2010-11. State Finances: A study of Budget 2010-11 Pg: 65

65
 Table: 2.3

Tax to GDP Ratio

Period Total Direct Indirect

Tax Tax

2001–02 8.1% 3.0% 5.1%

2002–03 8.7% 3.4% 5.3%

2003–04 9.1% 3.8% 5.3%

2004–05 9.7% 4.2% 5.4%

2005–06 10.2% 4.6% 5.6%

2006–07 11.5% 5.3% 5.8%

2007–08 12.6% 6.3% 5.9%

2008–09 (BE) 12.9% 6.9% 6.0%

2008–09 (RE) 11.8% 6.5% 5.3%

2009–10 (BE) 10.9% 6.3% 4.6%

Source: Analysis of Union Budget 2011–2012, Confederation of Indian Industry, Feb 2011.

Table 2.3 & Exhibit 2.1 shows Tax-GDP ratio for 2011–12 is estimated to be 10.4
percent which has an improvement over the revised estimate for 2010–11. The
finance ministry has kept a target of 10.8 percent for 2012–13.

66
 Exhibit: 2.1

Tax to GDP ratio

 
Source: Analysis of Union Budget 2011–2012, Confederation of Indian Industry, Feb 2011.

67
 Exhibit: 2.2

Growth of Indirect Tax

Source: Analysis of Union Budget 2011–2012, Confederation of Indian Industry, Feb 2011.

The above Exhibit 2.2 shows that the indirect tax collections for 2011–12 are
estimated at Rs. 397816 Crore registering a growth of 17.4 percent over the 2010–11
RE with excise, customs and service expecting to grow by 19.1, 15.1 and 18.2 percent
respectively over 2010–11 RE.

68
 Exhibit: 2.3

Gross Tax Revenue

 
Source: Analysis of Union Budget 2011–2012, Confederation of Indian Industry, Feb 2011.

The contribution of direct and indirect taxes in Gross Tax revenue over the years,
direct tax has always been the major contributor with the present share 57.12 percent
in the total gross tax collections. The increase in direct tax collections reflects
improvement in the equity of tax system is shown in Exhibit 2.3.

69
 Table: 2.4

Review of CST/VAT as on 01–April–2010

State Existing Return State Existing Return

VAT Rates Filing VAT Filing
Rates
Andhra Pradesh 4% / Monthly Maharashtra 5% / Monthly
14.5% 12.5%
Assam 5% / Monthly New Delhi 5% / Monthly
13.5% 12.5%
Bihar 4% / Quarterly Orissa 4% / Monthly
12.5% 12.5%
Chandigarh 4% / Quarterly Punjab 5% / Quarterly
12.5% 12.5%
(10% Addl
Tax/Sur)
Chhattisgarh 4% / Quarterly Rajasthan 5% / 14% Quarterly
12.5%
Goa 4% / Quarterly Tamil Nadu 4% / Monthly
12.5% 12.5%
Gujarat (4%+1%) / Monthly Uttar Pradesh (4%+0.5% Monthly
(12.5% + +0.5%) /
2.5%) (12.5%
+1%)
Haryana 5% / Quarterly Uttarakhand 4%+0.5%/ Monthly
12.5% 12.5%+1%
Jharkhand 4% / Monthly West Bengal 4% / Quarterly
12.5% 12.5%
Karnataka 5% / Monthly Pondicherry 4% / Monthly
13.5% 12.5%
Kerala (4%+1%) / Monthly Himachal Pradesh 5% / Monthly
(12.5% 12.5%
+1%)
Madhya Pradesh 5% / Quarterly
12.5%

Source: http://www.caclubindia.com/forum/latest-VAT-rate-amendments-as-on-01-april-2010-76397.asp

70
2.7  OPERATIONAL DEFINITIONS OF VAT 
Tax exemption may also refer to a personal allowance or specific monetary
exemption which may be claimed by an individual to reduce taxable income under
some systems. Tax exempt status may provide a potential taxpayer complete relief
from tax, tax at a reduced rate, or tax on only a portion of the items subject to tax

CBEC The Central Board of Excise and Customs is the national agency
responsible for administering customs and excise in India. The Customs & Excise
department was established in the year 1855 by the then British Governor General of
India, to administer customs laws in India and collection of import duties / land
revenue

Transfer of business: No registration certificate issued or renewed shall be sold or

transferred. Where a registered dealer transfers his business to another dealer, the
transferee shall apply for a fresh registration in the manner prescribed and the issue of
registration certificate shall be considered by the registering authority in the same
manner as prescribed

Returns & Assessment: Every dealer is required to file a monthly return under the
VAT Act in the prescribed manner and in the prescribed form for the prescribed
period. Such return shall be accompanied by the challans of the tax paid/computed
after taking rebate/setoff as provided in the Acts/Rules.

VAT payable: Credit will be given within the same month for entire VAT paid within
the State on purchase of inputs and goods. This credit received is deducted from tax
liability and the balance tax is paid

Refund: Excess credit will be carried forward to next year. In case the credit is not
utilized for certain period, it is refunded to the dealer. On account of set-off provisions
the refund of tax is a normal feature of the law and is expected to be paid within the
prescribed time from the end of month in which return is filed. In a Sales tax regime,
refund instances are by way of exceptions and are generally not paid by the
Government in time.

71
Input Tax Credit: All registered dealers whether manufacturer or trader are eligible
to claim set-off of the tax paid on inputs i.e. Value added Tax paid on purchases of
raw material, other goods and packing materials. Even for stock transfer/consignment
sale of goods out of the State, input tax paid in excess of a certain percentage is
eligible for VAT credit. However no credit under VAT law is allowable in respect of
taxes paid on purchases made from other States.

Output tax: Output tax is the tax payable by a registered dealer on the sale of goods
effected.

Period: Period refers to the period for which the dealer is required to file returns. The
period under the VAT Act is likely to be monthly for VAT registered dealers and
quarterly for retail dealers with general registration

Self assessment: Self assessment is finalization of assessment by the department

based on the returns filed by the dealer without calling for and examining the books of
accounts. Since under VAT the tendency to evade tax is expected to be lower, the self
assessment turnover limit is expected to be higher.

RNR - revenue neutral rate: The revenue neutral rate is the rate of tax at which the
revenue accruing to the State Government under the present system of levy of tax and
VAT is neutral.

Tax credit: Credit will be given within the same period for entire tax paid within the
State on purchase of goods both for intra-State and inter-State sales, irrespective of
when those will be utilized or sold

Capital goods: Capital goods means plant, machinery and equipment used for the
purpose of manufacturing or processing of goods in the State for sale, where the
purchase thereof has been capitalized and includes purchase of right to use such
goods, whether such purchase is capitalized or not. This term does not include all the
capital assets of a dealer such as car, furniture and office equipments etc.

Exempted goods: Exempted goods means the goods specified in the list or the
schedule appended to the Act on the purchase or sale of which no tax is leviable. The

72
 exempted goods are common for all the State. No tax is leviable on the purchase or
sale of exempted goods

Zero rated sales: A Zero rated sales is one on which no output tax is payable but
input tax credit is eligible. The difference between an exempt sale and a Zero Rated
Sale should be properly understood. An exempt dealer pays VAT on his purchases,
but it is not entitled to claim input tax credit as he cannot charge VAT on his exempt
sales. A dealer effecting Zero Rated Sales claims refund of the VAT on his inputs but
pays no tax on his output. Eg. Exports.

Deemed sales in VAT: Deemed sales are those which are not really “sales” but have
been deemed as sales. For Instance, leasing and hire purchase transaction, work
contract, transfer of right to use goods are instances of deemed sales that are taxed
under the Sales Tax Act. The inclusion or otherwise of deemed sales under VAT
differs from State to State.

Casual trader: means a person who, whether a principal, agent or in any other
capacity, carries on occasional transactions of a business nature involving the buying,
selling, supplying or distribution of goods in the State, whether for cash or for
deferred payment, or for commission, remuneration or other valuable consideration.

2.8  SALIENT FEATURES OF VAT 

• VAT proposes to impose two types of rates of tax namely:

• 4% on declared goods or the goods commonly used.

• 10–12% on goods called Revenue Neutral Rates (RNR). There would

be no fall in such remaining goods.

• Two special rates will be imposed—1% on silver or gold and 20% on

liquor. Tax on petrol, diesel or aviation turbine fuel are proposed to be
kept out from the VAT system as they would be continued to be taxed,
as presently applicable by the CST Act.

• Uniform Rates in the VAT system, certain commodities are exempted from
tax. The taxable commodities are listed in the respective schedule with the
rates. VAT proposes to keep these rates uniform in all the States so the goods
sold or purchased across the country would suffer the same tax rate. Discretion

73
 has been given to the States when it comes to finalizing the revenue neutral
rates (RNR) along with the restrictions. The rate must not be less than 10%.
This will ensure by doing this that there will be level playing fields to avoid
the trade diversion in connection with the different States, particularly in
neighboring States

• No Tax concession to new industries is done away with in the new VAT
system. This was done as it creates discrepancy in investment decision. Under
the new VAT system, the tax would be fair and equitable to all.

