VAT

Q.1 Define value added tax and explain the basis on which the various state ‘laws are enacted?

Ans. Meaning: value added tax

(a) Is a multi-point tax on value addition i.e. increase in value
(b) Which is collected at different stages of sale; and
(c) With provisions for set-off for tax paid at the previous stage/ tax paid on inputs against the tax
collection, on sales before remitting to the government account.
Basis:
(a) Basic design; the empowered committee of state finance minister brought out a white paper, which
provided a base for the preparation of various state VAT legislations.
(b) State dependent: since VAT is a state subject the states will have freedom for appropriate aviations
consistent with the basic design as agreed upon at the empowered committee.
Purpose: the purpose of introduction of VAT is to being harmonization in the tax structure of various
states and rationalizes the overall tax burden.

Q.2 What are the objectives for introducing VAT?

Ans. The objective for introducing VAT are-

1. To avail credit on inputs leading to cost efficiency.
2. Ensure equitable distribution of tax impact amongst dealers.
3. Easy compliance through transparent and easy procedures exist under it and only two rates are there.
4. Easy computation of tax.
5. Avoids double taxation through input rebate.
6. Prevents distortions in trade and economy through uniform tax rates.

Q.3 In relation to VAT, define the following terms – (a) dealer (b) sales (c) turnover (d) inputs (e)
input tax (f) output (g) output tax (h) capital goods (i) exempted sale (j) Zero Rated sale

Ans. Definition terms

(A) Dealer means nay person

(a) who carries on the business of buying, selling, supplying or distributing goods,
(b) directly or otherwise
(c) Whether for cash or for deferred payment or for commission, remuneration or other valuable
consideration.

(B) Sale means-

(a) every transfer of the property in goods (other than by way of a mortgage, hypothecation, charge or
pledge)
(b) by one person to another
(c) In the course of business for cash, deferred payment or other valuable consideration.

(C) Turnover means, the aggregate amount for which goods are
(a) bought or sold, or delivered or supplied or otherwise disposed off in any of the ways referred to in
Sec.2 (33),
(b) by a dealer either directly or through another, on his own account or on account of others
(c) Whether for cash or for deferred payment or other valuable consideration.

Turnover includes-
Any sums charged for anything done by the dealer in respect of the goods sold at the time of, or before
the delivery thereof.
Turnover Excludes-
(a) proceeds of the sale by a person of agricultural or horticultural product, other than tea and rubber
(natural rubber later and all varieties and grades of raw rubber) grown within the state by himself or
on any land in which he has an interest whether as owner, unsfructuary Mortgage, tenant or
otherwise.
(b) Any cash or other discount on the price allowed in respect of any sale.
(c) Any amount refunded in respect of articles returned by customers.
(d) Any amount realized by a dealer by way of sale of his business as a whole.
(e) Any amount charged by a dealer by way of tax separately without including the same in the price of
the goods sold.
“Agricultural or horticultural produce” shall not include such produce as has been subjected to any
physical, chemical or other process for being made fit for consumption, save mere cleaning, grading,
sorting or dying.

(D) Inputs
Input are goods meant for re-sale or use in manufacture processing of other goods or packing of goods
manufactured

(E) Input tax means the

(a) tax paid or payable under this act
(b) by a registered dealer to another registered dealer on the purchase of goods
(c) Including capital goods in the course of business.

(F) Output
Output means sale of goods made by a registered dealer to other registered dealers and consumers in the
course of his business.

(G) Output tax

Output tax is tax collected on sale of goods from the buyer. The output tax is calculated by applying the
rate of tax on taxable turnover of these goods.

(H) Capital goods means-

1. plant, machinery, equipment, apparatus, tools, appliance or electrical installation for producing,
making, extracting or processing of any goods or for extracting of for bringing about any change in
any substance for the manufacture of final products;
2. Pollution control, quality control, laboratory and cold storage equipment;
3. Components spare parts and accessories specified at (a) and (b) above
4. Mould, dies, jigs and fixtures,
5. Refractors and refractory materials,
6. Tubes, pipes and fittings thereof; and
7. Storage tanks used in the state for the purpose of manufacture, processing, packing of storing of
goods in the course of business excluding civil structures and such goods as may be notified by the
government.

