Understanding VAT versus Sales Tax

Consider the following case:

• A widget manufacturer spends $1.00 on raw materials and uses them to make a widget.
• The widget is sold wholesale to a widget retailer for $1.20, making a gross margin of $0.20.
• The widget retailer then sells the widget to a widget consumer for $1.50, making a gross margin of $0.30.

Under Sales tax system :

A conventional or retail sales tax is charged only on the sale of an item to its final end user. To achieve this, a purchaser who is not an end user is usually required to provide the seller with a "resale certificate", which states that the seller is purchasing an item to resell it. The tax is charged on each item sold to purchasers who do not provide such a certificate.

With a 10% sales tax:-

• The manufacturer pays $1.00 for the raw materials, certifying it is not a final consumer.
• The manufacturer charges the retailer $1.20, checking that the retailer is not a consumer, leaving the same gross margin of $0.20.
• The retailer charges the consumer $1.50 + ($1.50 x 10%) = $1.65 and pays the government $0.15, leaving the gross margin of $0.30.

So the consumer has paid 10% ($0.15) extra, compared to the no taxation scheme, and the government has collected this amount in taxation. The retailers have not paid any tax directly (it is the consumer who has paid the tax), but the retailer has to do the paperwork in order to correctly pass on to the government the sales tax it has collected. Suppliers and manufacturers only have the administrative burden of supplying correct certifications, and checking that their customers (retailers) aren't consumers.

With a value added tax

With a 10% VAT:

• The manufacturer pays $1.10 ($1 + ($1 x 10%)) for the raw materials, and the seller of the raw materials pays the government $0.10.
• The manufacturer charges the retailer $1.32 ($1.20 + ($1.20 x 10%)) and pays the government $0.02 ($0.12 minus $0.10), leaving the same gross margin of $0.20. ($1.32 - $0.02 - $1.10 = $0.20)
• The retailer charges the consumer $1.65 ($1.50 + ($1.50 x 10%)) and pays the government $0.03 ($0.15 minus $0.12), leaving the same gross margin of $0.30 ($1.65 - $0.03 - $1.32 = $0.30)
• The obligation of the businesses is limited to assuming the necessary paperwork in order to pass on to the government the difference between what they collect in VAT (output tax, an 11th of their sales) and what they spend in VAT (input VAT, an 11th of their expenditure on goods and services subject to VAT). Under VAT, all sellers collect tax and pay it to the government. A purchaser has an incentive to deduct input VAT, but must prove it has the right to do so, which is usually achieved by holding an invoice quoting the VAT paid on the purchase, and indicating the VAT registration number of the supplier.

Note:

(1) Certain industries (small-scale services, for example) tend to have more VAT avoidance, particularly where cash transactions predominate, and VAT may be criticized for encouraging this. From the perspective of government, however, VAT may be preferable because it captures at least some of the value-added. For example, a carpenter may offer to provide services for cash (i.e. without a receipt, and without VAT) to a homeowner, who usually cannot claim input VAT back. The homeowner will hence bear lower costs and the carpenter may be able to avoid other taxes (profit or payroll taxes). The government, however, may still receive VAT for various other inputs (lumber, paint, gasoline, tools, etc.) sold to the carpenter, who would be unable to reclaim the VAT on these inputs (unless of course the carpenter also has at least some jobs done with receipt, and claims all purchased inputs to go to those jobs). While the total tax receipts may be lower compared to full compliance, it may not be lower than under other feasible taxation systems.

VAT in INDIA:

(1) Items covered under VAT

• All business transactions that are carried on within a State by individuals/partnerships/ companies etc. will be covered under VAT.

• More than 550 items are covered under the new Indian VAT regime out of which 46 natural & unprocessed local products will be exempt from VAT

• Nearly 270 items including drugs and medicines, all industrial and agricultural inputs, capital goods as well as declared goods would attract 4 % VAT in India.

• The remaining items would attract 12.5 % VAT. Precious metals such as gold and bullion will be taxed at 1%.

• Petrol and diesel are kept out of the VAT regime in India.

(2) Under the CST Act, general and specific exemptions are granted on certain goods while VAT does not permit such exemptions. Under the CST law, concessional rates are provided on certain taxes. The VAT regime will do away with such concessions as it would provide the full credit on the tax that has been paid earlier.

