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Taxes on Commodities and Services in India

Estimating Revenue Potential of Harmonized Central and State Taxes

Mahesh C Purohit

Foundation for Public Economics and Policy ResearchNew Delhi-110052

Taxes on Commodities and Services in India

Estimating Revenue Potential of Harmonized Central and State Taxes

(A Study Sponsored by the Twelfth Finance Commission)

Mahesh C Purohit

Foundation for Public Economics and Policy Research133, SFS, Ashok Vihar-IV

New Delhi-110052

ii

PrefaceThe Foundation for Public Economics and Policy Research is an autonomous,

non-profit organization whose major functions are to carry out research, undertake consultancy work, and conduct training in the area of public economics and policy.

The Foundation for Public Economics and Policy Research undertook this study, at the instance of the Twelfth Finance Commission of India. The objective of the study is to recommend a possible system of a Value Added Tax (VAT) for India, both in the short term as well as in the long-term.

The study draws upon the experiences of federal countries such as Brazil, Canada and also of the European Union. It presents the revenue implications of the introduction of value added tax at the state level, along with the Central VAT.

The study presents various options for the introduction of VAT in the long-term and also examines issues of vertical externality in exploiting the same base by the two tiers of government in a federal system. After considering the implications of both these aspects, it recommends, as a long-term solution, the introduction of a comprehensive State-VAT inclusive of CenVAT, sales taxes and service tax. Implications of such a proposal, on the devolution by the Twelfth Finance Commission, are also presented in the study.

The study is the result of the collective effort of the team of the staff members of the Institute. The Report was planned and guided by Mahesh C. Purohit, who also prepared the final draft of the study. Besides the faculty members of the Foundation, it had the assistance of senior administrators from the state finance department and also from the Central Board of Excise and Customs. We are greatly indebted to T.R Rustagi in revising chapter III, who took special pains in updating information relating to central taxes on commodities and services. Thanks are due to Vishnu Kanta who helped through out the work of the study and specially contributed in the drafting of chapters II and VI of the study. The team is deeply indebted to D.K. Srivastava for his suggestions during the course of discussions. Valuable suggestions received from G. C. Srivastava, D. N. Rao, M. N. Joshi, Brijesh Purohit, and K B L Mathur, are gratefully acknowledged. Mita Das provided excellent research assistance through out the tenure of this study.

The Governing Body of the Foundation does not bear any responsibility for the contents or views expressed in the report. The responsibility rests with the authors, in particular, the leader of the team

The Foundation is grateful to the Twelfth Finance Commission for entrusting and supporting this study.

New Delhi Mahesh C PurohitDecember 30, 2003 Director

Contents

Chapter Page

Prefacei

Executive Summary vi

1. Introduction 1

Objectives of the StudyFuture DirectionsStructure of the Report

2. Contribution of Taxes on Commodities and Services 5

Trends and Composition of Total Tax RevenueTrends in Taxes on Commodities & Services: Central GovernmentTrends in Taxes on Commodities & Services: State GovernmentsFactors Affecting Tax-GDP ratio

3. Central Taxes on Commodities and Services 19

CenVATStructure of CenVATAdministrative Controls under CenVATObligations under CenVATWeaknesses of the System under CenVATTaxation of ServicesAdministration of Service TaxFuture Horizon

4. State Taxes on Commodities and Services 41

Sales TaxState ExciseMotor Vehicles & Passengers & Goods TaxEntertainment TaxElectricity DutyOctroiEnvironmental TaxesService Tax

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5. Experiences of VAT in Federal Countries 65

BrazilFederal VATState VATHarmonization of Inter-Regional TradeManagement of ICMS: Case Study of Sao PauloFiscal FrontiersCanadaFederal VATProvincial/Retail Sales Tax (RST) and VATHarmonization of TaxesAdministration of Federal VATThe European UnionOrigin PrincipleDestination PrincipleLessons for India

6. Options for VAT in India 84

IntroductionTypes of VATOrigin or Destination Based VATVAT OptionsCentral VATDual VATState VAT

7. Proposed Harmonized VAT in India 92

Dual VAT in the Short RunComprehensive State VAT – The Long Term Goal

References 129

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List of TablesTable No Page

2.1 Tax-GDP Ratio 14

2.2 Tax Revenue: Centre and States (Combined) 15

2.3 Taxes on Commodities & Services: Central Government 16

2.4 Taxes on Commodities and Services: State Governments 17

2.5 Buoyancy: Total Tax Revenue, Direct Tax, Indirect Tax 18

3.1 Rates under CenVAT 34

3.2 List of Items Subjected to 16% Special Excise Duty 36

3.3 List of Services Presently Being Taxed 37

3.4 Trends in Revenue from Services 39

4.1 Rate Slabs of Sales Tax in Different States 53

4.2 Concessional Rate of Sales Tax on Inputs in Indian States 54

4.3 Rates of Surcharge and Additional Sales Tax in Indian States 55

4.4 Rate Structure of State Excise Duty in Indian States (2001-02) 56

4.5 Motor Vehicles Tax on Personal Vehicles 57

4.6 Motor Vehicles Tax on Commercial Passenger Vehicles 59

4.7 Motor Vehicles Tax on Goods Vehicles for Transportation 61

4.8 Major States and Local Taxes on Road Transport Industry 63

4.9 Tax Burden on Heavy Passenger and Goods Vehicles 63

4.10 Rates of Other Taxes in Indian States (2001-02) 64

5.1 List of VAT Rates Applied in the MSs of European Union 83

7.1 Estimating VAT Base (for the year 2001-02) RE – Scenario I 115

7.2 Estimating VAT Base (for the year 2001-02) RE – Scenario II 117

7.3 Estimating VAT Base (for the year 2001-02) RE – Scenario III 119

7.4 Concessional rate of Sales Tax on Inputs in Indian States 121

7.5 Trade Margins under VAT 122

7.6 Concessional Rates Under CST in Different States of India 123

7.7 Items to be brought under Sumptuary Excise under UEDs 126

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List of Exhibits

Exhibits No Page

3.1 Monthly Return under rule 7 of the CenVAT Credit Rules, 2002 407.1 Steps in Estimating Revenue Implications for Introduction of VAT 97

List of Annexures

7.1: Vertical Externality: Issues in Taxation of the same base by Central and

State Governments 112

7.2 Union List and State List 127

v

Executive Summary

Introduction

In recent years, the fiscal system has undergone revolutionary changes,

especially in the field of taxation. In general, in the arena of direct taxes, the peak

rates as well as the number of tax slabs have been reduced. Exemptions have also

been curtailed. In indirect taxes, the most remarkable phenomenon has been the

introduction of VAT.

Efforts have been made to introduce VAT in India. Here the administration of

union excise duties (UED) rests with the centre, while that of sales tax is with the

states. India’s federal structure and this dichotomy in the distribution of tax powers,

between the centre and the states, have made it very difficult to introduce a European

style harmonized VAT system. As a result, India will now have a system of dual VAT

where UED is to be converted into a central VAT and the sales tax into State-VAT.

Despite the centre’s policy decision of imposing a dual VAT system in the

country, it has so far not been able to introduce state-VAT, although the CenVAT has

come into existence. One of the reasons for this is the lack of information about

revenue implications of having this system at the state level. The states apprehend a

loss of revenue on introduction of VAT. Given the existing precarious financial

position of the states, they want to ensure that the centre or the Finance Commission

would compensate the loss of revenue, at least during the transitional period. To take

care of this aspect, this study analyses the revenue implications of introducing a dual

VAT in the country.

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As a long-term solution, the study recommends introduction of a

comprehensive State-VAT. This entails that the centre withdraws from the field of

domestic trade taxes from the point of view of revenue and the states levy VAT

designed on the destination principle.

Contribution of Taxes on Commodities and Services

Tax-GDP ratio in India is low in comparison to not only the developed

countries but also many developing countries. It was 13.8% in 1980-81, increased to

15.8% in 1990-91 but came down to 14.8% in 2001-02. Taxes on commodities and

services have an important role in the over all fiscal system. These contributed 76.2%

of the total tax revenue in the country, with a growth rate of 13.8%. The buoyancy

over the years was 1.02. Union excise duty contributed approximately 64% in 1980-

81 to the central kitty, but its share over the years came down. It was 59% in 2001-02.

At the state level, sales taxes contributed approximately 62% of the states’ own tax

revenue in 2001-02.

The tax-GDP ratio in India is low due to various factors including non-

taxation of agriculture and service sectors. Lack of adequate tax compliance, resulting

in considerable evasion of tax, has also been responsible for this low ratio. In recent

years there has been decline in the tax-GDP ratio due to tax reforms in consonance

with structural reforms and the adoption of liberalization. An analysis of the causal

variables responsible for this decline points out that reduction in the rates of customs

duty, conversion of UED from the production type VAT to consumption type VAT

and the global recession are some of the plausible factors that adversely affected the

tax-GDP ratio in the nineties.

Central Taxes on Commodities and Services

Union excise duty is the most important domestic trade tax levied on the

manufacturer by the central government. It is known as CenVAT and the general tax

rate is 16% although some items are taxed at 8% and 10% respectively. In addition,

the central government levies special excises on some commodities at the rate of 8%.

Some other excises are also levied to fulfill certain specific objectives.

Since 1994, under the residuary entry of the Constitution, the central

government is levying a tax on services as well. Initially, the tax was levied only on

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a few services, but over the years the scope has been enlarged to cover as many as 58

services.

Levy of Commodity Taxes by the States

States levy many taxes on commodities and services. These include sales tax,

state excise, motor vehicles tax, passengers & goods tax, electricity duty etc. Sales tax

is the most important tax and yields approximately 60% of the states own tax revenue.

Most of the states levy this tax on the first-point of sale. Only Punjab and

Delhi follow the last-point system for many commodities. In addition to general sales

tax, many of the states levy a turnover tax, surcharge and additional sales tax. Some of

the states also levy an entry tax on the goods being imported into the state. A luxury

tax is also levied by some of the states on the consumption of goods imported into the

state.

Haryana is the only state that has introduced value added tax (VAT) in place

of sales tax from April 2003. As no other state has so far introduced VAT, the

Haryana state government has retained the existing rates of sales tax and the CST.

Experiences of VAT in Federal Countries

VAT has been introduced in federal countries like Brazil, Canada and the

European Union (EU). A study of the fiscal system in these countries indicates that it

is possible for India to have a dual VAT as in Brazil and Canada. Even a system of a

full fledged state VAT, like that in the EU, has its advantages. Most important aspect

in the introduction of VAT in a federal country is to have a harmonized system of

interstate transactions. Brazilian State VAT (ICMS) follows the system of origin-

based tax. However, the importing state gives set-off for the tax paid by the dealer in

the exporting state. In addition, the differential rate for taxing interstate transactions

works as an equalizing mechanism in a Brazilian federation. Canada and the EU

follow the system of zero-rating of input tax. Also, the Canadian system of

harmonized sales tax (HST) suggests that the State VAT could be coordinated with

the federal VAT while the system of Quebec Sales Tax (QST) indicates that the same

be administered by the states.

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Options for VAT in Indian Federation

Various models of VAT in federal countries indicate that the design of the tax

should be a destination based consumption type VAT. Most unitary form of

governments levy a central VAT. Some of the federal countries too have adopted this

form. However, in recent years some schools of thought have recommended a dual

VAT or a State-VAT. In the Indian conditions of dichotomy of tax authority between

central and state governments, some experts have recommended that dual VAT would

be the best form of VAT. Others, however, feel that the state VAT should be best

adopted to take care of tax assignment and vertical tax externality.

Proposed Harmonized VAT in India

In the short-run it is useful to follow a system of dual VAT in India. This

implies that the union excise duty (UED) is converted into a Central VAT (CenVAT)

and the state’s sales tax is replaced by a state-VAT. While the central government has

already replaced UED by CenVAT, the states have not converted their sales tax into a

system of VAT apprehensive that it will drastically lower revenue collections.

The empirical estimates reveal that if state-VAT replaces sales tax, the states

would lose considerable revenue since CST has to be made destination based in order

to make India a common market. Also, loss due to input credit would not be

compensated unless the states are given the power to tax services. The Twelfth

Finance Commission (TFC) has to take into account the revenue implications of

implementing VAT while making its recommendations.

In the long-term, it is important to take care of vertical imbalance in taxing

powers of the federal and state governments plus vertical tax externality of taxing the

same tax base by the two governments. Keeping both these aspects in view, it is

important that the two important commodity taxes, viz, UED and sales tax, are

harmonized to have one comprehensive destination based state-VAT. This would

require a levy of sumptuary excise by the Central government to enable it to perform

its allocative and distributive roles. Also, the TFC has to allocate revenue from UED

on the basis of collection to enable the states to provide set-off of UED from the state

VAT.

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Restructuring State Finances

In addition, the states must restructure their taxes on commodities and services

such that most of these can be converted into one comprehensive state VAT. This

includes passengers and goods tax, electricity duty, tax on entertainment, amusements

and the luxury tax on hotels. By doing so, India would finally have a broad-based and

economically rational indirect tax system to make it a common market.

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1

Introduction

In recent years the fiscal system has under gone revolutionary changes,

especially in the field of taxation. Most of the developing countries have reformed

their tax systems by reducing the number of rates as well as exemptions. The tax base

has been enlarged and value added tax (VAT) has been introduced to replace the other

cascade type commodity taxes. The trend has been towards simplification and

rationalization.

In India, reforms have been initiated on the basis of recommendations of

various Committees and Study Groups. The Report of the Indirect Taxation Enquiry

Committee (1978), chaired by L K Jha, is the first Report that puts forth a most

exhaustive study on indirect taxation in India. It recommended introduction of

manufacturers’ value added tax (ManVAT) in the union excise duties. In the changed

economic scenario of globalization and structural reforms, sound advice on tax

reforms to enable India to compete globally was given by the Report of the Tax

Reforms Committee (1991-92), chaired by R. J. Chelliah. For the Tenth Five Year

Plan, the Advisory Group on Tax Policy and Tax Administration for the Tenth Plan,

chaired by Parthosharthi Shome (2001), has recommended further reforms. Path-

breaking recommendations have been presented in two separate Reports of the Task

Forces on Direct and Indirect Taxes (2002), chaired by Vijay Kelkar, for modernizing

tax administration and reducing the transaction cost of taxpayers.

Drawing upon the recommendations of the Jha Committee, India made a

beginning towards reforms in 1986, by initiating modified value added tax

(ModVAT) in the union excise duties. This has since been converted into a central

value added tax (CenVAT).

India being a federal country, the Constitution of India provides for division of

tax powers between the Centre and the States, under the Centre List and the States

1

Lists (of the Seventh Schedule), respectively. Any reform in the tax system would

have to be attempted under the constraints of these Lists. As the union excise duty

falls in the Central List and the sales taxes in the State List, introduction of a

comprehensive VAT in India faces some constraints.

A report of a study team titled Reform of Domestic Trade Taxes in India

(1994), prepared by the National Institute of Public Finance and Policy under the

leadership of A. Bagchi, had examined various options for VAT in India. It

recommended that given the constraints of the division of tax powers in the

Constitution, as an immediate policy tool, the most appropriate model could be a

system of dual-VAT --- central VAT (CenVAT) to be levied by the Central

Government (by converting union excise duty into a CenVAT) and state-VAT to be

adopted by the State Governments (by replacing the existing sales tax into a full

fledged VAT).

Objectives of the Study

During the last one decade India has followed the above strategy for reforms

in commodity taxes, although some long-term reforms have been suggested from time

to time.

Short-term reforms being significant, from the point of acceptability by both

the Centre and States, as well as relevant for the devolution by the Twelfth Finance

Commission (TFC), this study, as a first step, recommends a system of harmonized

commodity taxes under the umbrella of a dual-VAT. In doing so, it presents estimates

of revenue implications of the proposed system.

Future Directions

Further, this study also presents long-term measures for reforms in taxes on

commodities and services. It recognizes that in the long-term, restructuring of

commodity taxes should be so attempted that all the taxes are fully harmonized.

Many Committee Reports and economists have pleaded for a National VAT,

which brings all commodity taxes under the purview of the central government. Such

an arrangement would augment more concentration of resources with the central

government, which is already to the tune of 67 percent of the total resources. The TFC

2

would have an enhanced role in the devolution of resources between the centre and

states and among the states.

Vertical externality of taxing the same base by the centre as well as the states

being extremely important, some of the studies have suggested that a harmonized

VAT be levied at the state level. For the first time Purohit recommended the concept

of a complete State-VAT, where tax is levied only by the states and the CenVAT

becomes part and parcel of the State-VAT1. This implies the withdrawal of the centre

from the arena of commodity taxes from the point of revenue. Burgess, Howes and

Stern also elaborated on various options for VAT and suggested that the long-term

reform lies in having a comprehensive State-VAT, although some problems might

arise in administration of such a tax2. Taking earlier studies into account, this study

further elaborates on the concept of comprehensive State-VAT and recommends

restructuring of commodity taxes with long-term perspective.

Future perspective is particularly relevant for the TFC, which has for the first

time been asked to “review the state of finances of the Union and the States and

suggest a plan by which the Governments, collectively and severally, may bring about

a restructuring of the public finances restoring budgetary balance, achieving macro-

economic stability and debt reduction along with equitable growth”. In this context, it

is important that while restructuring the tax system, for a long-term perspective, the

TFC should take care of the objectives of growth with efficiency along with vertical

externality.

In this context the study not only recommends harmonization of union excise

duty and sales taxes but also goes one step further. It suggests that when sales tax is

converted into a State-VAT, some of the taxes on commodities and services in the

State List- electricity duty, entertainment tax, and luxury tax on hotels etc. could also

1 Purohit, Mahesh C. (1992), “Adoption of VAT in India: Problems and Prospects”, paper presented at the International Conference on Tax Reforms organized by the National Institute of Public Finance and Policy, New Delhi. The paper was subsequently published in Economic and Political Weekly, March 6, 1993. This concept was further elaborated in a recent paper titled, “Assignment of Taxing Powers for Fiscal Balance” in Srivastava D. K. (ed.) Fiscal Federalism in India: Contemporary Challenges - Issues Before the Eleventh Finance Commission , NIPFP, New Delhi, pp. 312-329.

2 Bugess, Robin, Stephen Howes and Nicholas Stern (1993), Tax Reforms of Indirect Taxes in India, Discussion Paper No. EF No. 7 of the Suntory-Toyota International Centre for Economic Research and Related Disciplines, London School of Economics, London.

3

be integrated into the State-VAT. It, therefore, recommends a comprehensive State-

VAT covering all other taxes, as a long-term goal for reforms in this direction.

Structure of the Report

Keeping all the above aspects in view, the scheme of presentation is as

follows: Chapter 2 presents an analysis of the contribution of taxes on commodities

and services to government revenues. The next chapter describes the structure and

administration of the union excise duties and tax on services levied by the Central

government. Chapter 4 brings forth an analysis of the taxes on commodities and

services levied by the States. This includes sales tax, state excise duties, motor

vehicles tax, passengers & goods tax, entertainment tax, electricity duty etc. To draw

lessons from the experiences of VAT in different federal countries, Chapter 5 presents

an analysis of VAT in Brazil, Canada, and the European Union with a special

reference to taxation of interstate trade. The next chapter analyses different options

for VAT in India. Short-term restructuring of commodity taxes is given in the first

part of the chapter, keeping in view the immediate relevance of the study for the

recommendations of the TFC. However, taking note of the vertical externality issue,

the long-term restructuring is presented in the next part.

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2

Contribution of Taxes on Commodities and Services

In the initial phase of development, the economy is based on primary activities

and industrial activities do not have a major role in the system. As a result, Gross

Domestic Product (GDP) is not very high and the government has to depend upon

taxes on commodities and services for mobilizing resources rather than on taxes on

income and property. Such a situation prevails in almost all the primary economies3.

As the economy develops, the proportion of revenue generated from taxes on income

and property rises.

Tax-GDP ratio (tax revenue as percentage of GDP) of India is very low in

comparison with not just the developed countries, but many developing countries as

well. Whereas developed countries like Sweden, Greece, United Kingdom, and USA

have tax-GDP ratio higher than 30 percent, many of the developing countries too have

a higher ratio- Korea 26 percent, Brazil 21 percent, and Mexico 18.5 percent. In

comparison, the tax-GDP ratio of India is very low, just 14.4 percent in 2001-02.

While the tax-GDP ratio in India (centre and states combined) was 13.8

percent in 1980-81, it increased to 15.8 in 1991-92. Owing to structural adjustments

and rationalization of tax structure during the nineties, the ratio declined to 13.4

percent in 1998-99. Since then the ratio has shown mild improvement. It reached 14.4

percent in 2001-02 (Table 2.1).

As in other developing countries, in India too, indirect taxes have contributed

significantly to the tax-GDP ratio. The ratio of indirect taxes to GDP was 11.53

percent in 1980-81 and increased to 13.68 percent in 1989-90. It plummeted to 10.56

percent in 1998-99 but then rose to 10.96 percent in 2001-02. Owing to

implementation of some major tax reforms in the central government in the nineties,

its tax-GDP ratio has declined but the tax revenue collected by the States, as a percent

to GDP, has increased steadily. The tax-GDP ratio of the states, taking the states own

3 Hinrichs, Harley H. (1966), A General Theory of Tax Structure Change during Economic Development, International Tax Programme, Harvard Law School, Cambridge.

5

tax revenue, has increased from 4.64 percent in 1980-81 to 5.30 percent in 1990-91

and reached a high of 5.8 percent in 2001-02. Similarly, the indirect tax-GDP ratio of

states has moved from 4.45 percent in 1980-81 to 5.08 percent in 1990-91 and further

to 5.62 percent in 2001-02.

Trends and Composition of Total Tax Revenue

Trends in total tax revenue in India indicate that whereas in 1980-81 total tax

revenue was Rs. 19,844 crore, it increased to Rs. 1,03,198 crore in 1991-92 and to Rs.

3,30,229 crore in 2001-02 (Table 2.2). It recorded a growth rate of 14.5 percent per

annum.

Taxes on commodities and services have an important role. These contribute

to almost three-fourth of the revenue received from all taxes taken together. These

taxes have grown from Rs.16,576 crore in 1980-81 to Rs. 75,462 crore in 1990-91. It

rose further to Rs. 2,51,728 crore in 2001-02, with a growth rate of 13.8 percent per

annum.

Taxes on income and property have contributed a small share, although over

the years their stake has increased. Whereas its contribution in 1980-81 was just 16.5

percent, it increased to approximately 24 percent in 2001-02. The share of taxes on

income and property has shown a fluctuating trend during 1980-81 to 1990-91, but

thereafter it showed steady growth. During the overall period of 1980-81 to 2001-02,

it has recorded an annual growth rate of 17 percent.

Buoyancy of total tax revenue4 of centre and states during 1980-81 to 2001-02

(as shown in Table 2.5) is 1.05. Buoyancy has, however, declined from 1.11 during

1980-81 to 1989-90 to 0.88 during 1990-91 to 2001-02. This is primarily due to

decline in the buoyancy of taxes on commodities and services, which has shown a

declining trend in 1990-91 to 2001-02 as compared to the buoyancy in the earlier

period i.e. during 1980-81 to 1989-90. As shown in Table 2.5, the buoyancy of these

taxes was 1.14 during 1980-81 to 1989-90 and 0.81 during 1990-91 to 2001-02.

Buoyancy of direct taxes has shown an increase from 0.94 during 1980-81 to 1989-90 4 This indicates percentage change in revenue with respect to change in GDP or any other base.

Symbolically, this is expressed as∂R/R ÷ ∂Y/Y

Where R and Y represent tax revenue and GDP, respectively.If the coefficient is greater than unity, revenue is said to be buoyant. The revenue performance of the governmental unit is said to be productive giving higher yields as GDP grows.

6

to 1.24 during the second decade of the study, indicating an encouraging

responsiveness.

Trends in Taxes on Commodities and Services: Central Government

Trends in tax revenue of centre and states, as given in Table 2.2, indicate that

the Central Government collected total tax revenue of the order of Rs. 67,361 crore in

1991-92, which increased to Rs. 1,96,693 crore in 2001-02, recording a growth rate of

14.02 percent per annum over the period. The major contributing taxes in the central

tax revenue are union excise duty and customs duty.

The yield from union excise duty (UED), the major contributor to the share of

commodity taxes, was of the order of Rs. 6,500 crore in 1980-81, contributing 63.83

percent to the indirect taxes of the centre. The share declined to 52.66 percent in

1990-91, which increased during 1994-95 and 1995-96 but again declined to 59.10

percent in 2001-02 (Table 2.3).

Customs duty is yet another important source of revenue to the central kitty. It

contributed to the order of Rs. 3,409 crore in 1980-81 and this increased to Rs. 40,268

crore in 2001-02. Its share in total commodity taxes has, however, changed

considerably over the period. While its share in 1980-81 was 33.48 percent, it

consistently increased up to 1990-91 and the share was recorded at 44.35 percent of

total indirect taxes of the centre (Table 2.3). Thereafter, ever since the policy of

liberalization was adopted and customs duty was adjusted to a lower level, its yield

has gone down. With minor fluctuations its share has been recorded at 32.80 percent

in 2001-02.

Service tax was introduced by the central government in 1994-95, when the

share of this tax was less than 1 percent (Table 2.3). By 2001-02, the share of this tax

has increased to approximately 3 percent.

Union Excise Duty

Yield from UED, the largest source of revenue obtained from taxes on

commodities and services by the centre was Rs. 6,500 crore in 1980-81. The revenue

has since increased to Rs. 24,514.4 crore in 1990-91 and to Rs. 72,555 crore in 2001-

02 (RE) (Table 2.3).

7

There has been a declining trend in the share of UED in the total tax revenue

of the central government during the period 1980-81 to 1990-91. It has decelerated

persistently from 63.8 percent in 1980-81 to 52.7 percent in 1990-91 except for the

years 1983-84 and 1989-90, when its share was 63 percent and 53.8 percent,

respectively. UED has witnessed upward trend in its share during 1991-92 to 1994-95.

The trend reversed thereafter until 1996-97, when it came down to 50 percent. Since

then there was a systematic increase in its share and it reached 59 percent in 2001-02

(Table 2.3). The growth rate of UED during the period (1980-81 to 1989-90) was 14.6

percent per annum. During the second phase i.e. 1990-91 to 2001-02, the growth rate

was only 10.4 percent per annum. The overall rate of growth over twenty years was

12.18 percent.

Customs Duties

Duties of customs, including export duties, are another source of revenue from

indirect taxes to the centre. Among these, import duty forms a major source of

revenue. Revenue collection from customs duty has shown a rising trend: it has

increased from Rs. 3,409.3 crore in 1980-81, to Rs. 20,643.8 crore in 1990-91, and to

Rs. 40,268.0 crore in 2001-02 (Table 2.3). But from 1990-91 onwards, the share of

customs duties in total tax revenue of Central government has decreased steadily, with

slight variations during mid-1990s. In 1980-81, its share in total tax revenue of Centre

was 33.5 percent, which went up to 44.4 percent in 1990-91 and then declined to 33

percent in 2001-02. The annual rate of growth during 1980-81 to 2001-02 was 13.36

percent. However, during the first half of this period i.e. during 1980-81 to 1989-90,

the growth rate was much higher-- 21.03 percent, as compared to growth rate of 8.6

percent during the latter half i.e. during 1990-91 to 2000-01.

The share of customs duty in total tax revenue, Centre and States taken

together, increased steadily from 17.2 percent in 1980-81 to 23.5 percent in 1990-91,

and then decreased to 12 percent in 2001-02.

Service Tax

With structural reforms and significant changes in the institutional framework

in India, the services sector has grown at a rapid rate. About 50 percent of GDP is

obtained from services sector. This made it important to levy tax on services. At

8

present, the Central government is levying and collecting service tax on 58 services.

The revenue realized from this tax forms part of the ‘divisible pool’ and is shared

between the Centre and the States, in accordance with provisions of Article 270 of the

Constitution. This tax was levied, for the first time, in 1994-95 by the centre on five

services. It generated revenue worth Rs. 407 crore. Revenue from this tax has

increased over time bringing it to Rs. 3,302 crore in the year 2001-02. Among all the

three taxes collected by Centre, service tax has increased at the rate of about 30.7

percent during the period 1990-91 to 2001-02. Since it is a new levy, its growth rate

has been the highest.

As it is a new tax, service tax has proved to be the most buoyant source of tax

revenue, having a buoyancy rate of 2.04 for the period 1994-95 to 2001-02. Customs

duty had also shown good responsiveness and recorded higher buoyancy in the first

half of the period as compared to the latter half. Its buoyancy was 0.95 during 1980-

81 to 2001-02. Similarly the buoyancy recorded for UED is 0.86 for the same period

(Table 2.5). As in other taxes, the buoyancy of both the UED and of customs duty has

fallen during this period. It was 1.03 in 1980-81 to 1989-90 and 0.75 in 1990-91 to

2001-02 for UED whereas it was 1.44 and 0.64, respectively for customs duties.

Trends in Taxes on Commodities and Services: State Governments

Total tax revenue of all the State governments has increased from Rs. 35,837

crore in 1991-92 to Rs. 1,33,536 crore in 2001-02, showing a growth rate of 15.3

percent per annum. Consequently, the States’ share in total revenue has gone up from

33.6 percent in 1980-81 to 34.4 percent in 1990-91 and to 40.5percent by 2001-02.

Revenue of the States, from taxes on commodities and services, shows a rising

trend. The revenue has increased from Rs.6,394 crore in 1980-81, to Rs. 28,915 crore

in 1990-91 and to Rs.1,28,979 crore in 2001-02. It has increased by as much as 20

times during the entire period, a growth rate of 15.35 percent per annum (Table 2.2).

The important taxes on commodities and services levied by the states are sales tax,

state excise, motor vehicles tax, passengers & goods tax, electricity duty and

entertainment tax. Sales tax alone contributes around 60 percent of taxes on

commodities and services, while state excise, motor vehicles tax and passengers &

goods tax together contribute 23 to 24 percent. Thus, these taxes contribute

9

approximately 84 percent of the states revenue from taxes on commodities and

services.

Sales Tax

This tax constitutes a major source of revenue for the State governments. The

yield from sales tax has shown an upsurge from Rs. 3,853.0 crore in 1980-81 to Rs.

17,460.0 crore in 1990-91 and to Rs. 79,855 crore in 2001-02 (Table 2.4). Sales tax

revenue collected by all the States expressed as a percentage of taxes on commodities

and services has risen steadily from 60.3 percent in 1980-81 to 62 percent in 2001-02.

The same trend is observed in its share in total tax revenue of Centre and States. This

has gone up from 19.4 percent in 1980-81 to 24 percent in 2001-02. Sales tax revenue

has witnessed a growth rate of 14.41 percent during 1990-91 to 2001-02 as compared

to 15.82 percent during 1980-81 to 1990-91. Sales tax is the most buoyant source of

revenue, even though its buoyancy has declined from 1.11 to 1.02 over time.

State Excise

This is another indirect tax levied by State governments and can be regarded

as the second largest source of revenue from such taxes. The yield from State excise

has recorded about a three-fold increase from Rs. 838.3 crore in 1980-81, to Rs.

4,798.4 crore in 1990-91 and to Rs.17,987 crore in 2001-02 (Table 2.4). However, the

revenue collected from State excise as a percentage of revenue collected from taxes

on commodities and services shows a different pattern. It increased from 13 percent in

1980-81 to 16.6 percent in 1990-91 but was 13.9 percent in 2001-02.

The share of state excise duty in the total revenue of the centre and the states

was 4.1 percent in 1980-81. That has increased to 5.5 percent in 1995-96. Since then

it has moved downwards and reached 5.4 percent in the year 2001-02. It has recorded

a growth rate of 12.85 percent during 1990-91 to 2001-02 as compared to the growth

rate of 17.09 percent during the period 1980-81 to 1989-90. The buoyancy of State

excise was higher in the first half of the period as compared to the latter half. It has

reduced from 1.20 to 0.92 during the latter half of the period.

Motor Vehicles and Passengers and Goods Tax

The primary reason for levying tax on motor vehicles is to regulate and control

motor traffic in the cities. But it has been observed that motor vehicles tax can also

10

serve as a good source of revenue. The revenue yield from it has increased from Rs.

1,535.4 crore in 1990-91 to Rs. 8,694.2 crore in 2001-02.

The share of passengers and goods tax in total revenue obtained from taxes on

commodities and services is lesser than that of motor vehicles tax. In 2001-02, it was

about 2.8 percent. The yield from this tax has gone up from Rs. 1,187.2 crore in 1990-

91 to Rs. 3,735.5 crore in 2001-02.