(I) Exempted sale

An exempted sale is a sale on which no tax is levied, and no input tax credit is allowed
 (J) Zero rated sale
Zero rate sales are a sale for which no tax is levied but the tax paid on local purchases is refunded to
dealer who affected that sale. The value added tax act specified the zero rated sales as-
1. export sec.5(1)
2. sale in the course of export [5 (3) of CST Act, 1956] (ie) sale to exporters
3. sale to international organizations
4. sale to SEZ

Q.4 Write a brief note on goods covered by VAT Law.

Ans. 1. Meaning: goods means-

(a) All kinds of movable property.
(b) It includes-
• All materials, commodities and articles
• Goods (as goods or in some other form) involved in the execution of works contract or those
goods to be used in the fitting out, improvement or repair of movable property;
• All growing crops, grass or things attached to or forming part of the and which are agreed to be
severed before sale or under the contract of sale.
(c) It excludes- newspapers, actionable claims, stock and shares & securities.

2. Coverage under vat: all goods except liquor, lottery tickets, petrol, diesel, aviation turbines fuel
and other motor spirits, whose prices are not fully market determined, are covered under VAT
and get the benefits of VAT credit. The goods not covered by VAT are taxed under the sales Act
or by making special notifications in this regard.

Q.5 Who are liable for registration?

Ans. The following persons are liable for registration:

1. Dealers whose total turnover in respect of purchase and sales in the state as per the state
VAT Act are to get registered under the Act.
2. Causal traders, agent of non-resident dealer and dealers in jeweler irrespective of
quantum of turnover shall obtain registration.
3. Dealers who intoned to commence the business, on option, may obtain registration.

Q.6 How to apply for registration?

Ans. 1. New dealer should file an application in the specified form along with fee to the registering authority
in whose jurisdiction, his principal place of business is situated with a sufficiently stamped self
addressed enveloped, with necessary documents required in the application form.

2. Head of the assessment circle in whose jurisdiction the dealer’s principal place of business is situated.

Q.7 Discuss the special cases of levy and collection?

Ans.
1. Based on space of activity of dealers:
(a) No Tax: Small dealers with gross annual turnover not exceeding specified limit are not liable to pay tax.
 (b) Compounded rate of tax: Small scale dealers with Gross Turnover not exceeding the specified limit,
who are otherwise liable to pay VAT, however, have an option to pay tax at a small percentage known
as ‘Composition Scheme’.

2. Works Contracts:
(a) Works Contracts include any agreement for carrying out for cash, deferred payment or other valuable
consideration, building construction, manufacture, processing, fabrication, erection, installation, fitting
out, improvement, modification, repair or commissioning, of any movable or immovable property.
(b) The dealers executing Works Contracts can either-
• Pay tax on the value of the goods at the time of incorporation of such goods in the works
executed, at the rates applicable to the goods, or
• They may opt to pay tax by way of composition at applicable rates on a certain percentage of the
total consideration received as may be prescribed. In such a case, they may not be entitled to any
VAT Credit or may be entitled to a partial VAT Credit.

COMPARISON BETWEEN SALES TAX SYSTEM AND VAT

10% Sales Tax 10% VAT
Particulars Price Government Price Government
Revenue Revenue
Mr. A sells goods to Mr. B 200 200
Sales Tax @ 10% 20 20 20 20
Total Cost to A 220 220
Mr. B processes them and creates final
products with the additional labour and 440 440
capital and sells them to C, a wholesaler
with 100% markup
Sales Tax/VAT 44 44 40 40-20=20
Total Cost to C 484 400
B sells to C, a retailer at a 25% mark-up 605 560
Sales Tax/VAT 60.5 60.5 56 56-40=16
Cost to P 665.5 560
P sells it to the consumer at 100% mark- 1331 1,120
up
Sales Tax/VAT 133 133 112 112-56=56
Cost to Final Consumer 1464 1,232
Total Proceeds to Government 257.50 112

Q.8 What are the variants of VAT?

