The amendments made in the Punjab VAT law and the Kerala VAT law have made the trade and industry wonder as to rather than inching towards a unified goods and services tax (GST) regime, are we back to square one?
The Punjab government, being concerned about the substantial compliance gap in taxation at the wholesale and retail levels and to plug any revenue loss from leakages down the supply chain, issued plethora of notifications amending the Schedule A (tax-free goods) and Schedule E (goods taxable at special rates). Schedule A amendments include addition of certain commodities that are tax-free at the wholesaler or distributor or retailer stage, provided that the tax has already been paid at the first point of sale, i.e. manufacturer or first importer’s stage.
These very goods have been added in Schedule E to be taxed at the first point with a higher rate—around 7%, 16% and 25% (in case of cold drinks). Now, what are these goods? These are the ones which are bought by general public every other day. These include, at a very broad level, cold drinks, mineral water, personal care products, soaps and detergents, branded or packaged food products, processed fruits and vegetables, drugs and medicines, consumer electronic goods, kitchen appliances and so on.
These amendments take us back to the pre-VAT days, where the tax base was very narrow as the tax was levied on the first point of sale and, hence, the value added after the first point was not subjected to tax. Since the tax was levied only at the first stage, there was a tremendous opportunity for evasion and avoidance of tax. To curb this, many state governments introduced border check posts for tracking inter-state movement of goods and link them up with the declarations filed by the dealers. The tax applied on the actual selling price of the first point distributor creates a risk of competitive distortions where one distributor makes a sale to a related distributor at a low price, and the second distributor resells the goods to wholesalers/retailers at a higher price.
Since the wholesaler or distributor or retailer will not be paying tax on the commodities if the tax has been paid by the manufacturer/first importer at the first stage, the implications of tax on inter-state sales also become critical. The Punjab government has issued a clarification that CST provisions will be applicable to the manufacturers/first importers as earlier. If any subsequent dealer makes an inter-state sale of these goods, the tax liability will be nil. Accordingly, the input tax credit will not be available to him. This provision effectively denies the benefit of zero-rating of inter-state sales to wholesalers and retailers. This is a serious issue which tantamount to one state exporting its taxes to another state. The Punjab government has gone back in history, which has landed them in the pre-VAT era, posing a challenge for the trade and industry. All these changes have created a very complex situation in the state of Punjab, particularly for those dealers simultaneously dealing in goods which are taxable at the first point, those which follow the VAT system, those under the optional MRP scheme and those which are tax-free. It has created administrative complexities for such dealers. For example, a retailer would find it extremely difficult to manage the inventory from the manufacturers/first importers who have paid tax at the first stage and those who are not subject to the first-stage taxation, let alone design a system for correct computation of the tax payable. It is a move back to the single/first-point tax that prevailed prior to 2005 and goes against the very fundamentals and spirit of the VAT system. In fact, it was to put an end to the distortions in the first-point sales tax system that the VAT was introduced in 2005.
Down south, in Kerala, a levy of a turnover tax (TOT) at the rate of 2% on textile products excluding ready-made garments which are exempted under the state VAT law has been introduced in the last state Budget. Dealers having a turnover of R1 crore or more are liable to pay the TOT on the turnover of textiles (excluding ready-mades). Dealers are not allowed to collect the tax from the consumers and are expected to pay it from their margins. Again, this scheme of levying a TOT is very much against the universal concept of VAT and is cascading in nature. The dealers tend to increase the prices if they have to maintain their margins resulting in increase in the prices of textile products in the state of Kerala.
The changes effected by the Punjab and Kerala governments have set a bad precedent for the other states who, in the interest of revenue, may be tempted to adopt such measures. More importantly, these changes are clearly a breach of a common understanding arrived at by the Empowered Committee of State Finance Ministers almost a decade ago and are against the spirit of unification of tax systems in India. Time is opportune for the trade and industry to highlight such aberrations that exist in the current VAT system. While one cannot prevent the states in adopting such measures given their fiscal autonomy, it is always wise to impress upon them the advantages of continuing with the VAT principles which work well in other parts of the world.
By Rahul Renavikar
The author is executive director, Tax & Regulatory Services, EY.
Views are personal