While examining the trends in revenue receipts from tax on motor vehicles

and passengers and goods, it is important to note that its revenue has almost doubled

during the period 1990-91 to 2001-02. It has steadily increased from Rs. 698.9 crore

in 1980-81, to Rs. 2,597.2 crore in 1990-91 and to Rs. 11,489.5 crore in 2001-02

(Table 2.4). However, its share in total revenue receipts from taxes on commodities

and services has decreased from 10.9 percent in 1980-81 to 8.9 percent in 2001-02. It

has recorded a growth rate of 14.59 percent during 1980-81 to 1989-90 and 13.50

percent during 1990-91 to 2001-02. Similarly, its buoyancy has also decreased from

1.03 to 0.96 during the same time periods (Table 2.5).

Electricity Duty

The consumers pay an additional amount, known as electricity duty, along

with the electricity rates for consuming electricity. This acts as a good source of

revenue for the State governments. The revenue from this tax was Rs. 228 crore in

1980-81 but went up to Rs. 1,596 crore in 1991-92 and stood at Rs. 5,677.7 crore in

2001-02 (Table 2.4), recording a growth rate of 20.45 percent during 1980-81 to

1989-90 and 13.64 percent during 1990-91 to 2001-02 (Table 2.5). Accordingly, its

buoyancy is also recorded at 1.41 and 0.97 during the two periods of time.

Entertainment Tax

Entertainment tax, levied on admission to places of amusement or

entertainment namely cinema, circus, theatrical performances, exhibition, sports and

games, variety entertainment etc. generated revenue to the tune of Rs. 233.6 crore in

1980-81. It went up to Rs. 1,203.7 crore in 2000-01 but has shown a slight decline in

2001-02 (Table 2.4). It has recorded a growth rate of 6.25 percent during the period

1980-81 to 1989-90 and of 9.19 percent during the period 1990-91 to 2001-02.

Accordingly, its share in the states own tax revenue from commodities and services

11

(from all States taken together) has also reduced from 3.7 percent in 1980-81 to 1.5

percent in 1990-91 and to 0.72 percent in 2001-02.

Factors Affecting Tax-GDP Ratio

Revenue obtained from taxes on commodities and services has increased

steadily overtime and with the development of the services sector, it is expected to

grow further. However, as pointed out earlier in this chapter, the tax-GDP ratio in

India is low due to various factors including non-taxation of agriculture and service

sectors, both of which contribute considerably to the GDP. Lack of adequate tax

compliance, resulting in considerable evasion of tax, has also been responsible for low

tax-GDP ratio.

In recent years there has been some down fall in tax-GDP ratio, as shown in

Table 2.1, due to tax reforms in consonance with structural reforms and the adoption

of liberalization.

These factors have had a major impact on the indirect tax-GDP ratio. An

analysis of tax wise break-up during recent years indicate that the main reason for

decline in tax-GDP ratio in the nineties was slump in the revenue from customs duty

and the union excise duty (UED) that account for over two-thirds of the central tax

revenues. The buoyancy of these two taxes with respect to GDP declined during this

period. It fell down from 1.03 for UED and 1.44 for customs duty in the eighties to

0.75 and 0.64 in the nineties.

An analysis of the causal variables responsible for this decline points out that from

the time of the advent of the policy of liberalization, the rates of customs duty have

gradually been brought down to bring these at par with other countries of the world

and to follow the WTO bindings. In the process of rationalization of UED, as

recommended by the Tax Reforms Committee, 1991-935, the tax rates on many of the

commodities were reduced. Extension of Modvat and efforts at conversion of UED,

from the production type VAT to consumption type VAT by giving input credit for

capital goods in one go, had a dampening effect on the revenue of UED. Sizeable

dampening effect of Modvat credit for raw materials as well as for capital goods has

been noticed during the period on the revenue from UED. An analysis of the trends in

5 Government of India (1991-93), Report of the Tax Reforms Committee, New Delhi.

12

Modvat credit in 1995-96, for example, indicates that while net revenue (gross

revenue minus input credit) would have grown at 16.4 percent (instead of 4.4 percent)

if no change had been made with respect to the scheme of Modvat credit.

Interestingly, the larger effect of Modvat credit that has been witnessed, on account of

credit for raw materials as compared to the credit for capital goods, is the decline of

the rate of growth of revenue6. Finally, the global recession seems to be another

possible reason of sluggishness in revenue from customs and UED, due to its adverse

effects on industrial production. All these factors have adversely affected the tax-GDP

ratio in the nineties.

6 Shome, Parthasarathi, Pawan K. Aggarwal and Mahesh C. Purohit (1996), Modified Value Added Tax: Development, Structure and Revenue Productivity, NIPFP, New Delhi.

13

Table 2.1

Tax-GDP Ratio

Year Tax-GDP Ratio (percent)

Direct Tax-GDP Ratio (percent)

Indirect Tax-GDP Ratio (percent)

1980-81 13.80 2.27 11.53

1981-82 14.32 2.45 11.87

1982-83 14.47 2.39 12.08

1983-84 14.36 2.24 12.13

1984-85 14.59 2.17 12.41

1985-86 15.56 2.25 13.31

1986-87 15.92 2.21 13.70

1987-88 16.08 2.11 13.97

1988-89 15.87 2.31 13.56

1989-90 15.98 2.30 13.68

1990-91 15.42 2.16 13.27

1991-92 15.80 2.55 13.25

1992-93 15.25 2.59 12.66

1993-94 14.19 2.53 11.67

1994-95 14.60 2.85 11.75

1995-96 14.75 3.01 11.74

1996-97 14.62 3.00 11.62

1997-98 13.49 3.32 11.17

1998-99 13.38 2.82 10.56

1999-2000 14.18 3.14 11.03

2000-01 14.51 3.41 11.10

2001-02(RE) 14.38 3.42 10.96

Source: Govt. of India (2002-03), Indian Public Finance Statistics, Ministry of Finance, New Delhi

14

Table 2.2

Tax Revenue: Centre and States (Combined)(Rs. Crore)

Year Centre States CombinedTaxes on Income & Property#

Taxes on Commodities & Services#

Total Central Taxes^

Taxes on Income & Property*

Taxes on Commodities & Services*

Total State Taxes^

Taxes on Income & Property

Taxes on Commodities &

Services

Total of Central & State

Taxes1980-81 2997 10182 13179 271 6394 6665 3268 16576 19844

(22.7) (77.3) (66.4) (4.1) (95.9) (33.6) (16.5) (83.5) (100.0)1981-82 3786 12061 15847 347 7948 8295 4133 20009 24142

(23.8) (76.1) (65.6) (4.2) (95.8) (34.4) (17.2) (82.8) (100.0)1982-83 4139 13557 17696 353 9193 9546 4492 22750 27242

(23.3) (76.6) (65.0) (3.6) (96.3) (35.0) (16.5) (83.5) (100.0)1983-84 4498 16223 20721 409 10395 10804 4907 26618 31525

(21.7) (78.2) (65.7) (3.7) (96.2) (34.3) (15.5) (84.4) (100.0)1984-85 4798 18673 23471 532 11811 12343 5330 30484 35814

(20.4) (79.5) (65.5) (4.3) (95.6) (34.5) (14.8) (85.1) (100.0)1985-86 5620 23051 28671 632 13965 14597 6252 37016 43268

(19.6) (80.3) (66.3) (4.3) (95.6) (33.7) (14.4) (85.5) (100.0)1986-87 6236 26601 32837 653 16048 16701 6889 42649 49538

(18.9) (81.0) (66.3) (3.9) (96.1) (33.7) (13.9) (86.1) (100.0)1987-88 6752 30914 37666 731 18580 19311 7483 49494 56977

(17.9) (82.1) (66.1) (3.7) (96.2) (33.9) (13.1) (86.8) (100.0)1988-89 8830 35644 44474 928 21524 22452 9758 57168 66926

(19.8) (80.1) (66.4) (4.1) (95.8) (33.6) (14.5) (85.4) (100.0)1989-90 10003 41633 51636 1162 24895 26057 11165 66528 77693

(19.3) (80.6) (66.4) (4.4) (95.5) (33.6) (14.3) (85.6) (100.0)1990-91 11030 46547 57577 1230 28915 30145 12260 75462 87722

(19.1) (80.8) (65.6) (4.1) (95.9) (34.4) (13.9) (86.0) (100.0)1991-92 15353 52008 67361 1304 34533 35837 16657 86541 103198

(22.7) (77.2) (65.2) (3.6) (96.3) (34.8) (16.1) (83.8) (100.0)1992-93 18140 56496 74636 1247 38283 39530 19387 94779 114166

(24.3) (75.6) (65.3) (3.1) (96.8) (34.7) (16.9) (83.0) (100.0)1993-94 20299 55443 75742 1414 44805 46219 21713 100248 121961

(26.8) (73.2) (62.1) (3.1) (96.9) (37.9) (17.8) (82.1) (100.0)1994-95 26973 65324 92297 1905 53647 55552 28878 118971 147849

(29.2) (70.7) (62.4) (3.4) (96.5) (37.6) (19.5) (80.4) (100.0)1995-96 33564 77660 111224 2213 61822 64035 35777 139482 175259

(30.1) (69.8) (63.4) (3.4) (96.5) (36.6) (20.4) (79.5) (100.0)1996-97 38898 90864 129762 2163 69131 71294 41061 159995 201056

(29.9) (70.0) (64.5) (3.0) (96.9) (35.5) (20.4) (79.5) (100.0)1997-98 48282 90938 139220 2256 79183 81439 50538 170121 220659

(34.6) (65.3) (63.1) (2.7) (97.2) (36.9) (22.9) (77.1) (100.0)1998-99 46601 97196 143797 2518 86702 89220 49119 183898 233017

(32.4) (67.5) (61.7) (2.8) (97.1) (38.3) (21.1) (78.9) (100.0)1999-00 57960 113792 171752 2904 99927 102831 60864 213719 274583

(33.7) (66.2) (62.5) (2.8) (97.1) (37.5) (22.1) (77.8) (100.0)2000-01 68305 120298 188603 3457 113260 116717 71762 233558 305320

(36.2) (63.7) (61.7) (2.9) (97.0) (38.3) (23.5) (76.4) (100.0)2001-02 (RE) 73944 122749 196693 4557 128979 133536 78501 251728 330229

(37.5) (62.4) (59.5) (3.4) (96.5) (40.5) (23.7) (76.2) (100.0)Growth Rate 17.43 12.76 14.02 13.12 15.35 15.27 17.13 13.87 14.47Source: Government of India, Budget Documents (various issues).Notes:1. Figures within parenthesis in columns marked with (#) are expressed as percentage of total taxes collected by Centre.2. Figures within parenthesis in columns marked with (*) are expressed as percentage of total taxes collected by States.3. Figures within parenthesis in columns marked with (^) are expressed as percentage of total taxes collected by Centre and

States combined.

15

Table 2.3Taxes on Commodities & Services: Central Government

(Rs. Crore)

Year Union Excise Duty Customs Duty Service Tax Total Taxes on Commodities &

Services1980-81 6500 3409.3 10182

(63.83) (33.48)1981-82 7420.7 4300.4 12061

(61.52) (35.65)1982-93 8058.5 5119.4 13557

(59.44) (37.76)1983-84 10221.8 5583.4 16223

(63.0) (34.41)1984-85 11150.8 7040.5 18673

(59.71) (37.70)1985-86 12955.7 9525.8 23051

(56.20) (41.32)1986-87 14470.2 11475 26601

(54.39) (43.13)1987-88 16425.7 13702.4 30914

(53.13) (44.32)1988-89 18841.3 15805.1 35644

(52.85) (44.34)1989-90 22406.3 18036.1 41633

(53.81) (43.32)1990-91 24514.4 20643.8 46547

(52.66) (44.35)1991-92 28109.8 22256.7 52008

(54.04) (42.79)1992-93 30831.5 23776.4 56496

(54.57) (42.08)1993-94 31696.6 22192.7 55443

(57.16) (40.02)1994-95 37347.2 26789.1 407 65324

(57.17) (41.0) (0.62)1995-96 40187.3 35756.8 862 77660

(51.74) (46.04) (1.10)1996-97 45037.8 42851 1059 90864

(49.56) (47.15) (1.16)1997-98 47961.6 40192.8 1586 90938

(52.74) (44.19) (1.74)1998-99 53246.2 40668.3 1957 97196

(54.78) (41.84) (2.01)1999- 2000 61901.8 48419.6 2128 113792

(54.39) (42.55) (1.87)2000- 2001 68526.1 47542 2613.4 120298

(56.96) (39.52) (2.17)2001-02 (RE) 72555 40268 3302 122749

(59.10) (32.80) (2.69)Growth Rate 12.18 13.36 30.72 12.76

Source: Government of India, Budget Documents (various issues).Note: Figures within parenthesis are expressed as ‘percentto total of taxes on commodities and service

collected by Central Government

16

Table 2.4

Taxes on Commodities & Services: State Governments

(Rs. Crore)

Year Sales Tax State Excise

Motor Vehicles & Passengers &

Goods Tax

Electricity Duty

Entertainment Tax

Total taxes on Commodities

& Services1980-81 3853.0 838.3 698.9 228.3 233.6 6394

(60.3) (13.1) (10.9) (3.6) (3.7)1981-82 4858.9 1128.5 770.6 269.1 269.1 7948

(61.1) (14.2) (9.7) (3.4) (3.4)1982-93 5440.7 1355.7 986.9 307.2 307.2 9193

(59.2) (14.7) (10.7) (3.3) (3.3)1983-84 6203.2 1582.8 1087.6 367.5 304.1 10395

(59.7) (15.2) (10.5) (3.5) (2.9)1984-85 7028.9 1857.4 1198.4 454.7 360.1 11811

(59.5) (15.7) (10.1) (3.8) (3.6)1985-86 8392.3 2071.1 1385.3 632.6 391.3 13965

(60.1) (14.8) (9.9) (4.5) (2.8)1986-87 9568.7 2426.7 1594.6 802.2 365.6 16048

(59.6) (15.1) (9.9) (5.0) (2.3)1987-88 11139.7 2880.3 1848.4 806.7 354.4 18580

(60.0) (15.5) (9.9) (4.3) (1.9)1988-89 13093.2 3098.0 2162.3 999.2 425.7 21524

(60.8) (14.4) (10.0) (4.6) (2.0)1989-90 15001.0 3886.0 2323.5 1084.0 427.5 24895

(60.3) (15.6) (9.3) (4.4) (1.7)1990-91 17460.0 4798.4 2597.2 1187.2 422.1 28915

(60.4) (16.6) (9.0) (4.1) (1.5)1991-92 20682.3 5466.8 2976.6 1596.0 468.5 34533

(59.9) (15.8) (8.6) (4.6) (1.4)1992-93 23004.5 6287.3 3404.0 1753.2 487.6 38283

(60.1) (16.4) (8.9) (4.6) (1.3)1993-94 27296.2 7120.8 3987.0 1739.4 560.4 44805

(60.9) (15.9) (8.9) (3.9) (1.3)1994-95 33089.0 7759.5 4555.4 2234.0 544.0 53647

(61.7) (14.5) (8.5) (4.2) (1.0)1995-96 35530.8 8606.9 5195.4 2375.6 703.4 61822

(57.5) (13.9) (8.4) (3.8) (1.1)1996-97 42027.4 8848.7 5793.3 2718.2 796.0 69131

(60.8) (12.8) (8.4) (3.9) (1.2)1997-98 45351.3 11383.9 6816.7 3194.3 1035.1 79183

(57.3) (14.4) (8.6) (4.0) (1.3)1998-99 49250.9 13438.8 7018.7 3772.9 926.6 86702

(56.8) (15.5) (8.1) (4.4) (1.1)1999-2000 57592.7 15093.0 8269.4 3667.3 907.4 99927

(57.6) (15.1) (8.3) (3.7) (0.9)2000-01 72547.7 15825.8 8548.2 4396.1 1203.7 113260.0

(64.1) (14.0) (7.5) (3.9) (1.1)2001-02(RE) 79854.8 17987.6 11489.5 5677.7 853.2 128979.0

(61.9) (13.9) (8.9) (4.4) (0.7)Growth Rate 15.33 15.24 13.13 15.84 7.19 15.35Source: Government of India, Budget Documents (various issues).

Note: Figures within parenthesis are expressed as ‘percentof total taxes on commodities and services collected by State governments’.

17

Table 2.5

Buoyancy: Total Tax Revenue, Direct Tax, Indirect Tax1980-81 to 1989 -90

1990-91 to 2001-02

1980-81 to2001-02

Combined (Centre and States)

Total Tax Revenue 1.11 0.88 1.05

Direct Tax 0.94 1.24 1.22

Indirect Tax 1.14 0.81 1.02

Centre

Total Tax Revenue 1.12 0.84 1.03

Direct Tax 0.92 1.25 1.24


1. Union Excise Duty 1.03 0.75 0.86

2. Customs Duty 1.44 0.64 0.95

3. Service Tax - 2.04* 2.04*

States

Total (States’ Own) Tax Revenue 1.09 0.97 1.11

Direct Tax 1.14 0.71 0.95


1. Sales Tax 1.11 1.02 1.08

2. State Excise 1.20 0.92 1.07

3. Motor Vehicles Tax & PGT

1.03 0.96 0.93

4. Electricity Duty 1.41 0.97 1.11

5. Entertainment Tax 0.46 0.68 0.52

Note: Buoyancy for service tax shown with ‘*’ has been calculated for the years 1994-5 to 2001-02.

18

3

Central Taxes on Commodities and Services

India’s indirect tax system is unique in that under the Constitution, the Union

government has the authority to impose a broad spectrum of excise duties on

production or manufacture while the States are assigned the power to levy sales tax on

consumption. In addition, States are empowered to levy tax on many other goods and

services in the form of entry tax, octroi, entertainment tax, electricity duty, motor

vehicles tax, passengers and goods tax, etc. Due to this dichotomy of authority under

the Constitution, India has been rather slow in the adoption of VAT. Also, it has

created an obstacle in introducing European-style VAT in India, although over the

years, tax reform committees have recommended that union excise duty, sales tax,

and other domestic trade taxes be replaced by a comprehensive VAT that could tax all

commodities and services.

CenVAT

At the Union level, at the time of Independence, India inherited a system of

commodity taxes in which Union excise duties (UEDs) were levied on about a dozen

articles yielding a small proportion of total tax revenue to the Centre. Following

Independence, the rates were raised, the base was enlarged, as more and more items

were brought into its net. Over time, there was a speedy extension of UEDs. It was

not only levied on finished goods but also on raw materials, intermediate goods and

capital goods.

Structure of CenVAT

In 1986, for the first time, reforms were initiated in the basic UEDs through

the introduction of modified value added tax (Modvat).7 This provided for set-off for

7 This was based on the recommendations of the Report of the Jha Committee. See, Government of India (1978), Report of the Indirect Taxation Enquiry Committee, Ministry of Finance, New Delhi.

19

taxes on inputs. Initially, it was introduced for a selected number of commodities. The

coverage was limited to 37 chapters out of a total of 91. Over time, Modvat was

extended to some additional commodities. Finally, it has been extended to almost all

commodities except light diesel oil, high-speed diesel, motor spirit (gasoline) (as

input) and matches (as final product).8 In effect, it has been replaced by Central VAT

(known as CenVAT) in the Budget 2000-01. The existing rate under CenVAT is 16

percent.

Basic Excise Duty: In common parlance, CenVAT is sometimes known as

basic excise duty which becomes payable at the time of clearance of such goods. This

duty is specified against each sub-heading in the First Schedule to the Central Excise

Tariff Act, 1985. There are, however, notifications issued by the Central Government

which grant either total or partial exemption from duty. These exemptions are both

general and conditional in nature. The effective rate of basic excise duty is thus

determinable only after reference to the relevant exemption notification. The rate as

applicable at present is given in Table 3.1.

In addition to the basic excise duties, some other taxes are also levied. These

include: Special Excise Duty, Additional Duties of Excise, and Cess, as given below:

Special Excise Duty (SED): This duty is leviable only on a few items. The rate

of duty and the items on which it is leviable are specified under the Second Schedule

to the Central Excise Tariff Act, 1985 (as shown in Table 2). In general, the SED is

levied at the rate of 8 percent, which is levied over and above CenVAT (Basic excise

duty). This makes the effective rate of most commodities covered under SED 24

percent. In the years to come, the Union government aims at having one rate category

for all items under CenVAT. Most of the items under SED are final products but some

of the items also fall in the category of intermediate goods.

Additional Duties of Excise: There are a number of additional duties leviable

under different enactments on various commodities. Under Additional Duties of

8 Under Rule 3, a manufacturer or producer of final products is allowed to take CenVAT credit in respect of the duty of excise specified in Central Excise Tariff Act (CETA), 1985 and leviable under the Act. However, the CenVAT credit that is allowed to be taken is restricted to the actual duty that is paid on the inputs. In other words, if the Central Excise duty on the inputs is less than the tariff rate prescribed in the First Schedule or the Second Schedule in CETA, 1985, through an exemption notification granting exemption, CenVAT credit is limited to the actual duty paid on such inputs.

20

Excise (Textile and Textile Articles) Act, 1978, duty of excise is chargeable on

specified textiles and textile articles. Additional Duties of Excise (Goods of Special

Importance) Act, 1957, prescribes additional duties on sugar, tobacco products and

textile articles in lieu of sales tax. AEDILST is a tax rental arrangement between the

Centre and the States. According to this arrangement, the Union government levies

additional excise duty in lieu of sales tax and the States refrain from levying sales tax

on these items. The net proceeds of this duty were being distributed among the States

until the Report of the Eleventh Finance Commission, which has recommended its

inclusion under the sharable taxes. Considering these recommendations and taking

note of the views of the States expressed in the States’ Finance Ministers Committee,

the Centre has amended the Additional Excise Duties Act in 2003 to enable the States

to levy sales tax on these items at a rate not exceeding 4 percent, without being denied

the share (1.5 percent) of revenue from AEDILST.

Cess : Different items are subject to levy of Cess at varying rates under

different enactments. Also, cesses on specified commodities are levied in addition to

CenVAT and AEDILST. However, these are primarily meant to raise resources for

the development of concerned industries. The revenue department administers these

levies but some other departments also contribute in this endeavour.

The CenVAT Scheme allows instant credit for excise duty, special excise duty

(SED), additional duty of excise (ADE)9 and countervailing duty (CVD)10 paid on

inputs and capital goods received in a factory for the manufacture of any dutiable final

product (except matches). The credit could be utilised to pay excise duty on any final

product. That is, all raw materials or inputs are covered except light diesel oil, high-

speed diesel and motor spirit (gasoline).11 Similarly, credit could be availed on capital

goods including pollution control equipment, components, spares, accessories,

moulds, dyes and paints, packaging material, greases/coolants and fuels.12

9 Additional duty of excise levied under the Additional Duties of Excise (Textiles and Textile Articles) Act, 1978, National Calamity Contingent duty, additional duty of excise levied on tea and tea waste under section 157 of the Finance Act, 2003. The credit in respect of such duties can be utilized for payment of such respective duty only.

10 This is levied as per the provisions of the Customs Act wherein this is referred to as Additional Duty of Customs. However, this is popularly known as CVD. The credit in respect of such duties can be utilized for payment of such respective duty only.

11 See Rule 2 and 3 of Cenvat Credit Rules, 2002.12 See Rule 2 Cenvat Credit Rules, 2002..

21

Through the introduction of CenVAT, credit can be taken by the

manufacturer immediately on receipt of eligible and duty-paid goods in the factory.

There is no need for the manufacturer to file any declaration or obtain any

permission.13 For capital goods, however, only 50 percent of the duty paid on the

goods can be availed of in a financial year; the remaining credit can be claimed in the

next financial year, provided the goods are still in use (except for spares and

components, refractories, moulds and dyes).14 Further, no depreciation should be

claimed by the manufacturer under Section 32 of the Income Tax Act, 1961 on that

part of the value of these capital goods which represents the amount of duty paid on

such goods.15 A manufacturer who manufactures only tax-exempt final products is not

allowed to take this credit. However, a manufacturer producing both dutiable and

exempted final products in the same factory is eligible to avail of its benefits. This is

subject to certain conditions viz., maintenance of separate records in respect of inputs

used to manufacture exempted products or payment of 8 percent of the total price

(excluding all taxes) of the exempted final products or in the case of a few specified

items, on reversal of the credit availed. Similarly, credit can be availed of on capital

goods, if not used exclusively for the manufacture of exempted final products.

The scheme of CenVAT, inter alia, provides the following facilities:

- Removal of inputs or capital goods on payment of an amount equal to the

credit availed in respect of such inputs or capital goods;16

- Removal of goods to job-workers for processing, testing, reconditioning or for

any other purpose, provided that the goods are received back within 180 days

or are removed from the premises of the job-worker;17

- Refund of credit accumulated due to export under bond of the final products is

also permissible;18

- Unutilised CenVAT credit can be transferred on account of shifting of a

factory to another site or due to change in ownership by sale, merger,

13 Rule 3 and 4 of Cenvat Credit Rules, 2002.14 Rule 4 of Cenvat Credit Rules, 2002.15 Rule 4 (4) of Cenvat Credit Rules, 2002. 16 See Rule 3 (4) of Cenvat Credit Rules, 2002.17 See Rule 4 (5)and 4 (6) of Cenvat Credit Rules, 2002.18 See Rule 5 of Cenvat Credit Rules, 2002.

22

amalgamation, lease or transfer to a joint venture wherein liabilities are also

transferred; and

- A special dispensation has been made in the case of goods manufactured in

specified areas of the North-East, Kutch district of Gujarat, state of Jammu &

Kashmir and State of Sikkim.19

The manufacturer should take reasonable steps to ensure that the appropriate

duty has been paid on inputs or capital goods on which credit is availed, as indicated

in the documents accompanying the goods.20

The reforms introduced in the last few years have resulted in transparency of

the tax burden under the UEDs. In addition, it has reduced the cascading effect of

input taxation as well as the pyramiding effect of the tax. It has also generated a

mechanism to check evasion of tax through self-policing. Empirical studies on the

impact of the introduction of CenVAT show that there is a definite positive effect. In

fact, industrial units have been able to save on interest (ranging between 0.5 and 1

percent of the total duty paid). Also, the overall effect has been revenue neutral and

has not caused any price effect.21

In addition, the reforms implemented under UEDs during last 15 years have

simplified its structure especially through CenVAT. While previously there was a

large number of rates, over the years it has been brought down considerably. As of

now, the general rate of CenVAT is 16 percent. However, in many cases the actual

duty paid on inputs could be less than the tariff rate through exemption notifications.

Also, a few commodities are subjected to 8 or 16 percent special excise. These are

also given credit for tax paid on inputs. Apart from rationalization of rate structure,

exemption notifications have also been curtailed and most specific rates are converted

into ad valorem rates. Further, the rate structure of CenVAT is linked to the

Harmonised System of Nomenclature (HSN). The HSN system is in vogue in most

countries and facilitates international trade.

Administrative Controls under CenVAT

19 See Rule 10 of Cenvat Credit Rules, 2002.20 These documents are prescribed in Rule 7 2.21 See for details, NIPFP (1989), The Operations of Modvat, New Delhi.

23

The administrative controls under CenVAT (or the UEDs) fall in some

categories, described below:

a. Physical Control: This is the oldest form of control under the Union excise

duty. Under this control, there is an assessment of tax by the Central Excise Officer

posted at the factory, before the removal of goods. Thereafter, the goods are moved

under his supervision and under the cover of an invoice countersigned by him. This

system is now restricted to cigarettes only.

b. Self-Assessment Procedure: Under this procedure, earlier known as self-

removal procedure, the assessee assesses the duty liability himself and pays it into the

account of the government. If duty rate is ad valorem and the assessee sells goods to a

related person or he has factories manufacturing similar goods in different Central

Excise Divisions or Commissionerates or he removes goods for captive consumption

etc., he can resort to self assessment. The assessee self-assesses his tax liability and

pays it monthly.

c. Compounded Levy Scheme: This procedure is meant for small-scale

decentralised sector and at present covers stainless steel, aluminium circles and

Pattis/Pattas. Under this scheme, the duty for a specified period is fixed on the basis

of the number and type of machines. Payment of tax under this procedure absolves the

manufacturer from observing day-to-day formalities of CenVAT regarding

maintenance of accounts and removal of goods etc.

d. Collection of Duty at the Point of Consumption: Tax under this system is

confined to Khandsari Molasses going for manufacture of alcohol, whether for

potable or industrial use. The duty is paid by the distillers on the date of receipt of

khandsari molasses. The CenVAT credit is admissible on khandsari molasses to the

extent that it is used for manufacture of excisable goods.

Obligations under CenVAT

As in the case of dealers under VAT in other countries, CenVAT has also

introduced VAT procedures under the new system. It has placed some obligations on

the part of the dealers paying CenVAT.

Declarative Obligations:

24

The administration of CenVAT requires various declarative obligations as

given below:

a. Tax Payer Registration: Every manufacturer of excisable goods (except

small-scale manufacturer) is required to get himself registered before the

commencement of production. Registration is valid for the premises it is granted. That

is, a manufacturer having more than one premises must obtain a separate registration

for each of the premises from the respective Range Superintendent having jurisdiction

over the premises, be it a factory or a depot/branch office. If a manufacturer desires to

start production of a new product, he should get his registration duly endorsed to this

effect. There is no fee for registration and there is no need for its renewal. In addition

to the manufacturer, since 1994, even wholesalers (i.e., dealers who intend to pass

CenVAT credit to its buyers) could be registered. This system has been introduced to

help small manufacturers.

b. Issue of Invoices: With effect from April 1, 1994, invoice has replaced the

gate pass (GP-1) as the clearance document. It is prescribed that an invoice must

accompany the consignment, each time the goods are transported from the factory to

the godown of the manufacturer. To keep track of the clearance of goods from the

factory, each accompanying page of the invoice book should be pre-authenticated by

the owner or working partner or the Managing Director or Company Secretary or any

other authorised officer of the assessee and be serially numbered in the book and the

numbers intimated to the Superintendent of Central Excise in advance. It is provided

that the CenVAT credit could be taken through the invoices issued by the first and the

second stage dealers of excisable goods only. The credit cannot be taken on the basis

of the invoices that are issued by the third and the subsequent stage dealers. Thus, the

scheme of invoices has the following features:

i. The first stage dealer is defined as one receiving inputs directly from a manufacturer or his depot under the cover of an invoice.22

ii. The second stage dealer is one who purchases from the first stage dealer.

iii. Both the first stage and the second stage dealers should be registered with the Central excise department.

22 This is issued under Rule 2 of Cenvat Credit Rules, 2002.

25

c. Monthly Return: The manufacturer is required to pay CenVAT on a

fortnightly basis and submit a monthly return (ER1) to the Superintendent of Central

Excise by the 10th of the month following the month during which duty was paid.

Manufacturers availing of the small-scale exemption, based on value or quantity of

clearances during a financial year, need to file their returns only on a quarterly basis.

The return must contain:

Particulars of goods manufactured and cleared, and amount of excise duty

paid;

Particulars of inputs received during the month and the amount of duty taken

as credit; and

Information on total duty paid through Personal Ledger Account (PLA)

(account current) and CenVAT credit giving details of disposal of inputs and

utilisation of the credit.

Accounting Obligations:

With the introduction of CenVAT, maintenance of statutory accounts has been

done away with. That is, the manufacturer himself shall maintain his records

regarding receipt, disposal, consumption and inventory of goods containing relevant

information.23 If CenVAT credit is taken or utilized wrongly, the same, along with

interest, will be recovered and if the same involves fraud, willful mis-statement,

collusion, suppression of facts or contravention of the provisions of the Act or the

Rules, mandatory penalty and interest will also be attracted.24

The duty is paid monthly. The amount of duty payable is recorded in the daily

stock account before clearance.

Manufacturers who are to pay duty on the final products cleared by them can

pay duty in cash or through the CenVAT credit.

Special Audit: In addition to the already existing powers, under section 14 of

the Central Excise Act (to summon persons to give evidence and to produce

documents), the Excise Department is empowered to go into the cost structure of the

23 The burden of proof regarding admissibility of the CenVAT credit lies upon the manufacturer.24 See Rule 12 of Cenvat Credit Rules, 2002 read with section 11A and 11AB.

26

goods manufactured through a cost audit to decide whether there is under-

invoicing.25As far as the Department is concerned, the cost audit report would prevail

to determine the assessable value, notwithstanding any cost audit done in the unit

under any law viz. the Companies Act, 1956. The expenses, including the fee for the

cost accountant, are borne by the Department.

Weaknesses of the System under CenVAT

The existing structure of CenVAT (i.e. UED) and the procedures for its

administration calling for specified obligations are characterised by the following

weaknesses:

Firstly, the existing procedures for physical controls are outmoded. In the

context of the liberalised economy, it is immaterial whether the tax is levied through

UED or CenVAT; physical control should have no place in the administrative system.

It needs to be replaced by a self-assessment procedure.

Secondly, the provision of registration of wholesalers has created a plethora of

loopholes in the system to avoid payment of tax. While it does help small dealers to

claim set-off for the tax on their inputs, the practice has created an additional work-

load for the Department, of cross-checking the sales and purchases with the claim of

set-off by the small manufacturers. The resulting cases of evasion are also large.