Ans. 1. Gross Product Variant:

(a) Principle: The Gross Product Variant allows deductions for taxes on all purchases of raw materials and
components. No deduction is allowed for taxes on capital taxes.
(b) Limitation:
• Capital Goods are taxed twice i.e., at the time of purchase and at the time of sale of goods produced
using capital goods.
• Modernization and upgrading of plant and machinery is delayed due to this doubled tax treatment.

2. Income Variant:
(a) Principle:
• The income variant of VAT allows for deductions on purchase of raw materials and components as well
as depreciation on capital goods. (i.e) credit on capital purchases are allowed in the ration of
depreciation over the life of the capital assets.
• This method provides incentives to classify purchase as current expenditure to claim set off.
(b) Limitation:
There are difficulties connected with the specification of any method of measuring depreciation which basically
depends on the life of an asset as well as on the rate of inflation.

(3) Consumption variant

(a) Principle:
• Consumption variant of VAT allows for deduction on all business purchases including capital assets.
• Gross investment is deductive in calculating value added.
• It neither distinguishes between capital and current expenditures nor specifies the life of assets or
depreciation allowances for different assets.
(b) Merits:
• It does not affect decisions regarding investment because the tax on capital goods is also set off against
the VAT liability. Hence, the system is tax natural in respect of techniques of production (labour or
capital intensive).
• Convenient from the point of administrative expediency as it simplifies tax administration by obviating
the need to distinguish between purchases of intermediate and capital goods on the one hand and
consumption goods on the other hand.

(c) Limitation:
The system is tax neutral from the view point of government as it lead to loss of revenues to the
government.

Q.9 Explain the input tax credit in the context of VAT?

Ans.
1. Eligibility:
(a) Dealer: a ‘dealer’ who is registered or is required to be registered under the respective state laws on
VAT is entitled to an input tax credit (i.e. VAT Credit).
(b) Eligible purchases: Tax paid on purchase which are meant for sale or for utilization in the process of
production for such sale.

2. tax payment: the VAT liability of the dealer is calculated by deducting VAT credit from tax payable on
sale during the tax/ payment period.

3. vat credit for stock transfer:

(a) Vat credit is given to a dealer for purchase of inputs/ supplies in a state meant for sales within the state
as well as in other states.
(b) Even for stock transfer/ consignment sale of goods out of the state input tax paid in excess of a certain
percentage is eligible for VAT credit.

4. carry forward of VAT credit: if the VAT credit exceeds the tax payable on sales in a month, the
excess credit may be carried over to the future month(s) and the unadjusted VAT credit at the end of the
specified period is eligible for refund.

5. Exempt and Zero rated goods:

(a) Exempt goods: goods on which VAT credit cannot be claimed and
 (b) Sales which are zero rates: VAT credit can be claimed in respect of purchases for such sale.

6. Non-Availability Of Input Tax Credit (N08): the following are not eligible for input tax credit
(a) purchase from unregistered dealer.
(b) Purchases from other states/ countries.
(c) Purchase of goofs used in manufacture of exempted goods.
(d) Purchase of capital goods (credit is available in instalments).
(e) Purchase of capital goods (credit is available in instalments).
(f) Purchase of goods used as fuel in power generation.
(g) Purchase of goods used in manufacture of goods to be dispatched outside any state as branch transfer/
consignments.
(h) Purchase of goods where the dealer does not have invoices showing amounts of tax charged separately
by the selling dealer.
(i) Purchase of non-creditable goods.
(j) Purchases from a dealer who has opted for composition scheme.

7. VAT credit on
(a) opening stock:
• All tax paid goods still in stock and purchased upto 1 year prior to the date on which VAT
become applicable are eligible for input tax credit. However, the VAT credit available on
opening stock is available over a period of 6 months after an interval of 3 months needed for
verification.
• Capital goods included in the opening stock are not eligible for input tax credit.

(b) Capital goods: VAT credit on all capital goods, except a few included in the negative list in respective
state laws may be adjusted over a maximum period of 36 equal installments (this period may be reduced
by the state).

