82256758 value added tax syatem

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VALUE ADDED TAX SYSTEM

(A study with reference to Thiruvallur District, Tamil Nadu, India).

A dissertation work submitted to the Pondicherry University in

partial fulfillment of the requirement for the degree of

MASTER OF PHILOSOPHY

(COMMERCE)

By

A. HARIKUMAR(Register No. 2100705)

Under the guidance of

Thiru.S.ARAVANAN,

ASSISTANT PROFESSOR (SG).

DEPARTMENT OF COMMERCESCHOOL OF MANAGEMENT

PONDICHERRY UNIVERSITYKalapet, Puducherry-14

NOVEMBER-2011


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S.ARAVANAN,

Assistant Professor (SG),Department of commerce,

School of Management,

Pondicherry University,Puducherry-14.

CERTIFICATE OF THE SUPERVISOR

This is to certify that the dissertation entitled VALUE ADDED TAX

SYSTEM(a study with reference to Thiruvallur District, Tamil Nadu,

India) is a bonafide record of research work done by Mr. A.HARI KUMAR

and submitted for the award of the degree of Master of Philosophy in

Commerce of Pondicherry University. The dissertation is a record of

independent research work undertaken by him under my supervision and

guidance and that it has not previously formed the basis for the award of any

degree, diploma, associateship, fellowship or any other similar title of this or

any other university.

Place: Puducherry Supervisor

Date:

Forwarded

Dean Head of Dept

School of management Department of commerce


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Mr. A.HARI KUMAR,

M.Phil Scholar in commerce,Department of commerce,

School of Management,

Pondicherry University,Puducherry-14.

DECLARATION

I hereby declare that the dissertation entitled VALUE ADDED TAX

SYSTEM(a study with reference to Thiruvallur District, Tamil Nadu, India),

submitted by me for the award of the Degree of Master of Philosophy in

Commerce is a record of original research work done by me under the

supervision and guidance of Thiru S.ARAVANAN,(Assistant Professor SG)

and that the dissertation has not previously formed the basis for award of any

degree, diploma, associateship, or any other similar title.

Place: Puducherry

Date: (A.HARIKUMAR)


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ACKNOWLEDGEMENT

I extend my heart full gratitude to the Almighty for his blessings showered on me to

complete this piece of work.

I express my wholehearted thanks to Dr.M.Ramadoss, Dean, School of Management,

and director of studies, Pondicherry University.

It is from my heart that I express my deep and sincere thanks to my guide and

supervisor Thiru. S. Aravanan, Assistant professor (SG) in Department of Commerce,

Pondicherry University who inspired me a lot while doing my dissertation. Without his

advice, guidance and supervision, I would not have submitted this research work in time; no

words are there to express my gratitude to my guide. I am really very proud to have a guide

like him.

I also express my gratitude to Dr. Malabika Deo, Professor and Head Department of

Commerce, Pondicherry University for her encouragement and support for doing M.Phil

research work.

I am extremely happy to extend my sincere thanks Dr.P.Palanichamy Professor in

Department of Commerce, Pondicherry University for his encouragement and valuable

suggestions.

I thank Dr.P.Natarajan, Professor, Department of Commerce, Pondicherry University

for his inspiration.

I thank Dr. Dr. G. Shanmugasundaram, Associate Professor, Department of

Commerce, Pondicherry University.

I thank Dr. D. Lazar, Associate Professor, Department of Commerce, Pondicherry

University.

My thanks to Mr. Nidheesh, Assistant professor, Department of Commerce,

Pondicherry University for his guidance.

I thank Dr. P.S. Velmurugan, Assistant professor, Department of Commerce,

Pondicherry University.


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I thank Dr. S. Shijin, Assistant professor, Department of Commerce, Pondicherry

University.

I thank to Mr A.N.Veerasalingam Assistant Commissioner of Commercial Tax

Department.

My sincere thanks to Mr.Lakshmipathy Aassistant Commissioner of Commercial Tax

Department.

And I thank Mr.Nandhagopal, M/s.Renu and Mr.Maduraipandian the superintendents

of Commercial Tax Department.

I also thank all my friends and co-researchers who helped me a lot academically. I

owe thanks to teaching and non-teaching staff of Pondicherry University. Especially non

teaching staff members of Department of Commerce, Pondicherry University.

Last, but not least, I thank all those friends who helped me either directly or indirectly

in the successful completion my research work. I am greatly indebted to all these persons.

Place: Puducherry

Date : A.HARI KUMAR


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i

CONTENTS

CHAPTERS Particulars Page No

I INTRODUCTION AND DESIGN OF

THE STUDY

1-10

II REVIEW OF LITERATURE 11-24

III THEORETICAL FRAMEWORKABOUT VAT

25-46

IV ANALYSIS AND

INTERPRETATIONS

47-87

V SUMMARY, FINDINGS AND

CONCLUSIONS

88-94

BIBLIOGRAPHY 95-97

ANNEXURE 98-108


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ii

LIST OF TABLES

Sl. No. Particulars Page No.

VAT Payers Demographic Vari ables

4.1 Gender 47

4.2 Age Group 48

4.3 Marital Status 49

4.4 Educational Qualifications 50

4.5 Type of Business 51

4.6 Annual Turnover 52

4.7 Respondents Business Age 53

VAT Off icial s Demographic Variables

4.8 Gender Status 54

4.9 Age Group 55

4.10Marital Status

56

4.11 Education Level 57

4.12 Respondents Designation 58

4.13 Income 59

Factor Analysis Of VAT Of fi cials

4.14(a) KMO and Bartlett's Test 60

4.14(b) Total Variance Explained 60

4.14(c) Rotated Component Matrix 62

4.14(d) List of factors 64

Factor Analysis Of VAT Payers

4.15(a) KMO and Bartlett's Test 66

4.15(b) Total Variance Explained 66

4.15(c) Rotated Component Matrix 68


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4.15(d) List of Factors 68

Cross tabulation results Relati ng To VAT Payers

4.16 Gender * Work Burden 69

4.17 Education * Work Burden 70

4.18 Business * Work Burden 71

4.19 Turnover * Work Burden 71

4.20 Turnover * Incidence 72

4.21 Age of Business * Incidence 72

4.22 Education * Rate Knowledge 73

Cross tabulation results Relating To VAT Off icial s

4.23 Gender * Work Burden 74

4.24 Designation * Work Burden 74

4.25 Age Group * Work Burden 75

One Way ANOVA Relating VAT Payers

4.26 Age of Business and Work burden 75

4.27 Education and Awareness of Exemptions 76

4.28 Registration and Incidence of Tax 76

4.29 Turnover and Convenience to pay tax 77

4.30 Age and business and Tax evasion 77

4.31 Turnover and Tax avoidance 78

One Way ANOVA Relating VAT Of fi cials

4.32 Education and Work burden 78

4.33 Designation and Registration 79

Results of Correlation

4.34(a)Commercial Tax Department Gross Receipts

79

4.34(b) Correlations 80


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Resul t of Paired t-Test

4.35(a) Total Revenue of the Government 80

4.35(b) Paired samples statistics 80

4.35(c) Paired samples test 81

VAT officials opinion

4.36 knowledge of VAT rates 81

4.37 VAT or TNGST continue in Tamil Nadu 82

4.38 Awareness of proposed GST 82

4.39 Assistant from VAT consultant 82

4.40 Registration 83

VAT payers opinion

4.41 System to continue in Tamil Nadu 83

Revenue coll ection under VAT

4.42 Commercial Tax Department Gross Receipts (Amount in Crores) 86



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LIST OF FIGURES

Sl. No. Particulars Page No.

VAT Payers Demographic Variables

4.1 Gender 47

4.2 Age Group 48

4.3 Marital Status 49

4.4 Educational Qualifications 50

4.5 Type of Business 51

4.6 Annual Turnover 52

4.7 Respondents Business Age 53

VAT Off icial s Demographic Variables

4.8 Gender Status 54

4.9 Age Group 55

4.10Marital Status

56

4.11 Education Level 57

4.12 Income 58

4.13 Respondents Designation 59

Result of Factor analysis

4.14 Scree plot of VAT officials 62

4.15 Scree plot of VAT payers 67

Revenue coll ection under VAT




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1

CHAPTER I

INTRODUCTION AND DESIGN OF THE STUDY

1.1 Introduction:

A tax is a back bone of every country to meet their social obligations. Without tax

the government cannot do any social benefit activities. Government is the only person to levy

tax. Hence tax is compulsory payment or contribution by the people to the government for

which there is no direct return to the tax payers. Tax imposes a personal obligation on the

people to pay the tax if they are liable to pay it. The general public should be taxed according

to their ability to pay, and the people in the same financial position should be taxed in the

same way without any discrimination(1)

.