Earlier, when Modvat provisions were liberalised and dealers in excisable goods were

also permitted to register themselves under Rule 174 of the Central Excise Rules,

1944, any dealer of excisable goods could register himself with the Superintendent of

Central Excise in charge of the Range in which he had his premises. Under the

liberalised procedures, there was no distinction between a manufacturer, a first-stage

dealer, second-stage dealer or a subsequent-stage dealer. This led to fraud at a large

scale when fictitious dealers were issuing modvatable invoices said to cover duty-paid

excisable goods, on the basis of which Modvat credit was being taken fraudulently by

various manufacturers. The detection of such fictitious invoices and fraudulent dealers

25 The new sections 14A and 14AA make provision for special audit in certain cases. These sections envisage an audit within a limited period with some important conditions stipulated. It is important to note that the powers under section 14A is exercised by the Chief Commissioner of Central Excise and under 14AA is exercised by the Commissioner of Central Excise. In other words, the provisions of these two sections are invoked only under extraordinary circumstances and not as a matter of routine.

27

became difficult because cross-verification could not be done within a reasonable

time, through correspondence or through other means. As a result, a number of

fictitious invoices, said to cover duty-paid excisable goods, were floating in the

system resulting in an enormous loss of revenue. When this was detected, the Modvat

credit was restricted to manufacturers, first-stage dealers and second-stage dealers.

This has reduced fraud and issue of fictitious invoices to some extent. In fact, it could

be further reduced if this facility is restricted to only the first-stage dealers and all the

Central Excise Ranges and Divisions in the country are linked through a computer

network.

Thirdly, the coverage of CenVAT, as noted above, has not been extended to

all the commodities. Initially (under Modvat), half the revenue was being derived

through the commodities covered under it. Over the years the coverage has been

expanded. Now it accounts for approximately 92 percent of the revenue through

commodities under CenVAT. The time is ripe to incorporate other excises also into

the ambit of CenVAT.

Fourthly, deemed credit scheme on the central excise side was visualized as an

administrative friendly measure to provide for Modvat credit in respect of various

items, which are bought from the market and for which duty paying documents may

not be readily available to link the purchase to the original manufacturer. Over the

years, it has been found that this measure has been misused and Modvat credit has

been availed not on genuine duty paying documents. Further, this diluted the broad

objective of maintaining the CenVAT chain, where duty is paid at every stage and

Cenvat credit is taken on the basis of actual duty paying documents. This has been

particularly a problem in the textile industry where the scheme was allowed in respect

of various chemicals and yarn. In the budget of 2003-04, the deemed credit scheme

was done away with and now Cenvat credit is being allowed only on the basis of

actual duty paying documents. However, in the case of textiles a variant of the

deemed credit facility has been permitted. In the Budget 2003-04, the Government

had imposed excise duty on grey fabrics produced by power looms. Subsequently,

however, exemption has been allowed to small power looms on turnover basis. The

exempted power looms do not pay duty. However, power loom owners have been

allowed to endorse invoiced or issue challans in respect of the excise duty paid on

28

yarn and on the basis of these invoices and challans, the processors can take Cenvat

credit for the duty paid on yarn. Similar facility has been extended to garments or

accessories manufacturers. It is visualized that this would discourage evasion of duty

and ensures documentary discipline, which is so vital in a VAT system. This would

have the additional benefit of ensuring duty payment at all stages, with the down

stream process ensuring duty compliance by the upstream manufacture of yarn and

chemicals.

Finally, while it is true that the declarative and accounting obligations have

been reformed considerably, there is room for reforms in the procedures for PLA.

Taxation of Services

Although there is no specific provision in the Constitution of India on the levy

of tax on services, the Union Government, by virtue of Entry 97 of the Union List in

the Constitution of India, levies taxes on selected services. Through the Finance Act,

1994, the Union Government has used its powers to tax a few services. The tax was

levied with effect from 1st July 1994 under the Service Tax Rules 1994, which give

details of administration procedures and operation of the tax.

Historically, the Taxation Enquiry Commission (1953-54) did not recommend

levy of tax on services due to administrative considerations. The Indirect Taxation

Enquiry Committee, (1978) suggested that service tax could be levied only after

estimating its revenue potential and carefully examining the practical problems

associated with it. However, with a significant rise in share of services in GDP over

the years, the Tax Reform Committee (1991) recommended that some services should

be taxed, but over time these must be brought under the VAT regime. The Expert

Group on Taxation of Services (2001) also suggested that the tax base is required to

be expanded by bringing in services under the tax net. The Advisory Group on Tax

Policy and Tax Administration for the Tenth Plan (May 2001) recommended the

integration of services with the CenVAT so as to arrive at a full-fledged VAT at the

Centre. Recently, the Task Forces on Indirect Taxes (December 2002) further

recommended that the tax base be expanded by including more and more services in

the tax net.

29

Based on the recommendations of various Committees and Study Groups, the

base of service tax was extended to some more services through the Finance (No. 2)

Act 1996. It covered services provided by advertising agencies, courier agencies, and

of radio paging, which were made applicable from 1st November, 1996.

The Finance Acts of 1997, 1998 and 2003 further extended the scope of

service tax to cover as many as 58 services (Table 3.3). The rate of service tax has

also been increased from 5 percent to 8 percent on all the taxable services with effect

from 14th May 2003.

Under Section 67 of the Finance Act, 1994, service tax is levied on the gross

or aggregate amount charged by the service provider on the receiver. However, in

terms of Rule 6 of Service Tax Rules, 1994, the tax is permitted to be paid on the

value received. This has been done to ensure that providers of professional services

are not inconvenienced, as in many cases, the entire amount charged/billed may not

be received by the service provider and calling upon him to pay the tax on the billed

amount in advance would mean asking him to pay from his own pocket. It would also

make the levy a direct tax, which is against the scheme of service tax.

Administration of Service Tax

Service tax is administered by the Central Excise Commissionerates, working

under the Central Board of Excise & Customs, Department of Revenue, Ministry of

Finance, Government of India. The unique feature of service tax is reliance on

collection of tax, primarily through voluntary compliance.

The tax is levied, as stated above, on specified 58 services and the

responsibility of payment of the tax rests with the service providers. System of self-

assessment has been introduced in this tax with effect from April 1, 2001. The

jurisdictional Superintendent of Central Excise is authorized to cross verify the

correctness of self assessed returns. Tax returns are expected to be filed half yearly.

Central excise officers are authorized to conduct surveys to bring the

prospective service tax assessees under the tax net. Directorate of service tax at

Mumbai oversees the activities at the field level for technical and policy level

coordination.

30

Corporate assessees are required to pay tax on the value of taxable service,

provided by them in a month, by the 25th of the following month to enable them to

finalize the accounts. Further, the individual assessees are required to pay the levy

only once in a quarter. The process of registration of assessees has been considerably

simplified. No separate accounts have been prescribed for the purposes of service tax.

It has been provided that accounts being maintained by the assessees under any other

law in force would be sufficient. Frequency of filing the returns has been made half

yearly in place of monthly/quarterly returns prescribed earlier.

The service tax credit rules were amended in 2003 so as to allow credit for the

service tax paid on any input-service towards payment of the tax to be paid on any

final service. This is a step in the right direction. It will reduce the cascading impact

of tax and help in restoring competitiveness of service sector. This facility will go a

long way in raising the tax compliance level and reducing disputes in administration

of tax on services.

Future Horizon

The authority to levy tax on commodities and services vests with both the

centre and the states. The centre levies CenVAT and some excises at the level of

manufacturing. The states also levy a variety of taxes on commodity and services.

The authority to levy tax on services, however, was not explicitly provided in

the Constitution. Article 265 of the Constitution lays down that no tax shall be levied

or collected except by the authority of law. This authority is provided by the Seventh

Schedule which provides for three Lists: (i) Union list (only Central Government has

power of legislation); (ii) State list (only State Government has power of legislation);

and (iii) Concurrent list (both Central and State Government can pass legislation). In

view of the fact that ‘tax on services’ does not find specific mention in any of the

above lists, the Central Government has introduced tax on services taking recourse to

the residuary powers vested in it under Entry 97 in the Union List of the Seventh

Schedule of the Constitution.

The States have now decided to introduce VAT in lieu of the existing sales tax

system and suggested to the Central Government, through the auspices of the

31

Empowered Committee, that they would eventually be having VAT on commodities

as well as services.

Taking note of the request of the States, the Union Cabinet has recently

legislated 95th Constitutional Amendment Act, 2003. Consequently, it has approved a

proposal to amend the Constitution by:

i. Inserting a new entry (no. 92C – Taxes on services) in the

Union List, Seventh Schedule of the Constitution, to give the Union

Government the power to levy taxes on services as a specific item of taxation.

ii. Introducing a new Article (Article 268A) in the Constitution to

enable the Union Government to levy the said tax and empowering both the

Union and the State Governments to collect and appropriate the proceeds of

the tax in accordance with a (new) law to be enacted by the Parliament, and

iii. Including, as a consequential measure, Article 268A among the

Articles excluded from the purview of operation of Article 270.

This would enable parliament to formulate by law, principles for determining

the modalities of levying service tax by the Central Government and collection of the

proceeds thereof by the Centre and the States. Thus, the Centre would be able to

i. levy tax on services as a specific entry by the Union

Government.

ii. Collect and appropriate proceeds of this tax by the Union

Government as well as the State Governments, i.e., without the revenue from

the tax on services becoming a part of the divisible pool under Article 270,

and

iii. Enable the State Governments to fully exploit the potential of

tax on services in order to enhance their financial resources.

A Working Group, comprising representatives of Central Government

(Ministry of Finance and Company Affairs) and some selected State Governments

was constituted by the Central Government to prepare the draft of a new legislation to

govern tax on services, as envisaged in clauses (2) of the proposed new Article 268A.

Based on the recommendations of the Working Group, draft legislation has been

32

prepared. It is being examined by the Ministry of Finance and Company Affairs. On

completion of this examination, the draft legislation on tax on services would be

forwarded to the Empowered Committee of State Finance Ministers on VAT for

detailed consideration, comments and suggestions for changes, if any, consistent with

the proposed Constitutional amendment. The Central Government would like the

process to be completed as expeditiously as possible, with the active collaboration of

the States, so as to be able to introduce the new legislation after the proposed

Constitutional amendment comes into effect and VAT is introduced by the States and

Union Territories.

33

Table 3.1Rates under CenVAT

Sl. No.

Commodities CenVAT rate

1. Plastic lay flat tubing 82. 100% wood free particles or fibre board made from bagasse or other agro-

waste8

3. Paper, paperboard or articles thereof made from pulp containing not less than 75% by weight of pulp made from non-wood materials

8

4. T.V. chassis for B & W T.V. sets 85. Electrically operated vehicles 86. Cars for physically handicapped persons 87. Sugar confectionery 88. Biscuits 89. Scented supari 810. Matches made with use of power 811. Rough ophthalmic blanks 812. Pressure cookers 813. Dentists’ chairs 814. Cakes and pastry 815. Wafer biscuits 816. Ceramic tiles manufactured in a factory not using electricity or LPG or

propane gas for firing the kiln8

17. Candles 818. Table and kitchenware of glass 819. Imitation jewellary 820. B & W T.V. sets 821. Electrical bulbs of retail price not exceeding Rs. 20 per bulb 822. Sunglasses for correcting vision 823. Watches and clocks of retail price not exceeding Rs. 500 per piece 824. Toothbrushes 825. Solid or hollow building blocks in which more than 25% by weight of red

mud, press mud or other specified materials are used8

26. Blocks, slabs, concrete beans and stairs used in pre-fabricated buildings 827. Laboratory glassware 828. Power driven pumps for handling water 829. Crankshafts intended for use in sewing machines 830. Specified medical equipment 831. Mechano-therapy appliances, massage apparatus, etc. 832. Prefabricated buildings 833. Cotton yarn 834. Cotton fabrics (woven) 835. Woollen fabrics 836. Woven synthetic fabrics 837. Pile or chennile fabrics of wool, cotton or man made fibres 838. Long pile fabrics of cotton or man made fibres 839. Looped pile fabrics of cotton or man made fibres 840. Terry toweling and similar woven terry fabrics of cotton or man made fibres 841. Knitted or croacheted fabrics of cotton 842. Terry toweling and similar woven terry fabrics of textile materials other than

cotton or man made fibres10

43. Long pile fabrics, other than that of cotton or man made fibres 10Contd . . . .

34

Table 3.1 (Contd . . .)Rates under CenVAT

Sl. No.

Commodities CenVAT rate

44. Looped pile fabrics, other than that of cottn or man made fibres 1045. Woven fabrics of metal thread or of metallic yarn 1046. Narrow woven fabrics 1047. Woven fabrics of coarse animal hair or horse hair 1048. Woven fabrics of flax 1049. Woven fabrics of jute 1050. Woven fabrics of paper yarn 1051. Woven fabrics of other vegetable textile fibres 1052. Pile and chennile fabrics of textile material, other than wool, cotton, man

made fibres10

53. Ready-made garments and specified clothing accessories 1054. Embroidery, in the piece, in strips or in motifs 1055 High speed diesel 1456 All other goods not enumerated above in any other Table 16

35

Table 3.2

Rates of Special Excise Duty (in addition to 16% CenVAT)

Sl. No. Commodities SED rate (%)

1. Pan Masala 162. Aerated water 83. Chewing tobacco, snuff 164. Petrol 145. Special Boiling Point Spirits 166. Tyres for cars, buses, trucks, multi-utility vehicles 87. Tyre flaps 88. Tyre tubes 89. Polyester yarn 8

10. Air-conditioners 811. Cars, multi-utility vehicles 812. Chassis for cars, multi-utility vehicles 8

36

Table 3. 3

LIST OF SERVICES PRESENTLY BEING TAXED

Initially, the following three services were taxed:

(1) Telephone(2) Stockbroker

The Finance Act (2) 1996 enlarged the scope of levy of Service Tax covering three more services, viz.,

(3) Advertising agencies,(4) Courier agencies(5) Radio pager services.

But tax on these services was made applicable from 1st November, 1996.

The Finance Acts of 1997 and 1998 further extended the scope of service tax to cover a larger number of services rendered by the following service providers, from the dates indicated against each of them.

(6) Consulting engineers (7th July, 1997)(7) Custom house agents (15th June, 1997)(8) Steamer agents (15th June, 1997)(9) Clearing & forwarding agents (16th July, 1997)(10) Air travel agents --- (1st July, 1997)(11) Tour operators (exempted upto 31.3.2000 Notification No.52/98, 8th July, 1998, reintroduced w.e.f. 1.4.2000) (12) Rent-a-Cab Operators (exempted upto 31.3.2000 Vide Notification No.3/99 Dt.28.2.99, reintroduced w.e.f. 1.4.2000)(13) Manpower recruitment Agency (1st July, 1997)(14) Mandap Keepers (1st July, 1997)

The services provided by goods transport operators, out door caterers and pandal shamiana contractors were brought under the tax net in the budget 1997-98, but abolished vide Notification No.49/98, 2nd June,1998.

The Service Tax is leviable on the 'gross amount' charged by the service provider from the client, from the dates as notified and indicated above.

Service Tax has been announced on 12 new services in 1998-99 union Budget. These services listed below were notified on 7th October, 1998 and were subjected to levy of Service Tax w.e.f. 16th October, 1998.

(15) Architects(16) Interior Decorators(17) Management Consultants(18) Practicing Chartered Accountants(19) Practicing Company Secretaries(20) Practicing Cost Accountants(21) Real Estates Agents/Consultants(22) Credit Rating Agencies(23) Private Security Agencies(24) Market Research Agencies

37

(25) Underwriters Agencies

In case of mechanized slaughter houses, since exempted, vide Notification No.58/98 dtd. 07.10.1998, the rate of Service Tax was used to be a specific rate based on per animal slaughtered. In the Finance Act’2001, the levy of service tax has been extended to 14 more services, which are listed below. This levy is effective from 16.07.2001.

(26) Scientific and technical consultancy services (27) Photography(28) Convention(29) Telegraph(30) Telex(31) Facsimile (fax)(32) Online information and database access or retrieval(33) Video-tape production(34) Sound recording(35) Broadcasting(36) Insurance services(37) Banking and other financial services(38) Port(39) Authorised Service Stations(40) Leased circuits Services

In the Budget 2002-2003, 10 more services have been added to the tax net which are listed below. This levy is effective from 16.08.2002.

(41) Auxiliary services to life insurance(42) Cargo handling(43) Storage and warehousing services(44) Event Management(45) Cable operators(46) Beauty parlours(47) Health and fitness centres(48) Fashion designer(49) Rail travel agents.(50) Dry cleaning services.(51) Auxiliary Insurance Services(52) Business Auxiliary Services(53) Commercial Coaching & Training Services(54) Commissioning & Installation(55) Franchise Services(56) Maintenance or Repair Services(57) Pager (58) Technical Testing & Analysis and Technical Inspection & Certification

38

Table 3.4

Trends in Revenue from Services (Rs. Crore)

Financial Year No. of Services Taxed No. of Assessees Revenue Received

1994-95 3 3,943 410

1995-96 3 4,866 846

1996-97 6 13,982 1022

1997-98 18 45,991 1515

1998-99 30 1,07,479 1787

1999-00 27 1,15,495 2072

2000-01 26 1,22,326 2540

2001-02 41 1,87,577 3305

2002-03 51 2,32,048 4125

Growth Rate 29.38

39

Exhibit 3.1

Form(See sub-rule (5) of rule 7)

MONTHLY RETURN UNDER RULE 7 OF THE CENVAT Credit Rules, 2002

INPUTSSl. No.

Type of document1

Number and Date of document

Name of the supplier

Type of supplier2

ECC number of the supplier

Date on which inputs received

Value3 Details of credit Taken For the main item in the document4

CENVAT SED AED(TTA)

AED(GSI)

Addl. Duty

Other Descrip. Sub-heading

Qty.

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17

CAPITAL GOODS

Sl. No.

Type of document1

Number and Date of document

Name of the supplier

Type of supplier2

ECC number of the supplier

Date on which capital goods received

Value3 Details of credit Taken For the main item in the document4

CENVAT SED AED(TTA)

AED(GSI)

Addl. Duty

Other Description

Sub-heading

Qty.

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17

1. Indicate whether invoice, Bill of Entry or any other document

2. Indicate whether manufacturer, first stage dealer, second stage dealer or importer

3. Indicate full value of the goods covered by the document

4. Give details with respect to the item with maximum duty covered by the invoice

ABSTRACT

1. INPUT CREDIT

Opening balance Credit taken during the month

Credit utilized during the month

Closing balance

CENVAT SED AED (TTA) AED (GSI) ADDL. DUTY OTHER (pl. specify)

2. GOODS CREDIT

Opening balance

Credit taken during the month

Credit utilized during the month

Closing balance

CENVAT SED AED (TTA) AED (GSI) ADDL. DUTY OTHER (pl. specify)

Place: Signature of the assessee or theDate: authorised signatory

Name in capital lettersDesignationSeal of the assessee

40

4

State Taxes on Commodities and Services

The structure of domestic trade taxes levied by the central government has

been analyzed in the preceding chapter. This included an analysis of union excise duty

on goods produced or manufactured in India and taxes levied by the central

government on services. The present chapter deals with an analysis of the taxes on

commodities and services levied by the State Governments26. The most important of

these are sales tax, state excise, motor vehicles tax, passengers & goods tax,

entertainment tax, electricity duty etc.

Sales Tax

Sales tax is the most important tax on commodities levied by the states. Most

of the states levy sales tax at the first-point of sale, i.e. on the sale made by the

manufacturer or the wholesaler.27 Some of the states levy tax on the last registered

dealer who sells commodities to the consumer or to the unregistered dealer28. Haryana

is the only state that has replaced its sales tax by value added tax (VAT).

The rate structure of sales tax is so designed that many of the commodities

used by the poor strata of society are exempted from the tax. Necessities, raw

materials and capital goods are taxed at the rate of 4 percent. However, the general

rate of sales tax in most of the states is 8 percent, levied on majority of the

commodities. Goods falling in the category “Luxuries” are taxed at a high rate of 12.5

percent. In addition, there are two exceptions: bullion and precious stones are taxed at

1 percent and liquor is taxed at 20 percent or higher.

26 Annexure 7.2.27 Purohit, Mahesh C. (2001), Sales Tax and Value Added Tax in India, Gayatri Publications,

Delhi.28 The last-point tax is akin to a retail sales tax in the literature on public finance. In the Indian

context, the sale is taxable only when made by the last registered dealer to a consumer. For details of exclusions in different countries, see Due, John F. (1984), "The Exclusion of Small Firms from Sales and Related Taxes", Public Finance, vol. 39, No.2, pp. 202-212. Also, see Due John F “VAT Treatment of Farmers and Small Firms in Malcolm Gill’s (1990), Value Added Tax in Developing Countries, World Bank, Washington, D.C., pp. 58-69.

41

The existing rate structure of sales tax in Indian states indicate that most of

them now follow the uniform floor rates of 0%, 4%, 8% and 12%, as recommended

by the Empowered Committee of States Finance Ministers. In spite of this, variations

do exist because the states have the freedom to levy rates higher than the uniform

floor rates. Owing to these variations, there are umpteen rate categories (Table 4.1).

The rate of sales tax for inputs, including raw materials, intermediary goods

and capital goods, generally has a differential treatment under sales tax statute. As

shown in Table 4.2, this treatment could be classified into three categories:

First, inputs are allowed total exemption from tax in some of the

states/territories such as Delhi, Goa, Himachal Pradesh, Jammu & Kashmir, Manipur

and Punjab. However, with the exception of Jammu & Kashmir and Delhi, all these

states grant exemption only for raw materials used in the manufacture of taxable

goods sold within the state. That is, the exemption is not available when the inputs are

used to manufacture goods which are exempted from sales tax or when the

manufactured taxable goods do not pay any tax to the state because of their

consignment transfer to another state. However, in states like Delhi and Punjab where

sales tax is imposed at the last-point on approximately half the commodities, no tax is

levied on inputs used for producing goods falling under the last-point system. The tax

is collected when the final goods are sold within the state29.

Second, inputs are given concessional treatment in some states. The form and

extent of concession, however, varies from state to state. Andhra Pradesh, Gujarat,

Maharashtra, Orissa and Tamil Nadu tax raw materials at a concessional rate of four

percent; Bihar and Tamil Nadu at three percent while Kerala and West Bengal have a

rate of two percent. Rajasthan levies a concessional rate of 3 percent when the inputs

are used to manufacture taxable goods and 4 percent when used to produce tax-

exempt goods.

Finally, Assam does not grant any concessional treatment or exemption of tax

on raw materials purchased for manufacturing purposes. However, small-scale

manufacturing units (whose total fixed capital investment does not exceed Rs. 6.5

lakh), registered as small scale industrial units with the Director of Industries, are

29 In Punjab the commodities taxable at the first point, many of the raw materials (numbering 81) have been notified for set-off on the input tax provided the final goods are taxable and their sale is within State, in inter-State trade or for export out of the country.

42

allowed a set-off or draw back by way of refund of taxes, paid on raw materials after

assessment.

In brief, between the two principles of taxation of inputs, viz., physical

ingredient rule and the direct use rule, all the states follow the former.30 Even when

the physical ingredient rule is adopted, it varies in its application.

In addition to general sales tax, many of the states levy a turnover tax on all

transactions; surcharge (SC) on the basic sales tax liability31 and additional sales tax

(AST). Most of the states levy different combinations of these variants (Table 4.3).

Surcharge is levied in 14 states. The nomenclature of the tax in some of the

states is, however, different. In Gujarat, for example, it is known as AST, although the

tax is in the nature of a surcharge. Seven of the states levy surcharge which covers all

tax paying dealers but other states differentiate the levy as per turnover or tax liability

or levy tax on a few select commodities. Maharashtra, for example, levies surcharge

of one rupee per litre on petrol and diesel only. The rate of surcharge, in general,

varies between 5 and 20 percent. Some of the states levy surcharge with a graduated

rate structure.

AST is imposed in nine states. The rates vary between 0.5 and 15 percent in

different states according to the turnover of tax paying dealers. Kerala levies 15

percent AST on all goods (except petroleum products and liquor). In some of the

states, AST is known as turnover tax. Rajasthan levies turnover tax on all dealers

except those having turnover up to Rs 30 lakh. West Bengal levies a turnover tax to

the tune of 0.5 percent on resale of goods other than LPG, diesel, petrol, kerosene and

furnace oil. In addition, it has increased the rate of turnover tax for large dealers.

Seven of the states levy both surcharge and AST.

In addition to AST and surcharge, some of the states levy an entry tax. Kerala

levies an entry tax on a variety of goods. Coverage includes electrical goods, water

30 According to the physical ingredient rule, a commodity is exempted from the levy of tax if it becomes a physical ingredient or component of other goods which are processed and sold. That is, when a commodity does not become a physical part of the new product, the concession is withdrawn and the usual tax is levied. Accordingly, fuel, tools, machinery, equipment and furnishings, and packing material are not exempt from tax. According to the direct use rule , all commodities which are used directly in the production process are exempt from tax. This rule includes a large number of commodities. It produces a narrow tax base as compared to the physical ingredient rule.

31 Such a surcharge may be given different names. For example, in Gujarat it is called Additional Sales Tax but the tax is in the nature of a surcharge.

43

supply and sanitary equipment & fittings, edible and inedible oils (including refined

oil, hydrogenated oil and margarine), timber and a host of other items including

petroleum products. Assam levies entry tax on some items on which sales tax is not

collected. At the same time it has introduced entry tax on certain items, which have

been exempted from the purview of sales tax, to prevent diversion of trade.

Maharashtra imposes entry tax on selected commodities. Rajasthan has also imposed

an entry tax ranging from 1 to 4 percent. The rate of tax is 1 percent on petrol, high-

speed diesel, kerosene and other petroleum products, 2 percent on furnace oil and 4

percent on light speed diesel oil.

On the same pattern, Tamil Nadu also levies entry tax on 15 items. These

include petroleum products, aluminium, asbestos cement sheets, PVC pipes, woven

fabrics, sanitary ware, newsprint, iron and steel, tobacco, wheat products etc. The rate

is 4 percent for all items except tobacco, which is taxed at 10 percent. In Karnataka

too, some of the items that have a high rate of sales tax, also have an entry tax levied

on them to prevent diversion of trade.

Luxury tax is yet another tax imposed in some of the states. It is levied on

consumer items imported into the state. It is levied over and above the levy of existing

sales tax. Such a tax earlier existed in West Bengal. Now other states are also levying

this tax. Assam has introduced this tax in the budget for 2002-03 on items such as

tobacco, gutka, tobacco mixed pan-masala, hand-made and mill-made silk fabrics,

woollen and terry wool suiting. It has also levied a cess on crude oil. On similar lines,

Delhi has also introduced luxury tax on a few selected commodities, viz., cigarettes,

gutka, pan-masala, smoking mixtures and other tobacco products.

VAT in Haryana

Haryana has switched over to VAT from April 1, 2003. In view of the fact that

the other states have not switched over to VAT, it has adopted the rates levied by the

rest of the states, viz., 0, 4, 8, and 12 percent. However, the levy is 1 percent for

bullion and precious stones and is 20 percent for petrol and diesel32. It gives full

credit for all inputs including capital goods. Input tax credit on capital goods is,

however, restricted for use in manufacture of taxable goods for sale. However, on

lines similar to provisions of the CST Act, 1956, manufacturers and certain other

32 Tax rates as applicable under the HGST Act on March 31, 2003 have been used for VAT because other states did not enforce VAT with effect from 1-4-2003.

44

categories of VAT dealers have been allowed to buy inputs taxable at a higher rate, on

payment of tax at the rate of 4 percent. To have low compliance cost for small dealers,

Haryana has provided for payment of lump sum tax for specified category of dealers.

The dealers included in this category are: works-contractors, halwaii (dealers in

sweetmeats), plywood manufacturers, lottery dealers and retailers (not including

importers)33.

Sales tax exemption already given to industrial units has been converted into

deferment of tax for the remaining period and for the balance amount of benefit. In

addition, these units have been granted the option for making payment at 50% of tax

liability (along with tax-returns), which will be deemed as full payment and full credit

passed on to the purchasing VAT dealer. In case of deferment, deferred tax is to be

converted compulsorily into interest free loan, so that the tax credit could be passed

on to the purchasing VAT dealer.

The following table shows the growth rate in tax receipts (Figures are in rupees in lakh):

Month 2003 2002 % IncreaseApril 22705 20077 13.09%May 31745 29604 7.23%June 22417 19611 14.31%July 23069 17249 33.74%August 21639 15988 35.34%September 16306

Growth rate in ST receipts in 2001-02 & 2002-03 has been 16.8% & 14.4%,

respectively. Here it is important to note that Haryana has not given input credit for

goods going out of the State. Also, the CST continues to be levied at the existing rate.

Variants of VAT

While Haryana has already introduced VAT to replace the existing sales tax

from April 1, 2003, some other attempts at introducing VAT on select transactions or

on select commodities have also been made.

Experience of the introduction of VAT (in some form or the other), by some

of the state governments in the past is of great importance to the other states

experimenting with VAT.

33 This scheme is not popular among retailers because it does not permit import of goods from outside the state.

45

From April 1, 1995, Andhra Pradesh levied VAT, on some select items, for

resellers, at the rate of 4 percent rate on inputs. It is applicable to all manufacturers.

Prior to the introduction of VAT, Andhra Pradesh abolished the (then) existing

surcharge and turnover tax. It also reduced the rate slabs to six only.

Madhya Pradesh followed the threshold approach and introduced sales tax in

addition to first-point tax on the value added34 for dealers with turnover higher than

Rs. 1 crore, with effect from April 1, 1997. It brought down the threshold to Rs 50

lakh with effect from April 1, 1998. Also, it introduced one rate slab of 8 percent for

all dealers falling under VAT.

State Excise:

Another important state tax on commodities is state excise. This is duty on

“alcoholic liquors for human consumption and opium, Indian hemp and other narcotic

drugs and narcotics; but not including medicinal and toilet preparations containing

alcohol”. A major part of the revenue under this tax comes from production and

consumption of spirituous beverages, of which alcohol is the most important

component.

Consumption of alcohol being injurious to health, individuals have not been

granted any right to trade in this commodity; state governments have pre-empted

monopoly in this trade. The revenue from this, however, depends upon the policy of

prohibition of the state.

A system of auction or licensing is followed by which the individuals are

given the right to trade in this commodity. In this context, it is observed that the

present base is narrow and yields considerable low revenue in most of the states. This

is primarily because the auction price of the shops or licenses has no relevance to the

sale price of the commodity. It is proposed that the base of the tax should be changed

to collect tax in relation to the price charged at the last-point of levy.

To implement this suggestion, all the states have to enact legislation, on the

pattern of Maharashtra legislation, to empower it to levy this tax on maximum retail

price (MRP)35. To enable the government to do so, some amendments have to be

34 As the tax is to be paid on additional base (sales minus purchases), it is called VAT.35 See for example, Bombay Prohibition Act, 1949 and the amended rules called the Maharashtra

Distillation of Spirit and Manufacture of Potable Liquor (Amendment) Rules 1996.

46

done in the Excise Act. The important points that have to be focused on are as

follows:

a. The government has the power to levy differential tax according to the place of consumption, strength of quality and the manufacturing cost of the commodity.

b. The manufacturing cost has to be determined and declared with reference to the principles enunciated by law.

c. The MRP has to be printed on the bottles sold.

Motor Vehicles and Passengers & Goods Tax36

Motor vehicles tax is levied on acquisition of vehicles and includes one-off

payment under Indian Motor Vehicles Act, 1939. The main objectives of this Act are

to control and regulate the vehicular traffic in the country.37 The levies charged under

this Act are for: (i) registering motor vehicles (ii) obtaining driving licenses (iii)

transfer of ownership of motor vehicles (iv) trade certificates issued to manufacturers,

dealers and repairs of vehicles (v) permit for transport vehicles (vi) certificate of

fitness for transport. The levies include fees for registration, permit and driving

license. The fees are raised and restructured from time to time. The states also levy

tax on mechanically propelled vehicles. Although it is a central tax, its yield is

assigned to the state.

The states, under their respective Motor Vehicles Taxation Acts, also levy this

tax. The tax rates, as shown in Tables 4.5 and 4.6, vary from one state to another

according to type of vehicle (such as private motor car, taxi, stage carriage etc.) or

laden/unladen weight or cost of vehicle. Generally, private carriers are taxed at a

higher rate as compared to public carriers (Table 4.7).

The existing structure shows wide variations in tax rate. In fact, it is difficult

to make comparisons of rates levied in different types of vehicles in different states.