GST: Goods and Services Tax

Why Goods and service tax?

i. Avoid cascading effect of taxation

One of the main reasons of the introduction of GST is to avoid cascading effect of taxes in India. For example manufacturing of a product attract CENVAT. The manufacturer pays CENVAT on goods produced. So the CENVAT element is loaded on the product. According VAT rules, the sales tax is payable on the aggregate selling price which include CENVAT. Here there is no set off benefits available. Likewise there are many situations in the nature of cascading effect for instance, State VAT on CST, Entry tax on VAT etc. Now Govt has decided to abolish tax on tax effect by implementing GST.

ii. Shortfall of Existing VAT

Indirect taxes like luxury tax, entertainment tax, are yet to be included in the VAT. These taxes are still existing and payable.

iii. Shortfall of Existing CENVAT

Several taxes like additional customs duty, surcharges not included under CENVAT.Input tax and service tax set off is out of reach to the manufacturer and dealers.

Benefits of GST

1. GST provide comprehensive and wider coverage of input credit setoff, you can use service tax credit for the payment of tax on sale of goods etc.
2. CST will be removed and need not pay. At present there is no input tax credit available for CST.
3. Many indirect taxes in state and central level subsumed by GST, You need to pay a single GSTinstead of all.
4. Uniformity of tax rates across the states
5. Ensure better compliance due to aggregate tax rate reduces.
6. By reducing the tax burden the competitiveness of Indian products in international market is expected to increase and there by development of the nation.
7. Prices of goods are expected to reduce in the long run as the benefits of less tax burden would be passed on to the consumer.
8. Overall tax compliance cost will reduce for government and can concentrate on GST

Indirect taxes subsumed under GST

The following indirect taxes from state and central level is going to integrated with GST

State taxes

1. VAT/Sales tax
2. Entertainment Tax ( unless it is levied by local bodies)
3. Luxury tax
4. Taxes on lottery, betting and gambling.
5. State cesses and surcharges in so far as they relate to supply of goods and services.
6. Entry tax not on in lieu of octri.
7. Purchase tax ( This is not sure still under discussion )

Central Taxes

1. Central Excise Duty.
2. Additional Excise Duty.
3. The Excise Duty levied under the medical and Toiletries Preparation Act
4. Service Tax.
5. Additional Customs Duty, commonly known as countervailing Duty ( CVD)
6. Special Additional duty of custums-4% ( SAD)
7. Surcharges
8. Cessess

The above taxes dissolve under GST; instead only CGST & SGST exists.

The GST model in India

Many countries are following single GST. But it is proposed that dual CST is suitable for federal country like India. The end user, i.e. consumer cannot recover taxes but a business can recover by claiming input tax setoff.

Dual GST

Dual GST means, the proposed model will have two component called

1. CGST – Central goods and service tax for levied by central Govt.
2. SGST – State goods and service tax levied by state Govt.

There would have multiple statute one CGST statute and SGST statute for every state.

Taxable event

Supply of goods and supply of services will be considered as taxable event under GST. Any economic activity which is not supply of goods is treated a supply of service.

Tax payer identification number

Each tax payer allotted a pan based identification number containing 13 or 15 digit number.

Payment of tax

The central GST would be paid to central and state GST paid to state government in the prescribed account head.

Collection of GST

It is same as VAT; Tax is collected on the basis of value addition on each stage of sale. Both CGST and SGST would have to be charged in an every service bill and sale bill and paid after adjusting input credit available on both.

Input tax credit setoff

The input tax credit of SGST can be utilized for the payment of SGST only and input tax credit on CGST can be utilized for the payment of CGST only. This means that cross utilization of input tax credit will not be allowed.

Making it clearer; input tax credit of CGST cannot be utilized for the payment of SGST and vice versa. However there is an exemption for the above in the case of interstate transaction .For interstate transaction IGST is proposed and would be implemented along with CGST and SGST.

Constitution amendment for levying service tax by the states

The power of levying service tax is rest with central Government and a constitutional amendment is necessary for empowering states for levying service tax.

Applicability of CGST and SGST

The applicability of taxes is as usual there would be a prescribed limit of annual turnover, also some goods and services are exempted under GST. The dealer whose turnover is below prescribed limit need not pay tax.

Threshold for annual turnover for goods and services would be 10 lakh for SGST and threshold of CGST for goods may be 1.5 crore and service would have a separate threshold that too will be appropriately high.

GST rates

The rate structure would be as follow;but not final

1. A lower rates for essential commodities
2. Standard rates for general goods
3. Special rates for precious metals
4. For services may be single rates for CGST and SGST.

GST rates is not yet announced by government, however it is assumed that aggregate total of CGST & SGST would be 14 % to20%.

Periodical return

Taxpayer would have to submit periodical return as prescribed by law in common format for CGST and SGST.