ILLUSTRATION -- OPERATIONS OF VAT

Ans. The operation of vat is explained with the help of the following illustration-

STAGE I – RAW MATERIAL (A) TRADER SELLS TO MANUFACTURER (B):

A is a trader selling raw materials to a manufacturer of finished products. He imports his stock-in trade as well
as purchases the same in the local markets. If the rate of VAT is assumed to be 12.5% ad valorem, he will pay
VAT as under-
Particulars Rs.
Cost of imported materials (from other state) 10,00,000
Deposit of duty paid noted above 1,25,000
Cost of materials purchased local market [VAT charged by local
suppliers Rs. 2, 50,000] 20,00,000
Other expenditure incurred ( including profit margin of A) 8,75,000
Sale price of goods 40,00,000
Add: VAT on the above @ 12.5% 5,00,000
Invoice value charged to the manufacturer B 45,00,000
A’s liability for VAT

Particulars Rs. Rs.

Tax on sales price 5, 00,000
Less: Set-off of VAT paid on purchases
On Imported Goods NIL
On Local Goods 2, 50,000 (2, 50,000)
Net Tax Payable 2, 50,000

Note: set off of vat paid on imported goods from outside countries or other States is not allowed.

STAGE II – MANUFACTURER [B] SELLS TO WHOLESALER/TRADER OF FINISHED GOODS [C]

B manufactures finished products from the raw materials purchased from A and other materials purchased from
other suppliers. His liability would be as under:

Particulars Rs.
Cost of materials purchased from A [excluding VAT recovered on the above Rs. 5,
00,000] 40, 00,000
Cost of Other Materials
Local Purchases (excluding VAT Paid Rs.2, 50,000) 20, 00,000
Inter-State purchases (including CST paid Rs. 40, 000) 10, 40,000
Manufacturing and other expenses (including Profit Margin of B) 29, 60,000
Sale Price of finished goods 1, 00, 00,000
Add: VAT on the above @ 12.5% 12, 50,000
Invoice value charged by B to the Wholesaler [C] 1, 12, 50, 000

B’s liability for VAT

Particulars Rs. Rs.

Tax on the Sales Price 12, 50,000
Less: Set-off of VAT on purchases –
Purchase from A 5, 00,000
Purchase from Other Suppliers 2, 50,000 (7, 50,000)
Net Tax Payable 5, 00,000
STAGE III – WHOLESALER/TRADER OF FINISHED GOODS [C] SELLS TO CONSUMERS:

When C sells the goods to the consumers, the position would be as under:

Particulars Rs.
C’s Cost of Goods (excluding VAT Recovered by C Rs 12, 50,000) 1, 00, 00,000
Add: Expenses incurred and profit earned by C 40, 00,000
Sale price of goods 1, 40, 00,000
Add: VAT on the above @ 12.5% 17, 50,000
Invoice value charged by C to the consumers 1, 57, 50,000

C’s liability for VAT

Particulars Rs.
Tax on the sales Price 17, 50,000
Less: Set-off of VAT paid by C 12, 50,000
Net tax payable 5, 00,000

TOTAL RECOVERY: VAT is collected at various stages as under –

Particulars Rs.
Paid by suppliers selling raw materials 2, 50,000
Net tax paid by A on his sales to B 2, 50,000
Paid by suppliers selling other materials to B 2, 50,000
Net tax paid by B 5, 00,000
Net tax paid by C 5, 00,000
Total Recovery of Revenue 17, 50,000

Q.10 What are the methods for computation of VAT?

Ans. The various methods of computation of VAT are:

1. Addition Method:
(a) Suitability: This method is mainly used with income variant of VAT.
(b) Demerits: This method does not easily accommodate exemptions of intermediate dealers. It does not
facilitate matching of invoices for detecting evasion.
(c) Computation:
Step1 - Aggregate all the factor payments including profits to arrive at the total value addition.
Step2 – Apply the rate on Step1 to calculate the tax.