• Adjustment of the tax paid on the goods purchased from the tax payable on the
goods of sale All the tax, paid on the goods purchased within the State, would
be adjusted against the tax, payable on the sale, whether within the State or in
the course of interstate. In case of export, the tax, paid on purchase outside
India, would be refunded. In case of the branch transfer or consignment of sale
outside the State, no refund would be provided.

• Collection of tax by seller/dealer at each stage. The seller/dealer would collect

the tax on the full price of the goods sold and shows separately in the sales
invoice issued by him.

• VAT is not cascading or additive though the tax on the goods sold is collected
at each stage, because the net effect is as follows: - the tax, previously paid on
the sale of goods, would be fully adjusted. It will be like levying tax on goods,
sold in the last State or at retail stage.

2.9  SIGNIFICANCE OF VAT IN TAXATION REGIME 

• Simplification- Under the CST Act, there are 8 types of tax rates-1%, 2%,
4%, 8%, 10%, 12%, 20%, and 25%. But under VAT system, there are only 2
types of taxes 4% on declared goods and 10–12% on RNR. This will eliminate
any disputes that relate to rates of tax and classification of goods as this is the
most usual cause of litigation. It also helps to determine the relevant stage of
the tax. Under the VAT system, tax would be levied at each stage of the goods
of sale or purchase.

• Adjustment of tax paid on purchased goods-Under VAT systems, the tax

paid on the manufactured goods would be adjusted against the tax payable on

74
 the manufactured goods not necessarily the goods must be either be
manufactured or sold.

• Transparency – In the VAT system, the amount of tax at each and every
stage of goods of sale or purchase is transparent..

• Fair and Equitable- VAT introduces the uniform tax rates across the State so
that unfair advantages cannot be taken while levying the tax.

• Procedure of simplification- Procedures, relating to filing of returns,

payment of tax, furnishing declaration and assessment are simple..

• Minimize the discretion- The VAT system minimizes the discretion with the
assessing officer so that every person is treated alike.

• Computerization- The VAT system is purely based on computerization

which focuses on the tax evaders by generating Exception Report.. The
management information system, forms a part of integral computerization, and
makes the tax department more efficient and responsive.

2.10  SHORT COMINGS OF VAT 
The main advantages which have been identified in connection with the Value Added
Tax:

• VAT is regressive: The tax is regressive as its burden falls disproportionately

on the poor since the poor are likely to spend more of their income than the
relatively rich person. Further, there is now a tendency in most countries to
reduce this progressivity of taxes as has been done in Guyana where a flat rate
of income tax has been introduced.

• VAT is inflationary - Some businessmen seize almost any opportunity to

raise prices, and the introduction of VAT certainly offers such an opportunity.
However, temporary price controls some careful setting of the rate of VAT
and the significance of the taxes they replace should generally ensure that
there is no increase if any in the cost of living. To the extent that they lead to a
reduction in income tax, any price increases may be offset by increases in
take-home pay.

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 • VAT favors the capital intensive firm- It is also argued that VAT places a
heavy direct impact of tax on the labour - intensive firm compared to the
capital – intensive competitor, since the ratio of value added to selling price is
greater for the former. This is a real problem for labour – intensive economies
and industries.

2.11  OPPOSITION TO VAT IN INDIA 
There has been opposition to VAT on several grounds.

1. Firstly, the traders lobby is opposed to the introduction of VAT. The traders
lobby cites the possibility of harassment by the tax inspectors as the outward
reason for their opposition. Further, the trade lobbyists claim that VAT is good
for manufacturers, but bad for traders. The traders’ lobbyists contend that the
extensive procedural formalities that will have to be followed by traders’
under this regime which may result in increased transaction costs.
2. Secondly, some businessmen have expressed apprehensions that introduction
of VAT would lead to inflation.
3. Thirdly, some States in India have feared to introduce VAT because it would
reduce the revenue. The Central Government has acknowledged the possibility
of reduction in revenue following substitution of sales tax by VAT and had
offered to compensate the States for the revenue reduction for three years.
Initially there might be a fall in the revenue, after a period of time the revenue
would improve.
4. Further, politicians are opposed to VAT because it would be a negation of the
federal principle as it would concentrate more powers at the Central
Government and also because it is being introduced at the behest of the World
Trade Organization (“WTO“).

2.12  VAT AND CST DISTINGUISHED 

2.12.1 About CST 

The Central Sales Tax (CST) is a levy of tax on sales, which are effected in the course
of inter-State trade or commerce. According to the Constitution of India, no State can
levy sales tax on any sales or purchase of goods that takes place in the course of

76
interstate trade or commerce. Only parliament can levy tax on such transaction. The
Central Sales Tax Act was enacted in 1956 to formulate principles for determining
when a sale or purchase of goods takes place in the course of interstate trade or
commerce. The Act also provides for the levy and collection of taxes on sales of
goods in the course of interstate trade and commerce and to declare certain goods to
be of special importance in the interstate commerce or trade. The central sales tax is
an indirect tax on consumers.

Though CST is central levy, however it is administered by the concerned State

in which the sale originates. The seller or a dealer of goods in a State has to collect
State Sales Tax on the sale of goods within the State as well as z central Sales Tax on
Sales that takes place in the course interstate trade or commerce. The objects of the
Central Sales Tax Act, 1956 are given in the preamble of the Act which Says that it is
an Act to formulate principles for determining when a sale or purchase of goods takes
place in the course of inter-state trade or commerce or outside the State or in the
course of import into or export from India, to provide for the levy, collection and
distribution of taxes on sales of goods in the course of inter-State trade or commerce
and to declare certain goods to be of special importance in inter-State trade or
commerce and specify the restrictions and conditions to which State laws imposing
taxes on the sale or purchase of such goods of special importance shall be subject.

VAT as already has been discussed, is not a new tax but a new system of
taxation, different from CST in concept, approach and procedure. Both VAT and CST
are tax levied on sale or purchase of goods/commodities. These are several points of
distinction between VAT and CST is presented here under in a tabular form
(Table 2.5).

77
 Table: 2.5
VAT vs CST
Sl. Point of VAT CST Sl. Point of VAT CST
No. Distinction No. Distinction
1 Liability to tax Dealer Dealer 9 Classification of More or less similar in Classification Varies
goods for all the States from State to State.
determining tax rate
2 Administrative More or less remain More or less similar 10 Tax on exempt List of exempted goods Taxed at nil rate
procedures similar to CST with to VAT with some goods reduced. Taxed at nil
some procedural procedural changes. rate
changes
3 Point of tax Multi-point taxation Single point taxation 11 Tax on declared 4 per cent 4 per cent
along with goods
additional levies
4 Tax credit Entire tax credit Concessional rate of 12 Tax on essential 4 per cent. However, 4 per cent. List of
available on inputs tax is permitted goods there is difference in essential goods is
against declaration. list of essential goods different to VAT
under VAT and CST
5 Tax on value Tax only value No such concept tax 13 Tax on other goods Single rate in all Rates vary from State
addition only on sale or States (likely to be to State (5% to 30%)
purchase of goods 12.5%)
6 Tax rates Only 2–3 rates Numerous rates 14 Tax on gold, Single rate Rates vary from ½ per
varying from State jewellery, etc., cent to 4 per cent
to State.
7 Additional levies No Numerous, varying 15 Tax on lease At notified rate or at Rates vary from State
from State to State contracts rate applicable to to State
goods under contract
8 Resale tax No Yes

78
 Table: 2.5
VAT vs CST (Continued)

Sl. Point of VAT CST Sl. Point of VAT CST

No. Distinction No. Distinction
16 Tax on works At notified rate or at Rates vary from 19 Goods exported out Input tax credit or Full set off permissible
contract rate applicable to State to State of country refund available upon furnishing prescribed
goods under declaration
contract
17 Tax on packing Same rate as Same rate as 20 Effect on cash flow Comparatively less as Comparatively more as
material applicable to goods applicable to goods tax is required to be concessional rate is levied
packed packed paid first and credit is on furnishing relevant
available later on form.
18 Set-off of tax Full set-off available Usually not
paid on raw permitted. However
material, permitted by some
packing States.
material, stock
transfers,
finished good for
resale

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2.13  LEVY OF VAT 
VAT could be levied with three specific variants, viz., (a) Gross Product Variant, (b)
Income Type Variant, and (c) Consumption Type variant. It is further distinguished
through their methods of calculation, viz., addition method and subtraction method13.

2.13.1 Gross product variant: 
This variant allows deductions for all purchases of raw materials and components but
no deduction is allowed for business inputs. The, capital goods such as plant and
machinery are not deductible from the tax base in the year of purchase and
depreciation on the plant and machinery is not deductible in the subsequent years. The
economic base of gross product variant is equivalent to Gross National Product. In
this variant of VAT, capital goods carry a heavier tax burden as they are taxed twice.
Modernization and upgrading of plant and machinery is delayed due to this dual tax
treatment.