First, there are different schemes of classification of vehicles. Second, there is no

uniformity in the bases of various levies. Third, the tax is sometimes specific and

some times ad valorem. Finally, in some states there is a one-off levy and in others,

there is an ad valorem levy payable every year. 36 Purohit, Mahesh C. (1999), “Road User Taxation in India—A Comparative Perspective”,

Bulletin for International Fiscal Documentation, Vol. 53, No.5, May, pp.208-228.37 The tax was initially introduced through the Indian Motor Vehicles Act, 1914. Over time, with

the growth in the vehicular traffic and the expansion of the system of road transport, various amendments were introduced. Finally, a new law called the Indian Motor Vehicle Act, 1939 was introduced.

47

Lack of uniformity exists even in the case of scooters (two wheelers). Some

states levy on the basis of engine capacity defined in terms of c.c. while in others it is

on the basis of unladen weight (ULW). Some other states like Andhra Pradesh and

Maharashtra levy on an ad valorem basis.

The rate of tax on personal cars is levied on the basis of ULW and also on the

basis of number of seats. Bihar and Punjab levy the tax on the basis of the number of

seats while Andhra Pradesh, Gujarat, Himachal Pradesh. Karnataka, Kerala,

Maharashtra, Orissa, Tamil Nadu, and West Bengal follow the basis of ULW.

In the case of passenger transport vehicles, like stage or contract carriage, the

seating capacity and route length on which the carriage plies, form the tax base. The

period of payment also varies; some states charge the tax quarterly while others

charge annually. The tax on goods transport vehicles is primarily based on weight, i.e.

registered laden weight (RLW) or unladen weight (ULW).

Apart from using it as a source of revenue, motor vehicles tax is used as an

instrument for regulating and controlling vehicular emissions. This is done to protect

the environment. Similarly, passengers & goods tax is used as a tool for regulating the

flow of goods and the movement of people from one state to another.

Passengers & goods tax is levied on passengers and goods carried by road or

by inland waterways. Both these taxes are similar in nature. In fact, these are treated

as user charges or charge for construction and maintenance of roads. These taxes fall

on the same base and are paid ultimately by the same group of persons. Some of the

states levy both the motor vehicles tax and the passengers & goods tax, while others

have merged the two and levy a single tax.38 Some of the states levy an additional

surcharge on this tax. The rates of this tax, as given in Table 4.7, indicate considerable

variation. They vary according to the nature and use of vehicles. Accordingly,

vehicles are subjected to differential rates of tax. This is partly justified through the

“benefit principle”, i.e. the users of the vehicles should bear the costs of the

construction and maintenance of roads.

As per the definition of this tax in the Acts, it is levied on the use of motor

vehicles. The tax is known as road tax and regarded as the price charged by the states

for the services provided by them. Even in practice, a major proportion of this tax is

38 Rajasthan, for example, levies a combined tax called “special road tax”.

48

earmarked by the states for the construction and maintenance of roads in the state

concerned.39

The overall burden of the two taxes in different states shows that the incidence

is in the range of Rs. 24, 000 to Rs. 26,000 per vehicle per annum. Many of the states,

however, levy a substantially lower tax. Also, the combined tax incidence, captured

on the basis of compounded levy, indicates a burden in the range of Rs. 4,000 to Rs.

6,000. In some of the states, the burden is relatively low (ranging from Rs. 2,000 to

Rs. 2,400). A comparative analysis of the combined burden of certain passengers and

goods vehicles is shown in Tables 4.8 and 4.9

Entertainment Tax

This is a levy on admission to places of entertainment or amusement. The base

includes admission to cinema, circus, theatrical performance, exhibition, sports,

games, variety entertainment etc. Most of the states levy this tax at the state level but

some of the states have given this tax to local bodies. In general, the revenue of this

tax has declined over the years due to poor administration of the tax.

Electricity Duty

Electricity duty is charged along with electricity rates. The charges of

electricity are collected by the electricity authorities in different states as user charges

for the supply of power, whereas the electricity duty is a tax collected for state

Government. The yield of this tax primarily depends upon the consumption of

electricity by consumers. Normally, the revenue from this tax would go up with the

industrial development of the state, as the bulk consumers would in fact be industrial

users.

Octroi

It is a tax on the entry of goods into a local area for consumption, use or sale

therein. The local bodies levy it. Octroi is mostly a specific tax, based on quantity or

weight of the commodity. As a result there is a plethora of rates. This is a check-post

based levy and not account based, therefore, more prone to evasion. Accordingly,

39 Since local bodies also incur expenses on construction and maintenance of roads, these bodies are also authorized to charge some fees on the vehicles. On the recommendations of the Committee on Road Transportation Taxation, (popularly known as the Keskar Committee), the local bodies were denied the right to levy this tax. Instead, they were paid compensation out of the revenue raised from the motor vehicles tax. Basically, the tax on vehicles is largely on the users of roads in urban areas and the revenue is contributed by the urban users of the roads.

49

keeping in view the demerits of this levy, most of the Commissions and Committees

have recommended its abolition.

Various Committees and Study Groups have recommended that this tax should

be abolished. Hence, it is now prevalent only in a few municipal corporations or

municipalities. It is levied in four states viz., Gujarat, Maharashtra,40 Orissa and

Punjab yielding revenue to the tune of Rs. 300 crore in Gujarat, 928 crore in

Maharashtra and 300 crore in Orissa. Imphal Municipal Council in Manipur is also

levying this tax. However, the fiscal importance of octroi among different

municipalities in a state is not uniform. While in some of the states, the revenue from

octroi has equal fiscal importance in different municipalities/corporations, in the

states like Maharashtra and Gujarat, the revenue collection is basically from one

particular municipal corporation.

It is important to note that in order to levy octroi, the concerned local body

(such as urban local body –ULB) has to erect a check-post barrier to verify the goods

passing through its territory. It has to confirm that the goods entering into the said

local area are meant for consumption, use or sale therein and collect octroi on only

such goods that are meant for use or consumption in its territory. In view of the very

nature of collection of tax at the check-post, the assessment is arbitrary and causes

considerable corruption in the administration of the tax

Environmental taxes:

Like motor vehicles tax, environmental taxes are also regulatory in nature.

With economic development, it would be important to introduce taxes as a fiscal

measure to protect the deteriorating environmental conditions in the states. To

improve environmental standards in the states, it is important to recognize two

important factors that affect environment. First, the process of industrial production,

which is a technical transformation of inputs into output, leading to the production of

economic goods as well as waste-products (residuals). While the economic goods are

taken care of rationally and carefully, the residuals (which are unimportant

commercially) are dumped indiscriminately. Consequently, these residuals become a

major source of pollution. Secondly, the management of residuals is a costly affair for

the entrepreneur. Nineteen "polluting" industries have been identified by the Ministry

40 In Gujarat and Maharashtra it is abolished in all the municipalities of different classes, only municipal corporations are still empowered to levy this tax.

50

of Environment and Forests. It is essential that the foreign direct investment should

not be permitted into these industries. To accord an equal treatment to all the

industries and to check the outputs of the residuals of the existing units (foreign or

domestic) that fall in the category of polluting industries, it would be useful to

introduce a carbon tax on the pattern of the carbon tariff on all the industries that fail

to follow the minimum ambient standards (MINAS) prescribed by the Pollution

Control Boards. The rate of the tax should be equal to marginal abatement cost, which

is equal to the amount to be spent on reducing pollution caused by production of one

additional unit of output. This could be obtained by calculating the additional amount

to be spent for installing a better machinery or using better technique of production.

Service Tax

The services sector in India has been growing rapidly over the years. The

share of services in Gross Domestic Product (GDP) which was roughly 37.68% in

1960-61 and 36% in 1980-81, rose to nearly 47.1% in 1993-94 and approximately

48.8% in 2001-02. In 1953-54, Taxation Enquiry Commission didn’t recommend the

implementation of service tax due to some administrative and other considerations.

The Indirect Taxation Enquiry Committee, in 1978, also suggested that service tax

could be levied only after estimating its revenue potential and carefully examining the

practical problems associated with it. However, with a significant rise in share of

services in GDP by 1990-91, the Tax Reforms Committee recognized the revenue

yielding capacity of this sector and recommended that some services should be taxed.

Overtime, more services have been brought under the tax net.

Although there is no specific provision in the Constitution of India on the levy

of tax on services, the Government of India, by virtue of Entry 97 of the Union List in

the Constitution of India, levies taxes on selected services.

It is important to levy tax on services sector to stabilize the tax-GDP ratio of

our country, which has been declining since 1990-91. This would not only enable the

government to raise more resources, but would also rationalize the tax structure by

expanding the tax base and reducing the tax rate levied on goods. Further, this would

simplify the administrative procedures as the taxpayers as well as tax officials would

not be required to distinguish between goods and services used as inputs in the

production process. It has been noticed that traders who use services as inputs, find it

51

difficult to claim VAT on their service inputs that are largely untaxed. Introduction of

service tax would have a positive impact on relative prices of labour and capital

leading to better resource allocation. This would have positive effects on the prices of

the final products. Finally, it would make the tax structure more progressive.

52

Table 4.1: Rate Slabs of Sales Tax in Different States

States Rate-Slabs No. of Rate Slabs

Andhra Pradesh 0% 1% 4% 8% 10% 12% 16% 19.33% 20% 70%* 10Assam 0% 1% 4% 8% 12% 20% 6Delhi 0% 1% 4% 6% 8% 12% 20% 7Gujarat 0% 1% 2% 4% 6% 8% 12% 14% 15% 20% 22% 54%* 12Haryana 0% 1% 2% 4% 5% 8% 10% 12% 20% 9Himachal Pradesh 0% 1% 1.5% 3% 3.5% 4% 8% 10% 12% 15% 30%** 11Jammu & Kashmir 1% 4% 8% 12% 20% 30% 6Karnataka 0% 0.25

%1% 2% 4% 8% 10% 12% 15% 20% 60%* 11

Kerala(#) 1% 4% 8% 12% 17% 20% 24% 25% 27% 30% 37% 55% 85% 13Madhya Pradesh 0% 1% 2% 4% 8% 12% 20% 25%(a) 8Maharashtra $ 0% 0.5% 2% 4% 8% 10% 12% 13% 20% 24% 25% 27% 30% 33% 14Meghalaya 0% 1% 4% 8% 12% 20% 25% (b) 7Nagaland 0% 1% 4% 8% 12% 20% 6Orissa 0% 1% 2% 4% 6% 8% 10% 12% 16% 18% 20% 11Punjab 0% 1% 2% 3% 4% 5% 6% 8% 10% 12% 20% 11Rajasthan 0% 2% 4% 5% 6% 8% 10% 12% 16% 20% 22% (a) 43%* 12Sikkim 0% 1% 4% 8% 10% 12% 20% 7Tamil Nadu 0% 1% 2% 4% 8% 10% 11% 12% 16% 18% 20% 24% (a) 30% (d) 50%* 70%* 15Tripura 0% 2% 4% 5% 6% 7% 8% 10% 12% 13% 14% 15% 20% 13Uttar Pradesh 0% 1% 2% 2.5% 4% 5% 6.5% 7.5% 8% 10% 12% 12.5% 15% 20% 32.5% (e) 15West Bengal 0% 1% 2% 3% 4% 4.55% 5% 7% 7.5% 8% 10% 12% 15% 17% 20% 15

* Tax on liquor.** Tax on firewood, timber and liquor.a. Tax on motor spirit.b. Tax on lime.$ All rates greater than 20% are for motor spirit including aviation turbine fuel.(d) Tax on molasses.(e) This applies to liquor, narcotics and rectified spirit.(#) 24% on lubricating oil and other petroleum products not mentioned in the 2nd Schedule. 25% on non

alcoholic drinks, 27% on HSDO, 30% on petrol other than naphtha and aviation turbine fuel, 55% on beer & wine, 85% on other than beer & wine.

53

Table 4.2Concessional Rate of Sales Tax on Inputs in Indian States

State Tax rate (percent)Andhra Pradesh 4Assam No concessionBihar 3Delhi Ex.Goa Ex.Gujarat Set-off on saleHaryana Ex.Himachal Pradesh Ex.Jammu & Kashmir Ex.Karnataka 4Kerala 2Madhya Pradesh 4Maharashtra 4Meghalaya Set off on saleManipur Ex.Orissa 4Punjab Ex.Rajasthan 3 to 4Tamil Nadu 3Uttar Pradesh 2 (Ex. notified goods)West Bengal 2

Note : Ex = Exempted

54

Table 4.3Rates of Surcharge and Additional Sales Tax in Indian States

State Surcharge Coverage Additional Sales Tax(percent) Dealer/Turnover Turnover Group Tax Rate (percent)

Andhra Pradesh 10 All dealers 3 Lakh - 50 Lakh 0.5@50 Lakh - 100 Lakh 1.0

100 Lakh- and above 1.5Bihar 5 5 Lakh-10 Lakh All goods 1

10 Over 10 Lakh liquor 2Goa 10 Exceeding 20 Lakh

Gujarat 20 All dealers 50 Lakh- 2 Crore 1.0 on the turnover exceeding 50 Lakh

2 Crore-4 Crore 1.25 on addl turnoverOver 4 Crore 1.5 on addl. turnover

Haryana 10 All dealersJammu & Kashmir 5 All dealers

Kerala 5 Up to 5 Lakh Above 50 Lakh 3% on oil companies @ .10 Above 5 Lakh 0.5% on all other dealers

Karnataka 10 Lakh - 2 Crore 1.252 Crore - 5 Crore 2.15

Maharashtra 12Re. 1 per

litre##

Above 10 Lakh1 Over 12 Lakh (on goods under schedule C)

1.12

Orissa 10 Above 10 LakhPunjab 10 All dealers

Rajasthan 15 All dealersTamil Nadu 15 All Dealers 10 Lakh - 40 Lakh 1.25

40 Lakh- 1 Crore 1.5015+5 in Madras corpn.area

only1 Crore- 5 Crore 2.0

5 Crore - 10 Crore 2.25Over 10 Crore 2.5

Tripura Over 10 Lakh 0.25U.P. 25 All dealers

West Bengal 10 All dealers, Select commodities

Up to 1 Crore@Over 1 Crore

1.02.0

Notes ## = This surcharge is on perol and diesel only.* = This is known as additional sales tax@ = This additional tax is known as turnover tax1 = 50 percent of the yield is earmarked for Employment Guarantee Scheme.

55

Table 4.4.Rate Structure of State Excise Duty in Indian States (2001-02)

Tax STATESRate Rajasthan Andhra

PradeshTamil Nadu

Uttar Pradesh

Uttaranchal Gujarat Haryana Tripura Maharashtra

State Excise Duty:1.BeerA. Larger (up to

strength 5% v/v)B. Strong (strength

above 8% v/v)

C. Drough beer

Rs. 10 P. B.L.Rs. 15 P. B.L.As per

normal beer

Rs. 5 P.B.L.Rs. 5

P.B.L.

Rs. 19.50 per case

Rs. 13.10 P.B.L.

Rs. 23.08 P.B.L.

Rs. 41.54 P.B.L.

Rs. 20 p. kg

Rs. 11.55 P.B.L.

Rs. 23.10 PB.L.

Rs. 20 p. kg

Rs. 25 per P.L.

Rs. 8 P.B.L. Rs. 12 P.B.L.

Rs. 16 P.B.L.Rs. 18 P.B.L.

2.Alcoholic essences - Rs. 50 per P.L.

Not manufactured

-

3.Ale, portar, cidar and other fermented beer

- Rs. 23.08 P.B.L.

Rs. 25 per P.L.

Rs. 2.50 per 350 ml bottle

-

4.Liqueurs, cordials, mixtures and other preparations containing spirit

Rs. 100 per L.P.L.

Rs. 150/Rs. 100

per L.P.L.

Rs. 41 P.P.L.

Rs. 130 / L.P.L.

5.Rectified spirit Not applicable

Rs. 100 Rs. 15 P.P.L.

-

6.All sorts of spirits other than those specified above [but excluding denatureed spirit manufactured in India and Country liquor as defined in (State) country Liquor Rules].

- Half of the duty

notified on that spirit

Rs. 100 Not manufactured

- Rs. 60 P.P.L.

7.Country liquor Not imposed

N.A. Rs. 21 P.P.L.

Rs. 19.20 /L.P.L.

Rs. 20 P.P.L.

8.Wines (I.M.F.I.)A. Not stronger than

17%B. Stronger than

17%

Rs. 100 per IPI

Rs. 66.66 P.B.L. or 20% of MRP

Rs 25Rs. 100

Rs. 150 P.P.L.

56

Table 4.5Motor Vehicles Tax on Personal Vehicles

State Two wheelers Cars TaxisAndhra Pradesh Up to 60 cc Rs. 1050; Above 60 cc Rs.

1890 (Life Time Tax) or 7% of the cost, whichever is higher (life time tax)

ULW up to 500 kg Rs. 5880; from 500 to 1524 kg Rs. 10080; and 1524 to 2286 kg Rs. 11200 (life time tax) or 7% of the cost whichever is higher (life time tax)

Up to 4 seats Rs. 46 PS/PQ; 4 to 6 seats Rs. 207 PS/PQ; 7 seats Rs. 345PS/PQ; 7 seats (AIT permit) Rs. 414 PS/PQ.

Assam ULW up to 90 kg Rs. 960; Above 90 kg Rs. 1440; Additional tax for trailer/side car Rs. 360 (life time tax).

Up to 14 hp Rs. 3300; Above 14 hp Rs. 4300 (life time tax); Additional tax for. Light trailer Rs. 80 p.a.; Medium trailer Rs. 150 p.a.; Heavy trailer Rs. 300 p.a.

Motor cab up to 6 passengers Rs. 700 p.a.; Tourist taxi; up to 6 passengers Rs. 2240 p.a.; Omni. up to 15 passengers Rs. 5000

Bihar ULW up to 50 kg Rs. 900; 50 to 100 kg Rs. 1200; Above 100 kg Rs. 1500 (one time tax).

3 to 5 seats Rs. 3750 (one time tax). Up to 4 passengers Rs. 528; Above 4 passengers Rs. 616 plus Rs. 105. 50 for every additional passenger beyond 5.

Gujarat ULW up to 50 kg Rs. 500; Above 50 to 100 kg Rs. 1000; Above 100 kg Rs. 2000 (lumpsum); Additional Rs. 800 for Trailers/side car.

ULW up to 750 kg Rs. 5500; Above 750 to 1200 kg Rs. 10000; Above 1200 to 2250 kg Rs. 1500 (lumpsum)

4 passengers Rs. 800 p.a.; 4 to 6 passengers Rs. 800 p.a. plus Rs. 90 for every passenger in addition to 4; 7 to 9 passengers Rs. 660 plus RS. 60 for every passenger in addition to 6.

Haryana ULW up to 200 Ibs. Rs. 31.25 p.a.; Above 200 Ibs. Rs. 62.50 p.a.; Additional for side car Rs. 15.65 p.a.

NA Motor cabs Rs. 100 PS/p.a.; Tram cars Rs. 18.75 PS/p.a.

Himachal Pradesh ULW up to 90 kg Rs. 480;Above90 kg Rs.960 (lumpsum); Additional Rs. 240 for trailer.

ULW up to 1000 kg Rs. 2000; 1000 to 1500 kg Rs. 2500; 1500 to 2000 kg Rs. 3500; Rs. 2000 for every additional excess of 2000 kg (one time lumpsum).

Rs. 200 PS/p.a.

Jammu & Kashmir Rs. 60 p.a. Rs. 200 p.a. Rs. 340 p.a. Karnataka Up to 75 cc Rs. 1100; 50 to 300 cc Rs.

2500; above 300 cc Rs. 3000 or motor cycles attached with side car/trailers Rs. 3500 (life time tax).

Up to 800 cc Rs. 12000; 800 to 1500 cc Rs. 18000.Above 1500 cc Rs. 24000 (life time tax). Motor cars and jeeps exceeding 1500 cc and cost of vehicle exceeds more than Rs. 6 Lakh -Rs.45000;Omnibuses, private service vehicles having floor area up to 4 sq. mts - Rs. 30,000.

Up to 5 passengers Rs. 240 PS/p.a.

Kerala ULW up to 100 kg. Rs. 72 p.a.; 100 to 200 kg Rs. 88 p.a.; Above 200 kg Rs. 100 p.a.; Two wheelers attached with side car/trailer Rs. 120 p.a.

ULW up to 750 kg Rs. 440 p.a.; Above 750 to 1500 kg Rs. 600 p.a.; Above 1500 to 2250 kg Rs. 760 p.a.

4 to 6 passengers Rs. 760 p.a.; Tourist Rs. 1000 p.a.

Madhya Pradesh ULW up to 70 kg 3% of the cost (life time tax)Above 70 kg. 3% of the cost (life time tax)

Lifetime tax. ULW up to 800 kg 3%; 800 to 1600 kg 3%; 1600 to 2400 kg 3%; 2400 to 3200 kg 3%; Above 3200 kg 3%; ULW 800 to 3200 kg (life time tax) Rs. 4000 to Rs. 7000; Additional Rs. 92 for trailer; ULW up to 1000 kg Rs. 112 p.a.; Above 1000 kg Rs. 264 p.a.

Up to 6 passengers Rs. 100 PS/p.a.; Above 6 seats express Rs. 160 PS/p.a.; Ordinary Rs. 120 PS/p.a.

Maharashtra 7% of the cost or Rs. 1500 whichever is higher.

ULW up to 750 kg Rs. 4800 p.a.; 759 kg 1500 Rs. 7200 p.a.; 1500 to 2250 kg Rs. 9200; Exceeding 2250 kg Rs. 10000 p.a. (one time tax).

4 Passengers Rs. 320 p.a.; 5 Passengers Rs. 360 p.a.; 6 Passengers Rs. 500 p.a.

Orissa ULW Up to 91 kg Rs. 72 p.a.; Above 91 kg Rs. 90 p.a.; Additional Rs. 15 for trailer.

ULW up to 762 kg Rs. 144 p.a.; 762 kg to 1524 kg Rs. 222 p.a.; 1524 to 2286 kg Rs. 276 p.a.; Above 2286 to 3048 kg Rs. 330 p.a.; Above 3048 kg Rs. 402 p.a.; Additional for trailer: up to 1016 kg Rs. 90 p.a.; Above 1016 kg Rs. 180 p.a.

Up to 6 seats: Rs. 123 PS/p.a.

Punjab ULW up to 90.72 kg Rs. 150; Above 90.72 kg Rs. 500; (One time tax) additional Rs. 15.65 p.a. for trailer or side car.

Up to 4 seats Rs. 1800; 5 seats Rs. 2100; 6 seats Rs. 2400 (one time).

Up to 5 seats Rs. 500 p.a.; 6 to 12 seats Rs. 4000 p.a.

Contd . . .

57

Table 4.5 (Contd . . .)Motor Vehicles Tax on Personal Vehicles

State Two wheelers Cars TaxisRajasthan Two wheelers regd. in individual's

name: 5% on vehicles (mfg. in India); 6% on vehicles (mfg. outside); regd. in firm/company's name; 5% on vehicle (mfg. in India);10% on vehicle (outside India).

4 wheelers (up to 10 seats) in individual's name; 1.5% on vehicle (mfg. in India); 3.0% on vehicle (mfg. out side India); regd. in firm/company's name 3% on vehicle (mfg. in India); 6% on vehicle (mfg. outside India); 2/3 seats light vehicles 0.3% on vehicle; Agriculture tractor 0.3% on vehicle.

Tourist Permit:Up to 5 passengers Rs. 25 p. seat p. day; 5 to 12 passengers Rs. 25 p. seat p. day; More than 12 passengers Rs. 100 p. seat p. day; More than 40 seats Rs. 120 p. seat p. day.

Tamil Nadu 50 to 75 cc RS. 1220; Above 75 to 170 cc Rs. 1750 p.a.; Above 170 cc Rs. 2050 (one time tax).

ULW up to 700 kg Rs. 500 p.a.; Above 700 to 1500 kg Rs. 650 PQ; Above 1500 to 2000 kg Rs. 750 PQ; Above 2000 to 3000 kg Rs. 800 PQ; Above 3000 kg Rs. 900 PQ; Additional for trailers up to 1 tonne Rs. 20 PQ; Above 1 tonne Rs. 30 PQ.

Ordinary motor cab Rs. 150 PQ; Tourist motor cab/maxi cab up to 5 Passengers Rs. 200 PQ; Above 5 and up to 12 passengers Rs. 150 PS/PQ.

Uttar Pradesh ULW up to 80 kg Rs. 90 p.a.; Above 80 kg Rs. 150 p.a.

Rs. 500 p.a.; Additional Rs. 55 for trailer.ULW up to 2000 kg Rs. 528 p.a.; 2000 kg to 3000 kg Rs. 748 p.a.; 3000 kg to 4000 kg Rs. 1034 p.a.; 4000 kg to 5000 kg Rs. 1210 p.a.; Above 5000 kg Rs. 484 p.a. for every 1000 kg in excess of 5000 kg; trailer Rs. 110.

NA.

West Bengal Up to 100 cc Rs. 800 100 to 200 cc Rs. 1800; Above 200 cc Rs. 2400 (one time tax).

ULW up to 500 Rs. 500 p.a.; 501 to 800 kg Rs. 900 p.a.; 801 to 1000 kg Rs. 1000 p.a.; 1001 to 1200 kg Rs. 1200 p.a.; 1201 to 2000 kg Rs. 2500 p.a.; 2001 to 3000 kg Rs. 4000 p.a.; For every additional 100 kg or part thereof Rs. 200 p.a.

Up to 4 seats Rs. 600 p.a.; More than 4 seats Rs. 800 p.a. plus Rs. 100 for every additional seat beyond 5.

Delhi Auto rickshaw Rs. 310; Motorcycle Rs. 625 (One time tax).

Up to 1000 kg Rs. 1950; 1000 to 1500 kg Rs. 2500; 1500 to 2000 kg Rs. 3590 plus Rs. 2340 for every additional 10000 kg (one time tax).

Up to 4 passengers Rs. 310 p.a.; Above 4 to 6 passengers Rs. 580 p.a.

Notes: PY = per year, PQ = per quarter, PM = per month, ULW = unladen weight, PS = per seat, NA = not available.

58

Table 4.6Motor Vehicle Tax on Commercial Passenger Vehicles

State Stage Carriage Contract CarriageAndhra Pradesh Express Mafussil Rs. 680 PS/PQ Ordinary Mafussil Rs. 591

PS/PQ Express Town Rs. 513 PS/PQ Ordinary Town Rs. 412 PS/PQ

All permits Rs. 1575 PS/PQ Other CC buses Rs. 1050 PS/PQ Omnibuses Rs. 126 PS/PQ

Assam Minibus Rs. 120 PS/p.a. Others Rs. 90 PS/p.a.

For every seat Rs. 90 p.a. Tourist omnibus up to 35 seats Rs. 8400 p.a.

Bihar 13 to 26 passengers Rs. 1583.50 p.a. plus Rs. 105.50 for every additional person beyond 13 passengers. 27 to 32 passengers Rs. 3036 p.a. plus Rs. 79 for every additional person beyond 27 passengers. 33 or more passengers Rs. 3485 p.a. plus Rs. 53 for every additional person beyond 33 passengers

NA

Gujarat Up to 20 permitted person Rs. 540 p.a. Plus Rs. 20 p.a. for every additional person in excess of 20 persons

Ordinary omnibus: Up to 20 seats Rs. 2000 PS/p.a.Above 20 seats Rs. 3000PS/p.a. Luxury bus: Up to 20 seats Rs. 3000 PS/p.a. Above 20 seats Rs. 4000 PS/p.a.

Haryana Rs. 550 per seat subject to maximum Rs. 35000 p.a. Rs. 200 PS/p.a.Himachal Pradesh Rs. 500 PS/p.a. subject to maximum of Rs. 25000 p.a. Rs. 200 PS/p.a. subject to maximum of Rs. 8000 p.a.Jammu & Kashmir Rs. 1400 p.a. Mini Bus:

a) Tata-407 Rs. 1200 p.a.. b) Others Rs. 800 p.a.Karnataka Above 12 passengers Rs. 425 PS/PQ Luxury: above 12

passengers Rs. 1000 PS/PQ NA

Kerala Ordinary: Rs. 1200 PS/PY Express: Rs. 1400 PS/PY Additional Rs. 400 PY for every permitted standing passenger (Rs. 300 PY for vehicles with city/town permit)

Within state: 13 to 20 passengers Rs. 1400 PS/PY Above 20 passengers Rs. 2000 PS/PY Interstate: above 12 passengers Rs. 4000 PS/PY

Madhya Pradesh Ordinary: up to 80 km Rs. 1380 PS/p.a. Plus Rs. 120 PS/p.a. for each additional ten km or part thereof AC/Deluxe: Up to 100 km Rs. 2400 PS/p.a. Plus Rs. 240 PS/p.a. for each additional ten km of part thereof

Ordinary: Rs. 6000 PS/p.a. AC/Deluxe: Rs. 7200 PS/p.a. Omnibus: Up to 12 seats Rs. 100 PS/PQ Above 12 seats Rs. 350 PS/PQ

Maharashtra Rs. 71 p.a. for every permitted passenger Ordinary omnibuses: More than 6 passengers: Rs. 750 PS/p.a. Tourist vehicles: more than 6 passengers" Rs. 3000 PS/p.a. AaA/C vehicles: More than 6 passengers Rs. 4000 PS/p.a.

Orissa Up to 160 km Rs. 143 PS/p.a. 160 to 240 km Rs. 163 PS/p.a. 240 to 320 km Rs. 204 PS/p.a. Above 320 km Rs. 245 PS/p.a. Additional Rs. 152 PY for every standing passenger

6 to 25 passengers Rs. 600 PS/p.a. Above 25 passengers Rs. 1500 PS/p.a.

Punjab Per seat per km per day (in paise) Ordinary bus 4.65 Express Bus 5.81 Semi Deluxe Bus 6.97 Deluxe Bus 9.30 AC Bus 16.27

Tourist buses: Ordinary RS. 100000 p.a. Deluxe Rs. 125000 p.a. AC bus Rs. 144000 p.a. Mini bus: 1 to 15 seats Rs. 4400 p.a. 16 to 30 seats Rs. 6600 p.a. Other buses: per day (Rs.) Ord. Dlx. A/C1 to 15 seats 200 300 40016 to 30 seats 300 400 50031 to 34 seats 400 500 600

Rajasthan Cost of vehicle up to 200,000- 1.2% on vehicle; Above 200,000- 1.5% on vehicle; cost up to 400,000- 0.70% on chassis; Above 400,000- 0.8% on the classics regd: outside state; 5 seats Rs. 50 per day; 5 to 12 Rs. 80 per day. With all Rajasthan/all lndia permitSeat up to 5 0.80% on veh. 6 to 8 1.75% on veh. 9 seats 3% on veh.Further rate varies from 4 to 24 percent on the basis of seat and type of vehicleSpecial road tax on temporary permit for 4 wheelers: Seats 5 -Rs. 40 per day. It further increases as per seat and type of vehicle. The maximum rate is above 20 seats: ordinary Rs. 500 per day; deluxe Rs. 800 per day up.Road Tax on Passengers vehicles Cost up to Rs 1,75,000 2.25% on vehicleRs. 1,75,000 to 4,00,000 0.75% on vehicle Above Rs. 4,00,000 3.5% on vehicleCost of chassis up to Rs. 80,000 1.75% on chassisRs. 80,000 to Rs. 175,000 2.5% on chassis Rs. 175,000 to 400,000 2.0% on chassis Above Rs. 400,000 5.0% on chassis

Special road tax on private vehiclesUp to 12 seats 1.5% on vehicle13 to 40 seats 3.5% on vehicle

2.0% on chassisAbove 40 seats 5.0% on vehicle 3.5% on chassisSpecial road tax on vehicle operating on scheduled routes Seats 45

Up to 160 km route 0.60% on chassis161 km to 240 km 1.00% on chassisAbove 241 km 1.60% on chassis

Seating capacity above 45160 km 0.70% on chassis161 to 240 km 1.10% on chassis

Above 241 km 1.75% on chassis

Contd . . . .

59

Table 4.6 Contd . . .)Motor Vehicle Tax on Commercial Passenger Vehicles

State Stage Carriage Contract Carriage

Tamil Nadu Metropolitan area: Rs. 60 PS/PQ Town area: Rs. 275 PS/PQ Express service: Rs. 360 PS/PQ Plus 25% surcharge

Rs. 10000 PS/PQ

Uttar Pradesh Seating capacity of up to 42 persons Rs. 149 p. day; above 42 persons Rs. 248 p. day.Express 5% higher than rates under clause (a) or (b); Semi dlx. 8% higher than rates under clause (a) or (b);dlx. 20% higher than rates under clause (a) or (b); Air-conditioned 50% higher than rates under clause (a) or (b) of Article 1.