Tax can be defined as an involuntary fee or more precisely, unrequited payment,

paid by the individuals or businesses to a government (central or local).Taxes may be paid in

cash or kind (although payments in kind may not always be allowed or classified as taxes in

all systems). The means of taxation, and the uses to which the funds raised through taxation

should be put, are a matter of hot dispute in politics and economics, so discussions of taxationare frequently tendentious. A good tax system should not affect the ability and willingness of

the people to work, save and invest. If not, it will affect the development of trade and industry

and the economy as a whole. Thus, a sound tax system should contribute to the economic

development of a country. Hence taxation should not be like killing the goose that lays

golden eggs.

Indirect taxes are those taxes which have their primary burden or impact on a single

person. But that person succeeds in shifting his burden to others. In other words, an indirect

tax is imposed on one person but is paid partly or wholly by another. Indirect taxes are shifted

and the incidence of these taxes fall on persons other than the original payers. Commodity

taxes or sales tax, excise duties, customs duties etc, may be grouped as indirect taxes.

The Objectives of taxation are:

Main objectives

i. Generation of revenue

ii.

Maintenance of welfare state


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iii. Prevention of concentration of economic power

iv. Re-distribution of wealth for the common good.

Subsidiary objectives

i. Accelerate saving and thereby investment

ii. Repaid economic development

iii. Generation of employment.

1.2 Evolution of VAT

Origin: Sales Tax began in India with petrol tax introduced by the government of

Madhya Pradesh. During the British rule, arrack and toddy shops were functioning in Madras

Presidency. Following the Madhya Pradesh petrol tax, Madras Presidency introduced

Sales Tax in 1939. During the year 1939, the Government of Madras Presidency earned 8

crore rupees as revenue from the arrack and toddy shops. The Govt. was interested in

removing the liquor shops and compensate the loss of revenue by levying sales tax. Sales tax

initiated in Tamil Nadu has been levied throughout India. The Tamil Nadu General Sales Tax

Act was enacted in 1959and it is called TNGST Act 1959. Its purpose is to enable the govt.

levy sales and purchase tax with in Tamil Nadu. TNGST is replaced by VAT from the year

2007.Value Added Tax (VAT) is a general consumption tax assessed on the value added to

goods and services. It is a general tax that applies, in principle, to all commercial activities

involving the production and distribution of goods and the provision of services. It is a

consumption tax because it is borne ultimately by the final consumer. It is not a charge on

companies. It is charged as a percentage of prices, which means that the actual tax burden is

visible at each stage in the production and distribution chain. It is collected fractionally, via a

system of deductions whereby taxable persons can deduct from their VAT liability the

amount of tax they have paid to other taxable persons on purchases for their business

activities. This mechanism ensures that the tax is neutral regardless of how many transactions

are involved. In other words, it is a multi-stage tax, levied only on value added at each stage

in the chain of production of goods and services with the provision of a set-off for the tax

paid at earlier stages in the chain. The objective is to avoid 'cascading', which can have a

snowballing effect on prices. It is assumed that due to cross-checking in a multi-staged tax;

tax evasion will be checked, resulting in higher revenues to the government. Over 130


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countries worldwide have introduced VAT over the past three decades and India is amongst

the last few to introduce it.

In the present work study of Value Added Tax with reference to Thiruvallur District,

Tamil Nadu, India has been undertaken.

1.3 Scope of the study

This present study concentrates on the level of work burden of business concerns,

VAT officials and VAT consultants in Thiruvallur District in Tamil Nadu only. This study

also tries to prove whether the revenue derived from the VAT is more compared to other tax

systems like TNGST. For the purpose data has been proposed to be collected from both the

sources of primary and secondary. For the purpose of primary data suitable questionnaire has

been circulated to the respondents in Thiruvallur District. The data are collected from

Commercial Tax Offices, Tax consultancy offices and various shops i.e. VAT payers in

Thiruvallur District in Tamil Nadu. Secondary data are collected from Tamil Nadu Statistical

Reports 2010-11. The collected data are to be analysed using appropriate statistical tools.

1.4 Significance of the Study

The present study tries to focus on a elaborate explanation about the Value Added Tax

in Tamil Nadu.

This study also attempts to focus on the level of Work burden of VAT officials, VAT

consultants and VAT payers.

The growth of revenue appreciation of the Tamil Nadu State Government also has

been focused in this study.

Though many number of research studies have been undertaken in the area of Value

Added Tax system; only few researchers have done their research in Tamil Nadu

jurisdiction.

1.5 Objectives of the Study

To study about value added tax system in general.

To study the profile of VAT payers and VAT administrators.

To examine the influence of various factors on the work burden of VAT officials.


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To examine the influence of various factors on VAT compliance by VAT payers.

To examine whether value added tax system helps to revenue appreciation to the

government compared to other tax systems like TNGST and finally

To find whether VAT system is convenient to the VAT administrators as well as the

VAT payers.

1.6 Methodology

1.6.1 Research Design

The research problem having been formulated in clear cut terms, the researcher will

be required to prepare a research design, i.e., he will have to state the conceptual structure

within which research would be conducted. The preparation of such a design facilitates

research to be as efficient as possible yielding maximal information. In other words, the

function of research design is to provide for the collection of relevant evidence with minimal

expenditure of effort, time and money. But how all these can be achieved depends mainly on

the research purpose. Research purposes may be grouped into four categories, viz., (i)

Exploration, (ii) Description, (iii) Diagnosis, and (iv) Experimentation. A flexible research

design which provides opportunity for considering many different aspects of a problem is

considered appropriate if the purpose of the research study is that of exploration. But whenthe purpose happens to be an accurate description of a situation or of an association between

variables, the suitable design will be one that minimizes bias and maximizes the reliability of

the data collected and analyzed.

1.6.2 Sampling Method

The method followed for selection of sample respondents is convenient cum

judgement sampling. Sample respondents for VAT payers Groups are selected from the areas

of Ponneri, Kavarai Pettai and Gummudi Poondi of Thiruvallur District. Similarly Sample

respondents for VAT officials and Consultants Groups are selected from the areas of Ponneri,

Thiruvallur and some parts of Chennai which comes under jurisdiction of Thiruvallur

District. Respondents from each area are selected on convenient cum judgement basis. Thus

totally 260 respondents are selected, out of while 130 are in the VAT payers group and the

remaining 130 from the VAT officials and consultants.


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1.6.3 Study Area

The area of study is Commercial Tax Offices, Tax consultancy offices and various

shops in Thiruvallur district in Tamil Nadu.

1.6.4 Data Collection Procedure

For every qualitative study, data on the background and historical context are

gathered. This may not be a major part of data collection but at least, in proposing a particular

setting, the researcher gathers demographic data and describes geographic and historical

particulars. Primary data will be collected through well designed questionnaire (five point-

likert scale from strongly agree to strongly disagree) from VAT payers and VAT officials in

Thiruvallur Dist at Tamil Nadu. Both primary and secondary data are used in the work.

1.6.5 Primary data

The researcher has used questionnaire as a tool for collecting primary data. The

researcher has formulated a questionnaire consisting of 30 questions for VAT payers and 45

questions for VAT consultants and VAT officials and distributed among the 260 respondents.

The specimen questionnaire are given an appendix I and II.

The questionnaire of VAT payers consists of 30 questions, among them the first 9

questions are on demographic base of the respondents. The remaining 21 questions were

formed with a view that the responses fall under the following classification:

1. Assertion, 2.Awareness, 3.Personalized and 4.Opinions.

The questionnaire of VAT consultants and officials consists of 45 questions, out the

45; first 7 questions are on demographic base of the respondents. The remaining 38 questions

are formed with a view that the responses fall under the following classification:

1.Assertion, 2.Awareness, 3.Personalized and 4.Opinions.

1.6.6 Secondary Data

The Secondary data for this purpose were collected from various journals, books,

professional magazines, annual reports, statistical report and past records. In this study the

secondary data were collected for the purpose of analysing the revenue receipts of the Tamil

Nadu Government from the Tamil Nadu statistical report.


