VAT to have negative impact in short term

THIRUVANANTHAPURAM JAN. 25. The Government proposes to introduce the Kerala Value Added Sales Tax (VAT) Bill in the Assembly next month, so as to switch to the VAT regime from April 1, 2003, along with other States. It will have a negative impact on tax collection in the short term.

The State would be incurring a loss of about Rs. 400 crores to Rs. 500 crores in revenue on account of implementation of VAT. However, the Centre has promised the States to compensate for this.

The Union Government has decided to withdraw the Central Sales Tax in a phased manner as the States switch to VAT. In the first year, the rate will be reduced from four per cent to two per cent. It will be reduced to one per cent in the second year and abolished in the third year.

The State's major loss of revenue would be on account of this. It will lose its share of the Central tax amounting to around Rs. 150 crores. Other losses will arise from refund of taxes provided under the VAT regime. Exports and inter-State trade would qualify for such refunds. Besides, the State will have to forgo revenues from Additional Sales Tax. On the other hand, the Centre will be charging additional excise duty on tobacco, textiles and sugar, limiting the scope of States to collect VAT on them.

The Union Government will make up the revenue losses of the State in full during the first year. The losses will be calculated with respect to 2000-01. This will be disadvantageous to the State as it had recorded one of the lowest increases in Sales Tax revenue that year.

For the second and third year, the Centre is proposing to compensate 75 per cent and 50 per cent of the losses. In addition, it is also proposing to transfer the right to tax some of the services to the State Governments. The State Government has requested that the State should be allowed to collect tax on about 40 services including banking, insurance and transport. The Centre has not taken a decision on which services are to be allowed to be taxed by the States.

A major feature of VAT is the facility for claiming input tax credit, the input tax being the tax paid by one registered dealer to another registered dealer on the purchase of goods in the course of business. As a result, the tax payable on resale of the goods will be only the tax on the value added including margins. If value addition is by manufacture, input credit can be claimed on tax paid on the raw materials. Dealers will be required to pay VAT only if their turnover exceeds Rs. 2 lakhs but for some exceptions like agent of a non-resident dealer. Dealers with turnover between Rs. 2 lakhs and Rs. 5 lakhs need pay only a presumptive tax.

Rates are fixed under five schedules. The first schedule will have exempted goods. The tax on goods listed in the second schedule will be one per cent. Goods in the third schedule will attract four per cent tax.

The fourth schedule will consist of goods outside VAT such as liquor and petroleum products. These are kept outside VAT as 45 per cent to 50 per cent of the State revenues are from these items. The minimum tax chargeable by States on these is 20 per cent. Revenue neutral rates subject to a ceiling of 12.5 per cent would apply to goods in the last schedule. The items to be included in each schedule will be announced only in the Assembly. Generally, VAT on industrial raw materials will be four per cent. VAT on manufactured goods could be four per cent or 12.5 per cent.

The VAT is expected to widen the tax base and reduce tax evasion, besides minimising tax rates and exemptions. However, tax evasion by jewellers and others using smuggled items would continue. Though Kerala is a major market for gold in the country, the revenue realised from the sector is as low as Rs. 32 crores a year. According to a study by Ravi Raman of the Centre for Development Studies, this should have been five of six times higher. Tax evasion had reached such heights that the returns filed by many gold merchants showed sales amounting to almost quarter of a sovereign per day.

The VAT system encourages voluntary compliance. However, the Taxes Department will be strengthening its market intelligence and trade channel intelligence set-ups. A lot of data is to be collected and processed. To facilitate this, the department and checkposts are being computerised. Computerisation of district offices is expected to be complete in three to four months.

According to a study by the Asian Development Bank, VAT will have an immediate negative impact on tax collection and Government expenditure. However, as the system stabilises revenues will increase. The net impact on the poor will be negative in the short term. But, the situation will improve in the long term.