2.13.2 Income variant 
This variant of VAT, allows deduction for purchases of new materials and
components as well as depreciation on capital goods. It provides incentives to classify
purchases as current expenditures to claim set-off. Net investment (i.e. gross
investment minus depreciation) is taxed. The economic base of the income variant is
equivalent to net national product. In practice, there are difficulties connected with
specification of any method of measuring depreciation, which basically depend on the
life of an asset as well as on the rate of inflation.

2.13.3 Consumption Variant 
This variant allows deduction for all business purchases including capital assets.
Gross investment is deducted in calculation of value added. The economic base of the
tax, therefore, is equivalent to total private consumption. It neither distinguishes
between capital and current expenditures nor specifies the life of asset of depreciation
allowances for different assets. This form is neutral between different methods of

                                                            
13
Mahesh C.Purohit , “Value Added Tax”- Experiences of India and other Countries, Gayathri Publications , Delhi
2001.P.4

80
production; there would be no effect on tax liability due to the method of production
(i.e. substituting capital for labour or vice versa). The tax is also neutral between the
decision to save or consume.

Exhibit: 2.4

Different Stages of VAT

B Manufacturer C Wholesaler
Sale Value Rs.200.00 Sale Value Rs.300.00
Gross VAT 10%; Rs.20.0 Gross VAT 10%; Rs.30.0
Net VAT Rs.20-10=10.00 Net VAT Rs.30-20=10.00

A Raw Material Producer D Retailer

Sale Value Rs.100.00 Sale Value Rs.400.00
Gross VAT 10%; Rs.10.0 Gross VAT 10%; Rs.40
Net VAT Rs.10.00 Net VAT Rs.40-30=10.00
 
Source: Mahesh C. Purohit, Value Added Tax – Experience of India and Other Countries,
Gayathri Publications, New Delhi, 2001, pg. 5

Note: Total VAT collected at four point; Rs.10+10+10+10 = Rs.40.0

Among the three variants of VAT the consumption variant is widely used. Most
countries of Europe and other continents have adopted this variant. The reason for
preference of this variant is that it does not affect decision regarding investment
because the tax on capital goods is also set-off against VAT liability. The tax is
neutral in respect of techniques of production (labour or capital –intensive). The
consumption variant is more in harmony with the destination principle. In the foreign-
trade sector, this variant relieves all exports from taxation while imports are taxed.
Finally, this variant is convenient from the point of administrative expediency as it
simplifies tax administration by obviating the need to distinguish between purchases
of intermediate and capital goods on the one hand and consumption goods on the
other.

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 Exhibit: 2.5

Different Variants of VAT

Gross Product Income Consumption

Consumption Variant Variant

Tax levied on all sales Tax levied on all sales with Tax levied on all
with no deduction for set-off. For depreciation on sales with deduction
business inputs goods inputs for business inputs

Addition method Subtraction method

Identification of value added by Estimating value added by

the summation of wages, profit, taking difference between
rent and interest output and input

Direct subtraction Intermediate Indirect

Deducting aggregate tax Deducting tax inclusive Deducting tax on

(exclusive value of value of purchases from inputs from tax on
purchase) from the tax- sales and taxing sales for each tax paid
exclusive value of sales. difference between them

Source: Mahesh C.Purohit , “Value Added Tax”- Experiences of India and other Countries, Gayathri
Publications , Delhi 2001.P.4

2.14  METHODS OF COMPUTATION OF VAT 
VAT can be computed by adopting three different methods. They are:

• Addition method
• Subtraction method
• Tax-credit method

The methods calculated the VAT liability, which shown in Exhibit 2.2.

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2.14.1 Addition method: 
This method is based on the identification of value-added which can be estimated by
summation of all the elements of value-added (i.e.wages, profits, rent and interest).
This method is known as addition method or income approach. This is in line with the
income method of calculating national income.

2.14.2 Subtraction method: 
The subtraction method estimates value-added by means of difference between
outputs and inputs [i.e. T =t (output-input)]. This is also known as product approach
and has further variants in the way subtraction is attempted from among

• Direct subtraction method

• Intermediate subtraction method
• Indirect subtraction method

Direct subtraction method is equivalent to a business transfer tax whereby tax is

levied on the difference between the aggregate tax-exclusive value of sales and
aggregate tax-exclusive value of purchases. Intermediate subtraction method is based
on deduction of the aggregate tax-inclusive value of purchases from the aggregate tax-
inclusive value of sales and taxing the difference between them.

2.14.3 Tax‐credit method 

The indirect subtraction method entails deduction of tax on inputs from tax on sales
for each tax period, [i.e., t(output)- t(input)]. This method is also known as tax credit
method or invoice method. In practice, most countries use this method and employ
net- consumption VAT. A comparative picture of the three methods of calculating
VAT is presented in Table 2.6.

83
 Table: 2.6

Different Methods of Calculating Liability of Value

Added Tax: A Comparative study

SL. Methods Stage of production

No
Manufacturer Wholesaler Retailer Total
Economy
1 2 3 4
1. Addition method
Wages 150 300 200 650
Rent 50 100 20 170
Interest 25 75 20 120
Profit 25 25 10 60
Value Added 250 500 250 1000
(a+b+c+d)
VAT 25 50 25 100
2. Subtraction
method
Sales 350 850 1100 2300
Purchases 100 350 850 1300
Value added (a–b) 250 500 250 1000
VAT 25 50 25 100
3. Invoice method
Sales 350 850 1100 2300
Tax on sales 35 85 110 230
Purchases 100 350 850 1300
Tax on purchases 10 35 85 130
VAT (B–D) 25 50 25 100

Source: Mahesh C. Purohit, “Value Added Tax” – Experience of India and Other Countries,
Gayathri Publications, Delhi 2001.P.5–10.
Note: The Calculations are based on a uniform rate of 10 percent tax on value added.

84
2.15  VAT IN DIFFERENT COUNTRIES 

Russia

VAT in Russia is charged on the realization of goods, works and services on the
territory of Russia and on the import of goods into Russia. For VAT purposes,
"realization" is deemed to include barter operations and the free of charge transfer of
ownership of goods, of the results of work performed, or the rendering of services.
VAT is payable by all legal entities and individual entrepreneurs. Legal entities and
individual entrepreneurs agree exempted from VAT when the taxable revenues or less
than RUR 1 million during the three preceding months. VAT is levied on revenues
(including advance payments) received on the sale of goods, works and services. In
some cases, in accordance with Russian transfer pricing regulations, the tax
authorities may adjust the prices for tax purposes. With regard to imports, the taxable
base is defined as the customs value of the goods, plus customs duty and excise tax
when applicable. Russia currently has the following VAT rates: 20% - the standard
rate for goods, works and services; 10% - for certain non-excisable food products and
children's goods, in accordance with a number of lists endorsed by the government;
medicines and medical products; newspapers and magazines, and books related to
education, science and culture (provided they are not of an erotic or advertising
nature) and also certain services related to their production. Zero rate for export
goods.

Netherlands

Value added tax (VAT, in Dutch ‘BTW’) is levied in the Netherlands at each stage in
the chain of production and distribution of goods and services. The tax base is the
total amount charged for the transaction excluding VAT, with certain exceptions.
Because of deductions in previous stages of the chain, VAT is not cumulative. Every
taxable person is liable for VAT on his or her turnover (the output tax), from which
the VAT charged on expenses and investments (the input tax) may be deducted. If the
balance is positive, tax must be paid to the tax authorities. If the balance is negative, a
refund is received. The tax paid by the ultimate consumers of the goods or services is
not tax-deductible. The tax is based on the VAT rate applicable to the price of the
goods or services received; exclusive VAT. There is four taxable activities: supplying

85
goods; rendering services; acquisition of goods by businesses (since 1 January 1993);
importing goods. The general rate is 19%. A reduced rate of 6% is applicable to the
supply, import, and acquisition of goods and services mentioned in Annex 1 to the
VAT Act. The reduced rate is mainly applicable to foodstuffs and medicines. Other
goods and services subject to the lower rate include water, art, books, newspapers and
magazines, materials required by the visually handicapped, artificial limbs, certain
goods and services for agricultural use, passenger transport, hotel accommodation and
entrance fees for museums, cinemas, sports events, amusement parks, zoos and
circuses and some labour-intensive services. The zero rates is intended primarily for
exported goods, seagoing vessels and aircraft used for international transport, gold
destined for central banks, and any activities which may take place within bonded
warehouses or their equivalent. There is also a zero rate for goods that are transported
to another EU Member State on which VAT is levied because of the acquisition in
that Member State.