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1.7 Tools Used for Analyses:

1.7.1 SPSS Package

The abbreviation SPSS stands for Statistical Package for the Social Sciences and is a

comprehensive system for analysing data. SPSS package consists of a set of software tools

for data entry, data management, statistical analysis and presentation. SPSS is a very

powerful and user friendly program for statistical analyses. SPSS can take data from almost

any type of file and use them to generate tabulated reports, charts, and plots of distribution

and trends, descriptive statistics, and complex statistical analysis. Anyone with a basic

knowledge of statistics can easily learn how to run very complicated analysis in SPSS with a

simple click of the mouse. SPSS 16.0 version is used in this research for analysing the

datum(2)

.

1.7.2 Chi square Test

Chi-square is one of the very popular methods for testing hypothesis on discrete data.

The discrete data can be nominal or ordinal. Finding descriptive statistics for such data is

meaningless. The only summary statistics useful for such data are frequencies and

percentages. Contingency tables along with some chi-square statistics are used in such kind

of data. There are three different types of chi-square analysis:

1.

Chi-square test for goodness of fit.

2. Chi-square test for homogeneity.

3. Chi-square test of independence.

The chi-square test for goodness of fit determines if the sample under investigation

has been drawn from a population, which follows some specified distribution, while the test

for homogeneity investigates the issue whether several population are homogeneous with

respect to particular characteristic. The Chi-square test of independence is used to test the

hypothesis that two categorical variables are independent of each other. In this research the

researcher used the Chi-square test of independence.

The formula is

22 ( )O E

E

Where

O = the frequencies Observed

E = the frequencies Expected


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= the sum of

2 = Chi-square value.

1.7.3 Analysis of Variance (ANOVA)

ANOVA or analysis of variance is used to compare the means of more than two

populations. It uncovers the main and interaction effects of classification or independent

variables on one or more dependent variables. ANOVA has found extensive application in

psychological research using experimental data.

The formula for calculating F test is

2

2

B

w

S

F S

Where

F = Ratio of Variance (F Value)

2

BS = between group variance

2

wS = within group variance

1.7.4 Correlation

Correlation is a technique which measures the strength of association between two

variables. Both the variablesXand Ymay be random or may be that one variable is

independent (non-random) and the other to be correlated are dependent. When the changes in

one variable appear to be linked with the changes in the other variable, the two variables are

said to be correlated. When the two variables are meaningfully related and both increase or

both decrease simultaneously, then the correlation is termed as positive. If increase in any one

variable is associated with decrease in the other variable, the correlation is termed as negative

or inverse. Suppose marks in Mathematics are denoted byXand marks are Statistics are

denoted by Y. If small values ofXappear with small values of Yand large values ofXcome

with large values of Y, then correlation is said to be positive. On the other hand, a small value

ofXappears with large values of Y. It is a case of negative correlation. Where there are two

or more than two independent variables, the analysis concerning relationship is known as

multiple correlations. It has wide application in business and statistics(3)

.


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1.7.5 Dependent (paired) samples t-Tests

In case of independent samples test for testing the difference between means, it is

assumed that the observations on one sample are not dependent on the other. However, this

assumption limits the scope of analysis as in many cases the study has to be done on the same

set of elements to control some of the sample specific extraneous factors. Such experiments

where the observations are made on the same sample at two different times, is called

dependent or paired sample t-Test.

Where,

d = Difference between Matched Scores

N = Number of pairsof scores

1.7.6 Factor Analysis

Factor analysis is by far the most often used multivariate technique of research

studies, especially pertaining to social and behavioural sciences. Factor analysis, thus, seeks

to resolve a large set of measured variables in terms of relatively few categories, known as

factors. This technique allows the researcher to group variables into factors (based on

correlation between variables) and the factors so derived may be treated as new variables and

their value derived by summing the values of the original variables which have been grouped

into the factor (4).

Formula for factor analysis:

Y = X+ E

Where

Y= matrix of measured variables

X= matrix of common factors

=matrix of weights (factor loading)

E = matrix of unique factors, error variation.


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1.8 Limitations of the Study

The study concentrates in Thiruvallur district of Tamil Nadu only.

The period of the study is only six months.

The study is based on the respondents opinion which is based on their attitude, the

attitude may change.

The improper opinion of the respondents may also affect the nature of the results.

The respondents felt unwilling in answering some of the questions as they feel that the

opinion would turn against them.

1.9 Chapterization:

This study comprises of five chapters.

Chapter I: Deals with introduction, scope of the study, objectives of the study,

methodology of the study and limitation of study.

Chapter II: Presents the review of literature relating to the study.

Chapter III: Gives a theoretical framework about Value Added Tax system and its

explanation.

Chapter IV: Represents the detailed Analysis of the primary and secondary data and

interpretation with statistical calculations.

Chapter V: Presents main findings of the study, suggestions and conclusion of the

study.


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REFERENCES:

1. V.Balachandran Indirect Taxation, Sultan Chand Publications, New Delhi-02, 10th

EDITION, 2005.

2. Ajai S.Gaur and Sanjaya S.Gaur Statistical Methods For Practice and Research(A

Guide to data analysis using SPSS), Response Book, Business Books from SAGE

Publications Ltd, New Delhi-110 044.

3. http://www.emathzone.com/tutorials/basic-statistics/correlation.html

4. C.R.Kothari Research Methodology (Methods and Techniques), Wiley Eastern Ltd,

New Age International Ltd, New Delhi-110 002, Second Edition, 1994.


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CHAPTER II

REVIEW OF LITERATURE

Review of Literature

Introduction

Tax is a back bone of every country. It plays an important role in countries

developmental activities. Many researchers in the past had taken up various studies relating to

the value added tax in India and elsewhere in other parts of the world. This chapter reviews

various literatures relating to value added tax.

Need for review of literature

First review of literature demonstrates knowledge about the field. This means more

than reporting what the researcher is reading and understanding, the researcher needs

to read it critically and to write in such a way that shows the researcher has a feel for

the area and also know what the most important issues are and their relevance to his

work.

It justifies the reason about research. This is closely connected with demonstrating

what the researcher knows about the field. It is the knowledge of research field which

allows identifying the gap which the research could fill.

Finally it allows establishing the theoretical framework and methodological focus

even if the researcher is proposing a new theory or a new method. (www.uq.edu.au)

Now review of a few related works is given below:

Roberto Steiner and Carolina Soto, (1994),(1) TAX EVASION AND ELUSION

OF VALUE ADDED TAX IN COLOMBI A-They examine the three aspects to the value

added tax in Columbia. Fist they show that although the VATs productivity is at an

acceptable level according to international standards, it has recently been declining. Second,

they estimate tax evasion and elusion for 1994. Their results indicate that the international

VAT evasion rate is 32.6%, whereas the total evasion of the tax is 28.1%. Assuming that

there were neither evasion nor exemptions, the VAT rate that would generate the same

amount actually collected in 1994, would be 4.9%, compared to the actual general rate of


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14%. Finally, they verify if the tax is really as regressive as theory suggests, employing an

annual time frame analysis, also for 1994. According to the actual expenditure structure and

taking into account exemptions and excises, they conclude that the VAT is slightly

progressive, although its progressivity is not monotonic throughout income deciles.

However, as households are ordered by deciles on a consumption basis instead of an income

basis, the tax becomes clearly progressive.

Arindam Das Gupta and Ira N. Gang, (1996),(2)

VALUE ADDED TAX

EVASION, AUDI TING AND TRANSACTIONS MATCHI NG-They examined the impact

of enforcement on the revenue effectiveness and efficiency consequences of the VAT.

Transactions matching are shown to have very different effects from auditing: Even when

auditing alone is unable to induce non-zero taxpayer reports, and regardless of the expected

success rate in auditing of the tax administration, sufficiently intensive cross matching can

induce truthful reporting. On the other hand, matching leads to distorted purchase and sales

transactions. It can also distort input use and output decisions even if auditing alone has no

adverse effects. In the model, conditions under which the VAT leaves input prices

undistorted are found and the content of the often made claim, that a VAT is self-enforcing, is

explored. The ability of the tax administration to enforce compliance with the VAT is shown

to be sensitive to the knowledge that the tax administration has about the production

technology.

Laszlo Goerke, (1999),(3)

VALUE-ADDED TAX VERSUS SOCIAL SECURITY

CONTRIBUTIONS-It is a discussion paper in order to alleviate unemployment it is often

recommended to reduce social security contributions (SSC) and to compensate for the

ensuing loss in revenues by a rise in the value-added tax (VAT). Assuming unemployment to

be caused by efficiency wages, it is shown that a balanced-budget shift from a payroll tax to a

VAT will increase employment if the rise in the VAT does not alter consumer prices. If the

effects of a shift from SSC to the VAT on the worker's effort are neutralized, for example, by

imposing a constant wedge, the employment impact will depend on the nature of the

unemployment compensation system.