‘A’ Class route ‘B’ Class route (Rs.) (Rs.)Up to 4500 km 177 1984500 to 5700 223 2505700 to 7200 283 3147200 to 9000 376 3939000 to 11700 458 51111700 to 14400 565 63014400 to 18000 705 787Above 18000 705+177 for 787+ 198 for every every 4500 km extra 4500 km extra

West Bengal 8 to 26 seats Rs. 750 for 8 seats p.a. plus Rs. 75 for every additional seat27 to 32 seats Rs. 2155 for 27 seats p.a. plus Rs. 55 for every additional seat33 seats or more Rs. 2475 for 33 seats p.a. plus Rs. 40 for every additional seat

Rs. 800 p.a. for 5 seats Plus Rs. 100 for every additional seatOmnibus:Up to 8 seats Rs. 1000 p.a.9 to 20 seats Rs. 1100 p.a.For 9 seats plus Rs. 100 for every additional seat. Above 20 seats Rs. 2300 p.a. for 21 seats plus Rs. 100 for every additional seat

Delhi Up to 18 passengers Rs. 980 p.a. For every additional passenger Rs. 145 p.a. NA

Notes: PY = Per year, PQ = Per quarter, PM = Per month, SC Capacity, PS Per seat

60

Table 4.7Motor Vehicles Tax on Goods Vehicles for Transportation

State Trucks TrailerAndhra Pradesh 5500 to 9000 kg Rs. 1426 PQ

9000 to 12000 kg Rs. 1785 PQ12000 to 15000 kg Rs. 2174 PQ Above 15000 kg Rs. 2174 PQPlus Rs. 51 PQ for every additional 250 kg or part thereof

T.T. combination Up to 1000 kg Rs. 720 PQ Above 1000 kg Rs. 1150 PQ

Assam Up to 1 MT 735 p.a. Every additional 1/2 MT or part Rs. 180 p.a.

Light Rs. 360 p.a. Medium Rs. 560 p.a. Heavy Rs. 1060 p.a.

Bihar RLW 2000 kg to 4000 kg Rs. 502.50 to Rs. 838.50 Above 4000 to 8000 kg Rs. 838.50 to Rs. 1662.50 Above 8000 kg Rs. 1662.50 Plus Rs. 136.50 for every additional 250 kg or part thereof

RLW 500 kg Rs. 253 p.a. Above 500 to 2000 kg Rs. 253 p.a. to Rs. 427 p.a. Above 2000 to 4000 kg Rs. 432 to Rs. 752 p.a. Above 4000 to 8000 kg Rs. 760 p.a. to Rs. 1552 p.a. Above 8000 kg Rs. 1568 p.a. Plus Rs. 120 p.a. for every additional 250 kg or part thereof

Gujarat RLW up to 750 kg Rs. 290 p.a.Above 750 to 1500 kg Rs. 540 p.a. Above 1500 to 3000 kg Rs. 825 p.a. Above 3000 to 4500 kg Rs. 1190 p.a.Above 4500 to 6000 kg Rs. 1590 p.a.Above 6000 to 7500 kg Rs. 1720 p.a.Above 7500 kg Rs. 1720 Plus Rs. 130 for every additional 250 kg or part thereof

Tractors & trailers used for agricultural purpose are exempted from tax

Haryana ULW up to 12 CWT Rs. 207.00 p.a.12 CWT to 1 tonne 337.5 p.a. Above 1 tonne to 4 tonnes Rs. 660 to Rs. 1200 p.a. Above 4 tonnes Rs. 1500 p.a.Additional Rs. 75 p.a. for trailers.

NA

Himachal Pradesh ULW up to 600 kg Rs. 276 p.a. Above 600 kg to 4 tonnes Rs. 444 to Rs. 1368 p.a. Above 4 tonnes Rs. 2000 p.a. Additional Rs. 96 p.a. for trailers.

NA

Jammu & Kashmir Rs. 1400 p.a. Trailers used for agriculture purpose are exempted from the tax

Karnataka LW up to 1000 kg Rs. 600 p.a. Above 1000 to 3000 kg Rs. 1600 p.a. Above 3000 to 5500 kg Rs. 3200 p.a. Above 5500 to 15000 kg Rs. 4800 to 7200 p.a. Plus Rs. 75 for every additional 250 kg or part thereof

Rs. 500 at the time of registration (One time tax)

Kerala RLW up to 1000 kg Rs. 572 p.a.Above 1000 to 1500 kg Rs. 1100 p.a.Above 1500 to 2000 kg Rs. 1452 p.a.Above 2000 to 3000 kg Rs. 1892 p.a.Above 3000 to 4000 kg Rs. 2244 p.a.Above 4000 to 5500 kg Rs. 2992 p.a.Above 5500 to 15000 kg Rs. 3740 p.a. to Rs. 8272 p.a. Plus Rs. 176 p.a. for every additional 250 kg or part thereof

RLW up to 1000 kg Rs. 390 p.a.Above 1000 to 1500 kg Rs. 836 p.a. Above 1500 to 3000 kg Rs. 114 p.a. to 1540 p.a. Above 3000 to 5500 kg Rs. 2112 p.a. to Rs. 2684 p.a. Above 5500 to 15000 kg Rs. 3300 p.a. to Rs. 6204 p.a.Plus Rs. 176 p.a. for every additional 250 kg or part thereof

Madhya Pradesh RLW up to 2000 kg Rs. 327 PQ Above 2000 kg to 3000 kg Rs. 520 PQ Above 3000 kg to 4000 kg Rs. 629 PQ Above 16000 kg to 17000 kg Rs. 3025 PQ On every additional 1000 kg or part thereof Rs. 182 every additional RLW of 1000.

Rs. 264 p.a.

Maharashtra RLW 1500 to 3000 kg Rs. 1730 p.a.Above 3000 to 4500 kg Rs. 2070 p.a.Above 4500 to 16500 kg Rs. 2910 p.a. to Rs. 8510 p.a. Plus Rs. 375 p.a. for every additional 500 kg or part thereof exceeding 16500 kg

RLW up to 750 kg Rs. 860 p.a.Above 750 to 16500 kg Rs. 1200 to Rs. 8330 p.a.Plus Rs. 375 for every additional 500 kg or part thereof exceeding 16500 kg

Orissa RLW 1000 to 2000 kg Rs. 1963 p.a.Above 2000 to 5000 kg Rs. 2038 p.a.Above 5000 to 10000 kg Rs. 3144 p.a.Above 10000 to 13000 kg Rs. 4469 p.a.Above 13000 to 16200 kg Rs. 6500 p.a. For every additional 500 kg or part thereof Rs. 213 p.a.

RLW up to 1000 kg Rs. 163 p.a. Above 1000 to 3000 kg Rs. 625 p.a. Above 3000 kg Rs. 1250 p.a.

Contd . . .

61

Table 4.7 (Contd. . . )Motor Vehicles Tax on Goods Vehicles for Transportation

State Trucks TrailerPunjab ULW up to 1 tonne Rs. 800 p.a.

Above 1 to 2 tonne Rs. 1000 p.a.Above 2 to 3 tonne Rs. 1210 p.a.Above 3 to 4 tonne Rs. 1410 p.a.Above 4 tonne Rs. 1500 PM

NA

Rajasthan Road tax per yearCost of chassis/vehicle Up to 150,000 2.0% on chassis150,000 to 600,000 0.75% on chassis Above 600,000 0.80% on chassis Articulated (trailer) 1.5% on HPSpecial Road TaxCost up to 200,000 1.00% on chassis/vehicle 200,000 to 400,000 0.35% on chassis/vehicle 400,000 to 600,000 0.45% on chassis/vehicle Above 600,000 0.50% on chassis/vehicleGoods vehicle registered outside state Road tax GWV 7000 kg Rs. 110 per 1000 kg Above 7000 kg Rs. 50 per 1000 kg Spl. road tax 5000 kg Rs. 90 per 1000 kg for 30 days, Above 5000 kg Rs. 70 per 1000 kg

Rs. 1300 p.a. to Rs. 1800 p.a.

Tamil Nadu LW up to 3000 kg Rs. 545 PQ Above 3000 to 5500 kg Rs. 885 PQ Above 5500 to 9000 kg Rs. 1355 PQ Above 9000 to 12000 kg Rs. 1775 PQ Above 12000 to 13000 kg Rs. 1930 PQ Above 130000 to 15000 kg Rs. 2300 PQ Exceeding 15000 kg Rs. 2300 PQ plus Rs. 50 for every additional 250 kg or part thereof

LW up to 3000 kg Rs. 340 PQ Above 3000 to 5500 Rs. 400 PQ Above 5500 to 9000 Rs. 700 PQAbove 9000 to 12000 Rs. 810 PQ Above 12000 to 13000 Rs. 1010 PQ Above 13000 to 15000 kg Rs. 1220 PQ Exceeding 15000 kg Rs. 1220 PQ plus Rs. 50 for every additional 250 kg or part thereof.

Uttar Pradesh ULW up to 2000 kg Rs. 5282000 to 3000 kg Rs. 748 3000 to 4000 kg Rs. 1034 4000 to 5000 kg Rs. 1210 Additional Rs. 484 for every 1000 kg or part thereof above 5000 kg

Rs. 110 p.a.

West Bengal GVW up to 2000 kg Rs. 312.50 p.a.Above 2000 to 4000 kg Rs. 625 p.a.Above 4000 to 16250 kg Rs. 1365 to Rs. 6500 p.a.Rs. 250 for every additional 259 kg or part thereof exceeding 16250 kg

GVW up to 2000 kg Rs. 500 p.a. Above 2000 to 4000 kg Rs. 900 p.a. Above 4000 to 15000 kg Rs. 6650 p.a.Plus Rs. 200 for every additional 250 kg or part thereof

Notes: PY = Per year, PQ = Per quarter, PM = Per month, SC Capacity, PS Per seat

62

Table 4.8Major States and Local Taxes on Road Transport Industry (%)

States Tax Levied Motor Cycles etc. Light Vehicles (Motor Cars)

Heavy Vehicles (Buses & Trucks)

Madhya Pradesh Sales Tax 6 4 4

Octroi - - -MVT/PGT 3 3 Rs. 327

Maharashtra Sales Tax 10 10 10

Octroi 5 5 3

MVT/PGT 5 Rs. 4800 Rs. 1730

Rajasthan Sales Tax 6 6 6

Octroi 4 5 3

MVT/PGT 3 3 2

West Bengal Sales Tax 4 4 4

Octroi - - -

MVT/PGT Rs. 800 Rs. 500 Rs. 312.50

Table 4.9Tax Burden on Heavy Passenger and Goods Vehicles

State Tax Levied Buses (52 Seaters) Trucks (RLW 16200 kg/ ULW 7000 kg)

Stage Carriage Contract CarriageHaryana Motor vehicle (road) tax 28600 28600 1500

Passenger and Goods tax 48672 48672 3500

PGT- (for specified uses) 10400

Punjab Motor vehicle (road) tax 26000 26000 1500

Special road tax 53269 104000 1500

Rajasthan Motor vehicle (road) tax 5200 5200 3500

Special road tax 40560 46800 3500

Uttar Pradesh Motor vehicle (road) tax 5590 5590 3250

Passenger and goods tax. 56784 85000 4666

63

Table 4.10: Rate Structure of Other Taxes on Commodities & Services in Indian States

(2001-02)

States

Tax Rate

Andhra Pradesh

Gujarat Haryana Maharashtra Rajasthan Tamil Nadu Tripura Uttaranchal

Electricity Duty

1. Industrial consumer

2. Irrigation:

Metered

Non-Metered

3. Residential

4. Commercial

5. Others

6%*+ Rs. 37/26 p.m.

Flat rate of Rs. 200 to

Rs. 550 p.a.

6%*

-

-

N.A.

10 p. per unit

Fully exempted

10 p. per unit

10 p. per unit

10 p. per unit

6% *

30 p. per unit

12%*

13% *

30 p. per unit

25 p. per unit

4 p. per unit

5% of flat rate

25 p. per unit

25 p. per unit

35 p. per unit

5%*+Rs. 30 p.m.

Rs. 20 p. unit

Rs. 250 p.m.

5%*

5%*+Rs.30 p.m.

-

N.A.

4.17%* or 3.92%*

0.71%*

2.03%*

-

-

Entertainment Tax1. Cinema Halls

2. Horse Race

3. Compounding of tax

4. Other Rates

18%-30%

35%

-

-

N.A.119% of

admission rate

-

-

50% of admission rate

100%

Vary between 10%-25%

100% of rate of admission

Exempted

Rs. 10 per cable

connection p.m.

5% - 20% of gross payment of

admission

20%/20%+SC@ 5%

Rs. 6000 to Rs. 72000 yearly

N.A.22% to 25% of

gross collections p. show p. week

100% /125%

Luxury Tax 5% & 20%

N.A. 4% / 10% N.A. 10%

Note: ‘ * ’ refers to ‘of consumption charges’.

64

5.

Experiences of VAT in Federal Countries

Introduction

While VAT has been introduced in more than 170 countries, it is probably no

accident that it has not been possible to introduce a fully harmonized VAT in any of the

federations. To draw lessons from the experiences of introduction of VAT in some of the

federal countries, we present below case studies of the structure and administration of

VAT in federal countries such as Brazil, Canada, and the European Union.

Brazil

The overall system of taxes on commodities and services in Brazil is

characterized by a variety of taxes, which are levied by all the three tiers of government,

viz., federal, state and municipal governments. The prevailing indirect taxes could be

categorized into three major group.

The first group comprises value added taxes - IPI (Imposto Sobre Productos

Industrializados), which is a federal VAT on manufacturing sector and ICMS (Imposto

Sobre Operacoes Relativas A Circulacao De Mercadorias E Servicos), a state-VAT on

consumption covering agriculture, industry and a number of services.

The second group consists of taxes that are more sector specific. One of the

important taxes in this group is ISS (Imposto Sobre Servicos) - a tax on services that is

not included in the ICMS. It is a cascade type tax levied by municipalities and covers

services under industrial, commercial and professional sectors, with rates varying from

0.5 to 10.0% in different municipalities. The other indirect taxes under the second group

consist mainly of (i) tax on financial transactions (IOF), (ii) tax on retail sale of fuels

(IVVC) and (iii) tax on transmission of financial amounts and rights (IPMF).

65

The third group comprises contributions to social integration programme (PIS),

the public employees financial reserve fund (PASEP), and various other social

contributions41.

Federal VAT

VAT levied at the federal level is known as IPI (Imposto sobre Produtos

Industrializados)42. It is a selective tax restricted to the manufacturing sector, levied on all

transactions of taxable industrial products. The tax base consists of industrial value

added, keeping capital goods outside the creditable base. The scope of IPI is, however,

restricted to the delivery of industrial products at the producer level and is levied on (i)

importers of foreign products who subsequently sell them (ii) industrial establishments

performing any industrial process from which a chargeable product results even if it is

actually exempt or subject to zero rate and on (iii) establishments regarded by the law to

be industrial establishments.

The coverage for the taxable transactions under the IPI includes those industrial

products that have been the objects of an industrial process viz., changing the nature,

performance, completion, display or purpose of a product or improving its readiness for

consumption. However, agricultural and mineral products are excluded from the purview

of IPI. Also, retail and wholesale trade as well as services are excluded from its scope,

making it restricted to a few select industrial activities only43.

Rate Structure: The IPI has a multiplicity of rates with considerable variations

across commodities. This is primarily due to three factors: Firstly, on equity

considerations necessities are taxed at low rates. Secondly, the tax rates are based on the

degree of processing of commodities. That is, the rates vary according to the content of

processing. Finally, luxuries and sumptuary goods are taxed at high rates. The rates are

specified in a lengthy tariff list and are subject to frequent amendments. In general, IPI

rates are: 330 % on cigarettes, 200 % on beer, 77 % on perfumes, 40 to 50 % on

41 The existing federal arrangements are based on tax reforms of 1988 that introduced the state-VAT (ICMS). This was an improvement over the old system of ICM having an extended base to cover goods and services.

42 This This is levied on the strength of law 4502 of 30th November 1964 with subsequent amendments. The regulations were enacted vide Decree No. 87,981 of 23rd December 1982.

43 Purohit, Mahesh C (1997), "Value Added Tax in a Federal Structure-A Case Study of Brazil", Economic and Political Weekly, Vol. 32, No.7, February 15-21, pp.357-362.

66

automobiles, 20 % on wine, 8 to 10 % on chemical inputs, 4 to 15 % on paper, 4 to 10 %

on electrical machinery and equipment as well as non-metal minerals, and 4 to 6 % on

metals. Although the intention of rate variations is to differentiate tax burdens according

to the nature of the product, it is generally felt that such treatment is not easily

manageable at the level of manufacturing and is perhaps better implemented only at the

consumption level. An intermediate product (such as leather) could be used to produce a

necessity (such as shoes) or a luxury item (such as vanity purses). In addition, the

multiplicity of rates causes various administrative problems.

IPI levied on raw materials, intermediary products and packaging materials

entering into industrial establishments gets credit against the tax liability of the final

goods, provided the final goods are not exempt from tax. However, the credit is available

with respect to exports and production of certain exempt articles specified by law.

Acquisition of goods, which might not be a part of a new product but consumed in

the production of taxable articles (such as tools that undergo wear and tear) may also

claim tax credit. Specific machinery, apparatus and equipment produced in Brazil,

forming part of fixed assets used solely in the industrial process, are also eligible for tax

credit. The Ministry of Finance with the approval of the Coordinator of the Tax System

notifies the eligibility for such tax credit for additional items44. Industrial establishments

are allowed to take credit for the payment of tax on purchases from the unregistered

wholesalers as well45.

Imported goods are subject to IPI but the products exempt from import duties are

automatically exempt from IPI applicable on imports. Also, under Law 9000 of 16th

March 1995, import of various equipment, tools and machinery is exempt.

Exemptions under IPI: Major exemptions relate to: (i) some notified inputs (ii)

the outputs of firms installed in Manaus Free Zone - the ZFM (Zona Franca de Manaus)

area and approved by proper authority and (iii) a large number of specific products or

projects. About 60 products are either taxed at zero-rate or exempted from the IPI. These

44 This credit is available to indigenous machinery only. The Supreme Court of Brazil has upheld that such a subsidy to national industry is permissible.

45 Such a credit is based on the rate corresponding to the product on 50% of its price.

67

include food items, pharmaceuticals, fertilizers, shoes, skins and leathers. Exports are

zero-rated.

State VAT

VAT levied by the states, known as ICMS (Imposto Sobre Operacoes Relativas a

Circulacao De Mercadorias E Servicos), replaced the sales turnover taxes in sixties.

However, the coverage of ICMS is not all- inclusive. First, the base of the specific taxes

is explicitly excluded. Second, a large number of capital goods produced in Brazil are

exempt. For example, agricultural machinery and equipment were exempted in 1969.

Later in 1971, this exemption also covered a wide range of equipment and machinery for

the industrial sector, intended for the northern and north-eastern regions. Exemptions also

include intermediate imports, imports exempted from import tax, fertilizers and

pesticides, many inputs for agricultural production, vegetables, eggs, and sale of

agricultural equipment in the north-eastern states. Except for these exemptions, the base

of the ICMS includes the sale of goods at all stages of production-distribution process

including retail trade as well as agriculture and cattle raising sectors. However, it

excludes tax on services, which is levied separately under ISS46.

In general, there are five rate categories in the ICMS47: Sumptuary consumption

items such as liquor, cigarettes, tobacco, electronic goods, video games, sports,

communications, gas and alcohol are taxed at 25 %. Most of the other items are taxed at

18 % standard rate, while electrical consumption (50-200 kw) is taxed at 12 %. The tax

rate is 8.8 % on capital goods and 7 % for rice, beans, bread, salt, meat and food items.

Industrial exports are zero-rated with some exceptions.

The tax base of ICMS is inclusive of tax. This implies that the effective rate of tax

on the basic price is in fact higher than indicated in the tax law. Thus, given the standard

rate of 18% for consumer goods, the tax liability would be calculated as follows:

0.18 × {retail price (including tax)}.

46 Prior to the Constitutional Reforms of 1988, some of the goods and services (such as fuels, minerals, transport and communication) were excluded from the tax base. These have now been included in the base.

47 The 1988 Constitution delegated power to the states to establish internal rates. Accordingly, there are some variations in tax rates among the states.

68

i.e. for a price of $ 100, the tax is $18, the retail price excluding tax is $ 82.

If the tax is related to the base price, i.e. $ 82, the rate works out as:

(18/82) × 100 = 21.95 %.

The effective tax rate could still be higher in some cases where the base of ICMS

is inflated by inclusion of the estimated value added at the later stages of processing

(such as retailers). This system of inflating the base is referred to as Substituicao

Tributaria.

International and Inter-regional Transactions:

ICMS being a state-VAT, the tax is levied on all intrastate sales, that is, the sales

made within the state. However, in a federal country any sale within a state that involves

the movement of goods from one state to another does not remain a purely intrastate

transaction. Therefore, in treating inter-regional transactions, Brazil follows the "origin

principle"48 where the tax is levied by the exporting state. The importing state allows

credit for the tax paid in the state of origin.

However, to neutralize the impact of varying levels of development in different

states, the tax rate on inter-regional transactions varies according to destination. While

the general rate on interstate transactions is 12 %, the differential interstate rate is 7 % for

goods sent from south-east to north-east or to the central-west49. Through the levy of a

higher rate of tax (17 %) on sales and reimbursement at a lower rate (7 %), these states

raise 10 % on imports.

This adjustment operates as an equalization mechanism even when less developed

states export to rich states, yielding a corresponding revenue loss to the rich states. For

example, when the transaction takes place between a poor (exporting) state and rich

(importing) state, the poor state collects 12 % that is reimbursed by the rich state. Thus,

the rich state raises only 5 % (17 minus 12 %) on imports consumed in the state.

48 In general, two principles are followed for taxing inter-regional trade. These are `origin' and `destination' principles. According to the former principle, the tax is levied by the state originating movement of goods. The importing state allows set-off for this avoiding double taxation of the same base. In the destination principle exports are "zero-rated".

49 There are nine states in the North-East, four in the Central-West and seven in the North. These states are regarded as less developed states. In all, there are six states that are regarded as developed states.

69

This feature of "triangle trade" implies a revenue loss for the exporting state.50

However, these adjustments are intended to act as a regional equalization scheme through

which southern states support the states in the north by reducing interstate tax rates

selectively.51

Tax Harmonization:

National Public Finance Council (Conselho de Politica Fazendaria - CONFAZ)

plays an important role in harmonizing the interstate tax under ICMS. CONFAZ

determines the exemptions or reductions in the rates of ICMS through meetings at regular

intervals. However, the interstate rates are fixed by the enactment of the Senate.

CONFAZ consists of all states' representatives with 27 councilors. The CONFAZ can

change the rates but as this proposal has to get unanimous approval, the changes are

infrequent. Under the agreements of the CONFAZ, some specific products such as

vegetables, eggs and domestic fish are exempt. Also, it has granted exemptions to sale of

agricultural equipment to the north-east and to Para, Amapa, and Rondonia. Similarly,

agricultural exports including specified vegetables and fruits are exempt. Small

businesses are exempted on administrative considerations. Also, it is important to note

that although CONFAZ harmonizes interstate trade, some of the states try to grant

concessions (such as grant of payment deferrals to attract industries) that are not

permissible. Sales to ZFM area as well as industrial exports are zero-rated. However, the

credits earned by the exporters are rarely reimbursed in cash by the government. Export

credits are thus nonrefundable leading to an additional burden on the exporters.

Although, the Constitution grants immunity to exports, some semi-manufactured

goods are taxable. However, the list of exempted items has been gradually enlarged and

includes textiles and agricultural exports, including frozen meat and fruit juice.

Management of ICMS: Case Study of Sao Paulo

ICMS being a state subject, its administration varies from one state to another.

However, to understand the general features of VAT administration in Brazilian states,

50 Longo, C. A. (1992),”Federal Problems with VAT in Brazil”, paper presented at the International Conference on Tax Reforms, National Institute of Public Finance and Policy, New Delhi.

51 The arrangement is also beneficial to the exporting state because such an arrangement prevents the importing state from "shopping abroad", without having to pay VAT.

70

we present below a case study of administration of ICMS in Sao Paulo, which accounts

for 47% of GDP and 21% of population of Brazil.

Registration: All the dealers have to be registered prior to the commencement of

business. This procedure helps the VAT department to coordinate with federal income tax as

well as the environmental department. In this process, all dealers are required to fill in an

application form and declare their property. Also, they have to produce their credentials.

Dealers are classified into three categories according to the turnover, viz., micro

enterprises, retailers and large dealers. Micro enterprises are exempt from tax payment up

to a turnover of NCz$ 50,000 per year. Retailers52 are taxed according to their estimated

tax liability based on the sales of previous years.

Payment of Tax and Submission of Return: All registered dealers having

turnover above 10,000 units53 pay monthly tax and submit a form known as ICMS-2

before the 10th of every month. The ICMS-2 contains all the information relating to the

type of business operated by the dealer. It passes through four channels, each one having

some checks at the entry level. They also submit a monthly return in Form CEC. It

includes details relating to the economic activity, debits and credits of ICMS.

Auditing of Dealers: Information available, from the monthly return (CEC) and

other sources, form the basis of selection of dealers for audit. Since there are more than

0.7 million dealers, it’s not possible to audit all of them. The statistical section of the

department takes all the dealers from their population and selects a small number (one

percent only) of dealers. While selecting the dealer, they make use of information relating

to variation in trends of different dealers, variables as per data available from various

regional offices. Also, information collected at the fiscal check-posts is used for this

purpose. They also collect information relating to turnover and tax payments by the

dealer and compare it with the estimated sectoral trend. In case there are significant

variations, the dealer is selected for auditing.

Fiscal Frontiers

52 Except super markets and departmental stores.53 These units are fiscal units defined in terms of New Cruzado (NCz$). In view of the double digit

inflation, these units are indexed. Presently, a dealer having annual turnover of NCz$ 50,000 are exempt from payment of tax.

71

Fiscal frontiers have been established at various important border points of Sao

Paulo. They keep a record of the inflow and outflow of goods into and out of the state.

The information collected from these sources is sent for cross-checking.

Conclusion

Brazil is one of the federal countries that have dual-VAT: IPI at the federal level

and ICMS at the state level. IPI is primarily a tax on select commodities, restricted to the

manufacturing sector. There is a tendency on the part of the entrepreneurs to undervalue

output to reduce their tax liability. Exemption given to domestically produced machinery,

as against imported machinery, creates distortions in the system. ICMS is levied on all

goods used in the process of production and distribution process. Tax on services,

however, continues to be a cascade type turnover tax. It is not integrated with IPI or

ICMS.

Canada

Canada is one of those federal countries54 that have implemented a comprehensive

VAT at the Central (federal) level. It is known as goods and services tax (GST), which

replaced the prevailing manufacturers sales tax in January 1991.

At the sub-national (provincial) level, however, there are different forms of sales

taxes. To harmonise these taxes at the federal and state levels, serious efforts have been

made.

Federal VAT

GST, a federal VAT, covers almost all consumption goods and services at all

stages of the production-distribution process. While it excludes investment goods, input

tax credit is allowed for all non-labour inputs in the course of business. The tax is levied

at the rate of 7 percent on sale price. In spite of comprehensive coverage, GST provides

for a few exemptions and zero rating of goods and services. It also makes provision for

tax rebate and low income tax relief55.

54 It has two tiers of government: Federal and Provincial. There are ten autonomous Provinces and three territories under the Federal Government. These are Northwest Territories, Nunavut, and Yukon Territory.

55 Purohit, Mahesh C. (2001), “Structure and Administration of VAT in Canada- Lessons for India”, International VAT Monitor, Vol. 12, No. 6, November/December, pp. 311-323.

72

Exemptions: While most goods and services are taxable, some exemptions are

provided for economic, administrative and political reasons. Exempted items include

most goods and services supplied by governments. Also, sales made by small dealers

with an annual taxable turnover of less than $30,000 and occasional sales by private

individuals (such as private sale of a used car) are exempt. Residential rents (other than

temporary accommodation), most health and dental services, domestic financial services

(such as interest on loans, charges for accounts, credit card fees and commission on

transactions in stocks or other securities), day care services, and educational services are

also exempt56. Resale of old houses also falls in the category of exempted list57.

Zero Rated Items: In addition to the exemptions on the items mentioned above,

there are some zero rated items. For example, exports and international flights are zero-

rated under GST. Most agricultural and fish products, basic groceries58 (excluding snack

foods, non-food beverages, prepared foods and restaurant meals), prescription drugs and

medical devices also fall in this category. All purchases made by provincial and territory

governments are zero-rated either through mutual agreement or through treaties. Sales by

farmers are zero-rated. Individuals and organizations having diplomatic immunity also

fall in the category of those eligible to buy goods under zero-rating. Purchases by visitors

(for taking goods out of Canada) are also zero rated, provided the amount paid exceeds a

certain threshold. Visitors can claim refund of tax paid on accommodation59.

Tax Rebate: Institutions such as municipalities, academic institutions (including

universities), schools and hospitals, generally referred to as the MASH sector, that do not

engage in sales but provide services, pay GST on their purchases. Such institutions

receive partial rebate on taxes paid by them. Municipalities receive a rebate of 57.14

percent of the tax paid, while universities and public colleges receive 66 percent rebate.

56 Exemption is granted to most of the services enumerated in the category given. The word 'most' typifies non-exemption to some services. For example, 'most health services' do not include cosmetic surgery or a diamond denture. That is, only the basic services are exempt.

57 Sales of new homes are fully or partially taxable. There is a tax at the rate of 7 percent on new homes costing more than $450,000. Those costing less than $350,000 get a rebate of 2.5 percent. There is a phasing out of rebate for houses costing between $350,000 and $450,000.

58 A purchase of six or more doughnuts in a grocery store is treated as basic food and hence exempt from tax. Purchase of less than six doughnuts in a restaurant is treated as snacks, and therefore, taxable.

59 No refund for tax is given for goods consumed (viz., restaurant meals, gasoline, alcoholic beverages, tobacco) and services purchased while in Canada.

73

The rebate for schools is 68 percent and for public hospitals 83 percent. Government

registered charities and non-profit organizations are also entitled to 50 percent rebate on

all taxes paid on their purchases. Therefore, these services are partially zero-rated, as the

supplier claims a rebate for a portion of taxes paid on purchased inputs60.

Low Income Relief: To reduce the incidence of GST on low-income families,

there are provisions under the income tax laws of Canada, in addition to the provisions of

exemptions, zero-rating and tax rebate under GST, that provide a credit to families with

income below $30,000 per annum. This credit is given at the rate of $199 per adult, and

at the rate of $105 per child, per annum. The amount of tax credit is reduced by 5 percent

if the family income is in excess of $ 25,92l per year. Since, this provision relates to

income tax, the credit is given to the families through refund cheque from the income tax

department61 . However, the provision of low-income relief is absolutely unrelated to the

exact amount of GST paid by them. It could, in fact, be argued that this relief in

conjunction with the zero-rating of basic groceries does not make much sense.

Provincial Sales Tax and VAT

At the sub-national level, all provinces except Alberta levy sales tax62. There are

three different models among the provinces levying sales tax: Quebec levies a VAT

(known as Quebec Sales Tax – QST); three of the provinces (viz. Newfoundland, Nova

Scotia, and New Brunswick) levy a harmonized sales tax (HST) - a combination of GST

and state VAT63; and the rest of the provinces levy a retail sales tax (RST).

The coverage of QST as well as HST is comprehensive. Both these cover most of

the goods and services. However, RST is basically levied on goods, only with some

exceptions. Thus, the provinces following RST tax a lot of inputs and a few services. On

the contrary, QST as well as HST does not tax investment but taxes services. Most 60 Rebate is provided direct to these institutions by way of a specific rebate application that they have

to file with Canada Customs and Revenue Agency (CCRA) that verifies the amount and sends the rebate amount direct to them.

61 This is termed by Bird as “refundable GST credit” for low-income people. See Bird, Richard M. (1994b), Where Do We Go From Here?-Alternatives to the GST, KPMG, Toronto.

62 Since Alberta has considerable resources from the sale of petroleum, it does not levy a provincial sales tax. However, GST (being a federal tax) is the only sales tax levied in this province.

63 Mintz, Jack M., Thomas A. Wilson and Pierre-Pascal Gorden, (1994), “Canada’s GST: Sales Tax Harmonization is the Key to Simplification”, Tax Notes International, Tax Analysts; and Gendron, P. P, J. Mintz and T. Wilson (1996), “VAT Harmonization in Canada: Recent Developments and the Need for Flexibility”, International VAT Monitor, 7, pp. 332-342.

74

provinces exempt a few specified consumer and producers goods. Among the consumer

goods, exempt items include food, prescription drugs, medical appliances, books,

children clothing, farm products, seeds and crops, livestock, and fertilizers. Goods

purchased for resale are also exempted. In addition, there are differential rates under RST

in some taxes. In general, RST of Canadian provinces resembles the RST levied in the

states of USA. In both these systems, there are two kinds of exemptions: consumer

products and goods for resale. The first exemption attempts to mitigate the distributional

burden, the second is an integral part of any RST based on suspension technique.