China

Value Added Tax (VAT) was implemented in China in 1984. Initially, the tax was
levied on 24 specified items. The need for constructing a socialist market economy
system in China resulted in the proclamation of 'The Provisional Regulation of the
People's Republic of China or Value Added Tax' on January 1, 1994. As a type of
turnover tax, value-added tax (VAT) is levied on the increased value of commodities
at different stages of production or circulation, i.e. the value-added on the
commodities throughout the supply chain until the final customer bears the burden of
the tax for the whole production process. All enterprises or individuals engaged in the
sale of or import of goods or the provision of processing, repair or maintenance
services in China have to pay VAT In China, the VAT system is separated into two
taxpayer divisions: Small-scale taxpayers and Ordinary Tax payers VAT is divided
into three categories: Input VAT is defined as the VAT paid on the purchase value of
goods. Output VAT is defined as the VAT paid on the sales value of goods. Payable
VAT is the deduction of the Input VAT from the Output VAT. For general Tax
payers, there are two VAT tax rates, the basic rate of 17% and a lower rate of 13%
which is for the import or sales.

86
Germany

VAT is paid by the end user of a product or service. Companies transfer the VAT
received to the tax authorities on a monthly, quarterly, or annual basis. The frequency
generally depends on the level of company turnover.The normal VAT rate of 19
percent is just below the European average. A lower rate of seven percent is charged
for convenience goods and services needed on a day-to-day basis (such as food,
newspapers or public transport). Some services (including banking, healthcare, and
non-profit work) . The official German term for VAT is Umsatzsteuer, but it was
originally called Mehrwertsteuer and is often still referred to by this name.

Ireland

Ireland comes under the EU VAT regime, and is part of the European single market
economy. VAT Directives are issued by the EU which lay out the principles of the
VAT regime to be adopted by the member states. These Directives take precedent
over local VAT legislation. The Irish VAT law is contained within the Value Added
Tax Act 1972, which has been amended many times, including the move to the
European Union single market. It is administered by the Revenue Commissioners.
Foreign companies may register in Ireland for VAT without the need to form a local
company – known as non-resident VAT trading. There is no VAT threshold in Ireland
for the registration of non-resident traders – a VAT number must be in place before
the commencement of taxable supplies. There are strict rules on the situations where a
registration is permitted. Common scenarios which require an Irish VAT registration
include: Importing goods into Ireland; Buying and selling goods within Ireland; The
standard rate of tax is 9%;

South Africa

VAT was born as a tax for business enterprise in South Africa in 1991. All taxable
supplies of goods or services are liable to VAT – with some exemptions. There is an
annual VAT registration threshold of 1 million South African Rand (approx
€104,000) per annum. It is not compulsory to register if the annual sales turnover is
below this amount. The standard rate of VAT is 14%. Exports, certain foodstuffs and
other supplies are zero-rated, and certain supplies are exempt (mainly certain financial

87
services, residential accommodation and public transport).Periodic VAT returns must
be submitted by all companies with a South African VAT number, detailing all
taxable supplies (sales) and inputs.

Taiwan

VAT applies to goods and services used for production, trading and consumption in
Vietnam (including goods and services purchased by organizations and individuals
from abroad). When supplying goods and/or services subject to VAT, enterprises
must charge VAT on the value of supplied goods or services. In addition, VAT
applies to the duty paid value of imported goods. The importer must pay VAT to
Customs at the same time of paying import duties. Applicable VAT rates are 0%, 5%,
and 10%, respectively. The 0% rate is applied to exported goods and services. VAT
is calculated by adding the taxable price (net of tax) to the applicable VAT rate. With
respect to imported goods, VAT is calculated by adding the import price to the import
duty and the special sales tax (if applicable). The VAT system of Vietnam is also
characterized by two types of VAT payers: deduction method VAT payers and direct
method VAT payers. Most of companies and business organizations are deduction
method VAT payers, i.e. the businesses will have to pay the output tax after
deducting the input tax. Businesses must report VAT returns monthly to the tax
authorities. The tax authorities, in turn, will check the tax return and issue a tax
assessment notice to the tax payer. The payable VAT must be paid to the State
budget in the following month.

Austria

The Austrian VAT law in its present form was enacted by the Value Added Tax Act
of August 23, 1994, effective from January 1, 1995 (Federal Law as of August 19,
2005). Due to Austria’s accession to the European Community effective from January
1, 1995, the VAT law was substantially amended. In particular, the 6th EC VAT
Directive and the Single Market Regulations were implemented. The VAT Act of
1994 consists of two parts: The first part mainly provides the VAT rules on domestic
transactions and transactions involving non-EC Member States. The second part
contains the “Single Market Regulations”, which are an appendix to Section 29 of the
VAT Act of 1994 and contain specific rules for the taxation of intra-Community

88
transactions. VAT applies to the supply of goods or services which are carried out
within the territory of the country, the self supply by businesses and the importation
of goods from non-EC Member States as well as to intra-Community acquisition of
goods. The rate of tax is 20%.The standard VAT rate in Austria is 20% - since
January 1984. There are reduced rates of 19%, 12% and 10% for food, books,
accommodation rental and other goods and services.

Italy

Italy, comes under the EU VAT regime, and is part of the European Union single
market economy. VAT Directives are issued by the EU which lay out the principles of
the VAT regime to be adopted by the member’s states. These Directives take
precedent over the local legislation. The Italian VAT law is contained within the
specific VAT legislation and is backed up by case law from the Italian Tax
Commission (Commissione Tributaria Provinciale). It is administered by the Ministry
of Finance and the local tax offices. The standard VAT rate in Italy is 21% since
September 2011. There is a reduced rate of 10% and 4%.

Ukraine

Value Added Tax (VAT) was introduced in Ukraine in 1993. Since January 1, 2011 it
has been administrated by the Ukrainian State Tax Administration in accordance with
Chapter I and Chapter V of the Tax Code of Ukraine. Mandatory registration is must
be when the aggregate amount from transactions relating to supply of goods/services,
which are subject to VAT, accrued (paid) to such entity during the last 12 calendar
months exceeds UAH 300,000 (excluding the value added tax). Voluntary
registration can be made by the tax payer if at least 50% of the goods or services
produced are supplied to counter parties that are VAT payers. The law distinguishes
between the following major types of transactions which are subject to VAT and are
taxed at the standard rate of 20%. This applies to all turnovers from the sale of goods
and services in Ukraine apart from the exceptions. Zero–rate (0%) VAT for export of
goods and services .Non-VAT able transactions applies, to emission of stocks,
transfer of property for operational leasing, insurance and reinsurance transactions,
social and pension insurance, consulting, engineering, legal, accounting, audit,
actuarial, IT services and software development, supply and testing services, etc.

89
 VAT-exempt transactions are allowed to education services, healthcare services,
certain mass media services, religious services, charity, etc.

  Mexico
Value added tax is a tax applied in Mexico and other countries of Latin America.
In Chile it is also called Impuesto al Valor Agregado and in Peru it is called Impuesto
General a las Ventas (IGV).

Prior to the IVA (Spanish: impuesto a las ventas), a sales tax had been applied
in Mexico. In September 1966, the first attempt to apply the IVA took place when
revenue experts declared that the IVA should be a modern equivalent of the sales tax
as it occurred in France. At the convention of the Inter-American Center of Revenue
Administrators in April and May 1967, the Mexican representation declared that the
application of a value added tax would not be possible in Mexico at the time. In
November 1967, other experts declared that although this is one of the most equitable
indirect taxes, its application in Mexico could not take place.

In response to these statements, direct sampling of members in the private

sector took place as well as field trips to European countries where this tax was
applied or soon to be applied. In 1969, the first attempt to substitute the mercantile-
revenue tax for the value added tax took place. On December 29, 1978 the Federal
government published the official application of the tax beginning on January 1, 1980
in the Official Journal of the Federation.

As of 2010, the general VAT rate is 16%. This rate is applied all over Mexico
except for the region bordering the United States, where the rate is 11%. The main
exemptions are for books, food, and medicines on a 0% basis. Also some services are
exempt like a doctor’s medicine attention.

United States
Most States have a retail sales tax charged to the end buyer only. Unlike in the VAT,
wholesale sales and sales of raw materials or unfinished goods are not taxed. A
common misconception is that sales to businesses are untaxed. Sales to
businesses are taxed if the businesses (or its workers) are the end users of a consumer
good.

90
 State sales taxes range from 0%–13% and municipalities often add an
additional tax in the form of a local sales tax. In most stores, the price tags and/or
advertised prices do not include the taxes, and the taxes are added at the cash register
before the customer pays. In some States, no sales tax is charged for services. (In
many States, a use tax is imposed on items ordered online or purchased in a State with
lower or no sales tax, and brought into the taxpayer's home State.) This is a key
difference between most sales taxes levied throughout the United States and the value
added tax system in many other countries.

In the United States, the State of Michigan used a form of VAT known as the
"Single Business Tax" (SBT) as its form of general business taxation. It is the only
State in the United States to have used a VAT. When it was adopted in 1975, it
replaced seven business taxes, including a corporate income tax. On August 9, 2006,
the Michigan Legislature approved voter-initiated legislation to repeal the Single
Business Tax, which became effective from January 1, 2009.

