An Empirical Study on Value Added Tax(VAT) in Kerala

1. Impact of Value Added Tax: An Empirical Study of an
Indian State
I. INTRODUCTION
Taxation is one of the principal sources of public finance and an effective tool
for the government to utilize the taxation revenues for equality and justice. Over the
years, taxation laws have become unwieldy, procedure ridden and an impediment in
its effective administration, developing into a regressive element in trade and industry.
New laws are expected to bring simplicity in understanding and compliance, and
effectiveness in administration and enforcement (Singhvi, F.R, 2001). The rapid
development in areas of science coupled with socio- political growth has raised
aspirations of the people. We live in an era where the developments have given us a
standard of living distinctly better than any of our preceding generations. To fulfill
this need of ours, businesses are bound to become complex which in its turn has led
the taxation structure towards its own peril, because it failed to keep pace with the
aforesaid changes. This warranted a revision of the existing taxation system to
broaden the base for taxation. The need for reforming the existing taxation structure
by the States with a view to broadening the tax base, minimizing distortionary effects
and increases in cost and at the same time improving the equity of the system has been
recognized by the Committee of State Finance Ministers in India who gave their
recommendation to adopt the Value Added Tax (VAT) principle at their meeting at
New Delhi in August 1995.
The Committee issued a White Paper on 17th
January 2005 for the
implementation of VAT in India. Consequently, the government of India implemented
VAT from April 2005.The implementation has been done based on the assessment
that: (i) VAT can bring about transparency as regards the incidence and the quantum
of tax payable on goods, (ii) VAT will overcome transactions ‘without bill’ which the
present sales tax system encourages, (iii) With VAT, the dealers will get credit for the
input tax paid, (iv) VAT reduces compliances cost, number of tax rates and tax
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2. concessions, (v) VAT eliminates allied levies such as re-sale tax, turnover tax,
additional tax, cess and surcharge, (vi)VAT can be considered as a multipoint tax with
set off benefit for the tax paid on inputs and capital goods and so on.
The present paper focuses on India’s present taxation system, which has been
attracting attention since 2005 when the VAT system was introduced. This paper tries
to assess the impact of the present taxation system in India-VAT- on the various stake
holders, viz. manufacturers/traders, consumers, officials and the government. The
assessment has been made by considering the position of a well educated State in
India-Kerala. The descriptive study is based on both the primary and secondary data.
The primary data were collected from 150 manufactures/traders, 450 consumers and
90 VAT officials in Kerala with the help of scientifically pre-tested structured
interview schedules. The secondary data were collected from books, periodicals,
Committee Reports, official records, government publications and the internet. For
data analysis, statistical tools, viz. average, percentages, chi-square test and proportion
test were applied.
II. RESULTS AND DISCUSSION
A. Impact of VAT on Manufacturers/Traders
Before implementing VAT, the government of Kerala conducted various
meetings and seminars to educate the manufacturers/traders about the VAT law.
However, the majority of manufacturers/traders still depend on tax consultants to
understand and file returns and other forms with the departments. Even then, they do
not want to go back to Kerala General Sales Tax (KGST) because VAT is more
beneficial to them than KGST since they get credits for the input tax paid on their
purchases which will reduce the cost of manufacture/trade.
As per VAT law, refund has to be given within 3 months. However, there is
substantial delay in getting the refund order. In most of the cases the refunds are held
up even for minor technical defects. There are also numerous cases where refund is
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3. granted and after that on the basis of audit assessment, refunds granted are demanded
back. On account of the undue delay in getting the refund, the manufacturers will not
be in a position to pass on the benefit on account of the refund to the consumers or in
other words the prices will be higher. The so called benefit of VAT is thus lost.
Hence the ultimate loser will be the consumer.
The small scale industrial units which were enjoying substantial tax
exemptions/ reduced rate of tax and other benefits under the pre-VAT regime are also
losers under the VAT regime in so far as there are no exemptions and they are
compelled to compete with their bigger brothers to survive. Kerala, due to its
geographical and other constraints, is not in a position to nurture large industries and
this inability to provide benefits to small industries has a stifling impact on its
economic growth.
From the traders’ point of view also the introduction of VAT has only
complicated matters. A trader is required to maintain a large amount of information
regarding input tax credit, output tax, reverse tax, purchase tax, special rebate, refund,
etc. item wise for each commodity. This can practically be possible only by using the
assistance of computers and computer trained personnel which cannot be afforded by
small traders. The present VAT laws also do not permit carrying the input tax credit of
one year over to the next year. This lands a trader especially one who has made huge
stocks in March end and having input tax credit balance for which refund applications
have to be filed in a strange situation. While the trader has to wait for refund, the
processing of which presently takes several months, the trader is required to remit the
tax for April, which requires additional working capital, bearing additional interest
burden.