Michael Keen and Jack Mintz, (2000),(4)

THE OPTIMAL THRESHOLD FOR A

VALUE-ADDED TAX-They develop a simple rule characterizing the optimal threshold in

terms of a trade-off between tax revenues and collection costs. It then considers, in principle

and by simulation, the implications for the optimal threshold of the production inefficiencies


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implied by the differential treatment of those above and below the threshold. The analysis

here has focused on the central trade-offs to be faced in choosing the threshold for a VAT:

between the desires to increase tax revenue, reduce administration and compliance costs, and

minimize the distortions arising from the differential treatment of firms above and below the

threshold. One common advantage perceived in the value-added tax, for instance (and a

common source of resistance to its introduction) is the prospect of its yielding information

useful for enforcement of the income tax. In practice, distributional effects are naturally a

major concern. Much emphasis is often given, in particular, to the regressive nature of the

compliance costs associated with the VAT, generally thought to be more burdensome,

relative to value added, for smaller traders than large. Against this, however, must be borne

the competitive advantage enjoyed (at least in respect of sales to final consumers) by those

who remain below the threshold.

Sameer R. Rege, (2002),(5)

A GENERAL EQUILIBRIUM ANALYSIS OF VAT

IN INDIA-He evaluates the welfare implications of a VAT in the static and a sequentially

dynamic context after accounting for the political and administrative constraints facing the

Indian government in implementing a VAT. Replacing the old indirect tax structure with a

VAT is welfare worsening. The increase in final consumer prices on account of reduced tax

base leads to higher price of essentials, causing welfare loss. Zero rating v/s exemption plays

an important role on welfare, with lower welfare loss if essential commodities are exempt

from VAT. Agriculture sector unambiguously plays a crucial role in welfare. Finally he

concludes, replacing the old indirect tax structure with a VAT is welfare worsening. The

increase in final consumer prices on account of reduced tax base leads to higher price of

essentials, which causes welfare loss. When agriculture, food and food products and textiles

are exempted, the welfare loss is reduced by half on account of lower final tax rates on

consumption. Even a change in tax / subsidy policy of one sector (agriculture) produces a

dramatic change in welfare.

Paresh Kumar Narayan, (2003),(6)

THE MACROECONOMI C IMPACT OF THE

IMF RECOMMENDED VAT POLICY FOR THE F I JI ECONOMY: EVIDENCE FROM

A CGE MODEL-He uses a computable general equilibrium model to examine the economy

wide effects of this VAT policy and find that while the VAT improves government revenue

and brings about a small 0.6% increase in real GDP, it fails to address investment levels.

VAT actually leads to a decline in investments and a reduction in real consumption and

national welfare. He highlights that large amounts of tax revenue are owed to government.


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This is three times more than what government will collect from the 25% increase in VAT. In

this light, an alternative to VAT is to upgrade governments tax collecting mechanism. From

that they deduce that the IMF policy is misdirected.

Rao.M.Govinda,(2005),(7) TAX SYSTEM REFORMS IN INDIA:

ACHIEVEMENTS AND CHALLENGES AHEAD- He examined the Indian tax system

has come a long way from the narrow based, complicated and confiscatory to the one that is

far more efficient. Over the years, the thrust and direction of reforms have been to improve

revenue productivity while minimizing distortions. The reform to convert the state level sales

tax into VAT this year is a major initiative. The recent focus on tax administration promises

rich dividends. Despite reforms since 1991, much remains to be done to make the tax system

broad-based, productive and efficient. In corporate tax, excise, customs and sales taxes,

revenue concentration on diesel and petrol has high efficiency costs. The personal income tax

continues to be narrow based. Reform in the sales tax has only just begun and a lot remain to

be done to evolve destination-based retail VAT. The reforms in tax administration promise

increased revenues and, hopefully, that will provide the elbow room necessary for calibrating

future reforms.

Berhan, Bahro A.and Jenkins, Glenn P, (2005),

(8) THE HIGH COSTS OF

CONTROLLING GST AND VAT EVASION- They developed the Canada's goods andservices tax (GST) is sometimes said to be self-enforcing--vendors will always charge the tax

because purchasers will always want to claim input tax credits. Nonetheless, GST evasion is a

reality. Solutions to the problem usually involve increased audits (and therefore increased

compliance costs) for taxpayers and increased administration costs for governments; those

costs represent a diversion of resources from more productive activities and an economic loss

to the country. The GST is a value-added tax (VAT). Other countries that impose a VAT face

similar problems and have proposed various solutions. Northern Cyprus and Bolivia, for

example, refund some of the VAT paid on the purchases for which final consumers have

obtained official receipts from sellers. In this article, the authors measure the compliance

costs to taxpayers and the administration costs to the tax authorities in those two countries.

Although similar schemes are not likely to be directly copied in Canada, the authors provide

data to show how high compliance and administration costs can go when governments single-

mindedly pursue the goal of controlling VAT evasion. The total VAT compliance and

administration costs incurred by Northern Cyprus (in 2003) and Bolivia (in 2002) are

estimated at, respectively, 1.50 and 1.55 times the total budgetary expenditures to administer


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the entire domestic tax system. In both countries, the compliance and administration costs of

the VAT refund schemes amounted to more than the 5 percent of the total revenues collected

by the VAT systems.

Marna Kearney et al, (2005),(9)AN ANALYSIS OF SOUTH AFRICAS VALUE

ADDED TAX -In this paper, they describe South Africas value added tax (VAT), showing

that (1) the VAT is mildly regressive and (2) it is an effective source of government revenue,

compared to other tax instruments in South Africa. They evaluate the VAT in the context of

other distortions in the economy by computing the marginal cost of fundsthe effect of

raising government revenue by increasing the VAT rates on household welfare. Then they

evaluate alternative, revenue-neutral tax systems in which they reduce the VAT and raise

income taxes. For the analysis, they use a computable general equilibrium (CGE) model with

detailed specification of South Africas tax system. Households are d isaggregated into

income deciles. They demonstrate that alternative tax structures can benefit low-income

households without placing excess burdens on high-income households.

Graham Harrison and Russell Krelove, (2005),(10)

VATREFUNDS: A REVI EW

OF COUNTRY EXPERIENCE-In this paper they explained a key feature of the invoice-

credit form of value-added tax (VAT) is that some businessesnotably exporterswill pay

more tax on their purchases than is due on their sales, and so can seek refunds of excess

credits from government. While refunding is straightforward in principle, serious problems

arise in practice, including opportunities for fraud and corruption, and denial of refunds by

governments with cash shortages. This makes the refund process the Achilles heel of the

VAT. Finally they examine the refund approaches of tax administrations in 36 developing,

transitional, and developed countries. It evaluates the effectiveness of these approaches and

suggests a model of best practice that takes into consideration compliance issues faced by

countries during different stages of development.

Glenn P. Jenkins et al, (2006),(11)

I S THE VALUE ADDED TAX NATURALLY

PROGRESSIVE?-This paper employs a rich data set on household incomes and

expenditures for the Dominican Republic. The data set covers 2042 goods and services

purchased by households of different income and consumption levels. It also contains

information on the type of establishment from which the items were purchased. With this

information they estimate the effective rate of tax that has been paid on each item purchased

by households. These estimations include the effect of the different rates of the tax


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compliance across households with different expenditure levels. The results of the study

show that the burden of the current VAT in the Dominican Republic is progressive over all

the quintiles of household expenditure. Finally they conclude, however, have not taken into

account the fact that in developing countries the commodities, on which poor households

spend most of their income, even if they are included in the legal tax base, and are

administratively impractical to tax.

Arvind Ashta, (2007),(12)

EUROPEAN VAT GENERAL PRINCIPLES-In

1954, France became the first nation to adopt a value-added tax, a notion credited to Maurice

Laure. Today, this tax is growing in popularity, and about 40 nations use it, including all EU

member States. As a notable exception, it is not used by the United States on the

federal level. But most of the other large industrial nations use it. A peculiar reason

for not adopting VAT in most of the federal countries is that traditionally, sales taxes

and indirect taxes were invariably left to the States in the constitution. If a federal VAT

replaces these taxes, then the States would have no revenue base and the federal

countries would soon resemble Unitary States. State governments are loath to give up

their tax bases.