To conclude about 150 countries across the world have introduced GST in one
form or the other. The GST rate in various countries ranges from 5 per cent in Taiwan
to 25 per cent in Denmark. GST, consumption based destination tax, would be a
major deviation in the area of the indirect tax administration. The Table 2.7 below
shows the tax rates in different countries of the world.

91
 Table: 2.7

Tax Rates around the world

Country Income Tax VAT Country Income Tax VAT

Corporate Individual Corporate Individual
Argentina 35% 9–35% 21% Greece 25% 0–40% 21%
Australia 30% 17–45% 10%(GST) Hong kong 16.5% 2–17% –
Austria 25% 21%–50% 20% Hungary 19% 17% and 32% 25%
Belarus 26.28% 12% 20% India 30–40% 10–30% 12.5%
Belgium 33.99% 25–50% 21% Indonesia 28% 5–30% 10%
Brazil 34% 7.5–27.5% 17–25% Ireland 12.5% 20–41% 21%
Bulgaria 10% 10% 20% Israel 25% 10–45% 16%
Canada 19.5%(federal) 15–29%(Federal) 5%(GST) Italy 31.4% 23%–43% 20%
China 25% 5–45% 17% Japan 30% 5–50% 5%(Consump)
Croatia 20% 15–45% 23% Latvia 15% 23% 21%
Cyprus 10% 20–30% 15% Lithuania 15% 15%/20% 21%
Czech Rep. 20% 15% 20% Luxemburg 21% 0–38% 15%
Denmark 25% 38–59% 25% Malta 35% 15–35% 18%
Egypt 20% 10–20% 10%gst Mexico 28% 0–28% 15%
Estonia 21% 20% 20% Monaco 33.33% 0% 19.6%
Finland 26% 7.0–30.5% 22% Morocco 35% 0–41.5% 20%
France 33.33% 5.5–40% 19.6% Montenegro 9% 12% 17%
Germany 30–33%(effective) 14–45% 19% Netherlands 20–25.5% 0–52% 19%
Gibraltar 27% 0–40% – New Zealand 30% 0–39% 12.5%(GST)

92
 Table: 2.7

Tax Rates around the world (Continued)

Country Income Tax VAT Country Income Tax VAT

Corporate Individual Corporate Individual
Norway 28% 28–49% 25% South Africa 28% 0–40% 14%
Pakistan 35% 0–25% 15% Spain 30% 24–43% 16%
Panama 27.5% 15–25% 7% Sweden 26.3% 0–57% 25%
Philippines 30% 5–32% 12% Taiwan 17% 6–40% 5%
Poland 19% 18%/32% 22% Thailand 30% 5–37% 7%
Portugal 12.5/25% 0–42% 20% Tunisia 30% 15–35% 18%
Romania 16% 16% 19% Turkey 20% 15–35% 18%
Russia 20% 13% 18% U.K. 28% 0–40% 17.5%
Saudi Arabia 20% 20% – Ukraine 25% 15% 20%
Serbia 10% 10–20% 18% U.S.A. 15–35% 15–35% –
Singapore 17% 3.5%–20% 7% (GST) Vietnam 25% 5–35% 10%
Slovakia 19% 19% 19% Zambia 35% 0–35% 16%
Slovenia 20% 16%–41% 20%
Source: http://www.laowee.com/index.php/2010/08/tax–rates–vat–rates–around–the–world/

93
 Table: 2.8
VAT Compensation
(Rs. in crore)

Sr. Name of State Compensation Compensation Compensation Compensation Compensation Compensation Pending
Total
No. Government paid in paid in paid in paid in paid in paid in claims as on
Compensation
2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 31.12.2011
1. Andhra Pradesh 404.06 0 1.88 0 0 0 405.94 0
2. Assam 0 0 30.06 38.73 150.10 0 218.89 78.12
3. Bihar 165.87 78.23 0 0 0 0 244.10 0
4. Chhattisgarh 0 0 75.00 281.59 31.91 0 388.50 0
5. Haryana 0 0 0 27.84 59.85 0 87.69 0
6. Karnataka 1038.92 625.36 354.71 369.05 180.3 0 0 2568.34
7. Kerala 456.47 426.23 123.19 243.46 0 0 1249.35 0
8. Madhya Pradesh 0 0 46.24 0 0 0 46.24 40.74
9. Maharashtra 259.89 2814.72 1203.83 1895.00 1475.00 0 7648.44 277.40
10. Sikkim 1.84 4.03 0 0 0 10.92 16.79 0
11. Tripura 5.12 3.81 5.57 19.81 0 0 34.31 0
12. West Bengal 139.10 139.75 0 0 0 0 278.85 0
13. Tamil Nadu 0 0 2040.00 1000.00 0 0 3040.00 321.36
14. Delhi 0 0 0 362.81 855.07 37.70 1255.58 0
15. Orissa 0 0 0 18.93 163.32 0 182.25 0
16. Jharkhand - - - 104.73 86.450 0 191.18 0
Total 2471.27 4092.13 3880.48 4361.95 3002.00 48.62 17856.45 717.62

Source: Department of Revenue, Govt. of India, At a glance Budget 2011–2012.

94
 Table: 2.9

CST Compensation
(Rs. in crore)

Sl. Name of State Compensation Compensation Compensation Compensation Pending

Total
No. Government paid in paid in paid in paid in claims as on
Compensation
2007-08 2008-09 2009-10 2010-11 31.12.2011
1. Andhra Pradesh 0  905.24  1095.50  1540.86  3541.60  0 
2. Assam 70.89 0 228.79 150.90  450.58 0
3. Chhattisgarh 101.37 48.64 794.95 463.97  1408.93 0
4. Delhi 183.70 154.76 1052.00 1200.80  2591.46 0
5. Gujarat 338.14 156.57 796.04 661.21  1951.96 0
6. Haryana 150.00 400.00 1177.12 552.30  2279.42 689.60
7. Jharkhand 69.47 35.55 394.58 418.76  918.36 0
8. Karnataka 350.00 155.00 710.30 1098.87  2314.17 0
9. Orissa 131.53 5.49 483.90 425.99  1046.91 0
10. Punjab 0  24.32 9.95 324.55  358.82 0
11. Rajasthan 126.24 18.56 311.78 373.39  829.97 0
12. Tamil Nadu 647.54 0 759.00 469.61  1876.15 579.47
13. Uttarakhand 0  0 131.00 0  131.00 9.46
14. West Bengal 0  45.87 464.77 464.81  975.45 0
15. Maharashtra 0  0 123.00 0  123.00 83.67
16. Madhya Pradesh 0  0 110.96 106.06  217.02 55.96
17. Nagaland 0  0 4.43 0  4.43 1.63
18. Puducherry 0  0 86.91 143.78  230.69 0
19. Uttar Pradesh 0  0 0 0  0 118.87
Total 2168.88 1950.00 8735.18 8395.86 21249.92 1538.66

Source: Department of Revenue, Govt. of India, At a glance Budget 2011–2012.

95
2.16  TRENDS IN EXPENDITURE 
Salary expenditure increased in 2009–10 by 30.38% over 2008–09 due to
implementation of the recommendations of the 6th Central Pay Commission and
payment of arrears whereas non-salary expenditure increased by 85.53% during the
same period mainly on account of VAT/CST related expenditure. During 2009–10,
the VAT/CST related expenditure & grants to States towards VAT/CST compensation
constituted the very major portion of expenditure i.e. 96.25% of total expenditure
under Grant No.41 – Department of Revenue. In 2010–11, CST Compensation of
8396.24 crores has been released to various State Governments till 31st December
2010 whereas an amount of 179.25 crores has been released towards VAT and VAT
related expenditure till 31st December 2010. As on 31st December 2010, total VAT
Compensation of 17,856.45 crore has been provided to State Governments and CST
Compensation amounting to 21,249.92 crore has been provided, as detailed above in
Table 2.8 & 2.9.

2.16.1 Tax Evasion under the VAT system 
• Outright suppression of purchases and sales.

• Sales to Fictitious dealers.

• Maintenance of duplicate or multiple sets of account books.

• Changing the Place of business without prior permission or proper intimation

to the registration authority.

• Showing the sales below the taxable quantum.

• Fictitious place of business in other States and effecting consignments sales.

The below Exhibit 2.3 shows how tax evasion occurs.

