Taxes on Commodities and Services in India
Taxes on Commodities and Services in India
Estimating Revenue Potential of Harmonized Central and State Taxes
Mahesh C Purohit
Foundation for Public Economics and Policy Research
New Delhi-110052
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Taxes on Commodities and Services in India
Estimating Revenue Potential of Harmonized Central and State Taxes
(A Study Sponsored by the Twelfth Finance Commission)
Mahesh C Purohit
Foundation for Public Economics and Policy Research
133, SFS, Ashok Vihar-IV
New Delhi-110052
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Preface
The Foundation for Public Economics and Policy Research is an autonomous, non-profit organization whose major functions are to carry out research, undertake consultancy work, and conduct training in the area of public economics and policy.
The Foundation for Public Economics and Policy Research undertook this study, at the instance of the Twelfth Finance Commission of India. The objective of the study is to recommend a possible system of a Value Added Tax (VAT) for India, both in the short term as well as in the long-term.
The study draws upon the experiences of federal countries such as Brazil, Canada and also of the European Union. It presents the revenue implications of the introduction of value added tax at the state level, along with the Central VAT.
The study presents various options for the introduction of VAT in the long-term and also examines issues of vertical externality in exploiting the same base by the two tiers of government in a federal system. After considering the implications of both these aspects, it recommends, as a long-term solution, the introduction of a comprehensive State-VAT inclusive of CenVAT, sales taxes and service tax. Implications of such a proposal, on the devolution by the Twelfth Finance Commission, are also presented in the study.
The study is the result of the collective effort of the team of the staff members of the Institute. The Report was planned and guided by Mahesh C. Purohit, who also prepared the final draft of the study. Besides the faculty members of the Foundation, it had the assistance of senior administrators from the state finance department and also from the Central Board of Excise and Customs. We are greatly indebted to T.R Rustagi in revising chapter III, who took special pains in updating information relating to central taxes on commodities and services. Thanks are due to Vishnu Kanta who helped through out the work of the study and specially contributed in the drafting of chapters II and VI of the study. The team is deeply indebted to D.K. Srivastava for his suggestions during the course of discussions. Valuable suggestions received from G. C. Srivastava, D. N. Rao, M. N. Joshi, Brijesh Purohit, and K B L Mathur, are gratefully acknowledged. Mita Das provided excellent research assistance through out the tenure of this study.
The Governing Body of the Foundation does not bear any responsibility for the contents or views expressed in the report. The responsibility rests with the authors, in particular, the leader of the team
The Foundation is grateful to the Twelfth Finance Commission for entrusting and supporting this study.
New DelhiMahesh C Purohit
December 30, 2003Director
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Contents
ChapterPage
Prefacei
Executive Summaryvi
1.Introduction1
Objectives of the Study
Future Directions
Structure of the Report
2.Contribution of Taxes on Commodities and Services5
Trends and Composition of Total Tax Revenue
Trends in Taxes on Commodities & Services: Central Government
Trends in Taxes on Commodities & Services: State Governments
Factors Affecting Tax-GDP ratio
3.Central Taxes on Commodities and Services19
CenVAT
Structure of CenVAT
Administrative Controls under CenVAT
Obligations under CenVAT
Weaknesses of the System under CenVAT
Taxation of Services
Administration of Service Tax
Future Horizon
4.State Taxes on Commodities and Services41
SalesTax
State Excise
Motor Vehicles & Passengers & Goods Tax
Entertainment Tax
Electricity Duty
Octroi
Environmental Taxes
Service Tax
5.Experiences of VAT in Federal Countries65
Brazil
FederalVAT
State VAT
Harmonization of Inter-Regional Trade
Management of ICMS: Case Study of Sao Paulo
Fiscal Frontiers
Canada
Federal VAT
Provincial/Retail Sales Tax (RST) and VAT
Harmonization of Taxes
Administration of Federal VAT
The European Union
Origin Principle
Destination Principle
Lessons for India
6.Options for VAT in India84
Introduction
Types of VAT
Origin or Destination Based VAT
VATOptions
CentralVAT
DualVAT
State VAT
7.Proposed Harmonized VAT in India92
Dual VAT in the Short Run
Comprehensive State VAT – The Long Term Goal
References129
List of Tables
Table NoPage
2.1Tax-GDP Ratio 14
2.2Tax Revenue: Centre and States (Combined)15
2.3 Taxes on Commodities & Services: Central Government16
2.4 Taxes on Commodities and Services: State Governments 17
2.5 Buoyancy: Total Tax Revenue, Direct Tax, Indirect Tax 18
3.1 Rates under CenVAT 34
3.2 List of Items Subjected to 16% Special Excise Duty36
3.3 List of Services Presently Being Taxed37
3.4 Trends in Revenue from Services39
4.1 Rate Slabs of Sales Tax in Different States53
4.2 Concessional Rate of Sales Tax on Inputs in Indian States54
4.3 Rates of Surcharge and Additional Sales Tax in Indian States55
4.4 Rate Structure of State Excise Duty in Indian States (2001-02)56
4.5 Motor Vehicles Tax on Personal Vehicles57
4.6 Motor Vehicles Tax on Commercial Passenger Vehicles59
4.7 Motor Vehicles Tax on Goods Vehicles for Transportation61
4.8 MajorStates and Local Taxes on Road Transport Industry63