Exemptions under RST vary from one province to another. Most services are

exempt under RST. However, over the years, many provinces have attempted to bring

services, such as car repairs, hotel/motel accommodation, under the purview of RST.

Insurance premium, for example, is taxable in Newfoundland with different rates for

different schemes. Telephone and other communication services also fall in the category

of taxable services. Similarly, computer software, and labour services are taxable in most

provinces. Many provinces provide for separate tax on specified goods and services, such

as alcoholic beverages, restaurant meals and telephone services.

The rates of RST/ VAT in force in different provinces are as follows:

Prince Edward Island 10% PST

Ontario 8% PST

Manitoba 7% PST

British Columbia 7% PST

Saskatchewan 6% PST

Quebec 7.5% VAT

Newfoundland 8% HST (VAT)

Nova Scotia 8% HST (VAT)

New Brunswick 8% HST (VAT)

The rates given above are standard rate; these are applicable to most commodities.

Special rates are levied on alcoholic beverages. For example, Prince Edward Island levies

a tax of 25 percent, Ontario and Manitoba of 12 percent, British Columbia 10 percent and

Quebec of 8 percent. In some of the provinces, this tax is levied over and above the

75

normal RST/VAT. In addition, most provinces have liquor sales monopolies, which are

also taxing agencies.

Administration of Federal VAT

GST administration calls for certain declarative and accounting obligations. First,

all dealers having a turnover of more than C$ 30,000 p.a. need to get their units registered

with the tax department. While applying for registration, the dealer has to provide

information relating to GST/HST, payroll deduction, import/export and corporate income

tax etc. After receiving the application form, the department provides a business number

(BN) to the dealer. Businesses registered for the GST are automatically registered for the

HST.

All the registered dealers are required to submit a return periodically. The

periodicity, however, depends upon the size of dealer. Available data indicates that 92

percent of the dealers pay tax quarterly and submit an annual return, while remaining

taxpayers submit returns on quarterly or monthly basis. The efforts of the department

have also been directed towards reducing the frequency of submission of return.

The department permits the use of a ‘quick method’ for estimating the tax liability

for dealers having turnover less than C$ 500,000. Such dealers have to pay a percentage

(determined by the department) of total sales as tax. This method is used mainly by

convenience stores, small dealers hiring one or two individuals and businesses dealing in

mixed inventory. The dealers opting for this method for estimating their tax liability need

to use it at least for one year. Different percentages for the dealers opting for this are as

follows: vendors of goods – 3%; vendors of services – 5%; grocery vendors (50% or

more grocery sales) – 1%; and grocery vendors (25% to 50% of grocery sales) – 1.75%.

One of the important components of GST management relates to auditing of

dealers. In this context, the department adopts various criteria for selecting a firm for

audit purpose. This criterion include sector profile, industry profile, financial ratios,

standard industrial classification (SIC), constancy in filing returns, large fluctuations in

GST collections, claim of ITC without corresponding reference of fixed assets and de-

registration. Once the selection is completed, audit information management system

(AIMS) helps in verification, enforcement and compliance (VEC) of dealers. Auditor is

76

given a specific assignment and is provided with all the relevant information related to

the dealer.

While department undertakes auditing of a small number of dealers, it does result

in significant revenue recovery, which varies from 0.2% in communication and utilities to

7.7% in finance and insurance.

Management Information System (MIS) is the other main activity of the GST

management. MIS integrates the entire system into an interwoven network. It records

data relating to registration, tax payment and processing of returns. Client services are

given considerable importance. All taxpayers are supplied with requisite information on

dos and don’ts. Various publications are brought out for clients.

To conclude, Canada is one of the federal countries that have implemented a

comprehensive VAT at the central level and have different combinations at the state

level. These include (i) separate federal and provincial VAT administered provincially

(ii) joint federal and provincial VAT administered federally and (iii) provincial RST

administered provincially64.

The European Union

The VAT structure of the European Union could also be considered an illustration

of VAT under a federal system, wherein VAT is levied by all the Member States (MSs).

Coverage of VAT in the European Union includes both goods and services. The

basis of assessment was substantially harmonized in 1979 through the entry into effect of

the Sixth Directive. Further, a degree of rate harmonization was achieved by the Union

stipulating that there shall be a minimum standard rate of 15%, with one or two reduced

rates on a few specified items, with a minimum of 5% following the removal of border

controls. The standard rate ranges from 15 to 25% (Table 5.1). The Finance and

Economic Ministers of the Member States reached an agreement to this effect in 1992.

The European Union has ensured that any country, which wishes to be part of the

Union, adopts a VAT and must refrain from levying any effective tax on intra-

Community transactions. Prior to the abolition of internal fiscal frontiers within the 64 Bird, Richard M. (2000), “CVAT, VIVAT and Dual VAT: Vertical Sharing and Inter-State Trade

(mimeo), (Revised).

77

Union (1st January 1993), exports of goods from MS of origin were zero-rated and these

imported goods taxed in the MS of destination. As from the abolition of fiscal internal

frontiers, the concept of zero-rated exports of goods was replaced by zero-rated intra-

Community supplies of goods and the concept of taxed importation of goods was

replaced by taxed intra-Community acquisitions of goods. From 1st January 1993, the

concept of zero-rated export was restricted to the movement of goods from one MS to

non-EU countries and the concept of taxed importation of goods was restricted to imports

into the European Union from non-EU countries.

Thus the European Union has succeeded in preserving the common market with a

harmonized VAT. In order to achieve this, it proposed two systems. The first relates to

the origin principle, that requires a clearinghouse mechanism and the second relates to the

traditional destination principle65.

Origin principle: The European Commission’s initial idea of harmonizing VAT in

the European Union was based on the origin principle necessitating the establishment of a

clearinghouse. The Commission’s idea was that supplies of goods transported from one

MS to another would be taxed in the MS from which the goods were supplied (MS of

origin) and the customer in the Member State of destination would be entitled to a tax

credit. To make the system work, the exporting state would remit the VAT collected on

exports to the administration of the importing state. Only net balances would have to be

settled, through a mechanism of a central clearing house. It was thought that each

Member State would calculate its total VAT sales and purchases for intra-Community

trade for the month, by aggregating all VAT charged and claimed by registered traders on

sales and purchases to EU Member States. The net position would be calculated vis-à-vis

the European Union and not against each individual state. So each country would create a

monthly statement showing its total VAT input and output figures for intra-Community

trade. The statement would establish a claim or payment. Under this system, clearing

would be a perpetually on-going process.

While the benefits of the clearinghouse mechanism were recognized, the

Members of the European Union anticipated problems relating to the accuracy of likely

65 Purohit, Mahesh C. (2002), “Harmonizing Taxation of Interstate Trade under a Sub-National VAT – Lessons from International Experience”, International VAT Monitor, Vol. 13, No. 3, May/June, pp. 169-179.

78

claims involving large flows of money. The Commission proposed to tackle this through

the mechanism of standardized audit trails, improved control and cooperation between

MSs. Subsequently, the Commission proposed clearing on the basis of estimates of

consumption in MSs.

However, considering the different levels of commitment towards making the

clearing house work66, the MSs were not ready politically or administratively to

implement the system of the clearing house mechanism.

Destination principle: The European Union subsequently adopted a transitional

regime to deal with the treatment of intra-Community transactions in goods. In

conjunction with this, a VAT information exchange system (VIES) was set up to monitor

intra-Community trade of goods67. As per the ‘transitional regime’ the taxable event in

cross-border transactions takes place in the country of destination. For example, a

manufacturing firm producing finished goods, located say in France, ‘imports’ raw

material worth EURO 500 from the United Kingdom where this transaction is subject to

17.5% VAT. When the transaction involves the movement of goods from United

Kingdom to France, the transaction is taxed at the zero rates in the United Kingdom

provided the sale is made to a registered trader in France. With a view to ensuring that

non-registered traders do not benefit from this zero rate, the registration number of the

French customer would have to be mentioned on the invoice of the UK supplier. Thus,

the supplier who sends goods to other EU countries will need to obtain the VAT

registration number of its foreign customer and quote it with his own VAT number on the

sales invoice. Thus, the ‘exports’ to France would effectively be free of UK tax, but the

French customer has to account for French VAT on the intra-Community acquisition

(19.6% of EURO 500). The French customer pays the same amount of VAT on goods

purchased from suppliers in other Member States, as he would have to pay to French

suppliers.

66 Lee, Pearson and Smith (1988), An Analysis of the Commission’s Proposals, Institute of Fiscal Studies, London.

67 Purohit, Mahesh C. (2001), Value Added Tax: Experiences of India and Other Countries, Gayatri Publications, Delhi; and Cnossen, Sijbren (2001), Tax Policy in the European Union: A Review of Issues and Options, Erasmus University, Rotterdam.

79

In addition, when the UK supplier dispatches goods, there is no paperwork to

present to customs officials because for VAT purposes fiscal frontiers have been

abolished. Apart from spot checks for drugs, anti-terrorism measures etc. there would be

no delays in the transportation of goods from one MS to another.

Similarly, the French dealer is not required to clear the goods into France nor is

he required to pay French VAT to French customs officials at the time the goods enter the

country. When the goods arrive at his premises, the French dealer accounts for French

'acquisition' VAT on his VAT return. If he has acquired these goods for resale, he is

entitled to deduct the acquisition VAT on the same VAT return. The same procedure

applies in reverse if the goods are moving from France to the United Kingdom68. In this

regime, taxation of intra-Community transactions in goods takes place in the consuming

state.

This scheme was originally scheduled to apply only from 1993 through 199669.

However, there has been no consensus among the MSs about changing to the new

regime. Hence, the transitional regime still continues70.

Lessons for India

Case studies given above point to the fact that:

(i) While introducing VAT in the states, as attempted in Canada while

introducing HST, the centre should give some grant to compensate states for abolition of

central sales tax, which at present yields them around 18 percent of the total sales tax

revenue. The centre should compensate them during the transitional period.

(ii) India could also think of having a harmonized central and state VAT in the

States that are not so well administered. The States having a very good system of

administration could be given the power to collect CenVAT along with state VAT, as in

Quebec.

68 Buckett, Alan (1992), VAT in the European Community, Butterworths, London.69 The EC Commission was supposed to report to the EcoFin Council before December 31, 1994 on the

workings of the regime and submit proposal for a final system. However, as of today the same transitional system is in vogue.

70 European Community (1987), Completing the Internal Market—The Introduction of a VAT Clearing Mechanism for Intra-Community Sales, pp. 7.

80

(iii) Brazilian ICMS has a system of tax inclusive price. In Canada also tax is

included in the price. India should follow the pattern of tax inclusive prices so as to avoid

any opposition of VAT by the public at large. This would also help public to insist on

invoices to check evasion of tax.

(iv) Physical internal controls and checks need to be applied to different

activities that reveal inconsistency in the system and help the department to select the

traders for special audit.

(v) Drawing upon the system of EU and Brazil, India should have a

centralized mechanism to oversee operations of VAT. VAT Council of States that

comprises of finance ministers is one such regulatory body. Standing Council of

Commissioners should also look into the operational problems of VAT implementation.

(vi) For effective implementation of VAT, it’s very important that the duties of

various departments are separated from each other. For instance in Canada, the work

related to revenue receipts and follow up action against defaulters is performed by

separate departments. This is essential to ensure that VAT authorities operate efficiently.

(vii) For the implementation of VAT, a management information system (MIS)

should be set up to integrate the information obtained from all tax departments.

(viii) The most important component being risk management, the tax

department has to make use of the information collected through registration, submission

of VAT returns, claims for input credit, refunds and information flowing from income tax

returns etc. This information is used to classify traders into small, medium and large

categories. Risk management needs to be attempted for selecting traders from different

size groups in order to perform a thorough audit. In the Indian context, it is important to

evolve procedures to undertake risk management prior to the introduction of VAT.

(ix) Finally, the interaction between traders and tax department officials need

to be reduced. Setting up taxpayers’ services department that provides requisite

information, in a simplified format, to all traders can solve this problem.

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Table 5.1

List of VAT rates applied in the MSs

(As on 1st May 2003)

MSs Super Reduced Rate

Reduced Rate Standard Rate Parking Rate

Austria - 10 20 12Belgium - 6 21 12Denmark - - 25 -Finland - 8/17 22 -France 2.1 5.5 19.6 -Germany - 7 16 -Greece 4 8 18 -Ireland 4.3 13.5 21 13.5Italy 4 10 20 -Luxembourg 3 6 15 12Netherlands - 6 19 -Portugal - 5/12 19 -Spain 4 7 16 -Sweden - 6/12 25 -U. K. - 5 17.5 -

Source: European Commission (2003): ‘VAT rates applied in the Member MSs of the European Community’, Directorate-General, Taxation and Customs Union Tax Policy.N.B.: Exemptions with a refund of tax paid at preceding stages (zero rates) are not included above.

82

6.

Options for VAT in Indian Federation

Introduction

As discussed in the earlier chapter, VAT is a tax on all goods and services (except

exports and government services) on the value added at each stage from production to the

retail stage. To simplify the calculations of value added, each taxpayer is allowed to

deduct the tax paid on his inputs from the tax payable on his output.

VAT, in its comprehensive form, should replace all other domestic indirect taxes

and also be extended to cover imports. Imported goods and domestically produced goods

are treated at par and subjected to a single system of commodity taxation.

The introduction of VAT in a country requires a number of decisions regarding

the design of VAT such as (a) what type of VAT to adopt, viz., gross product, income

variant or consumption type (b) should it be origin based or destination based and (c) last

but not the least, in a federal country like India, which level or levels of government

should levy VAT?

Types of VAT

There are three different variants of VAT. Gross product VAT covers all value

added without giving any credit for the taxes paid on capital purchases or depreciation.

This provides the broadest base for tax. In the income type VAT, the tax is initially levied

on consumption as well as capital goods. Full tax credit on consumption inputs would be

given but for the capital inputs, refund of tax would be given over economic life of the

capital inputs, which is equal to the depreciation. Thus under income type tax, input

credit would be provided on non-capital inputs and depreciation. In consumption type

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VAT, tax credit is allowed for all business purchases including capital assets. The

economic base of this tax is, therefore, equivalent to total private consumption. This form

is neutral between different methods of production. Most of the countries have adopted

consumption type VAT.

Origin or Destination Based VAT

If VAT is levied where goods and services are produced, it is known as origin

based tax, whereas if it is levied on the basis of consumption, it is said to be destination

based. In fact, consumption type VAT should necessarily be destination based. Under the

destination based system, all value added in goods sold within the country, irrespective of

whether produced domestically or imported, are taxed. Exports are zero-rated and

interstate transactions are taxed on the basis of consumption.

VAT Options

India being a federal country, tax powers are distributed between the centre and

the states. If VAT is to replace all domestic commodity and service taxes, then some

constitutional amendment is required to authorize the concerned governments to levy one

comprehensive VAT.

Various Committees such as Jha Committee71, Chelliah Committee72, Study Team

of the National Institute of Public Finance and Policy73 and some other experts on the

subject have different views regarding the form of VAT. Broadly speaking, there are the

three forms of VAT in a given federal structure. These are:

Central VAT

As suggested by the Jha Committee and further reiterated by the Chelliah

Committee, one school of thought believes that in any country, especially in a federal

form of government, the most suitable and attractive proposition, for a unified system of

taxing domestic trade, is to have a national VAT imposed and administered by central

71 Government of India (1978), Report of the Indirect Taxes Enquiry Committee, Department of Revenue, New Delhi.

72 Government of India (1991-92), Report of the Tax Reforms Committee, Department of Revenue, New Delhi.

73 NIPFP, Reform of Domestic Trade Taxes in India: Issues and Options, National Institute of Public Finance and Policy, New Delhi.

84

government. This system would bring harmonization in taxation of interstate trade.

Federal countries like Argentina, Australia, Germany and Mexico have central VAT. In

such a system the tax is entirely regulated by the centre. It is completely harmonized

across the states. However, the revenue could either be collected by the centre and shared

with the states or alternatively collected by the states on behalf of centre, the revenue

share being decided by an independent body or organization. The central VAT would

have the advantage of having a uniform rate across the country, thereby avoiding all the

complexities that would arise if different states had different rates. Due to the existence

of a uniform rate system, taxpayer would need to be familiar with a single set of VAT

rules. The states would find it easier to share the information as central VAT ensures a

unified administration and limits the occurrence of tax evasion.

However, this could have significant consequences for the distribution of

revenues between the centre and states. The States would be deprived of their main

source of revenue and the right to decide the tax structure. In the Indian context, the sales

tax alone provides approximately 60 percent of the states own tax revenue and its share in

total commodity taxes is around 38 percent. The States lose the revenue that they get

from sales tax and other indirect taxes. This implies that they would have to depend upon

the Central government for approximately 70% of their current expenditure that is

financed through the sales tax and other transfers from the centre, in the form of tax

devolution. Thus they would oppose this transition. Under the present circumstances, a

constitutional amendment has to be passed which would allow the Centre to impose

VAT.

Central VAT would also have adverse effects on states initiatives to raise more

revenues and efficient utilization of funds. It will also be against the efficiency criteria,

which is the base for fiscal decentralization. It would seriously undermine fiscal

accountability, as the revenue raising and expenditure decisions will increasingly be

divergent. Also, the centre would have to depend upon states for administering central

VAT as given the existing tax machinery, the centre would not be able to handle the

increased number of dealers due to implementation of VAT. If revenue is collected by the

states but pooled and distributed by the central government, states would have little

85

incentive to effectively administer the tax unless the tax revenue is distributed on the

basis of revenue collection.

Dual VAT

It is possible that the earlier option, i.e., centrally run VAT would not be

acceptable to the states. Also, to implement this option a constitutional amendment has to

be made, especially in the seventh schedule. In view of lack of agreement amongst

different political parties on these issues, it may not be possible to make the necessary

amendments to the Constitution. Under these circumstances, the only option available is

to have some form of dual VAT, as recommended by the Chelliah Committee74 and many

other experts75. Such a VAT may have three variants:

The First option is to have a system of VAT where both the centre and state

governments have the power to levy tax with common base, where both governments

have the freedom to decide the base and the rate of the tax. That is, both the tiers of

government would levy tax on manufacture, wholesale and the retail level. This option is

used in Canada where the federal VAT (GST) is levied on all transactions and provides

concurrent jurisdiction to the states in taxation of goods and services. As discussed in

chapter 5, Canada provides a combination of various choices. First, state VAT, known as

QST, is levied by Quebec on almost a similar base as in GST. Second, three of the

provinces: Newfoundland, Nova Scotia and New Brunswick levy a Harmonized Sales

Tax (HST). Both QST and HST are value-added taxes. Finally, rest of the provinces, viz.,

British Columbia, Ontario, Manitoba, Prince Edward Island and Saskatchewan levy

Retail Sales Tax (RST) on all goods and a few services. It is important to note that some

of the provinces levy retail sales tax on price exclusive of GST, while others levy

inclusive of GST.76 Responsibility of collecting VAT at both the levels of government

also varies among states. For example, one state (Quebec) collects both the GST and the

74 Government of India (1991-92), Report of the Tax Reforms Committee, Department of Revenue, New Delhi.

75 Poddar, Satya (2001), “Zero-Rating of Inter-State Sales under a Sub-National VAT: A New Approach”, paper presented at the 94th Annual Conference of NTA, Baltimore, November 8-10.Also see, Poddar, S. N. (1990), Options for a VAT at the State Level” in Gills, M C Shoup and P.Sicat (Eds) Value Added Taxation in Developing Countries, Washington D.C. World Bank. P

76 Four of the provinces viz., Ontario, Manitoba, British Columbia, and Prince Edward Island levy provincial RST on the price exclusive of GST. One small province, Prince Edward Island levies RST on the GST inclusive base.

86

state VAT and gives the GST revenue to the federal government. Three states

(Newfoundland, Nova Scotia and New Brunswick) levy a Harmonized Sales Tax (HST),

which is a combination of GST and state VAT. The federal government, on the basis of

collection, gives the state revenue of 8% to them. The rest of the states collect their own

RST and retain the revenue.

The Tax Reforms Committee (TRC) headed by Dr. R. J. Chelliah recommends the

second option. The TRC has suggested that under present circumstances to have fiscal

reforms, the only possible solution is to have an admixture of VAT (then called Modvat

and now known as CenVAT) at the central level extended up to the wholesale level

(extending the existing base of union excise duties from the manufacture to the

wholesale) with the condition that the wholesale level would be administered by the

states and the revenue so generated would also be retained by the states. At the state

level, existing sales tax is converted into a system of VAT being levied on all

transactions. The TRC had proposed that for this purpose, wholesaler be defined to

include dealers in excisable goods with an annual turnover in excess of say Rs. 50 lakh or

1 crore. These dealers would pay tax on their value added. Notwithstanding the merits of

the proposal, its implementation would also require constitutional amendment. It would

also involve identification of dealers dispatching goods from where the goods originate

and of those dealers receiving goods where these are consumed. Lack of coordination

among states, as well as between centre and states, would also cause many problems in

implementing this option.

The Third Option relates to having independent dual VAT system. That is, central

government continues to have the existing union excise duty but converts this into a

central VAT up to the manufacturing level and the existing sales tax is converted into a

state VAT, both operating independently with or without harmonization and

coordination.

State VAT

Under the state VAT system, central government has to retreat from the domestic

trade tax arena. Each state has to convert its present sales tax into VAT, which would be

87

levied and administered by the states. This system would promote fiscal responsibility

and discipline on the part of states.

However, this system will reduce the revenue of the central government. The

revenue loss due to changed system can be taken care of in two ways:

-By permitting centre to levy special excise duty, which is non-rebatable and non-

sharable, on some select sumptuary items which yield equal amount of revenue as

retained by the centre under the existing situation after devolution and

-By bringing down the level of transfers from the central funds to states

The states would be empowered to levy a full-fledged state VAT on all

commodities and services in the country. The taxes levied at the stage of manufacture

(i.e. CenVAT at present) would be given set-off at the time of levy of state VAT (i.e. at

the time of sale). Thus, all late transactions would cover additional value added in the

process till it reaches the consumer. However, for the reasons of administrative

efficiency, the centre should continue to levy VAT at the manufacturing stage. The

revenue so collected should be distributed to the states on the basis of collection. This

would enable states to allow set-off from the VAT on sales for successive transactions.

Inter-state transactions would be treated on destination principle. Each state

would tax the interstate sales but the importing state would give set-off for the tax already

paid in the exporting state. Alternatively, the exporting state would tax CST at the rate of

zero percent and provide set-off for the taxes already paid by the dealers. In any case, the

documentation formalities of the CST would continue.

Under this system different degrees of harmonization can be applied. Either there

can be complete harmonization among the states regarding the tax base, rate structure and

administrative procedures or states can choose to have different tax bases depending upon

the level of development, type of activities, and size of administrative facilities available.

If states have harmony in rate structure and administration, it would help checking

evasion of tax through cross checking between centre and states, and also between states.

As stated in an earlier chapter, Brazil has a state VAT. Even the VAT in the

European Union could be considered an example of state VAT. However, the

88

implementation of state VAT in India could confront some problems. First, a pure state

VAT would involve rethinking about the fiscal relationship between the centre and the

states. There is one school of thought suggesting that such a system will have adverse

effect on the revenue position of the centre. It is believed that there would be no

possibility that the centre would be able to increase its non-sharable portion of revenue,

unless there is a major shift in the distribution of powers and functions between the centre

and the states.

Also, it is believed that shifting of union excise duty from the centre to the states

will impair centre’s capacity to give grants to the states. These have a perceptible

equalizing effect on the distribution of resources.

As there are significant differences in the levels of development of the states,

without the interference of the central government, it would be difficult to correct it by

inducing flow of trade and industry in the backward states. On the contrary, it may

accentuate the disparity by aggravating the concentration of revenue in relatively

advanced states.

Another school of thought propagates state VAT as a long-term policy measure,

which is argued on the line of decentralization of powers, efficiency criteria and fiscal

responsibility77. It is, however, important to note that the state VAT system would require

a mechanism for taxing or regulating interstate trade, which at present requires

involvement of the central government due to the interstate tax being origin based. If the

interstate tax is changed to destination based consumption tax, then the interstate

disparity can be resolved to some extent as the states’ revenue earning potentiality would

improve.

Interstate trade tax may have four options.78 First option provides exports to VAT

registered dealers to be zero-rated. Imports would be taxed and rebated at a rate chosen

by the importing states (this mechanism is used in the EU). Second, exports to VAT

registered dealers would be taxed by exporting states at the same rate as exports to non-

77 Burgess, Robin, Stephen Howes and Nicholas Stern (1995), "The Reform of Indirect Taxes in India" in Purohit, Mahesh C and Vishnu Kanta Purohit, Commodity Taxes in India: Directions for Reform, Gayatri Publications, Delhi; and Purohit, Mahesh C (1993), 'Adoption of Value Added Tax in India: Problems and Prospects', Economic and Political Weekly, 28: 393-404, March 6.

78 Burgess, Robin, Stephen Howes and Nicholas Stern (1995), "The Reform of Indirect Taxes in India" op. cit.

89

registered dealers. Inter-state imports would be tax free, but the tax paid by the exporter

would be rebatable to the importer from its own government if the importer is a VAT

registered dealer. Such a system is followed in Brazil. Third, option is to have a

clearinghouse mechanism added to the second option so that rebate becomes the fiscal

responsibility of exporting states. Fourth option is to zero-rate the exports. That is, no tax

is levied on the transaction entering into interstate trade and any tax that has already gone

into it in previous transactions, in the form of raw material or intermediate stage, has to

be refunded at the time of export. The state VAT thus provides a harmonized system of

taxation of domestic trade, where states can opt for uniform tax rates and tax procedures.

Since states have already adopted a system of uniform floor rates under sales tax, it

would be possible for them to do the same under VAT as well.

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7

Proposed Harmonized VAT in India

Various options discussed in the foregoing chapter suggest that in the short run

it would be useful to follow a system of dual VAT. In the long run, however, it would

be beneficial to have a system of comprehensive state VAT.

Dual VAT in the Short Run

In view of the fact that the present policy of the government is to follow a

system of dual VAT —Central VAT to be levied by the Central Government and

State-VAT by the state governments, this chapter analyses the revenue implications of

adopting dual VAT in India. This is basically a short-term measure for VAT

implementation. The following section attempts to analyze how long-term reforms

could help in harmonizing commodity taxes.

Central VAT

As a first step in the introduction of dual VAT, a central VAT was put in place

of the then existing union excise duty (UED). In this context, a beginning was made by

the central government, as far back as in 1986, when it introduced the principles of

VAT in its UED, through modified value added tax (Modvat).79 This provided set-off

in UED for taxes on inputs, as given in Chapter 3. It was initially for a select number

of commodities but over time, the base of Modvat was extended to more commodities.

Finally, it covered almost all commodities except high-speed diesel, motor spirit

(gasoline) and matches. Modvat has now been replaced by a Central VAT (known as

CenVAT).

79 Modvat was recommended by the Jha Committee. See, Government of India (1978), Report of the Indirect Taxation Enquiry Committee, Ministry of Finance, New Delhi.

91

Despite all efforts of the central government in introducing a CenVAT, at the

state level, the states continue to levy a first-point sales tax, as explained in chapter 4.

Haryana is the only state that has introduced State-VAT to replace its sales tax with

effect from April 2003.

To follow the model of dual VAT, it is important that sales tax, a state levy

characterised by a large number of weaknesses, is also converted into a system of state

VAT. Sales tax tends to distort the pattern of production and trade thereby adding to

transaction costs and inefficiency.

Earlier Efforts to Introduce State-VAT

Efforts have been made in the past several years to replace sales tax with VAT.

The Committees of States’ Finance Ministers (1995 and 1998, respectively) and the

Committee of Chief Ministers (1999) have put forth recommendations to replace sales

tax with VAT. The Conference of Chief Ministers and Finance Ministers ratified this

in November 1999 and resolved to introduce some major reforms.

The first reform relates to the adoption of a four-rate structure (i.e., zero, 4, 8

and 12%) in the existing sales tax. In addition, there are two special rates of 1% and

20% for a few specific items. The recommended rates are floor rates – the States have

the freedom to adopt a higher rate on any of the commodities from the list, but they

should not fix tax rates below these rates. This helps checking rate war and prevents

diversion of trade. However, when the States started implementing the four-rate

categories many of them found it difficult to follow these rates. Either the

classification had some ambiguity or there were administrative difficulties in

implementing the floor rates. Hence, the Committee of Finance Ministers made a few

changes in the items falling under the exemption list and in other categories. The

Committee had pointed out that problems could arise. The Report of the Finance

Ministers Committee (1995) emphasized that "fine tuning of this classification would

have to be done by a special group". The Empowered Committee has now come up

with three rate categories of zero percent, 4% and a revenue neutral rate (RNR) of

12.5% (replacing the initial four rates structure) for VAT implementation in all the

States.

The second reform pertains to the abolition of sales tax-related incentives. In

the past, all the States granted such incentives to new industries. These were given in

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the form of exemption from sales tax on the purchase of inputs as well as on the sale

of finished goods. Incentives were also available in the form of sales tax loans and/or

tax deferral. Various studies and committee reports80 have argued against such

incentives. In terms of loss of revenue, all the States put together forgo about 25% of

the sales tax base due to these incentives. In addition, the incentives promote tax

competition (war) or harmful tax practices. In view of this, all the new units that are

likely to come up will now not be given any sales tax-related incentive. The States will

find it convenient to adopt VAT, once these reforms are implemented.

TFC Devolution and Loss of Revenue due to VAT

While considerable efforts have already been made for the introduction of

VAT, the States are apprehensive of losing revenue if sales tax is converted into VAT.

The possible loss of revenue and various political factors are the reasons why the

introduction of VAT has been postponed. It is important that to enable the states to

implement state-VAT, the Twelfth Finance Commission (TFC) takes this into account

while making its recommendations.

Estimating Revenue Implications of Dual VAT

To estimate the revenue implications of introducing State-VAT under the

umbrella of dual VAT, it is vital to note that the existing sales tax yields revenue from

different components of sales tax, viz., state sales tax (popularly known as GST) levied

on intrastate transactions, motor spirit taxation (MST) levied on petroleum products--

sometimes levied under a separate enactment, purchase tax on sugarcane, additional

sales tax, surcharge on sales tax and central sales tax (CST) levied on interstate

transactions. The revenue implications on components concerning intrastate

transactions and those related to interstate transactions would be different.

Revenue Implications of Introduction of State-VAT

Revenue implications could be estimated through the following three

approaches:

(a) Consumption approach, (b) Turnover approach and (c) Revenue approach.

80 Report of the Finance Ministers Committee to Chart a Time Path for the Introduction of VAT (August 1998) and the Report of the Committee of Finance Secretaries for Identification of Backward Areas (November 1999).

93

Consumption approach estimates the exact tax yield in any state because the

tax basically falls only on final consumption. Unfortunately, the data on consumption

available from the NSS are not suited to meet this requirement because the break up of

consumption is not available according to rate categories. The methodology used for

the collection of data is also not very sound. Hence, use of these data for revenue

estimates may not yield reliable results. In addition, using these data would give

inflated estimates of the tax revenue of states, given the volume of existing tax evasion

in the system.

Tax turnover method is more appropriate. This method can estimate the exact

revenue loss in any state, provided the state has the requisite management information

system to collect revenue and turnover statistics according to commodity

classification. Efforts in this direction have already been made to estimate revenue

implications for some select states81. However, in view of the time constraint in

collecting data from each state, this method could not be used in this study.

Revenue approach is based on the published data available from the RBI82 and

data that were made available by some of the states. In this context, all the states were

requested to supply data specifically related to a few components of revenue.

Wherever the required data were not made available, estimated ratios were applied to

the revenue base of different states. In this study, revenue approach is the method

adopted and the estimation is based on the following formula:

EVR=[{ST- (CST+MST+ICgst+ICcst)}+{(ABvat+SRvat+RRvat+ADLSvat)+MST}]

Where

EVR = Estimated VAT revenue,

ST = total sales tax revenue

CST= central sales tax,

MST= revenue from petroleum including petrol and diesel,

ICgst= input credit due to manufacturers,

ICcst= input credit due to exports out of state,

ABvat= additional base due to VAT,

81 Purohit, Mahesh C, Gautam Naresh and Ajay Halen (2003), Revenue Implications and Economic Impact of Introduction of VAT in Assam, National Institute of Public Finance and Policy, New Delhi.

82 Reserve Bank of India, Finances of State Governments, (various issues), RBI, Bombay.

94

SRvat=additional base due to service taxation given to the

states,

RRvat=additional base due to rate rationalization,

ADLSvat=additional base due to taxation of additional excise

duty items.

The above steps for using this approach are also summed up in Box 7.1.

Following the revenue approach, this study presents estimates of loss of

revenue for the year 2001-02 (RE), using revenue data in the state budgets (Column 1,

Tables 7.1 through 7.3).

To find out revenue implications of VAT implementation certain adjustments

have to be made, as the new system will bring basic changes in the tax system.