96
 Exhibit: 2.6

Evasion of Tax

Opening Stock
Goods taxable at Purchase Total stock
12.5 p.c=Rs.7 Goods taxable at Goods taxable at
lakh 12.5 p.c = Rs.10 lakh 12.5 p.c = Rs.17 lakh
& 4 p.c = Rs. 3 & 4 p.c = Rs.5 lakh & 4 p.c = Rs.8 lakh
lakh. Total value Rs. 15 Total value Rs. 25 lakh
 
Total value Rs. lakh (shown in the
10 lakh (shown returns)
  in the returns)
Sale
 
Goods taxable at
 
Tax paid
12.5 p.c = Rs.15 lakh &
(break up)
4 p.c = Rs. 3 lakh Total
  Rs. 1.25 lakh on Discloses value Rs. 1.88 lakh on
Rs. 10 lakh taxable Total value Rs. 18 lakh Rs. 15 lakh taxable at
 
at 12.5 p.c. & (No difference in total 12.5 p.c & Rs. 0.12 lakh
  Rs. 0.32 lakh on turnover) on Rs. 3 lakh taxable at
Rs. 8 lakh taxable at 4 p.c. Total tax collected
  4 p.c. Total tax paid = Rs. 2 lakh
= Rs. 1.57 lakh
 

  Impact
  • No difference in the overall turnover sold and
disclosed.
  • Collects tax of Rs. 2 lakh
• Deposits tax of Rs. 1.57 lakh
 
• Retains tax of Rs. 43, 000
  In absence of breakup of taxability of goods,
details of goods lying in stock could not be
 
ascertained.
 
Source: Dr. A. Jayakumar & Su. Sabanayagam the management accountant journal, November, 2009
pg.866 titled Audit & Inspection under VAT Act

97
2.17  VAT FRAUDS  
VAT (Value-Added Tax) fraud is a scheme through which businesses avoid paying
VAT and even claim refunds for VAT they never pay. Such businesses actualize their
criminal intents using different established methods. Thus, different types of VAT
fraud can be identified, which governments of VAT-administering countries have
spent huge amounts of money to investigate and checkmate.

2.17.1 Inflated Refund Claims 
This is a VAT fraud scheme through which traders acquire invoices for purchases
they never make. Their intention is to claim more refunds from tax-collecting
authorities than they deserve. Such traders acquire fake invoices because invoices are
needed to claim refunds. (Invoices give evidence of merchandise purchases which
traders have made and on which they have paid refundable VAT.) There is an
established crime network dealing in such fabricated invoices, which business people
purchase to defraud government.

2.17.2 Underreported Sales 
Traders conceal their actual amount of sales from domestic markets in order to evade
their obligation to charge VAT on these sales. Such a fraud is designed to enable them
to claim more refunds (credits) than they deserve. In addition, this scheme has the
natural potential of boosting the business of such traders because it will encourage
patronage on account of the relatively cheap goods and services the traders offer to
buyers.

2.17.3 Fictitious Traders 
Traders set up unreal enterprises and register them for VAT, thus creating fictitious
traders of themselves. They make fake commodity purchases and sales, and defraud
the authorities by the registration of their non-existent business transactions. Their
aim is to have grounds for VAT-refund claims. In addition to setting up fake
enterprises, they make fake export invoices. To avoid being exposed, they try to make
fast profits and to disappear quickly.

98
2.17.4 Domestic Sales Disguised As Exports 
Under this scheme, traders sell goods and services on a domestic market but claim to
have sold them on an export market. For this purpose, they acquire fake export
invoices. Fake export invoices contain claims about the amount of purchases greater
than the actual amount such traders made. Such fabricated invoices apparently justify
their claims to greater VAT payments and therefore to greater VAT refunds.

2.17.5 Missing Trader Intra‐EU Fraud or Carousel Fraud 
This is the one of the biggest problem EU member nations faces and loses money.
This fraud allows traders to evade their VAT obligations in two different EU
countries by capitalizing on goods or services that are in high demand in a particular
EU country. For instance, after registering for VAT in one EU country, say, France,
they can purchase goods and services that are in high demand in Ireland on which
they cleverly avoid paying VAT. They then return to France to quickly sell such
goods or services at VAT-inclusive prices (having registered for VAT there).
Thereafter, they quickly disappear without paying their VAT. In its simplest form, a
fraudster obtains a VAT registration to acquire goods tax-free from a trader in another
country within the European Union. Typically, these goods are small, high-value,
easily transportable items, such as computer chips or mobile phones. The goods are
then sold on at a higher, VAT-inclusive price, but the seller disappears without paying
the tax to Tax Authorities. Officially, this type of crime is known as “missing trader
intra-community” fraud. This kind of fraud differs from straight tax evasion because
there’s a double-whammy loss to the authorities. Not only does the original importer
of the goods abscond with the VAT money, but the re-exporter fraudulently
‘reclaims’ the (never-paid) VAT.

As taxpayers start filing invoice level returns, the common GST portal can
start analyzing the data for tax evasion and fraud. Common formats for returns and
payments, combined with electronic filing and electronic payments, and a
standardized PAN-based registration makes the data consistent, and amenable to
mining. The common frauds and how they may be combated is shown in Table 2.10.
Assuming VAT collections of Rs.1,50,000 crores across all States, and a potential for
a 20% increase in collections, the common GST portal can lead to additional revenues
of up to Rs.30,000 crores.

99
 Table: 2.10

Detection of Frauds

Type of Fraud Common GST Portal:

Intelligence based Deterrence

Fraudulent bills Matching

Improper Input Tax Credit Matching

Fraudulent use of ‘exempt’ rules Electronic returns

False payment proofs Electronic challans

Unrecorded sales Data mining

Misuse of composition method Data mining

Wrongful application of lower tax Data mining

Under-invoicing Data mining

Non-existent dealers Data mining

Non-existent dealers Data mining

Source: Ministry of Finance, The IT Strategy for GST, July 2010

2.18  VAT AUDIT 
The assumption while introducing VAT was that the efficiency processing the returns
would enhance revenue and compliance. The self-checking mechanism reduces the
scope for evasion and improves the revenue. But it has been found that the evaders
have resorted to innovative methods like bogus invoicing, suppressing of turnover and
faking of refund claims. New auditing methods are required to detect such advanced
modes of evasion and to short – list habitual offenders.

It is true that under VAT the auditing system is more accurate and reliable.
But only in some countries all returns and firms are audited comprehensively. The
resource constraints do not permit cross-checking of all invoices and transactions.
Some countries concentrate on sensitive commodities and sectors to avoid
unnecessary wastage. Only selected units are audited thoroughly by scrutinizing the

100
stock, private documents, correspondents and competitors’ price. Income tax returns
are also verified to ascertain weather they reflected undisclosed income accrued
through evasion.

In India, tax returns are audited mainly by collecting agency. An independent

authority working under the comptroller and Auditor General of India also audits
them. But over a period of time, audit tends to become a routine check of returns and
registers. They do not yield any significant results other than pointing out some
arithmetical inaccuracies or deficiencies in documentation. Under the VAT scheme,
audit has to be more sensitive to the possibilities of manipulation. It has to use data
base of the system to unearth suspect firms and sales. Since audit is done on post
clearance basis, regular processing wings should be separate from the audit. The
concept of third party audit by the comptroller and Auditor General of India will
become redundant when automated system for audit is installed. The recommendation
of KTF to abolish AG’s audit is a sensible step towards reducing duplication of work.
Frequent visits of audit practice belonging to different agencies for scrutinizing the
same document over and over again is a major irritant to taxpayers. It can be
dispensed with if electronic database is used by all agencies for any kind of enquiry.
A typical audit modal is presented here to indicate the broad outline of VAT audit.

101
 Exhibit: 2.7
A VAT Audit Model
VAT RETURNS
PURCHASES Sales
Taxed goods Taxable goods
Imported goods Exempt Goods
Exempted Goods Exported Goods

VAT Purchase worksheet VAT Sale worksheet

Import Export
documents documents

Adjustment Debit Purchase Sales Credit Adjustment

Summary Note invoices invoices Note Summary

External information

Despatch document Despatch document

(Inward) (Outward)

Raw material register Production register

Financial Books of
accounts

Source: Dr. G.K. Pillai,VAT A way out of the Indian Tax Muddle- Problems and Prospects of Adopting
Value Added Tax, JAICO PUBLISHING HOUSE,Mumbai,2005.P.113.

102
2.18  SNAPSHOTS ON PUDUCHERRY 
Puducherry is a Union Territory with legislature extending over an area of 479 Sq.
Kms. Comprising, four regions viz., Puducherry, Karaikal, Mahe and Yanam. The
U.T of Puducherry consists of two districts viz., Puducherry District comprising of
Puducherry, Mahe and Yanam regions and Karaikal District comprising of Karaikal
region. There are 5 Municipalities and 10 Commune Panchayats. Total population of
the U.T is 12,44,464 as per 2010 Census. Average literacy rate of Puducherry
(Pondicherry) district is 86.13 percent. Total literates in Puducherry district are
733,075 people.

Under Revenue Account, the total expenditure incurred during 2008–09

(Actual) has been Rs.2570.48 Crores. During 2009–10 (RE) an amount of Rs.3302.55
Crores has been incurred. The Quick Estimates of the Gross State Domestic Product
of Puducherry in 2009–10 with base year 2004–2005 has been worked out to
Rs.11255.23 Crores (QE) at current prices. The Per Capita income for the year 2009–
10 (QE) has been estimated at Rs.82,767 and Rs.69704 at current and constant prices
respectively. The Consumer Price Index for Industrial workers of the Union Territory
of Puducherry stands at 171 during July 2010 revealing that there exist increasing
trend of prices in the Union Territory.