2. Invoice Method:
(a) Suitability: Under Central Excise Law, this method is followed.
(b) Salient features: The most important aspect of this method is that at each stage, tax is to be charged
separately in the invoice. This method is also called the “Tax Credit Method” or “Voucher Method”.
(c) Merits: In this method the beneficiary is the trade and industry because the tax collection at all
stages is very much lesser than the tax received by the state because of the availability of set-off of
tax paid. The possibility of tax evasion is reduced to minimum, because credit can be claimed only
when purchase invoice is produced.
(d) Computation:
Step1 – Compute the tax to be imposed at each stage of sales on the entire sale value.
Step2 – Set-off the tax paid at the earlier stage. (i.e., at the stage of purchases is set-off).
 Step3 – The differential tax is paid.

3. Subtraction Method:
(a) Suitability: This method is normally applied where the tax is not charged separately.
(b) Salient Features: Tax is charged only on the value added at each stage of the sale of goods. There is
no tax credit as the total value of goods sold is not taken into account.
(c) Method of determination of value added:
(a) Direct Subtraction method:
Value added=Total value of sales exclusive of tax
Less: Total value of purchase exclusive of tax.

(b) Intermediate subtraction method:

Value added = Total value of sales inclusive of tax.
Less: Total value of purchases inclusive of tax.
(c) Indirect Subtraction Method

4. Computation:
Step1 – Compute the value added under neither of the above method.
Step2 – Apply the rate of tax on the amount calculated on Step1.

ILLUSTRAION --

Methods of Computation of VAT – Inputs taxable at different rates

Inputs used for the production of output ‘M’ are ‘X’ and ‘Y’ respectively. The following are the details of inputs
–
Input Vat Rate Invoice Price (inclusive of VAT)

Product X 12.5% 45, 000

Product Y 4% 26, 000

The following are the details of Sales and the rate of VAT applicable for the Output ‘M’ is 12.5% --

Description A to B B to C C to D D to E E to Consumer

Invoice price Rs. 76,500 Rs. 1, 12,500 Rs. 1, 80,000 Rs. 2, 25,000 Rs. 2, 70,000

From the above details, Calculate the VAT collected at each stage and the VAT finally remitted using the two
different methods i.e. (a) Invoice Method; and (b) Subtraction Method.

Solution:

A. INVOICE METHOD (Amount in Rs.)

Particulars Invoice Material Value VAT Input Tax Credit Net
(1) (2) (3) (4) (5) (6)
Inputs for A
Product X (@ 12.50%) 45,000 40,000 5,000 -- 5,000
Product Y (@ 4%) 26,000 25,000 1,000 -- 1,000
Sale by A to B 76,500 68,000 8,500 6,000 2,500
Sale by B to C 1, 12,500 1, 00,000 12,500 8,500 4,000
Sale by C to B 1, 80,000 1, 60,000 20,000 12,500 7,500
Sale by d to E 2, 25,000 2, 00,000 25,000 20,000 5,000
Sale by E to Consumer 2, 70,000 2, 40,000 30,000 25,000 5,000
Final 2, 70,000 2, 40,000 30,000 30,000

B. SUBTRACTION METHOD (Amount in Rs.)

Particulars Invoice Purchase Price Value Added Input Tax Credit
(1) (2) (3) (4) (5) = 4 x 12.50/112.50
On Input 71,000 --- --- 6,000
Sale by A to B 76,500 71,000 5,500 610
Sale by B to C 1, 12,500 76,500 36,000 4,000
Sale by C to D 1, 80,000 1, 12,500 67,500 7,500
Sale by D to E 2, 25,000 1, 80,000 45,000 5,000
Sale by E to Consumer 2, 70,000 2, 25,000 45,000 5,000
Final 2, 70,000 --- --- 28,110

Inference: In the above illustration, total collections under Invoice Method and Subtraction Method differ due
to differences in rates of VAT on inputs and outputs.

DETERMINATION OF VALUE ADDED TAX – N 07

Q.11 Compute the invoice value to be charged and amount of tax payable under VAT by a dealer who
had purchased goods for Rs. 1, 20,000 and after adding for expenses of Rs. 10,000 and of profit Rs. 15,000
had sold out the same. The rate of VAT on purchases and sales is 12.5%.