Adjustments required are related to CST treatment, MST to be deducted from VAT,

input credit treatment for intrastate and interstate transactions, additional tax base due

to VAT and services to be included in the tax base. Each one of these are analysed in

the following segment.

Harmonizing Interstate Sales Tax

Since CST is levied by the exporting state on the basis of ‘origin’, when goods

are sold to another state83, the revenue collected from the tax is at present being

retained by the exporting state and is a substantial amount in most of the states. As

shown in column 2, Table 7.1, it varies from 10 to 38 percent of sales tax revenue.

While converting existing sales tax into VAT, which is truly a destination based tax,

the incidence of CST has to be reduced to zero84. When CST becomes zero, the

revenue so collected by the exporting states then vanishes. Hence, the net tax revenue

of the exporting states would be less, as shown in column 3 of Table 7.1. The net tax

revenue .

83 The rate of tax on such transactions is 4% when the goods are sold to a registered dealer and 10% when sold to a non-registered trader or to a consumer. The higher rate of tax is charged to the non-registered trader to prevent him from entering into inter-state trade for any competitive advantage

84 There could be many ways to handle the issue of CST. See for details, Purohit, Mahesh C. (2001) Sales Tax and Value Added Tax in India, Gayatri Publications, Delhi-110052.

95

Exhibit 7.1:Steps in Estimating Revenue Implications for Introduction of VAT

Total State Sales Tax RevenueMinus

Central Sales Tax Equals

Sales Tax Revenue from Intrastate Transactions (GST)Minus

Revenue from Petrol and Diesel Minus

Input tax Credit to ManufacturersMinus

Input Tax Credit due to Insterstate TransactionsEquals

VAT Base of Existing GSTPlus

Revenue gain from capturing value added by the wholesalers and retailersPlus

Base broadening due to Taxation of ServicesEquals

VAT Revenue with Existing RatesPlus

Base broadening due to Rate rationalizationPlus

Broadening of tax base due to better administrationPlus

VAT Revenue on sugar, textiles and tobaccoPlus

Revenue from Petrol and DieselEquals

Tax revenue Under VAT

96

is obtained by deducting CST revenue from the total sales tax revenue. The states

would, therefore, have to raise additional resources or the TFC will have to

compensate the states for this loss.

Exclusion of Revenue from Petrol and Diesel

As suggested by the Empowered Committee of States Finance Ministers, the

design of VAT that is being adopted by the states is such that revenue from diesel and

petrol (referred to as revenue from MST) would not be covered under VAT. The

revenue from these items would be collected through first-point sales tax as is done at

present and no set-off on tax paid on these inputs would be provided, even when sales

tax is converted into VAT. Hence for estimating revenue implications of VAT,

revenue from these items has been excluded, as shown in column 4 of Table 7.1. 85 The

GST revenue of the states, net of CST as well as MST, is shown in column 5 in Tables

7.1 through 7.3. It indicates revenue realized by the states if VAT is implemented.

Input Credit to Manufacturers

The existing sales tax revenue collected from general sales tax (GST) of the

state is inclusive of sales tax on inputs including raw materials, intermediary goods

and capital goods used in the process of manufacture. Under VAT regime, however,

tax is effectively levied only on final goods. All taxes levied on inputs will get set off.

Hence, the value of inputs embedded in taxable intrastate turnover has to be estimated

and subtracted to derive net VAT yield.

This is estimated by employing input-output model where the inter-industry

demand (IID) is given as:

Where

aij = the input-output coefficient indicating the input of ith commodity per unit of output of the jth product; and

Xj = the total output of the jth product.

In matrix form it can be expressed as

85 The revenue estimates for this component (i.e. revenue from petrol and diesel) is primarily based on the data supplied by the states. In some cases where the estimates were not available, the average ratio of revenue from these products to the total GST in the state, which is 12 percent of the GST, has been applied.

97

i.e. the coefficient matrix A is post multiplied by the vector X to obtain the IID

for the State.

To estimate set-off for inputs for each of the states, it would be most

appropriate to use states’ input-output table. However, such tables for each of the

States, prepared on any uniform method, are not available86. Hence, we have used the

all-India input-output ratio for taxable commodities as per the latest input-output

matrix available for 1993-94. On this basis we have arrived at input-output ratio of 50

percent. Although, as shown in Table 7.4, many states have announced concessional

tax rates on inputs, in this study the rate of input tax is assumed to be 4 percent in all

the states. Accordingly, 20 percent (4% applied to the input-output proportion of 50%)

of sales tax revenue is treated as input credit, as is shown in column 6 of Tables 7.1

through 7.3. To obtain tax revenue net of input tax, this component has been deducted

from the total sales tax revenue net of CST as well as MST (column 5 in Table 7.1

through 7.3).

Refund of Input credit due to Interstate Transactions

Another effect of introducing destination based VAT would be to give set-off

for the taxes already levied and collected by the states, on all those transactions that

enter into interstate trade. That is, in addition to not collecting any revenue from CST,

the exporting states would have to give set-off for the taxes already collected in earlier

transactions on inputs, raw materials, intermediate goods, and on finished goods prior

to their export out of the state. This would further reduce the states' revenue from

interstate transaction, as shown in column 7 of Tables 7.1 through 7.3. Deducting this,

as well as the input credit due to manufacturer, shown in column 6 from the GST net

of CST and MST (column 5), we get the VAT base of existing GST (column 8, Tables

7.1 through 7.3).

Additional Base Due to VAT

Adoption of VAT would mean that the base of the tax would include not only

the value at the manufacturing stage, as under the first-point tax, but also the entire 86 The only input-output matrix available for all the states is for 1965. See Venketaramaiah, P. et

el (1980), Regional Input Output Matrices- India 1965, Gokhale Institute of Politics and Economics, Pune-4.

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value added to commodities, right down to the retail level. Hence, VAT would yield in

the medium term much higher revenue than the first-point tax. Further, the

introduction of VAT would also bring down under valuation at the manufacturing

stage considerably. Although the last-point would be defined in terms of exemption

threshold, it would certainly increase the base of the tax. To be conservative, one could

take estimates for value addition by wholesalers and retailers, on the basis of data

available from the Directory of Trade Establishments87 or of trade margins from

Sarvekshan88 (Table 7.5). Both these sources indicate considerable increase in the

base.

Taxation provisions of “declared goods” under the CST Act has already been

amended to allow the states to levy tax on additional points, as compared to the earlier

system of allowing the states to levy tax only at one point. As the list of declared

goods is pretty large, there would be substantial increase in the tax base, given the

states tax value addition of these goods at various levels of transactions.

It is also likely that the states would be able to raise additional revenue due to

better administration brought about by the self-policing mechanism of VAT, as

compared to the revenue raised through sales tax.

All states have already abolished the system of granting sales tax related

incentives, as decided by the Conference of Chief Ministers and Finance Ministers in

November 1999. This would also lead to a substantial increase in revenue to most of

the states.

As per estimates, all these measures mentioned above would lead to an

increase in VAT revenue of the states, at least by 5 percent of the base, as shown in

column 9 of Table 7.1. Results have also been simulated for expansion in the base by

assuming this proportion as 10 percent. The calculated revenue implications are shown

in Table 7.2.

Taxation of Services

The states would also be empowered to levy tax on services, as discussed at the

Conference of Chief Ministers held in June 2000 and July 2001. Accordingly, the

87 Government of India (1989), Directory of Trade Establishment Survey- Report on Trade Sector, Central Statistical Organisation, New Delhi.

88 Government of India, Sarvekshana, Central Statistical Organization, April-June 2000.

99

central government has already appointed a Committee89 to study the levy of VAT on

services, its feasibility and modalities taking into consideration the views expressed by

the other committees on the subject. Simultaneously, a Working Group was set up to

prepare a Draft Service Tax Bill. The draft has been prepared and is presently being

vetted by the Law Ministry. In the meanwhile the central government has already

amended the Constitution to shift the power to levy tax services from the Residuary

List to the Union List. When the Draft Service Tax Bill is enacted, the states would

also be given concurrent or exclusive taxing powers.

Notwithstanding these developments, in view of the fact that already 58

services are being taxed by the centre (as shown in chapter 3), it is not clear how many

services would be given to the states. However, it is estimated that the states would be

able to raise at least 10 percent of their VAT revenue if empowered to tax services.

Revenue implications of taxation of services are shown in column 10 of Table 7.1. The

effect of simulation on revenue by changing this component to 15 percent and 20

percent has also been estimated and shown in column 10 of Tables 7.2 and 7.3,

respectively.

Effect of Rationalizing of VAT Rates

The introduction of uniform floor rates under sales tax in 1999-2000 led to a

substantial increase in revenue from sales tax in most of the states. When VAT is

introduced, the states will have to convert their existing four-rate sales tax structure to

a three-rate structure. Such rate rationalization would have positive revenue

implications in the States. This is primarily because half of the goods falling in the

category of 8 percent would then be shifted to the 12.5 percent category. Also, in most

revenue yielding items of 12 percent, there is an increase in the tax rate by 0.5 percent,

which means an increase of more than 4 percent. Also, the new tax regime would

further reduce exemptions90. All these measures would increase tax buoyancy and

hence revenue due to VAT.

Revenue would also increase due to changes in the existing provision of

taxation of sugar, textiles and tobacco—the items presently under additional excise

89 Vide Resolution No. 34/42/200-ST dated 30th July 2001.90 With the introduction of VAT, exemption from tax of a particular commodity would only

mean exemption from tax of a very small part of value added at that particular stage. Moreover, every exemption creates a break in the chain of VAT credit and, therefore, puts the concerned dealers at a disadvantage (as those who purchase the exempted commodity from them would not be able to claim input tax in their tax return).

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duty in lieu of sales tax (AEDILST). As per the agreement made in 1956 between the

union and the state governments, states were debarred from levying sales tax on these

items. Instead AEDILST was levied by the centre on these goods in 1957. As agreed

upon by the central government, the states are now allowed to levy tax on these goods

if VAT is introduced by the states. This is considered as a measure of augmenting

resources through the levy of 4% tax on sugar, tobacco and textiles, which are items of

mass consumption. The states would now levy state VAT on these goods in addition to

the AEDILST, which has now become part and parcel of the overall sharable pool.

The measures of rationalization in rates mentioned above would have

considerable increase in VAT revenue of the states. It is estimated that this will lead to

an increase of 10 percent of the states sales tax revenue. This is shown in Column 12

of Table 7.1. Simulation results by changing these to 15% and 20% are given in Tables

7.2 and 7.3, respectively.

Net effect on States’ Revenue

Having obtained the estimated revenue from the GST exclusive of the yield

drawn from petrol and diesel, the MST revenue is now added to the estimated revenue,

as shown in column 4 of Table 7.1. The changes in the state revenue due to the

introduction of VAT would be the difference between estimated VAT revenue and the

existing total sales tax revenue. Assuming different proportions for these three

variables, the effect on VAT revenue is shown in Tables 7.2 and 7.3. Here it is

important to note that in these calculations, we have assumed that the centre would

transfer services for additional revenue at least to the extent of 10% of the GST of the

state. Estimates have also been made assuming this proportion to be 15% as well as

20%. As mentioned earlier, the revenue estimates given in the tables assume that

services would be transferred to the states. If this does not come about, the adjustment

in the net revenue would have to be done once again.

Comprehensive State VAT-- The Long Term Goal

While the above section has presented revenue implications of adopting a dual

VAT, it is proposed that in the long run it is important to take care of some of the

issues that would be imperative from the point of efficiency and equity in a federal

structure. This section, therefore, analyses long term restructuring of commodity taxes

in India.

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Vertical Imbalance in Taxing Powers

One of the important aspects in reforming commodity taxes in India relates to

the vertical imbalance in assigning taxation powers under the Indian Constitution.

This is evident from the given distribution of powers between the centre and the

states, whereby most of the buoyant sources of tax revenue have been assigned to the

central government91 and the expenditures have been assigned to the states. This

imbalance in the assignment of powers is based inter alia on the belief that:

(a) Broad based taxes having all-India coverage should be given to the

central government to have buoyancy and uniformity in the tax system.

This has resulted in a situation whereby the states find themselves

starved of revenues, causing a vertical fiscal imbalance.

(b) The central government needs “excess” revenue to carry out its

allocative and distributive roles (via intergovernmental transfers) to

influence state actions and achieve both “incentive compatibility” and

horizontal equity92.

Two Constitutional (Amendment) Acts of 1992 have further accentuated the

imbalance with the creation of a third tier of government and introducing additional

allocation of function for states93.

To remove this imbalance, the Constitution provided for a mechanism of

revenue sharing, revenue-assignment, revenue distribution and grants-in-aid for the

states. All the Finance Commissions have contributed to this end through their

recommendations. However, in the long run it is important that a fresh review of the

provisions, related to assignment of taxation powers between the centre and the states,

be made to rectify this fiscal imbalance.

91 Accordingly, the centre collects approximately 65% of the tax revenue and the states bring together only 35% of the total tax collections.

92 Bird, Richard M. (1993), "Aspects of Federal Finance: A Comparative Perspective" in A Reforma Fiscal No Brasil, proceedings of an International Symposium on Fiscal Reform, Sao Paulo, pp.77- 101.

93 The Constitutional Amendment Act of 1992 lays down the third tier of government viz., the local government. It inserts a new schedule – the Twelfth Schedule -- to the Constitution that assigns many functions and responsibilities to the local bodies. In all, it designates 18 functions to the urban bodies and 27 to the rural bodies. Thus, it provides for increased functional responsibilities at the local level due to increase in net additional liabilities for enlarging their role.

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In attempting this, it is vital to keep in mind the importance of a rational tax

design. This is imperative in view of the adoption of the structural adjustment

programme and the process of globalization of the economy. Also, the free trade

agreement with SAARC countries makes it almost a necessity to review the system of

commodity taxes so that there exists a neutral and efficient commodity tax structure in

the country.

As explained in chapters 3 and 4, the Union List empowers the central

government to levy UED and the State List provides the authority to the states to levy

sales tax. The framers of the Constitution had conceived the UED as a tax levied by

the central government on the manufacturers of a few commodities. Initially, it

remained so and the revenue contribution from this was small. Over time, in their zeal

to mop up larger revenues to fulfill the targets of "additional resource mobilisation",

both the central and the state governments exploited these bases extensively.

Consequently, UED is now levied on all the manufactured items, causing high

incidence of tax.94 Also, UED and sales tax are levied primarily on the same base,95

causing extensive double taxation at the manufacturing level by the two tiers of

government. The end result has been considerable cascading and pyramiding,

bringing about distortions in the economy. This has given rise to several problems that

have been analysed in chapters 3 and 4.

Introduction of dual VAT takes care of some of these weaknesses of both

these commodity taxes (UED and sales tax). The dual VAT would remove cascading

within the manufacturing sector as a result of CenVAT and the state-VAT would do

the same thing at the state level. The CenVAT levied at the manufacturing level

would cascade when the sales tax is levied on CenVAT inclusive price. The same

cascading effect will occur from state VAT on inputs, when CenVAT is levied on

sales tax (or state VAT) inclusive price. Hence to avoid such cascading and to reduce

the transaction cost for the manufacturers, it is important that the commodity taxes are

94 . Some special UEDs are also levied with different nomenclature such as additional excises, cess on specified commodities, and additional duty of excise on textiles In addition to UED's levied by the centre for its own purposes, it also levies additional excise duty in lieu of sales tax on tobacco, textiles and sugar under a rental arrangement between the centre and the states. See for details Purohit, Mahesh C. (1990), Exemptions Under Additional Excise Duties in Lieu of Sales Tax: An Empirical Analysis of Loss of Revenue to the States, National Institute of Public Finance and Policy, New Delhi.

95 The sales tax is levied on UED inclusive base. In addition, there might be some addition in value due to transaction cost. Notwithstanding these variations, the base remains more or less the same.

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reassigned in such a way so that the powers to levy both these taxes are assigned to

the states. This means the centre withdraws from the field of commodity taxes for

revenue purposes and the states levy a comprehensive state VAT covering all goods

and services. In addition to eliminating deficiencies of the commodity taxes, this

would also reduce vertical fiscal imbalance.

Vertical Tax Externality

Another important problem under dual VAT relates to vertical tax externality

in taxing the same base, by the two tiers of government. This happens when both the

levels of government, Centre and States, levy tax on the same base. Then the tax

policy decisions of one level of government affect the tax base of the other. Such an

impact, known as vertical externality, is important in a federal structure. For instance,

when the central government increases the tax rate levied on a commodity, the tax

liability of taxpayers rises. In turn, the consumer reduces the demand for the

commodity which reduces the total tax amount payable to both the levels of

government. This leads to a reduction in the tax base, which adversely affects tax

revenue of the states as well as the central government.

To illustrate, let us assume that there is no tax competition among states. We

also assume the states are identical. Another assumption made is that the Central

government recognizes the adverse impact of increasing its tax rate on state revenues

but the state governments do not. If both the centre and the states now levy tax on the

same base, this could give rise to two situations depending on whether the state is

leviathan or benevolent.

If state government is leviathan and seeks to maximize its tax revenue, then

the response of the state government to an arbitrary federal tax would be to have a

revenue maximizing tax rate. Now suppose that the Central government raises the tax

rate on a particular commodity. This raises the consumer price (which is the

summation of producer price and tax amount payable). Consequently, the demand for

the commodity declines, adversely affecting the tax base of the state government. In

case the states are leviathan, they would try to maximize their total tax revenue

collections by raising the tax rate.

If the states were benevolent, they would levy the tax with the aim of

maximizing consumer’s welfare. It encompasses the welfare loss that the consumer

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suffers due to the increased consumer price that reduces demand. This would lead to a

reduction in their tax revenue, thereby leading to less provision for public goods

provided by them. Less production of state public goods would result in an increase in

their marginal valuation and offer the attractive option of raising the tax rate so as to

provide more public goods. Thus the state governments would raise the tax rate.

Hence, whether the states are leviathan or benevolent, an increase in tax rate

by the central government would motivate them to raise the state tax rate also. The

total tax burden on consumer would go up and at equilibrium, the quantity of taxed

goods (private goods) consumed would be too less.

The next issue that needs to be addressed is that whether or not the tax rate

levied by State governments would be too high. Based on the assumption that the

state governments do not recognize the loss suffered by the central government due to

an increase in state tax rate, one can presume that the state governments would set a

tax rate that is too high. This is because the marginal cost of raising public funds

(MCPF) calculated by the state governments would be less than the social marginal

cost of raising public funds. Social marginal cost is obtained by adding up the loss

incurred by the central and the state governments due to reduction in (common) tax

base, while the marginal cost calculated by state governments covers only the loss

incurred by the state governments themselves. The states would determine the

equilibrium tax rate by equating the marginal value to the consumer of an additional

rupee spent on state public goods with marginal cost of public funds and thus would

set an excessively high tax rate, given the increase in the tax rate of the central

government.

Here it is important to take note of the exceptions to this phenomenon.

1) When there exists tax competition among the states, then two types of

forces viz., horizontal fiscal externality (among the states) and vertical fiscal

externality (between centre and states) would operate. If horizontal fiscal externality

is dominant, then state tax rates would be too low at equilibrium. With an increase in

central tax rate, when one of the states raises the state tax rate, the tax rates prevailing

in all other states would be less as compared to that particular state. Consequently, the

tax base would flee from the state with the high tax rates to the states with relatively

low tax rates. The state that raised the tax rate would now have to reduce it.

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Conversely, if vertical fiscal externality were dominant, equilibrium state tax rates

would be too high.

2) If state governments recognize the adverse impact of raising state tax rate

on Central tax base, then they would not levy very high tax rates.

3) The Central government could reduce the loss incurred by state

governments, due to an increase in Central tax rate, by providing grants to them. In

this scenario, the State governments would not levy a State tax that is too high.

4) If the spending of the two levels of the governments is such that the

increase in tax rate by one level results in an increase in the tax base of the other level

of government, then vertical externality can be beneficial. Take the case where state

governments levy tax on cigarettes and spend the amount on highways, while central

government imposes tax on gasoline. Then an increase in tax on cigarettes, which is

used to improve or extend highways, would lead to an increase in demand for

gasoline. Thus the Central government gets a bigger tax base and a higher tax levy.

Thus, apart for the exceptional case of vertical externality being beneficial, in

most cases there is a reduction in tax base for the states when tax is levied on the same

base by the central government96. In the current case of CenVAT being levied by the

central government at the rate of 16%, can the states think in terms of raising their

state-VAT rate beyond 12.5%?

Proposed Comprehensive State VAT

In view of the vertical imbalance in distribution of tax powers and vertical

externality in taxing the same base, it is proposed that instead of having a dual VAT,

India should follow a comprehensive state VAT,97 wherein the centre withdraws from

the field of taxes on commodities from the revenue point of view, but for

administrative reasons it continues to levy cenVAT and the states levy state-VAT.

The Finance Commissions would recommend distribution of cenVAT revenue.

96 To understand as to why in most of the cases the state governments will also raise the tax rate when the central government increases the tax rate if both are exploiting the same base simultaneously, see Keen, Michael (1998): ‘Vertical Tax Externalities in the Theory of Fiscal Federalism’, IMF Staff Papers, Vol. 45, No. 3, September and Annexure A7.1.

97 Such a proposal is given in many studies. See for example, Purohit, Mahesh C. (1993), "Adoption of State VAT in India: Problems and Prospects", Economic and Political Weekly, March 6, pp.393-404; Burgess, Howes and Stern in Purohit, Mahesh C. and Vishnu Kanta Purohit (1995), Commodity Taxes in India, Gayatri Publications, Delhi.

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Changes in Tax System and Distribution of Revenue

In the proposed scheme of a comprehensive state VAT the following features

are an integral part of the system.

a) The scheme of CenVAT would be operative more or less the same way as

is presently being done. However, the rate of CenVAT has to be

compatible with the rate of state-VAT. This should be done in such a way

that the combined incidence of both the taxes will be the same for all the

dealers. For example, when the CenVAT rate at present is 16 per cent, the

rate of state-VAT should be higher than the CenVAT so that the states

could provide set-off for the CenVAT.

b) To have harmony in the commodity taxes in the country it would be useful

to adopt a central mechanism on the pattern of CONFAZ in Brazil or the

Parliament of the European Union, with representatives from the centre

and the states as its members. A VAT council of Centre and States could

be the operational body to implement the rationalisation of rates.

c) CenVAT would continue to be levied on the manufacture price at the time

of clearance and collected by the central government. States would levy

state-VAT on the sale price of the commodity.

d) To mitigate cascading of cenVAT under the State-VAT and of the State-

VAT under the cenVAT, the system of set-offs should be operative for

both the taxes. That is, the cenVAT levied on manufacturing level by the

Central government would be provided set-off by the states under the state-

VAT. The states would also be provided set-off for the CenVAT paid by

the manufacturers. This can be expressed as follows: assume that the

collection of CenVAT at the Central level from different states is X1, X2, X3,

X4, ....Xn where the total tax collection equals

Similarly, sales tax collection for n states is S1, S2, S3, S4,……… Sn. When

a state has to give set-off for the tax under Central VAT, the state’s

collection from sales tax revenue will be reduced. This is indicated as S1’,

S2’, S3’, S4’,....Sn’ where S1’<S1, etc.

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Let Fi = Si - Si’ (where i varies from 1 to n)

Denote the fall in sales tax revenue due to set-off in various states.98

e) Since the states would give set-off for the cenVAT paid by the manufacturers, it

is important that the tax collected by the centre is transferred to the states.

Therefore, the Finance commission should distribute this revenue to the states

on the basis of collection; it should not form part of the divisible pool for

transferring resources to the various states.

f) When the goods are exported out of state, the tax so collected by the producing

state would be zero-rated by the states and hence refunded to the producer or to

the next dealer in the chain. This would make the comprehensive VAT a truly

consumption based tax.

g) The devolution of the CenVAT on the basis of the recommendation of the

Finance Commission would be made in such a way that the principle of

collection is followed only for those states that introduce a comprehensive state-

VAT. For the states continuing to have cascade type sales tax, the Finance

Commission would announce different principles of devolution.

Levy of Sumptuary Excises by the Centre

In assigning the power to levy state-VAT to the states and asking the centre to

withdraw from the field of commodity taxes, the centre would be left with resources

less than that required to carry out its allocative and distributive roles (through inter-

governmental transfers) to influence state activities. This has to be done to achieve

“incentive compatibility” and to achieve horizontal equity99. In a federal set up this is

required to provide justice to the poor states.

To take care of the allocative and distributive functions of the centre, it is

proposed that the centre should levy, in addition to the CenVAT, sumptuary excises

(SEs) on a few select commodities. These would at the most be a dozen in number.

The centre would retain the revenue generated from the SEs. The SEs would yield to

98 In addition, the centre would also deduct its cost of collection on an actual basis. This would however be less than the cost of collection by the states.

99 Bird, Richard M. (1993), "Aspects of Federal Finance: A Comparative Perspective" in A Reforma Fiscal No Brasil, proceedings of an International Symposium on Fiscal Reform, Sao Paulo, pp.77- 101.

108

the centre approximately half the revenue from the UEDs (Table 7.7). The central

kitty would, therefore, not be affected by the proposed change in the system.

Restructuring State Finances

In addition to change in assignment of taxing powers, the states must make

their existing assigned taxes broad-based and income-elastic to cope with their

responsibilities. They should restructure their finances by expanding the existing

bases of the taxes assigned to them. Some proposals in this regard are presented

below:

In the long run, VAT would reduce economic distortions, encourage industrial

development and consequently raise more resources. Also, this would capture the

value added beyond the first point tax and would increase the tax base considerably.

At present the state government is levying the following taxes on commodities

and services:

1. Taxes on the sale and purchase of goods other than newspapers;2. Excise on alcoholic liquor for human consumption, Indian hemp and other

narcotic drugs;3. Taxes on the entry of goods into local areas for consumption, use or sale

therein (octroi levied and collected by local authorities through delegated power);

4. Tax on the consumption or sale of electricity;5. Tax on goods and passengers carried by road or inland water ways;6. Tax on vehicles suitable for use on roads;7. Tax on animals and boats;8. Tolls9. Tax on luxuries including tax on entertainment, amusements, betting and

gambling.

In the proposed scheme of restructuring of taxes, as suggested earlier, sales tax

is converted into a state VAT. However, in the course of time, these other taxes too

must become part of the state VAT. That includes tax on electricity, tax on

entertainment, amusements, the luxury tax on hotels, passengers and goods tax. This

should be integrated with the state VAT. After this restructuring the structure of

indirect taxes levied by states would be as follows:

1. A comprehensive state VAT2. Excise on alcoholic liquor

109

3. A toll tax on new roads and bridges4. Motor vehicles tax for regulation of vehicles5. A tax on gambling, horse races and lotteries.

With these reforms in the state taxes on commodities and services (mentioned

above), India would finally have a broad-based and economically rational indirect tax

system.

110

Annexure 7.1

Vertical Externality: Issues in Taxation of the same base by Central and State

Governments: Excerpts from a paper by Keen, Michael (1998): ‘Vertical Tax

Externalities in the Theory of Fiscal Federalism’, IMF Staff Papers, Vol. 45, No. 3,

September

In federal countries, when both central and state governments co-occupy the

same tax base, vertical externality arises and affects the tax revenue receipts of both

levels of governments.

The following model examines the impact of such externality on the

equilibrium levels of central and state tax rates.

The Model

The assumptions are as follows:

i. States are identical to each other.

ii. Each state consists of a single consumer.

iii. The states are not so large so that each can have a negative impact on the central tax base.

iv. Tax base is completely immobile across states, that is, horizontal tax competition among states does not play any role.

v. Preference function of consumers:

v (q) + (g, G) …………………………………(1)

Where

v (.) and (.) are strictly concave.

Preference function is additive implying that the utility derived from private good is independent of that derived from public good. G and g represents the quantity of central public good and state public good respectively. Consumer price of taxed (private) good is q such that:

q = p + t + T …………………………………(2)

Where

p is producer price

t is state tax rate

T is central tax rate.

States set the value of t, taking T and G as given.

There can be two cases:

111

A. State governments are leviathan, that is, it maximizes total tax revenue,

t.x (q) where x(q) is the demand for the taxed good. It would use inverse

elasticity rule to determine revenue maximizing tax rate:

t/q = 1/e (q) ………………………………………(3)

Where

e (q) is price elasticity of demand and e (q) > 0.

When T changes and hence q changes, then ‘t’ will generally have to change to restore equation (3), and the direction in which it must change is uncertain. The direction of change will depend on the way the elasticity of demand varies.

With increase in central tax rate, price of taxed good (q) would go up and consequently, its demand would decline from OQ0 to OQ1 (Figure 1). The tax base and hence tax revenue of state government would reduce. In case e (.) is constant, t needs to be increased in order to restore equilibrium as given in eq. (3).

Price

p+t0+T1 A`

A

p+t0+T0

O Q1 Q0 Quantity demanded

FIGURE 1: The Effect of a Higher Federal Tax on the Revenue- Maximizing State Tax.

If the demand curve is linear, the tax rate would be equal to:

t = - { 1/ x`(q)/x (q) } where x`(q) is constant. ……………..(4)

x (q) declines with increase in q and hence t declines.

B. If state governments are benevolent, then they would consider two

more aspects of higher central tax rate. First, welfare loss that the consumer

suffers due to increased consumer price. Second, decrease in demand for taxed

good, leading to a decrease in tax revenue and the consequent decline in

112

provision for public goods. This would initiate the state governments to raise

the tax rate.

Therefore, in both cases the state governments would increase state tax rate with an increase in central tax rate.

The state governments would set t and g so that:

g = [1 – (t/q). e (q)]-1 MCPF …………………………..(5)

Where

g is marginal value to the consumer of an additional dollar spent on state public good .

MCPF refers to marginal cost of public funds and covers up the loss incurred by state government due to increase in central tax rate.

But the true social marginal cost of public funds (SMCPF), which recognizes the erosion of central tax base, is equal to:

SMCPF = [1 – ( /q). e (q)]-1………………………….(6)

where, = t +T, is the consolidated tax rate and at equilibrium, SMCPF > MCPF. The state governments would use eq. (5) so as to determine equilibrium tax rate, which implies that they would set excessively high tax rate. The crucial distinction is that while the MCPF recognized by the states directly depends only on the state tax t, the social MCPF reflects the consolidated tax rate.