103
 Table: 2.11

Population – 2010 Census

 
Source: Directorate of Census Operations, Puducherry, 2010.

104
 Table: 2.12

State Finance and Banking Expenditure on Sales Tax

(Rs. In lakhs)
Sl.
Particulars 2003–04 2004–05 2005–06 2006–07 2007–08 2008–09 2009–10
No
Puducherry 16755.66 19619.83 23967.48 28316.39 45131.51 46683.77 51051.99
(Total Revenue)
1 Total expenditure 174.56 180.25 175.13 220.84 273.69 323.01 368.13
on the
Department
2 Percentage 1.04 0.92 0.73 0.78 0.37 0.69 0.72
distribution to
Revenue
collections
Karaikal 856.25 1318.77 1677.17 2201.32 2506.00 3255.00 3933.00
(Total Revenue)
1 Total expenditure 11.42 12.48 13.07 17.32 15.29 24.58 29.95
on the
Department
2 Percentage 1.33 0.95 0.78 0.79 1.60 0.75 0.76
distribution to
Revenue
collections
Mahe(Total 2467.66 3182.76 3885.22 4574.71 4347.85 4585.07 5851.29
Revenue)
1 Total expenditure 6.66 6.91 7.49 8.51 7.48 13.79 17.27
on the
Department
2 Percentage 0.27 0.22 0.19 0.19 0.17 0.30 0.29
distribution to
Revenue
collections
Yanam(Total 577.24 812.93 1127.47 1373.07 1559.59 1817.14 2842.03
Revenue)
1 Total expenditure 5.12 4.88 5.18 7.33 6.49 9.88 11.42
on the
Department
2 Percentage 0.89 0.60 0.46 0.53 0.42 0.54 0.40
distribution to
Revenue
collections
Source: Commercial Taxes Department, Puducherry, 2011

105
 Table 2.12 shows the relationship between the revenue and expenditure on sales tax.
It is highest during 2008-2009 when compared to all the other years.

Table 2.13 shows the performance of Commercial Taxes department,

Puducherry pertaining to the assessment the aggregate cases. It has combined
assessment cases into an aggregate total, without having any distinction between
different regions. The total number of cases due for disposal was highest during the
year 2006–07, compared to all the other years. The number of cases disposed during
the 2009–10 is 520, which is the lowest in all the other years. This department has to
be more vibrant in settling of cases in a speedier manner.

Table: 2.13

State Finance and Banking - Assessment Cases

Sl. Particulars Unit 2003– 2004– 2005– 2006- 2007- 2008- 2009-
No 04 05 06 07 08 09 10
1 2 3 4 5 6 7 8 9 10
Puducherry, Nos.
Karikal, Mahe
and Yanam
1 Due for ” 19665 20749 24466 28235 29412 23202 20558
disposal
2 Disposal ’’ 7015 4649 8678 9697 12053 2644 520
3 Pending at the ’’ 12650 16040 15888 18541 17359 20558 20038
end of the year
Source: Commercial Taxes Department, Puducherry, 2011

106
 Exhibit: 2.8

State Finance and Banking

Source: Commercial Taxes Department, Puducherry, 2011

107
 Table: 2.14

State Finance and Banking

Sales Tax Collection
(Rs. in Lakh)

Sl.
Particulars 2003–04 2004–05 2005–06 2006–07 2007–08 2008–09 2009–10
No
1 2 3 4 5 6 7 8 9
PUDUCHERRY
1 Under PGST 16143.45 19315.31 23715.31 28316.39 27480.87 29420.58 33326.22
2 Under CST 7227.50 10336.63 11719.69 16014.13 17650.64 17263.19 17725.77
3 Total 23640.95 29651.94 35434.96 44330.52 45131.51 46683.77 51051.99
4 Percentage 23.23 25.42 19.50 25.10 1.81 3.43 9.35
variation over
previous year
KARAIKAL
1 Under PGST 867.94 1329.33 1687.27 2201.92 2174.00 2803.00 3541.00
2 Under CST 154.79 130.02 133.56 284.89 332.00 452.00 392.00
3 Total 1022.73 1459.35 1820.83 2486.81 2506.00 3255.00 3933.00
4 Percentage 46.61 42.69 24.76 36.57 0.77 29.88 20.83
variation over
previous year
MAHE
1 Under PGST 2478.51 3188.44 3889.87 4574.71 4342.58 4580.89 5845.78
2 Under CST 9.44 6.43 10.08 12.20 5.27 4.18 5.51
3 Total 2487.95 3194.87 3899.95 4586.91 4347.85 4585.07 5851.29
4 Percentage 43.17 28.41 22.06 17.61 –5.21 5.46 27.62
variation over
previous year
YANAM
1 Under PGST 559.05 814.71 1129.41 1373.07 1502.63 1632.10 2598.11
2 Under CST 308.84 287.19 185.26 132.22 56.96 185.03 243.92
3 Total 867.89 1101.90 1314.67 1505.29 1559.59 1817.14 2842.03
4 Percentage 61.80 26.96 19.30 14.49 3.61 16.51 56.4
variation over
previous year
Source: Commercial Taxes Department, Puducherry, 2011

Table 2.14 shows that the Sales Tax Collection has increased during 2009–10 for
Puducherry, Mahe and Yanam. It has come down in Karaikal, the highest percentage
variations is with reference to Yanam where it is 56.4%. The trend of all the other
years shows a mixture of both increasing and decreasing trend.

108
 Table: 2.15

State Finance and Banking

Registered Dealers under the Sales Tax Act

Sl. 2003– 2004– 2005– 2006– 2007– 2008– 2009–

Particulars Unit
No 04 05 06 07 08 09 10
1 2 3 4 5 6 7 8 9 10
Puducherry
1 Under PGST alone Nos 141 205 156 59 377 185 154
2 Same dealer both ’’ 590 593 470 613 985 798 772
under CST & PGST
3 Total New Registration ’’ 731 798 626 672 1362 983 926
4 Cumulative Total ’’ 4758 5556 6182 6854 8216 9199 10125
Registration
Karaikal
1 Under PGST alone ’’ 10 7 19 8 86 98 49
2 Same dealer both ’’ 73 50 112 69 146 91 121
under CST & PGST
3 Total New Registration ’’ 83 57 131 77 232 189 170
4 Cumulative Total ’’ 975 1032 1163 1240 1472 1661 1831
Registration
MAHE
1 Under PGST alone ’’ 3 1 1 0 02
2 Same dealer both ’’ 60 63 39 52 89 60 31
under CST & PGST
3 Total New Registration ’’ 63 63 40 53 89 60 33
4 Cumulative Total ’’ 554 617 657 710 799 859 892
Registration
YANAM
1 Under PGST alone ’’ 3 1 1 1 2 09 18
2 Same dealer both ’’ 56 56 41 40 129 61 41
under CST & PGST
3 Total New Registration ’’ 59 57 42 41 131 70 59
4 Cumulative Total ’’ 460 517 559 600 731 801 860
Registration

Source: Commercial Taxes Department , Puducherry, 2011

 

The cumulative total registration of dealers has shown an increasing trend for all the
regions in Puducherry during 2009–10. As in the case of total new registration of
dealers under sales Act has reduced tremendously in 2008–09, 2009–10, when
compared to 2007–08 for Puducherry region, Karaikal, Mahe except Yanam region,
and it is shown in Table 2.15.

109
 Table: 2.16
State Finance - The State Budget - Revenue Receipts from Taxes and Duties
(Rs. In lakhs)
State Finance and Banking
The State Budget-Revenue Receipts from Taxes and duties
Sl. Items Actuals Actuals Actuals Actuals Actuals Actuals Actuals Revised Budget
No.
2002–03 2003–04 2004–05 2005–06 2006–07 2007–08 2008–09 Estimates Estimates
2009–10 2010–11
1 2 3 4 5 6 7 8 9 10 11
I. Taxes on
Property and
Capital
1 Land 23.58 29.56 28.88 31.70 91.41 53.85 38.28 79.00 111.50
Revenue
2 Stamps and 1,619.76 2,027.12 2,352.62 2,396.52 3,100.83 4,136.89 3,079.78 7,000 1,0200
registration
fees
II. Taxes on
Commodities
3 State Excise 8,769.68 10,566.48 11,029.19 12,517.49 14,349.44 22,402.31 27,959.63 32,500 47,500
4 Sales Tax 15,009.36 20,318.96 24,647.63 30,421.75 36,489.22 35,497.69 38,186.40 47,000 68,078
5 Taxes on 2,194.56 2,318.73 2,387.24 2,556.43 2,901.02 3,160.49 3,245.66 4,000 5,800
Vehicles
6 Other Taxes 21.37 15.90 13.04 16.55 23.08 33.59 25.15 21.00 22.00
and duties
Total 27,638.31 35,276.75 40,458.60 47,939.91 56,955.00 65,284.82 72,534.90 NA NA

Source: Department of Statistics, Puducherry, 2011

110
 Based on State Finance Budget documents of Puducherry State, it is evident that the
taxes on land revenue and stamps and registration fees have been less in during 2008–
09, when compared to the previous five years. Taxes on commodities have shown an
increasing trend except other taxes and duties.

