India is proposing to introduce value-added tax (VAT) in the Union Budget for 2003-2004 (dated February 28 2003). This is a significant reform in the country's tax regime.
VAT, a multistage tax, would be levied on value added at different stages of production and distribution of commodities and services. India will introduce VAT from April 1 2003.
The move has the following implications:
- It avoids cascading of taxes, that is, it prevents tax levy on taxes paid at previous stages of processing and value addition that is built into the price at each stage.
- It increases revenue as the coverage expands to value addition at all stages of sale in the production and distribution chain.
- The Central Sales Tax (CST) will be phased out. The ceiling rate of CST will be reduced from 4% to 2%.
- It will unify local taxes. VAT will replace entry tax, purchase tax, luxury tax and state- level sales tax. However, it will not give set-off to taxes paid in other states, Customs Duty and CST. It will not cover octroi duty, levied by local municipalities. Ideally, all central and state indirect taxes should be integrated in a single VAT chain. This is unlikely in a federal nature of polity. Nonetheless, a dual VAT is superior to the existing system of cascading state-level taxes.
- It will encourage tax compliance. VAT has an inbuilt incentive for tax compliance since only by collecting and remitting taxes, can a seller claim the offset that is due to it on its purchases.
To address fears expressed by the states regarding revenue loss, the government has agreed to compensate states in the early years.
The introduction of VAT and the commitment to phase out CST are laudable steps and will lead to a single tax scheme similar to that which prevails in most parts of the world.