B. Impact of VAT on Consumers
After the introduction of VAT, the prices did not fall as predicted by the
advocates of VAT system. The benefits of refund, set off, etc. are not passed on to the
consumers. This was due to the reason that the manufacturers are not able to reap the
benefits of VAT due to procedural formalities associated with taking input tax credit,
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4. refund, etc. From 1.4.2008 the State government has also introduced one per cent cess
on taxes. This additional levy has effectively resulted in the tax rates of all goods
going up higher than those in other states and ultimately this burden is also passed on
to the consumers. The consumers understood the VAT scheme as beneficial for price
slash down and making more goods available. But in practice, the large industries and
business class denied passing on the input tax credit and refunds privilege under the
VAT system to the consumers. Hence, the consumers may not really benefit the
scheme.
In the study, consumers were asked to respond to the statement “Introduction
of VAT has resulted in decrease in the prices of goods” to test the null hypothesis that
the introduction of Value Added Tax has not led to a decrease in the prices of goods.
Most of the respondents (72.9%) are of the opinion that the introduction has not
resulted in decrease in the prices of goods (Table1). But 27.1 per cent have said ‘yes’.
The chi-square test finds no significant difference of opinion among respondents in
the three zones of Kerala.
TABLE 1: INTRODUCTION OF VAT HAS RESULTED IN DECREASE IN THE PRICES
OF GOODS (OPINION OF CONSUMERS)
Source: Primary data.
Chi square (df=2) = 0.16, p value = 0.92 >0.05
*95% Confidence limit= 69% to 79%.
The foregoing analysis comprehensively establishes the fact that the
introduction of VAT has not resulted any decrease in the prices of goods with 95 per
cent confidence limits of the proportion varying from 69 per cent to 79 per cent (i.e. if
we put the statement to the entire population, not less than 69 per cent will state in the
same direction, but not more than 79 per cent). Thus, the null hypothesis formulated
that the introduction of Value Added Tax has not led to a decrease in the prices of
goods is accepted with 95 per cent confidence.
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Opinion
South Central North Total
No. % No. % No. % No. %
Yes
No
41
109
27.3
72.7
42
108
28.0
72.0
39
111
26.0
74.0
122
328
27.1
72.9*
Total 150 100.0 150 100.0 150 100.0 450 100.0

5. C. Impact of VAT on Government
The real benefit of VAT would not surface in the short run. This is mainly due
to the fixation of the tax rate at the revenue neutral tax rate of 12.5 per cent. The
Centre has also guaranteed the States to compensate for the short fall in revenue to the
extents of 100 per cent, 75 per cent and 50 per cent in the first 3 years of
implementing VAT. This ensures that the State revenues would not be affected
severely. Some products could actually be costlier depending on the tax rate that they
suffered earlier. The pressure to get registered would increase, as the sellers would
want to utilize their tax credit. This would increase the tax registration transactions
that were not recorded. Hence the improvement in the short term would be more
because of better accounting of economic activity.
The situation will improve in the long term as Central Sales Tax (CST) reforms
are completed by 2006. The government has set the ball rolling by reducing the CST
rate to 2 per cent. There are indications that the multiple rates of tax would merge into
a single rate of VAT and the provision of VAT credit would be extended to services
also. Increased tax base and better compliance would ensure that the tax revenues do
not decrease. This would result in lower prices accelerating the economy.
The government of Kerala has outlined an agenda for a more fool proof sales
tax collection through which an increase in revenue can be effected, so that the State
can move ahead with its proposed plan of accelerated development. According to the
government, though there has been an increase in sales tax collection after the
introduction of VAT, it is far from the desired level due to various reasons. It is said
that one of the reasons for the fall in collection of tax was due to abolition of entry tax.
Another reason is the lack of scrutiny of returns filed by the dealers. At present only
30 per cent of the returns are subjected to scrutiny. According to the government, if
sales tax collection is increased by 20 per cent a year, revenue deficit can be overcome
by 2010-11, as 70 per cent of the revenue earnings accrue from sales tax.
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6. The sales tax collection of the government of Kerala for four years before the
implementation of VAT reveals an increasing trend in the tax collection in all the
years, showing a period average of Rs.5733.84 crore (an increase of 13.29%)(Table
2). As against the sales tax collection before VAT, the collection of sales tax after
VAT shows a better position. The average total collection (VAT and non-VAT) for
the last four years (from 2005-06 to 2008-09) is Rs.9981.71 crore. The average VAT
and non-VAT collection during the period are Rs.4752.51 (22.5% increase) and
Rs.4479.20 crore (14.62% increase) respectively. The poor performance in sales tax
collection in the year 2005-06 was due to availing of input tax credit by the dealers on
the goods lying as closing stock as on 1.4.2005. Abnormal increase in non-VAT
collection during the year 2008-09 is due to an increase in the prices of petroleum
products and IMFL (Table 2).
TABLE 2: SALES TAX (2000-05) AND VAT (2005-09) COLLECTIONS
(Rs. in crore)
Year
Sales
Tax/VAT
Collection
% increase
Non-VAT
collection
% increase Total
2001-02
2002-03
2003-04
2004-05
4676.18
5380.63
6081.13
6797.42
-
15.06
13.02
11.78
Total 22,935.36
Average 5733.84 13.29
2005-06 3321.98 - 3661.27 - 6983.25
2006-07 4482.12 34.92 4204.71 14.84 8686.83
2007-08 5132.06 14.50 4553.28 8.29 9685.34
2008-09 6073.88 18.35 5497.54 20.74 11571.42
Total 19010.04 17916.80 36926.84
Average 4752.51 22.59 4479.20 14.62 9981.71
Source: Department of Commercial Taxes, Government of Kerala.