Ans. 1. Computation of Invoice Value

Particulars Rs.
Cost of goods purchased 1, 20,000
Add: Additional expenses 10,000
Add: Profit Share 15,000
Total Invoice Value 1, 45,000

2. Computation of Tax Payable

Particulars Rs.
VAT on Invoice Value @ 12.5% 18,125
Less: Input Tax Credit – VAT on purchases @ 12.5% (1, 20,000 x 12.5%) (15,000)
VAT Payable 3,125

Q.12 What are the administrative procedures adopted by different states?

Ans.
1. Invoice:
 (a) VAT system is based on documentation of tax invoice, cash memo or bill.
(b) Every registered dealer, having turnover of sales above the specified amount, shall issue to the
purchaser serially numbered tax invoice signed and dated by the dealer or his regular employee,
showing the required particulars.
(c) The dealer should keep a counterfoil of such tax invoice duly signed and dated.

2. Registration:
(a) Registration of dealers with gross annual turnover above a specified amount is compulsory.
(b) A new dealer is generally allowed 30 days time from the date of liability to get registered.

3. Taxpayer’s Identification Number:

(a) The taxpayer’s identification number will consist of 11 digit numerals throughout the country.
(b) First two characters represent the State Code. The set-up of the next nine characters may, however,
be different in different States which includes 2 check digits.

4. Self-Assessment:
(a) All the assessments are self-assessments as all returns files are to be accepted.
(b) Dealers need not appear before assessing authority or produce the accounts for annual assessments.
(c) The assessing authority shall accept the returns filed by the dealer and pass assessment order after
the assessment year is over.
(d) The orders shall be served on dealers in the manner prescribed in Rules.

5. Return: Returns are to be filed monthly/quarterly as specified in the State Acts/Rules, and should be
accompanied with payment challans. Every return furnished by dealers will be scrutinized expeditiously
within prescribed time-limit from the date of filing the return.

6. Audit: Correctness of self-assessment will be checked through a system of departmental audit. A certain
percentage of the dealers will be taken up for audit very year on a scientific for basis. This audit wing
will remain de-linked from tax collection wing to remove any bias.

7. Coverage of goods under VAT: All goods, including declared goods will be covered under VAT and
will get the benefit of input tax credit. However, there are a few goods which are outside VAT.
Exempted category includes liquor, lottery tickets, petrol, diesel, aviation turbine fuel and other motor
spirit since their prices are not fully market determined.

8. VAT rates and classification of commodities:

(a) Under the VAT system covering about 550 goods, there will be only two basic VAT rates of 4% and
12.5%.
(b) Moreover, there is a specific category of tax-exempted goods.
(c) Also, a special VAT Rate of 1% is applicable only for gold and silver ornaments, etc.

Q.13 Summarize the merits of the VAT System vis-à-vis traditional Sales Tax System?
Ans. The following are the merits of VAT ---
1. Proper Accounting systems: under Vat, credit of tax paid is allowed against the liability on the final
product manufactured or sold. Therefore, unless proper records are kept in respect of various inputs, it is
not possible to claim credit. Since the tax paid on an earlier stage is to be received back, the system will
promote better accounting practices.

2. Deterrent to tax evasion (M 08): Better and perfect records will create and leave Audit trail. A perfect
system of VAT will be a perfect chain where tax evasion is difficult.
 3. Neutrality (M 08): Since the system has anti-cascading effect, it is neutral with regard to choice of
production technique, as well as business organization. VAT facilitates precise identification and rebate
of the tax on purchases and thus ensures that there is no cascading effect of tax. In short, the allocation
of resources is left to be decided by the free play of market forces and competition.

4. Certainty (N 07): The VAT is a system based simply on transaction. Thus there is no need to go
through complicated definitions like sales, sales price, turnover of purchases and turnover of sales, the
tax is also broad-based and applicable to all sales in business leaving little room for different
interpretations. Thus, this system brings certainty to a great extent.

5. Transparency: Under VAT system, the buyer knows, out of the total consideration paid for purchase of
material, what is tax component. Thus, the system ensures transparency also. This transparency enables
the State Government to know as to what is the exact amount of tax inflows at each stage. Thus, it is a
great aid to the Government while taking decisions with regards to rate of tax, etc.