4.9 Tax Burden on Heavy Passenger and Goods Vehicles63
4.10 Rates of Other Taxes in Indian States (2001-02) 64
5.1 List of VAT Rates Applied in the MSs of European Union 83
7.1Estimating VAT Base (for the year 2001-02) RE – Scenario I 115
7.2Estimating VAT Base (for the year 2001-02) RE – Scenario II 117
7.3Estimating VAT Base (for the year 2001-02) RE – Scenario III 119
7.4Concessional rate of Sales Tax on Inputs in Indian States 121
7.5Trade Margins under VAT 122
7.6Concessional Rates Under CST in Different States of India123
7.7Items to be brought under Sumptuary Excise under UEDs 126
List of Exhibits
Exhibits NoPage
3.1 Monthly Return under rule 7 of the CenVAT Credit Rules, 200240
7.1 Steps in Estimating Revenue Implications for Introduction of VAT 97
List of Annexures
7.1: Vertical Externality: Issues in Taxation of the same base by Central and
State Governments 112
7.2 Union List and State List 127
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Executive Summary
Introduction
In recent years, the fiscal system has undergone revolutionary changes, especially in the field of taxation. In general, in the arena of direct taxes, the peak rates as well as the number of tax slabs have been reduced. Exemptions have also been curtailed. In indirect taxes, the most remarkable phenomenon has been the introduction of VAT.
Efforts have been made to introduce VAT in India. Here the administration of union excise duties (UED) rests with the centre, while that of sales tax is with the states. India’s federal structure and this dichotomy in the distribution of tax powers, between the centre and the states, have made it very difficult to introduce a European style harmonized VAT system. As a result, India will now have a system of dual VAT where UED is to be converted into a central VAT and the sales tax into State-VAT.
Despite the centre’s policy decision of imposing a dual VAT system in the country, it has so far not been able to introduce state-VAT, although the CenVAT has come into existence. One of the reasons for this is the lack of information about revenue implications of having this system at the state level. The states apprehend a loss of revenue on introduction of VAT. Given the existing precarious financial position of the states, they want to ensure that the centre or the Finance Commission would compensate the loss of revenue, at least during the transitional period. To take care of this aspect, this study analyses the revenue implications of introducing a dual VAT in the country.
As a long-term solution, the study recommends introduction of a comprehensive State-VAT. This entails that the centre withdraws from the field of domestic trade taxes from the point of view of revenue and the states levy VAT designed on the destination principle.
Contribution of Taxes on Commodities and Services
Tax-GDP ratio in India is low in comparison to not only the developed countries but also many developing countries. It was 13.8% in 1980-81, increased to 15.8% in 1990-91 but came down to 14.8% in 2001-02. Taxes on commodities and services have an important role in the over all fiscal system. These contributed 76.2% of the total tax revenue in the country, with a growth rate of 13.8%. The buoyancy over the years was 1.02. Union excise duty contributed approximately 64% in 1980-81 to the central kitty, but its share over the years came down. It was 59% in 2001-02. At the state level, sales taxes contributed approximately 62% of the states’ own tax revenue in 2001-02.
The tax-GDP ratio in India is low due to various factors including non-taxation of agriculture and service sectors. Lack of adequate tax compliance, resulting in considerable evasion of tax, has also been responsible for this low ratio. In recent years there has been decline in the tax-GDP ratio due to tax reforms in consonance with structural reforms and the adoption of liberalization. An analysis of the causal variables responsible for this decline points out that reduction in the rates of customs duty, conversion of UED from the production type VAT to consumption type VAT and the global recession are some of the plausible factors that adversely affected the tax-GDP ratio in the nineties.
Central Taxes on Commodities and Services
Union excise duty is the most important domestic trade tax levied on the manufacturer by the central government. It is known as CenVAT and the general tax rate is 16% although some items are taxed at 8% and 10% respectively. In addition, the central government levies special excises on some commodities at the rate of 8%. Some other excises are also levied to fulfill certain specific objectives.
Since 1994, under the residuary entry of the Constitution, the central government is levying a tax on services as well. Initially, the tax was levied only on a few services, but over the years the scope has been enlarged to cover as many as 58 services.
Levy of Commodity Taxes by the States
States levy many taxes on commodities and services. These include sales tax, state excise, motor vehicles tax, passengers & goods tax, electricity duty etc. Sales tax is the most important tax and yields approximately 60% of the states own tax revenue.
Most of the states levy this tax on the first-point of sale. Only Punjab and Delhi follow the last-point system for many commodities. In addition to general sales tax, many of the states levy a turnover tax, surcharge and additional sales tax. Some of the states also levy an entry tax on the goods being imported into the state. A luxury tax is also levied by some of the states on the consumption of goods imported into the state.