Andrea Gebauer et al, (2007),(13)CAN REFORM MODELS OF VALUE ADDED

TAXATION STOP THE VAT EVASION AND REVENUE SHORTFALLS IN THE

EU?-They examined VAT evasion caused by the growth of carousel fraud has recently led

to significant VAT revenue losses in the EU. Carousel fraud works such that intra-EU firms

repeatedly carry out cross-border supply and purchase of goods and services, leading to the

fraudulent retention of revenue. This study discusses three reform models of the VAT system

in Germany, whose implementation would open up further possibilities for tax evasion and

lead to a considerable increase in administrative costs. The elimination of the problems in the

current VAT system should not lead to new abuses from which the negative effects on VAT

revenue may be just as large or even larger. One of the main problems after a system change

would seem to lay in the future coexistence of two VAT systems, which, due to the unclear

delimitation, would apply for most enterprises, as well as the fraud potential of using

identification numbers. Input-tax reimbursements are now often illegally claimed primarily

by the holder of an invoice, whereas the multiple use of an invoice for fraudulent purposes

plays no major role. Also, it would be a mistake to overestimate the control possibilities. For

all these reasons, before a radical change is made to the VAT system with unforeseeable

results, all available possibilities to make the present system more fraud-secure should be


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exhausted. Finally, it is not evident why the financial means required for the establishment of

extensive control mechanisms in a new system could not also be used for the improvement of

the present system.

Michael Keen and Ben Lockwood, (2007),(14)THE VALUE-ADDED TAX: ITS

CAUSES AND CONSEQUENCES- They proved that VAT, as its proponents claim, an

especially effective form of taxation? To address this, this paper first shows that a tax

innovationsuch as the introduction of a VATreduces the marginal cost of public funds if

and only if it also leads an optimizing government to increase the tax ratio. This leads to the

estimation, on a large panel, of a system of equations describing the probability of VAT

adoption and the revenue impact of the VAT. The sign of the revenue impact is generally

ambiguous, but most countries that have adopted a VAT seem to have gained a more

effective tax instrument in doing so.

Lyubomir P. Zabov, (2007),(15)

VALUE ADDED TAX AND SALES TAX

(COMPARATIVE OVERVIEW)- He reviewed and compared briefly the Pennsylvania

Sales Tax and the Bulgarian VAT. It focused on the questions of when tax is imposed, what

are the tax bases and the applicable tax rate and on the exclusions from the sales tax and the

credit method used for VAT purposes. Thus it revealed that the structures of the sales tax and

the VAT are different. However, the ultimate result of each of the two taxes is in principle the

same in taxing of the individual consumption. Accordingly, the Pennsylvania sales tax and

the Bulgarian VAT share many common features and the differences between them are often

subtle.

Benjamin A. Neil,(2009),(16)VAT: THE ELIXIR FOR AMERICAS ECONOMIC

ILLS?-In his research he develops America is one of the few nations without a value-added

tax (VAT), but there is growing pressure to impose the language. In simple terms, a VAT is a

type of national sales tax. However, instead of being collected at the cash register, it is

imposed on the value added at each stage of the production process. Some like the VAT

because it offers a new way to finance bigger government. Others like the VAT becauseat

least, compared to the income tax it does not impose as much damage on the economy.

Supporters of limited government oppose the tax because it makes it easier for politicians to

expend the size of government. For these reasons, and others, the VAT is very much a work

in progress, as more and more countries continue to adopt it and grapple with ways of

improving its design and implementation.


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Helena Blazic and Mira Dimitric, (2009),(17)

THE REDUCED VAT RATE FOR

SMALL BUSINESS IN CROATIA- In this paper they developed to assess the potential

effects of introduction of the reduced VAT rate for small business, based on the EU VAT

legislation development. The analysis includes effects on prices, sales, shadow economy and

employment. It starts with the assumption of no substantial effect. Survey for Croatia is done

by small business owners interviews and encompasses descriptive and inferential statistics

based on parametric tests. The EU expected existence of a link between VAT reduction, price

reduction, sales increase and positive effects on employment (as well as decline in the

shadow economy) is proved even in this research. However, the pass-through to prices is very

moderate as well as other effects. The reduced VAT rate could have some positive results for

the restaurants and bars only. There exists also some possibility for construction of housing

and construction services related to housing as well as some other labour intensive services.

Alan Schenk, (2009),(18)

WORLDWIDE VERSUS TERRITORIAL TAX

SYSTEMS: COMPARISON OF VALUE ADDED TAX AND INCOME TAX- In

designing an income tax or a VAT, a country generally must decide how broadly,

geographically, it wants to assert its tax authority. The country may choose to impose its

income tax or VAT under a worldwide or territorial principle. There are many countries with

worldwide and territorial income taxes. There are many countries that impose territorial VAT

systems, but relatively few impose a worldwide VAT system. To date, the literature fails to

recognize some existing VAT systems as worldwide systems. In this paper, he suggests that

at least the New Zealand and South Africa VATs can be analyzed as worldwide VAT

systems. He compares these systems with the commonly used territorial VATs. This paper

also raises the question of whether differences in the design of a VAT as a territorial or

worldwide VAT represent only differences in form or differences in substance.

Lumumba Omweri Martin and Bernard M.Obongo, (2010),(19)

THE

EFFECTIVENESS OF ELECTRONIC TAX REGISTERS IN PROCESSING OF VALUE

ADDED TAX RETURNS- They aimed to assess the effectiveness of Electronic Tax

Registers (ETRs) in the processing of Value Added Tax returns. The study sought to

determine the extent to which the Electronic Tax Registers are being used by the taxpayers,

the problems if any that they were encountering in using them as well as get possible

solutions to the problems. Since many researchers had concentrated much of their work on

tax systems, tax evasion, taxes and interest rates, a lot was desired especially in this area to


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assess the effectiveness of Electronic Tax Registers had been recently introduced by the

Kenyan tax authority. The study sought to establish if the Electronic Tax Registers had

increased the speed at which taxpayers processed their VAT returns and if there were any

associated costs in the processing of VAT. The population under study comprised of 98 VAT

registered taxpayers in Kisii town according to the regional KRA offices records which was

stratified into; service providers, wholesalers and large scale retailers and supermarkets. The

main instrument of collecting primary data was the questionnaires while secondary data was

obtained from the KRA regional office. The findings of this research project will assist the

Kenya Revenue Authority look for ways of improving the processing of VAT returns. Data

was collected from 78 registered VAT taxpayers in Kisii town. The respondents were senior,

middle level and low managers. Out of the 78 registered VAT taxpayers to whom the

questionnaires were administered, only 68 responded. This gives a response rate of 87%

percent. Data analysis tools used in the research were Excel and SPSS and data was presented

in form of tables and graphs.

Renata Dombrovski and Sabina Hodzic, (2010),(20) IMPACT OF VALUE

ADDED TAX ON TOURISM- They developed Republic of Croatia is currently carrying

out preparatory measures for accession to the European Union. One of them is the

harmonization of value added tax (VAT) with the requirements of Directive. Strong taxation

affects tourism negatively. Hoteliers in Croatia set aside large funds for facility investments,

which include partly high VAT rate of 23%, in order to achieve the market standards.

Tourists face higher bid prices which puts the country in an unenviable position among

Mediterranean competitors. It is important to find an optimal solution within the VAT system

to encourage tourism development. Budget funds collected from tourism need to be refunded

to the tourism industry.

Christian Hubert Ebeke, (2010),(21)REMITTANCES, VALUE ADDED TAX

AND TAX REVENUE IN DEVELOPING COUNTRIES- Here Christian Hubert Ebeke

examines the impact of international remittances on both the level and the instability of

government tax revenue in receiving countries. It investigates in particular whether the

presence of a value added tax (VAT) system increases the benefit of the inflows of

remittances in terms of high and less volatile tax revenue ratio. This is supported by the fact

that remittances are largely used for consumption purposes and contribute to smoothing

private consumption. Using a large sample of developing countries observed over the period


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1980-2006, and even after factoring in the endogeneity of remittances and VAT adoption, the

results highlight that remittances significantly increase both the level and the stability of

government tax revenue ratio in receiving countries that have adopted the VAT.

Rawat Deepa et al, (2010),(22)

MACRO ECONOMIC EFFECTS OF VAT IN

INDIA-They developed VAT is seen as a prospective substitute of the present tax system.