6. Better revenue collection and stability: The Government will receive its due tax on the final
consumer/retail sale price. There will be a minimum possibility of revenue leakage, since the tax credit
will be given only if the proof of tax paid at an earlier stage is purchased. Thus, in particular, an invoice
of VAT will be self enforcing and will induce business to demand invoice from the suppliers.

7. Effect on retail price: VAT does not have any inflationary impact as it merely replaces the existing
equal sales tax. With the introduction of VAT, he tax impact on the raw materials is to be totally
eliminated. Therefore, there may not be any increase in prices.

8. Self – Assessment: There will be self-assessment by dealers.

9. Other taxes: Other taxes such as turnover tax, surcharge, additional surcharge, etc. will be abolished.

10. Fairness: VAT is a move towards efficiency, equity in competition and fairness in the taxation system.
It helps common people, trade, industry and also the government. The overall tax burden is rationalized.

Q.14 What are the demerits of VAT?

Ans. The following are the demerits of VAT –

1. Differential Rates of Tax: The merits accrue in full measure only under a situation where there is only
one rate of VAT and VAT applies to all commodities without any question of exemptions whatsoever.
Concessions like differential rates of VAT, composition schemes, exemptions schemes, exempted
category of goods etc. distorts the systems. Thus, fundamental principle that VAT will totally eliminate
cascading effects of taxes will also be subject to qualifications.

2. Disintegration: So long as Central VAT is not integrated with the State VAT, it will be difficult to put
the purchases from other States at par with State purchases. Therefore, the advantage of the neutrality
will be confined only for purchases with the State.

3. Accounting costs: Compliance with the Vat provisions requires better accounting and records
maintenance which will cost more. Such incremental cost may not reflect any incremental benefits to
small traders.

4. Increasing working capital requirements: Since the tax is to be imposed or paid tat various stages and
not on last stage, it would increase the working capital requirements and the interest burden on the same.
5. Inequality of Taxation: VAT is a form of consumption tax. Since, the proportion of income spent on
consumption is larger for the poor than for the rich, VAT tends to be regressive.

6. Increase in Administration Costs: As a result of introduction of VAT, the administration cost to the
State can increase significantly as the number of dealers to be administered will also go up significantly.

7. Non-Coverage of both goods and services: The State Vat is characterized by non inclusion of services
which reduces its effectiveness as a comprehensive system.

8. Higher Base Rate: The base rate 12.54% is considered as relatively high. This rate is fixed so as to
ensure collection of equal revenues under the VAT system as compared to sales tax system. However, as
the rate is uniform in all the States, revenue neutrality may be difficult to achieve.

9. Floor Rate: Floor rates refer to the rates which have to be uniformly applied by all states. However
there is no flexibility available for states to tinker with the floor rates. This is contrary to what the
concept of floor rate actually refers to.

10. Treatment to exempted goods: A major deficiency is observed with regard to treatment of exempted
goods. No VAT is leviable on such goods, but no credit will be provided for taxes paid on their
purchases at the time of sales to final customers.

11. Need for Extensive definition: As there is scope for interpretations, there is a need for defining even a
simple term to avoid any confusion as to the rate to be applied for it and also the category in which it
falls i.e. whether capital or revenue.

12. Arbitrary classification of goods: The basis adopted for classification of goods under capital and
revenue category seems to be arbitrary which can lead to confusion and inequity with regard to
application of taxes on goods.

13. Concessional rates based on End Usage: VAT system is based on the principle that the consumer’s
end use (industrial use or export or domestic use) should not affect the levy of taxes on goods except
under special circumstances. However, in practice, several concessions being given for industrial inputs
which contravenes this principle.

14. Revenue loss due to concessional rate: Due to concessional rate, revenue losses from undeclared sales
of finished goods increase.

15. Huge volume of Exemptions: The basic structure of VAT does not allow many exemptions and it is to
be fairly comprehensive which has to lead to periodic elimination of exemptions provided under the
erstwhile sales tax system. However, in practice, due to continuous pressure from various industrial and
social sectors, the number of exemptions provided has been steadily on the rise which can lead to
administrative problems.