Haryana is the only state that has introduced value added tax (VAT) in place of sales tax from April 2003. As no other state has so far introduced VAT, the Haryana state government has retained the existing rates of sales tax and the CST.
Experiences of VAT in Federal Countries
VAT has been introduced in federal countries like Brazil, Canada and the European Union (EU). A study of the fiscal system in these countries indicates that it is possible for India to have a dual VAT as in Brazil and Canada. Even a system of a full fledged state VAT, like that in the EU, has its advantages. Most important aspect in the introduction of VAT in a federal country is to have a harmonized system of interstate transactions. Brazilian State VAT (ICMS) follows the system of origin- based tax. However, the importing state gives set-off for the tax paid by the dealer in the exporting state. In addition, the differential rate for taxing interstate transactions works as an equalizing mechanism in a Brazilian federation. Canada and the EU follow the system of zero-rating of input tax. Also, the Canadian system of harmonized sales tax (HST) suggests that the State VAT could be coordinated with the federal VAT while the system of Quebec Sales Tax (QST) indicates that the same be administered by the states.
Options for VAT in Indian Federation
Various models of VAT in federal countries indicate that the design of the tax should be a destination based consumption type VAT. Most unitary form of governments levy a central VAT. Some of the federal countries too have adopted this form. However, in recent years some schools of thought have recommended a dual VAT or a State-VAT. In the Indian conditions of dichotomy of tax authority between central and state governments, some experts have recommended that dual VAT would be the best form of VAT. Others, however, feel that the state VAT should be best adopted to take care of tax assignment and vertical tax externality.
Proposed Harmonized VAT in India
In the short-run it is useful to follow a system of dual VAT in India. This implies that the union excise duty (UED) is converted into a Central VAT (CenVAT) and the state’s sales tax is replaced by a state-VAT. While the central government has already replaced UED by CenVAT, the states have not converted their sales tax into a system of VAT apprehensive that it will drastically lower revenue collections.
The empirical estimates reveal that if state-VAT replaces sales tax, the states would lose considerable revenue since CST has to be made destination based in order to make India a common market. Also, loss due to input credit would not be compensated unless the states are given the power to tax services. The Twelfth Finance Commission (TFC) has to take into account the revenue implications of implementing VAT while making its recommendations.
In the long-term, it is important to take care of vertical imbalance in taxing powers of the federal and state governments plus vertical tax externality of taxing the same tax base by the two governments. Keeping both these aspects in view, it is important that the two important commodity taxes, viz, UED and sales tax, are harmonized to have one comprehensive destination based state-VAT. This would require a levy of sumptuary excise by the Central government to enable it to perform its allocative and distributive roles. Also, the TFC has to allocate revenue from UED on the basis of collection to enable the states to provide set-off of UED from the state VAT.
RestructuringState Finances
In addition, the states must restructure their taxes on commodities and services such that most of these can be converted into one comprehensive state VAT. This includes passengers and goods tax, electricity duty, tax on entertainment, amusements and the luxury tax on hotels. By doing so, India would finally have a broad-based and economically rational indirect tax system to make it a common market.
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1
Introduction
In recent years the fiscal system has under gone revolutionary changes, especially in the field of taxation. Most of the developing countries have reformed their tax systems by reducing the number of rates as well as exemptions. The tax base has been enlarged and value added tax (VAT) has been introduced to replace the other cascade type commodity taxes. The trend has been towards simplification and rationalization.
In India, reforms have been initiated on the basis of recommendations of various Committees and Study Groups. The Report of the Indirect Taxation Enquiry Committee (1978), chaired by L K Jha, is the first Report that puts forth a most exhaustive study on indirect taxation in India. It recommended introduction of manufacturers’ value added tax (ManVAT) in the union excise duties.In the changed economic scenario of globalization and structural reforms, sound advice on tax reforms to enable India to compete globally was given by the Report of the Tax Reforms Committee (1991-92), chaired by R. J. Chelliah. For the Tenth Five Year Plan, the Advisory Group on Tax Policy and Tax Administration for the Tenth Plan, chaired by Parthosharthi Shome (2001), has recommended further reforms. Path-breaking recommendations have been presented in two separate Reports of the Task Forces on Direct and Indirect Taxes (2002), chaired by Vijay Kelkar, for modernizing tax administration and reducing the transaction cost of taxpayers.
Drawing upon the recommendations of the Jha Committee, India made a beginning towards reforms in 1986, by initiating modified value added tax (ModVAT) in the union excise duties. This has since been converted into a central value added tax (CenVAT).
India being a federal country, the Constitution of India provides for division of tax powers between the Centre and the States, under the Centre List and the States Lists (of the Seventh Schedule), respectively. Any reform in the tax system would have to be attempted under the constraints of these Lists. As the union excise duty falls in the Central List and the sales taxes in the State List, introduction of a comprehensive VAT in India faces some constraints.