The data pertaining to 2007–08, 2008–09 and 2009–10, reveals that the
percentage variation of sales tax collection when compared to each previous year is
tremendously increasing for Puducherry and Yanam and shows a slight decrease in
case of Karaikal. Mahe shows a very sharp increase in collection of Sales Tax.

2.18.2 Procedure for Registration under Vat Act of Dealers Registered 
  Under the PGST Act14 
Dealers already registered under the PGST Act are deemed to be provisionally
registered and required to submit their application for registration within one month
under the proposed VAT Act. (Section 6(1)) Briefly the procedure are:

• The application in Form A with a fee of

• Rs.10000 in respect of medium and large-scale industries;

• Rs.5000 in respect of dealers in Indian Made Foreign Liquor; and
• Rs.100 in respect of other cases
• Form A to be accompanied with a tax return of estimated turnover for twelve
months (Rule 3(2)).

• Additional fee of Rs.100 for copy of registration certificate for every

additional place of business is also payable at the time of submission of
application for registration.

• The completed application form is to be submitted affixing the photograph(s)

of the applicant(s) and shall be signed by -

• in the case of a proprietary concern, by the proprietor or proprietor as

the case may be,
• in the case of a Hindu Undivided family, by the Karta,

                                                            
14
 Source: http://www.tnvat.com/pdyindex.asp 

111
 • in the case of a company, by all the Directors or any officer so
authorized by the Board of Directors with the Common Seal of the
Company,
• in the case of a local authority, by its principal officer ,
• in the case of a firm, by all partners thereof not being a minor and for a
minor partner by the guardian, ( Form – B, furnishing details regarding
the partners of the firm, along with application form to be submitted to
the registering authority for the registration of partnership firm )
• in case of any other dealer, by a person so authorised to act in his
behalf.
• in case of existing dealers under the repealed Pondicherry General
Sales Tax Act, 1967, there is no requirement to file estimated turnover
return
• The applications may be made within one month business.

• Within 30 from the date of receipt of the application from a dealer, the
registering authority shall, issue a certificate of registration in Form - D
allotting a tax payer identification number (TIN). (Rule 7(1))

112
 Table: 2.17

Report of the Comptroller and Auditor General of India for the

31st March 2009 Govt. of the Union Territory of Pondicherry
(Rs. In lakhs)

Year Amount Amount collected Penalities for Amount Net % of

collected at Pre- after register delay in Refunded collection column
assessment assessment payment of 2 to 6
stage (additional taxes and
demand) duties

1 2 3 4 5 6 7

2006–07 364.31 1.07 0.35 0.84 364.89 99.84

2007–08 35.30 4.43 0.37 0.12 354.98 98.68

2008–09 382.23 1.11 0.47 1.95 381.86 100.10

PGST/
VAT

Source: DTTE. Economics and Statistics, Puducherry.

113
2.18.3 Analysis of the Collection  
The table 2.17 shows the break-up of the total collection at pre-assessment stage and
after register assessment i.e., additional demand of sales tax under the PGST Act and
VAT for the year 2008–09 and the corresponding figures for the preceding two years
as furnished by the concerned department are mentioned in the above table. This
shows that the collection of revenue at the pre-assessment stage ranged between 98.68
and 100.10% during 2006–07 to 2008–09. This reveals that the Commercial Taxes
Department is prudent in Tax collection.

2.18.4 Administrative set up of the Commercial Taxes Department 
The Commercial Taxes Department is headed by the Commissioner (CT) and is
assisted by one Deputy Commissioner and two Assistant Commissioners. The Deputy
Commissioner normally assists the Commissioner (CT) in the overall administration
of the Department. Out of two Assistant Commissioners, one Assistant commissioner
looks after Audit & Intelligence and the other Assistant Commissioner serves as the
First Appellate Authority. For filing of returns and collection of tax, there are four
Assessment Divisions in Puducherry region and one each in three outlying regions of
Karaikal, Mahe and Yanam. In all the divisions in Puducherry the Commercial Tax
Officer is assisted by two Deputy Commercial Tax Officers and one Assistant
Commercial Tax officer. In Karaikal and Mahe the Commercial Tax Officer is
assisted by only one Assistant Commercial Tax Officer. In Yanam, the Deputy
Commercial Tax Officer is the incharge for assessment, audit and collection of tax.
The officers are Assessing Officers. All the registered dealers are assigned to a
particular Assessing Officer to report on turnover and pay tax. VAT Audits will
normally be conducted by a team headed by the Assessing Officer. The Assessment
Divisions of Puducherry regions are called as Division - I, Division - II, Intelligence
Wing and Industrial Assessment Circle. The registration of dealers is centralized in
Puducherry. The Deputy Commercial Tax Officer has been appointed as Registering
Authority for Puducherry region and is known as Deputy Commercial Tax Officer
(Registration Cell). In Karaikal and Mahe, the Assistant Commercial Tax Officer and
Commercial Tax Officer respectively are appointed as Registering Authorities. At
Yanam, the Deputy Commercial Tax Officer is the Registering Authority. In the
Office of the Commissioner, the Commercial Tax Officer (Headquarters) is

114
nominated as Public Relations Officer. The dealers may contact the said Officer for
any information, but clarifications in writing are issued only by the 'Authority for
Clarifications and Advance Rulings' consisting of, a chairman in the rank of the
Deputy Commissioner or Assistant Commissioner and two other members not below
the rank of the Commercial Tax Officer. For the purposes of the Right to Information
Act, 2005, the following officers are appointed as the Public Information Officers for
the respective offices and the Commissioner (CT) is appointed as the First Appellate
Authority for RTI appeal.

115
 Exhibit: 2. 9
Organization Chart of the Commercial Taxes Department, Puducherry
SECRETARY TO GOVERNMENT. (CT)

COMMISSIONER (CT)

Deputy Commissioner (CT) Assistant Commissioner (Audit & Intelligence) Appellate Assistant Commissioner (CT)

Administrative CTO-I CTO-II CTO-IW CTO-IAC CTO-Karaikal CTO-Mahe CTO-Yanam Appellate Wing
Wing

Commissioner’s
Office

Commissioner 
CTO CTO CTO
CTO CTO CTO DCTO AAC
Dy. Commissioner 
DCTO DCTO Addl.CTO
DCTO ACTO ACTO U.D.C  ACTO
Asst. Commissioner 
ADCTO ADCTO DCTO
ADCTO Assistant U.D.C Steno Gr.III
CTO (HQ) 
ACTO ACTO ADCTO
ACTO U.D.C Assistant
U.D.C
Assistant Assistant ACTO
Assistant L.D.C  L.D.C 
Law Officer 
U.D.C U.D.C Assistant
U.D.C
Superintendent. 
L.D.C  L.D.C  U.D.C
L.D.C 
DCTO 
L.D.C 
ACTO 
Source: Commercial Taxes Department Puducherry
116
 Right to Information Appeal

Sl. Designation of Public Concerned Office in the Designation of

No. Information Officer Commercial Taxes the First
Department of the Appellate
Union Territory Authority
1 Appellate Assistant Office of the Appellate
Commissioner (CT), Puducherry Assistant Commissioner
(CT)
2 Commercial Tax Officer, Division- Office of the Commercial
I, Puducherry Tax Officer, Division-I,
Puducherry
3 Commercial Tax Officer, Division- Office of the Commercial
II, Puducherry Tax Officer, Division-II,
Puducherry
4 Commercial Tax Officer, Division- Office of the Commercial
Intelligence Wing. Puducherry Tax Officer, Division-
Intelligence Wing,
Puducherry
5 Commercial Tax Officer, Division- Office of the Commercial
Industrial Assessment Circle, Tax Officer, Division- Commissioner
Puducherry Industrial Assessment (CT),
Circle, Puducherry Commercial
6 Commercial Tax Officer (Head Office of the Taxes
Quarters), Puducherry Commissioner (CT), Department,
Puducherry (For matters Puducherry
other than Establishment
& Accounts)
7 Superintendent (Establishment), Office of the
Commercial Taxes Department, Commissioner (CT),
Puducherry Puducherry (For matters
relating to Establishment
& Accounts)
8 Commercial Tax Officer, Karaikal Office of the Commercial
Tax Officer, Karaikal
9 Commercial Tax Officer, Mahe Office of the Commercial
Tax Officer, Mahe
10 Deputy Commercial Tax Officer, Office of the Commercial
Yanam Taxes Department,
Yanam
Source: Commercial Taxes Department Puducherry