It will encourage and result in a better administrated system that will close avenues of tax

evasion. If enforced properly it would help in fiscal consolidation for the country. It would

provide a steady source of revenue; this in turn could be used for reducing the debt burden in

due course. The central government must fully take the state governments in confidence

before imposing VAT. VAT is a comprehensive levy covering almost all production in its

fold. Thus there should be adequate education of the public and the trading community on the

features of VAT, its benefits, costs, simplicity, etc. The paper suggests that there should be no

other state levels taxes such as octroi, states additional tax, entry tax etc. There should be

immediate removal of CST, same legislation should be there for all states a grace period may

be provided are some of the other suggestions paper has submitted.

Dr. K. Shankaraiah and D.N. Rao, (2010),(23) VALUE ADDED TAX

ACCOUNTING: CONCEPTS AND ISSUES-The Value Added Tax Accounting (VATA)

is one of those newly emerged concepts, which emphasized much in the context of VISION2020 by the industry, business, profession, academic, administration, politicians etc. as

VATA is regarded as a source of stable revenue, conducive to investment, immune to

lobbying pressures and ensures the economic growth, which is also evident from the

successful introduction of VATA by developed countries. The concept and issues are

presented in this paper to make the people aware of the VATA and remove the

misconceptions or notions about VATA and to draw the attention and participation of the

different sections of the society for strengthening the VATA system.

Synthesis of review of literature:-

From the above review of literature relating to VAT the following points emerge:

VAT is slightly progressive, although its progressivity is not monotonic throughout

income deciles. However, as households are ordered by deciles on a consumption

basis instead of an income basis, the tax becomes clearly progressive.

Balanced-budget shift from a payroll tax to a VAT will increase employment if the

rise in the VAT does not alter consumer prices.


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The central trade-offs to be faced in choosing the threshold for a VAT: between the

desires to increase tax revenue, reduce administration and compliance costs, and

minimize the distortions arising from the differential treatment of firms above and

below the threshold.

Replacing the old indirect tax structure with a VAT is welfare worsening. The

increase in final consumer prices on account of reduced tax base leads to higher price

of essentials, causing welfare loss.

Large amounts of tax revenue are owed to government. This is three times more than

what government will collect from the 25% increase in VAT.

The reforms in tax administration promise increased revenues and, hopefully, that will

provide the elbow room necessary for calibrating future reforms.

The EU expected existence of a link between VAT reduction, price reduction, sales

increase and positive effects on employment.

New Zealand and South Africa VATs can be analyzed as worldwide VAT systems.

The Kenya Revenue Authority look for ways of improving the processing of VAT

returns.

The remittances significantly increase both the level and the stability of government

tax revenue ratio in receiving countries that have adopted the VAT.

Steps to be taken to make people aware of the VATA and remove the misconceptions

or notions about VATA and to draw the attention and participation of the different

sections of the society for strengthening the VATA system.

Research Gap(present study)

There are many studies done in the field of value added tax throughout the world. But

only few researchers did their research about value added tax in India. Among that few, very

few are conducted in Tamil Nadu in that field. The present research conducted in Tamil Nadu

especially in Thiruvallur District focuses on the level of work burden and revenue collection

of the State Government officials and also on the concerns of VAT payers.


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References

1.

Roberto Ste iner

and Carolina Soto, Tax Evasion and Elusion of Value Added

Tax in Colombia (Social Science Research Network, 1994)

2. Arindam Das Gupta and Ira N. Gang, Value Added Tax Evasion, Auditing

And Transactions Matching (Social Science Research Network, 1996)

3. Laszlo Goerke, Value Added Tax versus Social Security Contribution

(Social Science Research Network ,Aug 1999)

4. Michael Keen and Jack Mintz: The Optimal Threshold for a Value Added Tax

(Journal of Public Economics, 2004)

5.

Sameer R. Rege, A General Equilibrium Analysis Of Vat In India (Blackwell

Publishing Ltd, 2000)

6. Paresh Kumar Narayan, The Macroeconomic Impact of the IMF

Recommended VAT Policy for the FIJI Economy: evidence from a CGE

model (Blackwell Publishing Ltd. 2003)

7. Rao, M. Govinda,Tax Reforms in India: Achievements and Challenges ahead

(Journal of Asian Economics;Dec2005, Vol. 16 Issue 6, p993-1011, 19p)

8. Berhan, Bahro.A and Jenkins, Glenn.P, The high costs controlling CST and

VAT evasion (Canadian Tax Journal;2005, Vol. 53 Issue 3, p720-736, 17p)

9. Marna Kearney, Sherman Robinson and Karen Thierfelder, An Analysis Of

South Africas Value Added Tax (World Bank Policy Research Working

Paper 3671, August 2005)

10.Graham Harrison and Russell Krelove, VAT Refunds: A Review of Country

Experience(International Monetary Fund, 2005)


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11.

Glenn P. Jenkins et al, Is the Value Added Tax Naturally Progressive?

(Social Science Research Network 2006)

12.Arvind Ashta, European VatGeneral Principles (2007)

13.Andrea gebauer, chang woon nam & Rudiger parsche, Can Reform Models of

Value Added Taxation stop the VAT Evasion and Revenue Shortfalls in the

EU? (Journal of Economic Policy Reform Vol. 10, March 2007)

14.Michael Keen and Ben Lockwood, The Value-Added Tax: Its Causes and

Consequences ( International Monetary Fund ,2007)

15.Lyubomir P. Zabov, Value Added Tax And Sales Tax (Comparative

Overview) (Social Science Research Network, 2007)

16.

Benjamin A. Neil, VAT: The Elixir for Americas economic Ills? (Journal of

Finance and Accountancy, 2009)

17.Helena Blazic and Mira Dimitric, The Reduced VAT Rate for Small Business

in Croatia (Original scientific paper, 2009 page No 83-114)

18.

Alan Schenk, Worldwide Versus Territorial Tax Systems: Comparison of

Value Added Tax and Income Tax (Wayne State University Law School Legal

Studies Research Paper Series No. 09-27 December 8, 2009)

19.

Lumumba Omweri Martin et al, The Effectiveness of Electronic Tax Registers

in Processing of Value Added Tax Returns (African Journal of Business &

Management -AJBUMA Vol. 1 (2010), 11 pages)

20.Renata Dombrovski and Sabina Hodzic, Impact Of Value Added Tax On

Tourism (International business and economic research journal, vol.9, 2010)

21.Christian Hubert Ebeke, Remittances, Value Added Tax And Tax Revenue In

Developing Countries (2010)


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22.

Rawat DeepaAgarwal, KalpnaAgarwal And Gunjan,Macroeconomic Effects

of VAT in India (Finance India;Jun2010, Vol. 24 Issue 2, p493-504)

23.Dr. K. Shankaraiah and D.N. Rao, Value Added Tax Accounting: Concepts

And Issues (Social Science Research Network, 2010)


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CHAPTER III

THEORETICAL FRAMEWORK ABOUT VAT

This chapter gives a theoretical background of VAT in general and in Tamil Nadu in

particular.

3.1 Introduction of VAT

The concept of VAT was first adopted by France in 1954. By 2000, it was used by

Canada and 40 other industrialized countries. In most cases, the percentage of tax charged

varies based on the necessity of the particular product, so the tax on food would generally be

less than the tax on luxury items like boats. In recent years, VAT has been proposed for use

in the United States as a way to simplify business and personal income tax laws. Proponents

claim that VAT would replace other forms of taxation and reduce the costs of tax compliance.

In fact, some people say that adopting VAT would eliminate tax returns for individuals and

make the internal revenue service obsolete.

On the other hand, opponents argue that VAT would be more complicated to

implement than other tax-reform options, such as a national sales tax. They also worry that it

would increase the cost of food, medicine, and other necessities, which would hurt the poor.

3.2 Concept of VAT

Value Added Tax is a consumption tax which is levied at each stage of production

based on the value added to the product at the stage. It is an indirect tax on the domestic

consumption of goods and services except those that are zero-rated (such as essential foods

and drugs) or are otherwise exempt (such as exports). It is levied at each stage in the chain of

production and distribution from raw materials to the final sale based on the value (price)

added at each stage. It is not a cost to the producer or the distribution chain member, and

whereas its full brunt is borne by the end consumer, it avoids the double taxation (tax on tax)

of a direct sales tax. A Value Added Tax (VAT) is a fee that is assessed against business by a

government at various points in the production of goods and services-usually any time a

product is or value is added to it. For tax purposes, a value is added whenever the value of a

product increases as a result of the application of a companys factor of production, such as

labor and equipment.VAT must be paid by every company that handle a product during its

transition from raw materials to finished goods.