In VAT law, the disputes of the dealers have also drastically come down. As a
result the number of appeals filed before the Sales Tax Appellate Tribunal is much
less, compared to KGST appeals filed. The KGST appeals during pre-VAT period in
the beginning of the year 2001-02 were 13871. The total number of appeals filed
before the Sales Tax Appellate Tribunal during the period 2001-02 and 2004-05 was
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7. 14959 and the total number of appeals disposed of during the above period was 23804
(Table 3). The balance at the end of the year 2004-05 was 5026. However, the total
number of appeals filed under VAT Act during the period 2005-06 and 2008-09 was
467 and the total number of appeals disposed of came to 209, leaving a balance of 258
appeals by the end of 2008-09. The Sales Tax Appellate Tribunal is the second
appellate authority. Even after considering the number of appeals pending before the
first appellate authority, we can see that the disputes of the dealers have drastically
come down.
TABLE 3: APPEALS FILED DURING PRE-VAT (2001-05) AND POST-VAT (2005-2009)
PERIODS BEFORE THE SALES TAX APPELLATE TRIBUNAL
Year Opening Balance No. of Appeals Filed No. of Appeals
Disposed of
Balance at End of the
Year
2001-02
2002-03
2003-04
2004-05
KGST VAT Total KGST VAT Total KGST VAT Total KGST VAT Total
13871
9202
6684
5805
NIL
NIL
NIL
NIL
1387
1
9202
6684
5805
2797
4084
4726
3352
NIL
NIL
NIL
NIL
2797
4084
4726
3352
7466
6602
5605
4131
Nil
NIL
NIL
NIL
7466
6602
5605
4131
9202
6684
5805
5026
NIL
NIL
NIL
NIL
9202
6684
5805
5026
Total 35562 3556
2
14959 1495
9
23804 2380
4
26717 26717
Average 8891 8891 3740 3740 5951 5951 6680 6680
2005-06
2006-07
2007-08
2008-09
5026
2501
1720
1176
NIL
10
90
177
5026
2511
1810
1353
1641
1704
1297
2284
10
80
87
290
1651
1784
1384
2574
4166
2485
1841
1703
NIL
NIL
NIL
209
4166
2485
1841
2012
2501
1720
1176
1757
10
90
177
258
2511
1810
1353
2015
Total 10423 277 1070
0
6926 467 7393 10195 209 1050
4
7154 535 7689
Average 2606 69 2675 1732 117 1848 2549 52 2626 1789 134 1922
Source: Administrative Reports, Sales Tax Appellate Tribunal, Trivandrum.
D. Impact of VAT on VAT Officials
The government has conducted various seminars and workshops to educate the
tax officials about the VAT system. As a result, the majority of the officers are
remarkably aware about the VAT law. A well equipped and well maintained
computerized department is mandatory for the implementation of the VAT system.
But majority of the computers and related instruments are either unusable or below
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8. their capacity. A considerable number of staff members are also ignorant or reluctant
to operate the computer systems. Under the KGST Act, the officials have to
concentrate only on the first sellers and manufacturers. In each office the above
categories consist only of 40 to 50 numbers and others are second sellers and hence
exempted. Once the dealers prove that the purchases are made from registered dealers,
they are exempted and there is no need to burn the midnight oil. But under VAT
system, tax has to be levied on each sale point, each dealer has to be reckoned and
closely watched and scrutinized. At present, each official has at least 700 to 800
numbers of dealers and they have to be closely watched by the officials, which is very
difficult. For that reason, a considerable portion of the government revenue is
percolating. The functioning of the intelligence wing of the department is to be
strengthened so as to enable them to minimize tax evasion, to detect bogus input tax
claim and to arrest smuggling of goods by railways, port and airways. At present
there is no audit visit and no audit assessment is taking place. The audit assessment
wing is the heart of the VAT system and hence this system is to be strengthened and
revitalized. Scrutiny of the return has not become effective due to lack of sufficient
expertise in computer system. In the absence of 100 per cent computerization, the
input tax credit available from various dealers cannot be checked easily. As the
dealers are not willing to pass on the benefit of input tax claim to the ultimate
customers, there is no chance to reduce the prices.
III. CONCLUSION
This paper has assessed the impact of the present taxation system of an Indian
State on various stake holders’ perspective. Despite the various drawbacks, the impact
of VAT on the tax officials has been tremendous in comparison to their performance
during the pre-VAT period. The enthusiasm to know the law in detail to fix the dealers
is notable. The tax evaders are booked in a more intelligent manner. Their working
talent has improved. Reading of judgments, amendments, circulars and notifications
has become a regular habit among many of the officers. The performance of the
official machinery is with reasonable wisdom, duty cautions, diligence and perfection,
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9. to a great extent. The frequent conferences and discussions among them have paid off
in a better way.
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