Annexure I

ACMA RECOMMENDATIONS ON VAT

ACMA RECOMMENDATIONS ON VAT ACMA welcomes the initiatives taken by the Government over the years to move towards a rational and simplified tax structure. The introduction of a single CENVAT rate of 16 percent recently, was another major step forward in this direction. This has brought in a fundamental rationalisation in the tax structure. Similar attempts have been made at the state level also and the effort has been to bring down the number of sales tax rates and to bring in more transparency into the system. The introduction of VAT from next year at the Central and state level , it is hoped, will bring about a dynamic change in the Tax structure. In this context, ACMA has the following suggestions to make: The first and the primary objective of VAT system should be to increase the competitiveness of Indian industry by removing the cascading effect of the various taxes and levies. As a corollary of the above, in order to improve competitiveness of the industry, the removal of the multiple taxes which is prevalent in the Indian tax system is absolutely essential. Thirdly, it should also ensure that all barriers to inter-state trade and commerce should be removed and a unified national market is created. The VAT system should also ensure that there is simplicity and transparency in the system. The approach to move towards a VAT regime should be consistent in structure and approach. Ensuring revenue neutrality should also be the primary objective of a VAT regime. As far as possible the mechanism should be self regulated. The scope of VAT should cover set-off for service tax. Lastly during the transitory period, there are bound to be some teething problems and adequate provisions need to be incorporated to ease over this phase. It is understood that states will be allowed by the Central Government to levy service tax on 25 types of local services.

1. NEED OF THE HOUR-AN INTEGRATED MARKET WITHOUT BARRIERS The large market of India has been fragmented by inter-state barriers which has often hampered the free flow of goods and services within the country and the competitiveness of Indian industry. It is therefore essential that while moving towards a VAT regime these issues are addressed and the operating procedures, specifically those relating to rate structure, classification of products, set-off mechanism and documentary procedures are uniform across all states. 2. HOW TO UNIFY ALL STATE TAXES & LEVIES Ideally, with the introduction of VAT, various state taxes & local levies such as sales tax, turnover tax, entry tax, octroi and any other taxes on sale/movement of goods should be abolished. However, we are disturbed to note that some state governments are contemplating to impose some other forms of taxes such as entry tax, luxury tax/special additional tax on selected products etc., in addition to the Revenue Neutral Rate. Such measures eventually render the entire VAT system futile. RECOMMENDATION ACMA recommends that with the introduction of a Revenue Neutral Rate (RNR) all other taxes should be abolished. Therefore, the move by some states to introduce other forms of taxes will go against the basic purpose of unification of taxes expected in a VAT regime. 3. WHAT SHOULD BE THE RATE OF VAT An uniform rate structure across the country helps in avoiding diversion of trade from one state to another, checks unhealthy competition and reduces tax evasion. It also helps the industry to plan long-term investment based on the large size of the Indian market, rather than setting up state specific units which may not be competitive due to sub-optimal size. RECOMMENDATION To begin with, the VAT rates could be a 2-slab structure. Besides the exceptional rates of 0 %, 1 % and 20 % for specified items, there should be a 4% rate on items of mass consumption . Merit goods, and all other items should be at Revenue Neutral Rate (RNR) which could vary between 10 and 12%. There is a need for a cap of 12% on RNR as any rate higher than this will not be an acceptable rate and may lead to tax evasion. 4. THE IMPORTANCE OF A COMMON CLASSIFICATION OF GOODS 3

It is of utmost importance that the product classification and description of individual products should also be aligned to the Harmonised System of Nomenclature(HSN). This will reduce litigation. The uniform classification of products across all states and union territories alongwith the Central taxes like Excise and Custom Duty would create favourable environment for growth of trade and industry. RECOMMENDATION ACMA would request the Government that classification of individual products and their description should be aligned to the Harmonised System of Nomenclature(HSN). 5. INCENTIVE SCHEMES AVAILABLE FOR INDIAN INDUSTRY There are basically two types of incentive schemes which the Indian industry has been enjoying. (a) Output Based Incentives: This again has two variants: a. Exemption from Sales Tax for a limited period of time, linked to the investment amount with a cap. This is a very popular measure. b. Deferment of the amount collected as Sales Tax over a specified period and repayment thereof to the State Government after expiry of the period. (b) Input Based Exemptions: The grant of exemptions from sales tax on inputs purchased within the State.