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For example, tax is charged when a manufacturer sells to wholesaler and again a

wholesaler sells to a retailer. With VAT, the taxable amount is based on the value added at

each stage of the process of producing goods and bringing them to market.

As an example, say that a company that makes shocks buys cotton yarns for Rs.1,000;

adds Rs.500 to its value in terms of labor, depreciation of knitting mechanics, and profits;

then sells the complete shocks forRs.1,500. VAT would be calculated as a percentage of the

Rs.500 value added by turning cotton yarn into shocks.

Of course, the shock company would also get credit for the amount of VAT it paid on

the purchase of inputs, like cotton yarn. In general, the total VAT accrued during the

production of goods is reflected in the price of items sold to final consumers, because each

reseller along the way usually passes along its VAT costs. In this way, VAT is somewhat

similar to a national sales tax, and the two forms of taxation are often compared by

governments. An expert claims that VAT entails higher administrative costs but is easier to

enforce than a national sales tax.

VAT is a progressive and transparent system of taxation which eliminates the

cascading impact of multiple taxation and set-off principle. It promotes transparency,

compliance and equity and therefore, is both dealer friendly and consumer friendly.

VAT is being a multi point tax, envisages an increase in the number of dealers and it

is based on the concept of self-assessment and self-compliance. It is therefore, inevitable that

the sales tax department transforms itself into a dealer friendly, focused and dynamic

department to cater to ever increasing expectations of both the government and the trade and

industry.

Sales tax department has taken up the challenge to transform their selves and beavailable for assisting the dealers in complying with the provisions of the law. They are in the

process of installing a state-wide networked IT system to computerize entire tax

administration and hope to provide online service to the dealers in due course. They also are

realigning their organizational structure to meet the challenges of the new system and

stakeholders expectations.


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3.3 Necessity of VAT in India

India, particularly the trading community, has believed in accepting and adopting

loopholes in any system administered by the state or the Centre. If a well-administered

system comes in, it will close avenues for traders and businessmen to evade paying taxes.

They will also be compelled to keep proper records of their sales and purchases.

Many sections hold the view that the trading community has been amongst the biggest

offenders when it comes to evading taxes. Under the VAT system, no exemptions will be

given and a tax will be levied at each stage of manufacture of a product. At each stage of

value-addition, the tax levied on the inputs can be claimed back from the tax authorities.

At a macro level, there are two issues, which make the introduction of VAT critical

for India. Industry watchers say that the VAT system, if enforced properly, forms part of the

fiscal consolidation strategy for the country. It could, in fact, help address the fiscal deficit

problem and the revenues estimated to be collected could actually mean lowering of the fiscal

deficit burden for the government.

The International Monetary Fund (IMF), in its semi-annual World Economic Outlook

released on April 9, expressed its concern over India's large fiscal deficit - at 10 per cent of

the GDP. Further any globally accepted tax administrative system will only help India

integrate better in the World Trade Organisation regime.

In the conference of Chief Ministers of all the states held in November 1999, it was

agreed that all the states and union territories may implement the Value added tax (VAT). As

a result, the Government of India constituted an empowered committee of State finance

ministers in order to monitor the implementation of decision. The empowered committee has

agreed the broad structure and key features of the legislation on Value Added Tax.

It has held its meeting on 18th June 2004 in which it has unanimously decided that

Value Added Tax system would be introduced in all states and union territories with effect

from the 1stApril 2005(1).

3.4 Advantages of VAT

Since ages always a reform is made for the benefit in the process of development. It

was Chanakya who first wrote that a government should tax its people like a shepherd shears

his flock or a bee gets nectar from a flower. But apparently that fiscal wisdom died with him.

Let India not experience the same with VAT. It has a baggage full of benefits. Few

advantages of VAT in India are mentioned below.


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(i) Coverage

If the tax is carried through the retail level, it offers all the economic advantages of a tax that

includes the entire retail price within its scope, at the same time the direct payment of the tax

is spread out and over a large number of firms instead of being concentrated on particular

groups, such as wholesalers or retailers.

If retailers do evade, tax will be lost only on their margins because customers that are

registered firms gain nothing if their suppliers fail to collect tax, except delay in payment;

they will pay more to the government themselves. Under other forms of sales tax, both seller

and customer gain by evading tax. One particular advantage is that of the widening of the tax

base by bringing all transactions into the tax net. Specifically, VAT gives the new

government the opportunity to bring back into the tax system all those persons and entities

who were given tax exemptions in one form or another by the previous regime.

(ii) Revenue security

VAT represents an important instrument against tax evasion and is superior to a

business tax or a sales tax from the point of view of revenue security for three reasons. In the

first place, under VAT it is only buyers at the final stage who have an interest in undervaluing

their purchases, since the deduction system ensures that buyers at earlier stages will be

refunded the taxes on their purchases. Therefore, tax losses due to undervaluation should be

limited to the value added at the last stage. Under a retail sales tax, on the other hand, retailer

and consumer have a mutual interest in under declaring the actual purchase price.

Secondly, under VAT, if payment of tax is successfully avoided at one stage nothing

will be lost if it is picked up at a later stage; and even if it is not picked up subsequently, the

government will at least have collected the VAT paid at stages previous to that at which the

tax was avoided; while if evasion takes place at the final stage the state will lose only the tax

on the value added at that point.

If evasion takes place under a sales tax, on the other hand, all the taxes due on the

product are lost to the government. A significant advantage of the value added form in any

country is the cross-audit feature. Tax charged by one firm is reported as a deduction by the

firms buying from it. Only on the final sale to the consumer there is no possibility of cross

audit. Cross audit is possible with any form of sales tax, but the tax-credit feature emphasises

and simplifies it and is likely to make firms more careful not to evade because they know ofthe possibility of cross check.


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(iii) Selectivity

VAT may be selectively applied to specific goods or business entities. In addition the

VAT does not burden capital goods because the consumption-type VAT provides a full credit

for the tax included in purchases of capital goods. The credit does not subsidize the purchase

of capital goods; it simply eliminates the tax that has been imposed on them.

(iv) Co-ordination of VAT with direct taxation

Most taxpayers cheat on their sales not to evade VAT but to evade personal and corporate

income taxes. The operation of a VAT resembles that of the income tax more than that of

other taxes, and an effective VAT greatly aids income tax administration and revenue

collection. It is interesting to note that when Trinidad and Tobago set out to introduce VAT itchose one of its top income tax administrators as the VAT Commissioner. It must be

stressed once again that if properly implemented VAT can ultimately lead to a reduction in

overall rates of tax. Revenues will not be sacrificed but would in fact be enhanced as a

consequence of the broadened tax base. This does not seem to be a bad idea at all.

3.5 Disadvantages of VAT

The main disadvantages which have been identified in connection with the Value

Added Tax are:

(i) VAT is regressive

It is claimed that the tax is regressive, i.e. its burden falls disproportionately on

the poor since the poor are likely to spend more of their income than the relatively rich

person. There is merit in this argument, particularly if it attempts to replace direct or indirect

taxes with steep, progressive rates. However, observation from around the world has shown

that steep tax rates lead to evasion, and in the case of income tax act as a disincentive to

effort.

Further, there is now a tendency in most countries to reduce this progressivity of

taxes. In any case VAT recognises and makes room for progressivity by applying no or low

rates of tax on essential items such as food, clothes and medicine. In addition it allows for

steep rates of tax on luxury items, although this can create problems for administration and

open opportunities for evasion by way of deliberate misclassification, a problem incidentally

not peculiar to VAT, and which takes place extensively in the area of customs duties.


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(ii) VAT is too difficult to operate from the position of both the administration and

business.

(a) The administration

It is often argued that VAT places a special burden on tax administration. However, it

is worth noting that wherever VAT was introduced one of its effects was the rationalisation

and simplification of the previous indirect tax system and its administration. Each of the

previous indirect taxes such as customs duties, purchase tax and excise duties replaced by

VAT had its own rate structure as well as a different tax base and separate administrative

procedure. The consolidation and incorporation of numerous indirect taxes into the VAT

would simplify the rate structure, tax base, and administration of the indirect tax system,

thereby eliminating the overlapping auditing practices that had plagued those systems. In

addition, the abolition of a number of alternative indirect taxes releases experienced

personnel to focus on a single tax. It also means reduction in the number of forms used,

legislation to be applied and returns and accounts with which the business person has to

contend.