113

Table 7.1: Estimating VAT Base (2001-02) RE

(Rs. Lakh)

States Total GST

CST GST net of CST (1) -

(2)

MST (revenue

from petrol and diesel)

GST net of CST and MST (3) -

(4)

Input Credit due to

Manuf-acturer

(20 % of 5)

Input Credit due to Inter

state transactions (.06 % of 2)

VAT Base of existing

GST [(5)-(6)-(7)]

Additional base due to VAT (5%

of 8)

Additional base due to taxation of

services (10% of 8)

VAT revenue at

existing rates (8) + (9) +(10)

Revenue due to rate rationalizat

ion (10% of 11)

Total VAT revenue

from GST (11+ 12)

Total VAT after inclu-sion of MST

Revenue (13 + 4)

Net effect (+/-) due to introduction of VAT)

(14 - 1)1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

High Income StatesGujarat 600000 110000 490000 114700 375300 75060 66.00 300174.00 15008.70 30017.40 345200.10 34520.01 379720.11 494420.11 -105579.89

Haryana 305600 90576 215024 70054 144970 28994 54.35 115921.65 5796.08 11592.17 133309.90 13330.99 146640.89 216694.89 -88905.11

Maharashtra 1318000 181000 1137000 161734 975266 195053 108.60 780104.20 39005.21 78010.42 897119.83 89711.98 986831.81 1148565.81 -169434.19

Punjab 269000 30520 238480 32280 206200 41240 18.31 164941.69 8247.08 16494.17 189682.94 18968.29 208651.24 240931.24 -28068.76

Goa 50000 2504 47496 6000 41496 8299 1.50 33195.30 1659.76 3319.53 38174.59 3817.46 41992.05 47992.05 -2007.95

NCT of Delhi 379300 0 379300 0 379300 75860 0.00 303440.00 15172.00 30344.00 348956.00 34895.60 383851.60 383851.60 4551.60Middle Income StatesAndhra Pradesh 786012 79080 706932 94321 612611 122522 47.45 490041.35 24502.07 49004.14 563547.55 56354.76 619902.31 714223.31 -71788.69

Karnataka 558167 75142 483025 83725 399300 79860 45.09 319394.91 15969.75 31939.49 367304.15 36730.42 404034.57 487759.57 -70407.43

Kerala 486551 35623 450928 58386 392542 78508 21.37 314012.23 15700.61 31401.22 361114.06 36111.41 397225.47 455611.47 -30939.53

Tamil Nadu 844036 88677 755359 101284 654075 130815 53.21 523206.79 26160.34 52320.68 601687.81 60168.78 661856.59 763140.59 -80895.41

West Bengal 410000 32733 377267 66396 310871 62174 19.64 248677.16 12433.86 24867.72 285978.73 28597.87 314576.61 380972.61 -29027.39

Low Income StatesBihar 145000 11500 133500 17400 116100 23220 6.90 92873.10 4643.66 9287.31 106804.07 10680.41 117484.47 134884.47 -10115.53

Madhya Pradesh 254200 57997 196203 30504 165699 33140 34.80 132524.40 6626.22 13252.44 152403.06 15240.31 167643.37 198147.37 -56052.63

Orissa 148500 15400 133100 17820 115280 23056 9.24 92214.76 4610.74 9221.48 106046.97 10604.70 116651.67 134471.67 -14028.33

Rajasthan 315000 17781 297219 34915 262304 52461 10.67 209832.53 10491.63 20983.25 241307.41 24130.74 265438.15 300353.15 -14646.85

Uttar Pradesh 625724 41800 583924 83172 500752 100150 25.08 400576.52 20028.83 40057.65 460663.00 46066.30 506729.30 589901.30 -35822.70

114

Table 7.1: (Contd. . . .)Estimating VAT Base (2001-02) RE

(Rs. Lakh)

States Total GST

CST GST net of CST (1) -

(2)

MST (revenue



(4)

Input Credit due to

Manuf-acturer

(20 % of 5)




GST [(5)-(6)-(7)]


of 8)


services (10% of 8)

VAT revenue at



ion (10% of 11)

Total VAT revenue

from GST (11+ 12)

Total VAT after inclu-sion of MST

Revenue (13 + 4)


(14 - 1)1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Special Category StatesAssam 106461 14918 91543 23400 68143 13629 8.95 54505.45 2725.27 5450.54 62681.27 6268.13 68949.39 92349.39 -14111.61

Arunachal Pradesh 1234 0# 1234 0 1234 247 0.00 987.20 49.36 98.72 1135.28 113.53 1248.81 1248.81 14.81

Himachal Pradesh 35500 4000 31500 1110 30390 6078 2.40 24309.60 1215.48 2430.96 27956.04 2795.60 30751.64 31861.64 -3638.36

Jammu & Kashmir 40000 0# 40000 10000 30000 6000 0.00 24000.00 1200.00 2400.00 27600.00 2760.00 30360.00 40360.00 360.00

Manipur 3200 0# 3200 0 3200 640 0.00 2560.00 128.00 256.00 2944.00 294.40 3238.40 3238.40 38.40

Meghalaya 7280 1774 5506 2589 2917 583 1.06 2332.54 116.63 233.25 2682.42 268.24 2950.66 5539.66 -1740.34

Mizoram 900 0# 900 0 900 180 0.00 720.00 36.00 72.00 828.00 82.80 910.80 910.80 10.80

Nagaland 3041 0# 3041 0 3041 608 0.00 2432.80 121.64 243.28 2797.72 279.77 3077.49 3077.49 36.49

Sikkim 2150 0# 2150 0 2150 430 0.00 1720.00 86.00 172.00 1978.00 197.80 2175.80 2175.80 25.80

Tripura 9661 97.48 9563.52 3341 6222.52 1245 0.06 4977.96 248.90 497.80 5724.65 572.47 6297.12 9638.12 -22.88

Uttaranchal* 45000 2000 43000 11010 31990 6398 1.20 25590.80 1279.54 2559.08 29429.42 2942.94 32372.36 43382.36 -1617.64

Newly Formed StatesChattisgarh* 79512 28800 50712 9541 41171 8234 17.28 32919.52 1645.98 3291.95 37857.45 3785.74 41643.19 51184.19 -28327.81Jharkhand* 151500 25993 125507 18180 107327 21465 15.60 85846.00 4292.30 8584.60 98722.90 9872.29 108595.20 126775.20 -24724.80Total (All States) 7980529 947818 7032711 1051863 5980848 1196170 568.69 4784109.71 239205.49 478410.97 5501726.17 550172.62 6051898.78 7103761.78 -876767.22

Notes: 1. * indicates newly formed State.2. # shows that separate figures for CST are not available for these States. Hence, fresh calculations have to be done after obtaining data on this aspect.

115

Table 7.2: Estimating VAT Base (2001-02) RE

(Rs. Lakh)States Total

GSTCST GST net of

CST (1) -(2)

MST (revenue



(4)

Input Credit due to

Manufacturer (20 % of 5)




GST [(5)-

(6)+(7)]


of 8)


services (15% of 8)

VAT revenue at



ion (15% of 11)

Total VAT revenue

from GST (11+ 12)

Total VAT after

inclusion of MST

Revenue (13 + 4)


(14 - 1)

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15High Income StatesGujarat 600000 110000 490000 114700 375300 75060 66.00 300174.00 30017.40 45026.10 375217.50 56282.63 431500.13 546200.13 -53799.88

Haryana 305600 90576 215024 70054 144970 28994 54.35 115921.65 11592.17 17388.25 144902.07 21735.31 166637.38 236691.38 -68908.62Maharashtra 1318000 181000 1137000 161734 975266 195053 108.60 780104.20 78010.42 117015.63 975130.25 146269.54 1121399.79 1283133.79 -34866.21Punjab 269000 30520 238480 32280 206200 41240 18.31 164941.69 16494.17 24741.25 206177.11 30926.57 237103.68 269383.68 383.68Goa 50000 2504 47496 6000 41496 8299 1.50 33195.30 3319.53 4979.29 41494.12 6224.12 47718.24 53718.24 3718.24NCT of Delhi 379300 0 379300 0 379300 75860 0.00 303440.00 30344.00 45516.00 379300.00 56895.00 436195.00 436195.00 56895.00Middle Income StatesAndhra Pradesh 786012 79080 706932 94321 612611 122522 47.45 490041.35 49004.14 73506.20 612551.69 91882.75 704434.44 798755.44 12743.44

Karnataka 558167 75142 483025 83725 399300 79860 45.09 319394.91 31939.49 47909.24 399243.64 59886.55 459130.19 542855.19 -15311.81

Kerala 486551 35623 450928 58386 392542 78508 21.37 314012.23 31401.22 47101.83 392515.28 58877.29 451392.58 509778.58 23227.58

Tamil Nadu 844036 88677 755359 101284 654075 130815 53.21 523206.79 52320.68 78481.02 654008.49 98101.27 752109.77 853393.77 9357.77West Bengal 410000 32733 377267 66396 310871 62174 19.64 248677.16 24867.72 37301.57 310846.45 46626.97 357473.42 423869.42 13869.42

Low Income StatesBihar 145000 11500 133500 17400 116100 23220 6.90 92873.10 9287.31 13930.97 116091.38 17413.71 133505.08 150905.08 5905.08

Madhya Pradesh 254200 57997 196203 30504 165699 33140 34.80 132524.40 13252.44 19878.66 165655.50 24848.33 190503.83 221007.83 -33192.17Orissa 148500 15400 133100 17820 115280 23056 9.24 92214.76 9221.48 13832.21 115268.45 17290.27 132558.72 150378.72 1878.72

Rajasthan 315000 17781 297219 34915 262304 52461 10.67 209832.53 20983.25 31474.88 262290.66 39343.60 301634.26 336549.26 21549.26Bihar 145000 11500 133500 17400 116100 23220 6.90 92873.10 9287.31 13930.97 116091.38 17413.71 133505.08 150905.08 5905.08Uttar Pradesh 625724 41800 583924 83172 500752 100150 25.08 400576.52 40057.65 60086.48 500720.65 75108.10 575828.75 659000.75 33276.75

Contd . . . . .

116

Table 7.2: (Contd . . . )Estimating VAT Base (2001-02) RE


GSTCST GST net of

CST (1) -(2)

MST (revenue



(4)

Input Credit due to





GST [(5)-

(6)+(7)]


of 8)


services (15% of 8)

VAT revenue at


Revenue due to rate rationalization (15% of

11)

Total VAT revenue

from GST (11+ 12)

Total VAT after

inclusion of MST

Revenue (13 + 4)


(14 - 1)

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15Special Category StatesAssam 106461 14918 91543 23400 68143 13629 8.95 54505.45 5450.54 8175.82 68131.81 10219.77 78351.58 101751.58 -4709.42Arunachal Pradesh 1234 0# 1234 0 1234 247 0.00 987.20 98.72 148.08 1234.00 185.10 1419.10 1419.10 185.10Himachal Pradesh 35500 4000 31500 1110 30390 6078 2.40 24309.60 2430.96 3646.44 30387.00 4558.05 34945.05 36055.05 555.05

Jammu & Kashmir 40000 0# 40000 10000 30000 6000 0.00 24000.00 2400.00 3600.00 30000.00 4500.00 34500.00 44500.00 4500.00

Manipur 3200 0# 3200 0 3200 640 0.00 2560.00 256.00 384.00 3200.00 480.00 3680.00 3680.00 480.00Meghalaya 7280 1774 5506 2589 2917 583 1.06 2332.54 233.25 349.88 2915.67 437.35 3353.02 5942.02 -1337.98Mizoram 900 0# 900 0 900 180 0.00 720.00 72.00 108.00 900.00 135.00 1035.00 1035.00 135.00

Nagaland 3041 0# 3041 0 3041 608 0.00 2432.80 243.28 364.92 3041.00 456.15 3497.15 3497.15 456.15Sikkim 2150 0# 2150 0 2150 430 0.00 1720.00 172.00 258.00 2150.00 322.50 2472.50 2472.50 322.50Tripura 9661 97.48 9563.52 3341 6222.52 1245 0.06 4977.96 497.80 746.69 6222.45 933.37 7155.81 10496.81 835.81Uttaranchal* 45000 2000 43000 11010 31990 6398 1.20 25590.80 2559.08 3838.62 31988.50 4798.28 36786.78 47796.78 2796.77Newly Formed StatesChattisgarh* 79512 28800 50712 9541 41171 8234 17.28 32919.52 3291.95 4937.93 41149.40 6172.41 47321.81 56862.81 -22649.19Jharkhand* 151500 25993 125507 18180 107327 21465 15.60 85846.00 8584.60 12876.90 107307.51 16096.13 123403.63 141583.63 -9916.37Total (All States) 7980529 947818 7032711 1051863 5980848 1196170 568.69 4784109.71 478410.97 717616.46 5980137.14 897020.57 6877157.71 7929020.71 -51508.29

Notes: 1. * indicates newly formed State. 2. # shows that separate figures for CST are not available for these States. Hence, fresh calculations have to be done after obtaining data on this aspect.

117

Table 7.3:Estimating VAT Base (2001-02) RE


GSTCST GST net of

CST (1) -(2)

MST (revenue



(4)

Input Credit due to




VAT Base of existing GST [(5)-

(6)+(7)]


of 8)


services (20% of 8)

VAT revenue at



ion (20% of 11)

Total VAT revenue

from GST (11+ 12)

Total VAT after inclusion

of MST Revenue (13+4)


(14 - 1)1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

High Income StatesGujarat 600000 110000 490000 114700 375300 75060 66.00 300174.00 30017.40 60034.80 390226.20 78045.24 468271.44 582971.44 -17028.56Haryana 305600 90576 215024 70054 144970 28994 54.35 115921.65 11592.17 23184.33 150698.15 30139.63 180837.78 250891.78 -54708.22Maharashtra 1318000 181000 1137000 161734 975266 195053 108.60 780104.20 78010.42 156020.84 1014135.46 202827.09 1216962.55 1378696.55 60696.55Punjab 269000 30520 238480 32280 206200 41240 18.31 164941.69 16494.17 32988.34 214424.19 42884.84 257309.03 289589.03 20589.03Goa 50000 2504 47496 6000 41496 8299 1.50 33195.30 3319.53 6639.06 43153.89 8630.78 51784.66 57784.66 7784.66NCT of Delhi 379300 0 379300 0 379300 75860 0.00 303440.00 30344.00 60688.00 394472.00 78894.40 473366.40 473366.40 94066.40Middle Income StatesAndhra Pradesh 786012 79080 706932 94321 612611 122522 47.45 490041.35 49004.14 98008.27 637053.76 127410.75 764464.51 858785.51 72773.51Karnataka 558167 75142 483025 83725 399300 79860 45.09 319394.91 31939.49 63878.98 415213.39 83042.68 498256.07 581981.07 23814.07Kerala 486551 35623 450928 58386 392542 78508 21.37 314012.23 31401.22 62802.45 408215.89 81643.18 489859.07 548245.07 61694.07Tamil Nadu 844036 88677 755359 101284 654075 130815 53.21 523206.79 52320.68 104641.36 680168.83 136033.77 816202.60 917486.60 73450.60West Bengal 410000 32733 377267 66396 310871 62174 19.64 248677.16 24867.72 49735.43 323280.31 64656.06 387936.37 454332.37 44332.37

Low Income StatesBihar 145000 11500 133500 17400 116100 23220 6.90 92873.10 9287.31 18574.62 120735.03 24147.01 144882.04 162282.04 17282.04Madhya Pradesh 254200 57997 196203 30504 165699 33140 34.80 132524.40 13252.44 26504.88 172281.72 34456.34 206738.07 237242.07 -16957.93Orissa 148500 15400 133100 17820 115280 23056 9.24 92214.76 9221.48 18442.95 119879.19 23975.84 143855.03 161675.03 13175.03Rajasthan 315000 17781 297219 34915 262304 52461 10.67 209832.53 20983.25 41966.51 272782.29 54556.46 327338.75 362253.75 47253.75Uttar Pradesh 625724 41800 583924 83172 500752 100150 25.08 400576.52 40057.65 80115.30 520749.48 104149.90 624899.37 708071.37 82347.37

(Contd . . . )

118

Table 7.3: (Contd . . . )Estimating VAT Base (2001-02) RE


GSTCST GST net of

CST (1) -(2)

MST (revenue



(4)

Input Credit due to




VAT Base of existing GST [(5)-

(6)+(7)]


of 8)


services (20% of 8)

VAT revenue at


Revenue due to rate rationalization (20% of

11)

Total VAT revenue

from GST (11+ 12)

Total VAT after inclusion

of MST Revenue (13+4)


(14 - 1)1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Special Category StatesAssam 106461 14918 91543 23400 68143 13629 8.95 54505.45 5450.54 10901.09 70857.08 14171.42 85028.50 108428.50 1967.50

Arunachal Pradesh 1234 0# 1234 0 1234 247 0.00 987.20 98.72 197.44 1283.36 256.67 1540.03 1540.03 306.03

Himachal Pradesh 35500 4000 31500 1110 30390 6078 2.40 24309.60 2430.96 4861.92 31602.48 6320.50 37922.98 39032.98 3532.98

Jammu & Kashmir 40000 0# 40000 10000 30000 6000 0.00 24000.00 2400.00 4800.00 31200.00 6240.00 37440.00 47440.00 7440.00

Manipur 3200 0# 3200 0 3200 640 0.00 2560.00 256.00 512.00 3328.00 665.60 3993.60 3993.60 793.60

Meghalaya 7280 1774 5506 2589 2917 583 1.06 2332.54 233.25 466.51 3032.30 606.46 3638.76 6227.76 -1052.24

Mizoram 900 0# 900 0 900 180 0.00 720.00 72.00 144.00 936.00 187.20 1123.20 1123.20 223.20

Nagaland 3041 0# 3041 0 3041 608 0.00 2432.80 243.28 486.56 3162.64 632.53 3795.17 3795.17 754.17

Sikkim 2150 0# 2150 0 2150 430 0.00 1720.00 172.00 344.00 2236.00 447.20 2683.20 2683.20 533.20

Tripura 9661 97.48 9563.52 3341 6222.52 1245 0.06 4977.96 497.80 995.59 6471.34 1294.27 7765.61 11106.61 1445.61

Uttaranchal* 45000 2000 43000 11010 31990 6398 1.20 25590.80 2559.08 5118.16 33268.04 6653.61 39921.65 50931.65 5931.65

Newly Formed StatesChattisgarh* 79512 28800 50712 9541 41171 8234 17.28 32919.52 3291.95 6583.90 42795.38 8559.08 51354.45 60895.45 -18616.55

Jharkhand* 151500 25993 125507 18180 107327 21465 15.60 85846.00 8584.60 17169.20 111599.81 22319.96 133919.77 152099.77 599.77Total (All States) 7980529 947818 7032711 1051863 5980848 1196170 568.69 4784109.71 478410.97 956821.94 6219342.62 1243868.52 7463211.15 8515074.15 534545.15

Notes: 1. * indicates newly formed State.2. # shows that separate figures for CST are not available for these States. Hence, fresh calculations have to be done after obtaining data on this aspect.

119

Table 7.4:

Concessional Rate of Sales Tax on Inputs in Indian States

State Tax Rate (percent)

Andhra Pradesh 4

Assam No concession

Bihar 3

Delhi Ex.

Goa Ex.

Gujarat 2 (except prohibited goods)

Haryana Ex.

Himachal Pradesh Ex.

Jammu & Kashmir Ex.

Karnataka 3 (2 for SSIs)

Kerala 2

Madhya Pradesh 4

Maharashtra 3

Meghalaya Set off on sale

Manipur Ex.

Orissa 4

Punjab Ex.

Rajasthan 3 to 4

Tamil Nadu 3

Uttar Pradesh 2 for declared goods; 2.5 for other goods; 4-8 for specified goods

West Bengal 3-4

Note: Ex = Exempted

120

Table 7.5:Trade Margins under VAT

Commodity GroupTrade Margin

Wholesale trade Retail tradeCalculated Observed Calculated Observed

1. Rice 5.5 7.8 11.9 10.32. Wheat 2.3 7.7 12.9 10.03. Other cereals 8.6 8.6 13.7 11.84. Arhur 8.2 6.9 11.4 10.75. Gram 7.8 7.8 11.2 10.96. Other pulses 3.7 7.8 12.1 11.57. Biscuits 14.0 11.2 17.9 15.48. Bread 13.4 13.0 17.1 14.69. Sugar 9.2 4.5 8.5 8.810. Gur, candy, batasa 11.2 9.6 13.9 12.511. Milk 15.3 15.1 15.0 14.112. Other dairy products 8.9 8.7 11.4 12.313. Edible oil 6.6 5.8 9.7 10.214. Meat and Poultry 10.3 15.7 19.7 18.315. Fish 12.7 29.1 24.4 25.716. Egg 11.8 12.9 14.7 13.917. Salt 8.1 16.9 26.9 21.618. Spices including garam masala 21.1 13.4 24.3 16.219. Potato and onion 14.7 15.2 23.4 22.220. Other vegetables 22.2 21.9 27.4 26.121. Fruits 16.1 28.9 29.2 23.122. Dry fruit and nuts 8.4 17.8 19.9 15.223. Tea, coffee 7.7 7.8 13.8 12.824. Pan and pan masala 8.3 16.5 27.3 24.925. Bidi, cigarette & other tobacco products 3.0 10.8 13.0 14.426. Soap, detergent & washing powders 6.6 8.4 14.2 12.627. Tooth paste 0.0 7.1 15.9 10.328. Hair oil and shampoo 0.0 8.9 16.4 12.629. Other toilet preparations 0.7 10.1 12.1 13.730. Leather footwear 19.2 15.4 18.9 17.731. Non-leather footwear 21.3 16.2 15.4 18.432. Other leather products 11.3 14.8 18.6 19.233. Cotton textile 19.9 9.4 16.6 16.834. Other textile 9.9 10.0 17.0 17.635. Hosiery goods 13.4 13.3 11.3 17.436. Readymade garments 12.5 13.2 21.5 20.737. Woolen goods 6.8 11.6 21.9 19.138. Plastic goods 11.6 13.6 17.6 19.839. Other synthetic goods 12.4 33.5 12.8 18.640. Jewellery 441.1 10.5 0.7 14.741. Precious stones -8.1 8.1 9.9 22.442. Artificial jewellery 22.2 22.5 17.2 25.343. Bulbs and tubes -2.4 10.6 12.9 13.544. Fan, heater, irons etc. 4.8 9.8 11.8 14.645. TV, VCP, VCR 15.4 11.4 8.5 11.746. Fridge, washing machine 11.1 16.3 6.6 10.547. Radio, transistor, tape 11.0 10.8 15.7 16.648. Calculator & other electrical appliances 10.7 11.8 3.9 16.049. Crockery & glassware 41.4 20.2 5.4 19.050. Potteries 0.0 31.0 128.0 24.351. Fertilisers 42.5 7.2 8.6 10.452. Pesticides 0.0 8.7 13.2 13.553. Utensils & metal containers 12.2 12.9 16.4 17.354. Note books, writing & drawing pads 12.9 11.9 14.8 16.955. Books and periodicals 0.8 10.7 -82.3 15.556. Wood, cane & bamboo products 15.8 28.6 7.5 20.657. Bicycle 13.1 7.4 12.4 12.958. Soft drinks 10.7 14.9 50.0 22.559. Fruit juice 12.0 15.8 50.0 31.060. Wine and intoxicants 24.4 18.5 25.0 26.961. Toys and sports goods 31.7 15.3 25.2 21.762. Cement 5.4 5.6 9.5 7.963. Bricks 10.1 17.1 11.9 13.764. Iron rods -24.1 9.5 4.8 10.065. Coal, coke, fire wood 86.7 46.0 31.9 28.366. Watch, spectacles, sun glasses, lighters etc. 4.6 12.2 19.0 19.8

Source: Sarvekshana, April-June 2000.

121

Table 7.6: Concessional Rates Under CST in Different States of India

States Commodities RatesGoa Chemical, Ore Pallets, Mining machinery spares, Electronic weighing scale, Photographic

product, Electronic medical equipment, Betel nut, Cashew nut, Iron & steel, Raw cashew nut.2%

Himachal Pradesh

Goods manufactured by Industrial units(other than these manufactured by breweries, distilleries, non-fruit/ vegetable based wineries and bottling plants (both of country liquor and Indian made foreign liquor).Cereals like paddy, rice, wheat, jowar, bajra, maize, ragi, kodon etc.All types of yarn.

1%

1%1%

Kerala Beaten rice and purchased riceBullion and spicesKerosene stoveArecanutChloroquine TabletsCaprolactumCoconut OilCoconut Oil CakeCotton YarnDeclared goods other than Coconut (i.e. Cocos-Nucifera) or copra specified in schedule II to the KGST Act, 1963 (15 of 1963).Desiccated CoconutFibre foamGinger (Green or dried)Granite slab and Granite TilesNews PrintPepper (Garbled or ungarbled)Power TillerPushbutton Telephone(*SRO. 304/99 GO (P) No. 63/99/TD dt.31.3.99)Rubber ( SRO 215/97)

1%1%1%00

2%0

2%00

2%2%0

2%2%0

2%2%0

Karnataka Cotton yarnKST suffered silk fabricsKST suffered ArecanutKST suffered Coffee beans and Coffee seedsKST suffered Dry chilliesKST suffered Horsrgram and HalasandeKST suffered Tamarind and Tamarind seeds BicyclesCopraComputers, Computer peripherals etcCotton seedsDessicated coconutEdible oil refined and non-refinedGroundnuts and their seeds, safflower seeds and sun flower seedsKhandasari sugarLiquid glucose, dextrine etcMedical diagnostic imaging equipmentsWashed cotton seed oilBullion and specieEarth moving equipments-hydraulic excavator etcRechargeable lanternsRefrigerators, Washing machines, Microwave ovens and vaccum cleanersVideo cassette recorders, VCPs, audio and video CD players, radio, cassette recorders and radio cassette recordersPencilsKerosene wick stoves

2%000000

2%2%

0.25%2%2%2%2%2%2%2%2%

0.5%2%2%2%2%

00

Contd . . . . .

122

Table 7.6: (Contd . . .)Concessional Rates Under CST in Different States of India

States Commodities RatesDelhi Sale of goods (other than the goods specified in the First Schedule of the DST Act 1975)

in the course of inter-State trade or commerce by a dealer having his place of business in the territory of Delhi provided the sale is made to a registered dealer having his place of business outside the territory of Delhi and the goods are proved to have been imported into the territory of Delhi after being subjected to tax under the Central Act and then exported from the territory without undergoing any processing or change in identity.

Sale of goods (other than the goods specified in the First Schedule of the DST Act 1975) in the course of inter-State trade or commerce by a dealer having his place of business in the territory of Delhi provided the sale is made to a registered dealer having his place of business outside the territory of Delhi and the goods are proved to have been received by him in the territory of Delhi under the Central Sales Tax Act from his place of business in another State where he is registered under the sales tax law of the that State in respect of his such place of business or from the place of business of his Agent or Principal in another State where such agent or principal is registered under the Sales Tax Law of that State and in respect of which the importing dealer furnishes a certificate containing the declaration in the prescribed form that tax on the said goods has been paid or will be paid by him or his Agent or his Principal, as the case may be, under the Sales Tax Law of the State wherefrom the goods were received, and which are exported by the importing dealer from the said territory without under-going any processing or change in identity.Dry FruitsTeaSarson, toria, till or taramira oil (not being hydrogenated vegetable oil).

2%

2%

2%2%1%

Orissa Television sets and electronic goodsPig iron, gold and silver ornaments.

1%2%

Pondicherry Milk powder, cotton yarn, cotton waste, technical grade pesticides, SSI products for 14 years after expiry of 5 years tax holiday.Aluminium, art silk, and SSI products as stated above.Photographic goods, cinamatographic goods, medicines, surgical equipments, oil and oil cakes, hydraulic excavators, electronic goods and computers.Gensets, plastic goods, rubber goods, packing materials, chemicals, asbestos, cement sheets, food colours, footwear, iron and steel, ferrous and non-ferrous alloys, paper products.

1%

1.5%2%

3%

Sikkim Cardamom, ginger and orange 3%

West Bengal GoldGold and silver ornaments, articles and filigreeMustard seed, Rape seedPoultry feed additivesSilverAll non-cotton yarn other than pure silk yarn made in IndiaEdible rice bran oilFeed additives for cattle and pig Jute goods except specified elsewhereMustard oil, rape oil and mixture thereofPrecious stone including preal-real, artificial or culturedRice and broken particles of riceSynthetic fibre such as, acrylic fibre or polyester fibreWheat and broken particles of wheat Aluminium utensils

111112222222223

123

Table 7.6: (Contd . . .)Concessional Rates Under CST in Different States of India

States Commodities Rates

West BengalContinued

Gas mantle Hawai Chappal, Chappal and Sandals made of plasticHosiery goods excluding cotton, woolenMicro-cellular sheet, banawar sheetParts, accs., comp. Of cycle-rickshawPower tillersReadymade garments (excld. hosiery goods, garment of khadi)Umbrella and parts, comp. ThereofMill-made cotton fabrics, rayon or artificial silk fabrics and wollen fabricsTobacco, whether manufactured or notSugarNewprint (for publishing newspaper)Betel leavesCondomsBicyclesMotor Vehicles for use as taxisChloroquine phosphate tabletsInterstate sale of locally purchased single point goods on which due tax has been paid in West Bengal.Non-ferrous metals-tubes, pipes, rods, sections, wires, and sheetsTea Purchased at Calcutta Tea AuctionTea Purchased at Siliguri Tea AuctionCycle-rickshaws and components thereof Iron and SteelSale of motor cars:i. Sales effected under Section 8(1)Television and Vanaspatii. Sales effected under section 8(1)(b) of television………………………………………ii. Sales effected under section 8(1)(b) of VanaspatiLottery tickets Sales by industrial units holding eligibility certificateAluminium foil, aluminium foiled paper, and aluminium foil backed or inter-leaved with paperElectronic audio equipments

Personal Computer and peripheral devices, Refrigerator, Washing machine, Vacuum cleaner, Microwave oven, Video cassette recorder, Video cassette player, radio, Transistor radio, Music systems.Sale of inverter, generator and laminated jute bagsDrugs or medicines manufactured by the Small Scale Industrial Unit

Sale of TrekkerCoir mattress with or without foam and acrylic fibre

3 3 3 3 3 3 3 3 0 0 0 0 1 0 1 2 0 0 2 2 2 1 0

2

1 3 0 0 2

1 1

2 0 2 1

Source: Information supplied by the Offices of the Commissioner of Commercial Taxes.

124

Table 7.7Items to be brought under Sumptuary Excises for the Central Government

(Rs crore)Sl. No. Items Yield from 16%

Tax from CenVAT(2000-01)

Input Credit due to Manufacturer

(16% of 51%)

Revenue from Sumptuary

Excises(2000-01)

1. Petroleum Products 9466.49 757.32 10223.81

2. Tobacco & its products 501.85 40.15 542

3. Motor Cars, etc. 2291.61 183.33 2474.94

4. Cement Clinkers, etc. 3855.67 308.45 4164.12

5. Chemicals & Dyes 2264.15 181.13 2445.28

6. Tyres & Tubes 2389.26 191.14 2580.4

7. Plastics & articles thereof 3198.03 255.84 3453.87

8. Arms & Ammunitions, etc. 27.81 2.22 30.03

9. Precious Stones, etc. 33.97 2.72 36.69

Total Revenue from Sumptuary Excises

25951.14

Source: Govt. of India, 2000-01, Receipts Budget, February.

125

Annexure 7.2

List I – Union List

Relevant ItemsClauses82 Taxes on income other than agricultural income.83 Duties of customs including export duties.84 Duties of excise on tobacco and other goods manufactured or produced in India

except:(a) Alcoholic liquors for human consumption;(b) Opium, Indian hemp and other narcotic drugs and narcotics, but including medicinal

and toilet preparations containing alcohol or any substance included in sub-paragraph (b) of this entry.

85 Corporation Tax86 Taxes on the capital value of the assets, exclusive of agricultural land, of individuals and

companies; taxes on the capital of companies.87 Estate duty in respect of property other than agricultural land.88 Duties in respect of property other than agricultural land.89 Terminal taxes on goods or passengers, carried by railway, sea or air; taxes on railway fares

and freights.90 Taxes other than stamp duties on transactions in stock exchanges and future markets. 91 Rates of stamp duty in respect of bills of exchange, cheques, promissory notes, bill of lading,

letter of credit, policies of insurance, transfer of shares, debentures, proxies and receipts.92 Taxes on the sale or purchase of newspapers and on advertisements published therein.92A100 Taxes on the sale or purchase of goods other than newspapers, where such sale or purchase

takes place in the course of inter-state trade or commerce – 192B101 Taxes on consignment of goods (whether the consignment is to the person making to any

other person), where such consignment takes place in the course of inter-state trade or commerce – 297. Any other matter not enumerated in list II or list III including any tax not mentioned in either of those lists.

92C102 Taxes on services

List – II--State List

Relevant ItemsClauses45 Land revenue, including the assessment and collection of revenue, the maintenance of land

records, survey, for revenue purposes and records of rights, and alienation of revenues.46 Taxes on agricultural income.47 Duties in respect of succession to agricultural land.48 Estate duty in respect of agricultural land.49 Taxes on lands and buildings.50 Taxes on mineral rights subject to any limitations imposed by Parliament by law relating to

mineral development.51 Duties of excise on the following goods manufactured or produced in the State countervailing

duties at the same or lower rates on similar goods manufactured or produced elsewhere in India:

100 Inserted by the Constitution (Sixth Amendment) Act, 1956, sec.2 (w.e.f. 11-6-1956).101 Inserted by the Constitution (Forty-Sixth Amendment) Act 1982, Sec.5 (w.e.f.

2.2.1983).102 Inserted by the Constitution (Ninety-Fift Amendment) Act 2003.

127

(a) Alcoholic liquors for human consumption;(b) Opium, Indian hemp and other narcotic drugs and narcotics; but not including

medicinal and toilet preparations containing alcohol or any substance included in sub-paragraph (b) of this entry.

52 Taxes on the entry of goods into a local area of consumption, use or sale therein.53 Taxes on the consumption or sale of electricity.54 Taxes on the sale or purchase of goods other than newspapers, subject to the provisions of

entry 92A of List I. -355 Taxes on advertisements other than advertisements published in newspapers. –456 Taxes on goods and passengers carried by road or on inland waterways.57 Taxes on vehicles whether mechanically propelled or not suitable for use on roads, including

tramcars, subject to the provisions of entry 35 of List III.58 Taxes on animals and boats.59 Tolls60 Taxes on professions, trades, callings and employments.61 Capitation Taxes62 Taxes on luxuries, including taxes on entertainments, amusements, betting and gambling.63 Rates of stamp duty in respect of documents other than those specified in the provisions of

List I with regard to rates of stamp duty.

List III – Concurrent List

35 Mechanically propelled vehicles including the principles on which taxes on such vehicles are to be levied.

44 Stamp duties other than duties or fees collected by means of judicial stamps, but not including rates of stamp duty.

Source: Union and State Lists of Taxation and expenditure responsibilities in the Indian Constitution, Govt. of India (2003) pp. 364-372.

Notes:1. Inserted by the Constitution (Fifteenth Amendment) Act 1956, S.2.2. Inserted by the Constitution (Forty Sixth Amendment) Act, 1982, S.S.3. Submitted by the Constitution (Sixth Amendment) Act, 1956, S.2.4. Inserted by the Constitution (Sixth Amendment) Act 1956, S.57.

128

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