The above incentive schemes for Sales Tax should be suitably modified so that the companies who have invested in the States based on the promises made are not at a disadvantage. RECOMMENDATION ACMA would request the Government that the existing incentives which are available to Indian industry should be continued after the introduction of VAT. If discontinued, it will seriously affect the viability of the investment and adversely impact the countrys image as an investment destination. We would like to suggest the following two methods whereby the industry can continue to avail the sales tax incentives in the post VAT regime:

5a. TAX EXEMPTION ON OUTPUT CASES Input credit is availed by the Eligible Manufacturing Unit (EMU) and VAT is charged on the invoice while selling its output within the State. The gross amount of VAT collected is held by the EMU. At periodic intervals specified by the state government, an application will be submitted by the EMU giving details of VAT collected, the State Government would order "remission" of the amount so collected in adjustment against the incentive due to the EMU. Once the incentive limits are reached by the above process, the EMU would start remitting the VAT to the State Government. As it would be difficult to continue with input tax exemption after introduction of VAT, EMU earlier enjoying exemption of sales tax on inputs will have to pay VAT on inputs and claim set off. If credit on inputs is in excess of VAT on local sales, the excess credit should be refunded based on the periodical returns. In cases where input tax exemption have been given along with deferment on output, no set off of input tax should be there and input VAT should be refunded periodically. The treatment of incentives in the form of exemption /deferment of sales tax on output as well as input tax exemption in the VAT regime should be uniformly applicable to all states while honoring the commitment already made.

5b. ALTERNATIVE TO REFUNDS Since many refunds are kept pending for years due to paucity of funds,there should be some alternative to refunds. RECOMMENDATION The Central Government has over the years evolved a foolproof system of payments through the freely tradable Duty Entitlement Passbook scheme wherein an importer can buy this tradable instrument from the exporter and use this to pay the customs duty. It is therefore feasible to propose VAT entitlement certificates on the same lines whereby the state government, instead of refunding, issues such certificates, which can be sold to other taxpayers.

6. DENIAL OF INPUT TAX CREDIT ON INTERSTATE PURCHASE It is a fact that no industry can procure all its input materials from within the state where they are located. Further inter state trade is vibrant and free flow goods from one state to another contributes substantially to the economic activity in the country. Thus interstate transactions are a common occurrence. However it appears that the central sales tax (CST) paid on input sourced across the state border is not eligible for set off on the plea that the revenue flows to another state. Denial of input credit will affect industries severely, as it will increase the cost of production to the extent of input tax not allowed to be set off. Apart from the denial of input credit, it will also discriminate dealer of one state with that of another. ACMA believes, that this will encourage the customers of intermediate products to look for sources within their respective state as the effective sales tax (after set off) of such source is nil whereas the source across the border is costlier by 4% (rate of CST). This will have an adverse impact and may probably trigger the beginning of the end of the intermediate goods manufacturing in less developed states depending on the type of industry. RECOMMENDATION Denial of input credit will affect industries severely, as it will increase the cost of production to the extent of input tax not allowed to be set off. Apart from the denial of input credit, it will also discriminate dealer of one state with that of another. Hence, a mechanism should be developed for setting-off input tax credit on inter-state purchases 7. SET OFF CST PAYMENT THRU THE CLEARING HOUSE MECHANISM It is essential that a system should be introduced whereby CST paid in another state is allowed for set off. This is possible if a Clearing House mechanism is introduced to settle the CST paid in different states. It should be an independent body and not connected with centre or state and distribution should be on fortnightly basis. This mechanism will require that the tax collected by the exporting states is transferred to the importing states. In order to do this, the exporting state would have to transfer periodically the tax collected on inter-state transactions to the central pool and they will in turn distribute this amount to the various states in accordance with their respective imports. The proposed VAT design does not allow the set off of Input Sales Tax against the Output Tax simply because there is no sale during stock transfer. When the goods are sold in another state, revenues do not flow to the state in which the goods are manufactured and 6

hence set off will not be allowed. In other words, all goods transferred on stock transfer basis will be costlier to the extent of tax paid on inputs, which cannot be set off. This may be substantial since under VAT, effective rate of tax on inputs would increase considerably. Thus, there is strong possibility of goods under stock transfer becoming costlier under new VAT regime. RECOMMENDATION It is suggested that the tax may be imposed on stock transfers at the applicable VAT rate of 4% or RNR with the proviso for set off in the other states under a Clearing House mechanism. If CST is decreased over a period of time, the difference between VAT paid on local inputs and CST paid on the output within the same state would increase specially where ever inter-state exposure is high. There should be clear stipulation that tax paid on inter-state trade is allowed for set-off. The set-off mechanism of taxes under the VAT should be uniform in all states which will facilitate inter-state trade and reduce complexity. The documentation for set-off must be prescribed and should be in a standard format. It is important to ensure that basic requirements in the documentation such as registration number of the dealer, continuous serial number, specified copy for set-off claim etc, are listed to curb fraud and misuse.

8. TAX ON IMPORTS & EXPORTS All imported inputs used by industry for manufacture will ultimately attract VAT on the final product. Also imported goods sold as it is will be subject to VAT at the time of sale to consumer.

RECOMMENDATION Therefore, there should be no levy of import tax on imported goods. As a basic principle, exports should not have any type of tax to make the exported goods competitive in the international market. Therefore input credit should be allowed for VAT paid on the local purchases and excess credit should be refundable.