(b)Business

It is true that the VAT is collected from a larger number of firms than under any form

of income tax or single state sales tax; to the typical smaller firms the complexities of the tax

and the need for more extensive records (for example, to justify deductions) are likely to

prove serious. However, it is often overlooked that businesses already function with

considerable administrative responsibility for a number of laws including the National

Insurance Act and the Income Tax Act.

Under the Income Tax (Accounts and Records) Regulations of 1980 every person,

without exception is required to maintain detailed and extensive records of all its transactions.

Compliance with this will certainly ensure compliance with VAT regulations, and since there

is an actual benefit to be derived from accounting for VAT paid on input there is an incentive

for proper record-keeping. As noted before, VAT also allows for the exemption of small

businesses from the system.

Under any form of sales taxation, small businesses have to be granted special

treatment because of their inability to cope with the requirements of keeping adequate records

which larger enterprises can handle at a reasonable cost. The intent of the special treatment isto reduce the administrative burden on small enterprises, but not the taxes that normally


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would be charged on the goods and services they supply. The revenue loss at the final link in

the commercial cycle is limited only to the value added at that stage, whereas in the case of

income tax or sales tax the entire tax is lost.

To recover the loss from exemptions, a flat tax on turnover may be applied. In the

larger businesses with proper staff and computers, the task is really one of double entry book-

keeping and any additional work is hardly ever noticed.

(c) VAT is inflationary

Some businessmen seize almost any opportunity to raise prices, and the

introduction of VAT certainly offers such an opportunity. However, temporary price controls,

a careful setting of the rate of VAT and the significance of the taxes they replace should

generally ensure that there is no increase if any in the cost of living. To the extent that they

lead to a reduction in income tax, any price increases may be offset by increases in take-home

pay. In any case, any price consequence is one time only and prices should stabilise

thereafter.

(d) VAT favours the capital intensive firm

It is also argued that VAT places a heavy direct impact of tax on the labour-intensive

firm compared to the capital- intensive competitor, since the ratio of value added to selling

price is greater for the former. This is a real problem for labour-intensive economies and

industries.

3.6 Some reflections on VAT

3.6.1 VAT would not have cascading effect

The decision to introduce VAT was taken by the committee comprising finance

ministers of 28 states and two union territories. The advantage of VAT would become clear

when compared with the multi-point sales tax. It would not have a cascading effect and was

devoid stringent penal provisions. Small dealers with an annual gross turnover not exceeding

Rs. 5lakhs would be exempted from tax, he said.

Recalling the effects made by the centre since 1994 on the VAT, the committee, set

up in November 1999, met 90 times to evolve a consensus on the new tax system. Out of 550

goods brought under the VAT, 270 would incur a mere 4 percent tax and the rest would fall

under the general VAT rate of 12.5 percent. Around 46 commodities that had social

implications, including 10 items flexibly chosen by the states, were exempted. Problems that

came up while implementing the VAT would be looked at by the committee with an open

mind.


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3.6.2 Higher Economic Growth

Highlighting the importance of the VAT, Dr.Dasgupta said it would help consumers,

traders, industrialists and the government, as it provided for a set set-off for input tax as well

as tax paid on previous purchases, abolition of turn over tax, surcharge and additional

surcharge, rationalisation of the overall tax burden, reduction in prices, self-assessment by

dealers, enhanced transparency and higher revenue growth (2).

Economic growth can be facilitated through investment by both government and the

private sector. Savings by both parties are required in order to finance investment in a non-

inflationary manner. Compared to other broadly based taxes such as income tax VAT is

neutral with respect to choices on whether to consume now or save for future consumption.

Although VAT reduces the absolute return on savings it does not reduce the net rate of return

on saving. Income tax reduces the net rate of return as both the amount saved as well as the

return on that saving are subject to tax. In this regard VAT may be said to be superior tax in

promoting economic growth than income tax. Since VAT does not influence investment

decisions on firms, by increasing their costs, its effects on investment can be said to be a

neutral.

3.6.3 VAT Effect on Inflation

In considering the introduction of VAT, countries are often concerned that it would

cause an inflationary spiral. However there is no evidence to suggest that this is true. A

survey of OECD countries that introduced VAT indicated that VAT had little or no effect on

prices. In cases where there was an effect it was a onetime effect that simply shifted the trend

line of the consumer price index (CPI). To guard against any unforeseen price effects the

authorities may consider a tighter monetary policy stands at the introduction of VAT (3).

3.6.4 Distribution Effects of VAT

Value added tax is widely criticised as being regressive with respect to income that is

its burden falls heavily on the poor a on rich. This emanates from the facts that consumption

as a share of income falls as income rises. Hence a uniform VAT rate falls heavily on the


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poor a rich. This criticism is valid when VAT payments are expressed as a proportion of

current income.

However if, following the premise that welfare is demonstrated by the level of

consumption rather than income, consumption is used as the denominator the impact of VAT

would be proportional.

A proportional burden would also be demonstrated if lifetime income rather than

current income is used. A lifetime income concept considers the fact that many income

recipients are only temporally at lower income brackets as their earnings increase.

In order to address the regressive nature of VAT the following measures can be taken:

The VAT itself can be used to differentiate taxation of consumer items are consumed

primarily by the poor such that they pay less or at zero rate or to luxury goods at a

higher than standard rate.

VAT exemptions may also be granted on goods and services that are consumed

mostly by the poor.

Equity concerns may also be addressed through other ways, outside the VAT system,

such as other tax and spending instruments of government. This could be in the form

of lower basic income tax rates on the poor or some pro-poor expenditure of

government. The use of multiple rates of VAT has however been widely discouraged

for various reasons.

The fact that sometimes it is almost impossible to differentiate between higher quality

expensive products-e.g. food, consumed by the rich and ordinary products consumed

by the poor. Thus any concession extended may tend to benefit the rich much more

then the poor.

Increased costs of VAT administration as a differentiated rate structure brings with it

problems of delineating products and interpreting the rules on which rate to use.

Significantly increased costs of tax compliance for small firms, which are usually

unable to keep separate records/accounts for sales of differently taxed items. This

results in the use of presumptive methods of determining the tax liability, which leads

to more difficulties in monitoring the compliance.


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The higher compliance cost resultant from differentiation of VAT rates may also be

regressive with respect to income since smaller firms with lower income tend to bear

proportionately more of the burden a do larger firm.

Given the fact that the primary purpose of VAT is to raise government revenue in an efficient

manner and with as little distortions of economic activity as possible, distribution effects are

perhaps better addressed by other forms of tax and government expenditure policies which

can often be better targeted at these aims.

3.6.5 VAT exemptions

Exemptions refer to situations where output is not taxed but taxes paid on inputs are

not recoverable. The rationale behind exemptions is to reduce negative distributional effectson incomes. The effect exemption may also be as follows:

Falling of revenues-exemptions break the VAT chain. If exemptions are granted at

prior to final sale, it results in a loss of revenue since value added at the final stage

escapes tax.

Un-recovered taxation of some intermediate goods may lead to procedures

substituting away such inputs thus distorting the input choices of the said procedures.

Exemptions may create incentives to self supply i.e. tax avoidance by vertical

integration.

Exemptions tend to feed on each other giving rise to a phenomenon called exemption

creep. This arises from the fact that each gives rise to pressures on further

exemption.

For example creating an exemption to reduce the tax burden on a particular

commodity or goods may lead to increased pressure for exemption or zero rating of

inputs used for the production of such a commodity.

Based on the above, it is important that care is taken when introducing exemptions in

order to avoid distortions in the production process as well as to minimise revenue

loss resulting from such distortions.

3.7 Why VAT is preferred over Sales Tax

While theoretically the amount of revenue collected through VAT is equivalent to

sales tax collections at a similar rate, in practice VAT is likely to generate more revenue for

government a sales tax since it is administered on various stages on the production-


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distribution chain. With sales tax, if final sales are not covered by the tax system e.g. due to

difficulty of covering all the retailers, particular commodities may not yield any tax.

However, with VAT some revenue would have been collected through taxation ofearlier transactions, even if final retailers evade the tax net. There is also in-built pressure for

compliance and auditing under VAT since it will be in the interest of all who pay taxes to

ensure that their eligibility for tax credits can be demonstrated. VAT is also a fairer tax a

sales tax as it minimises or eliminates the problem of tax cascading, which often occurs with

sales tax. These are facilitated by the fact that VAT operates through a credit system so that

tax is only applied on value added at each stage in production- distribution chain.

At each intermediate stage credit will be given for t

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