SSIs in non-VAT States are at a disadvantage
R. Gopalakrishnan
Three full months after the introduction of the value added tax (VAT) in a majority of States in place of sales tax, the Empowered Committee of State Finance Ministers has emphasised that the revenue to the exchequer of the States concerned has only increased, and that whatever inflation has been experienced is not attributable to VAT.
Entrepreneurs, including small scale industries (SSIs), may not be much excited by news of increase in the revenue of State governments but such a view would be misconceived because once States are able to increase their tax collections substantially and consistently, they are likely to abandon the tendency to fix high rates of taxes or introduce irrational taxes. Also, any increase in State revenues should help public investment in infrastructure and the social sector, both of which would benefit manufacturing industry.
The question that now arises is whether SSIs in the few States, including Tamil Nadu, which have refused to implement VAT for stated and unstated reasons are at a competitive disadvantage
It was just six months ago that this column dealt with the "deafening silence" on the part of SSIs on the question of VAT. That was when the Empowered Committee had come out with its White Paper on the proposed State-level VAT system. Since then, VAT has been introduced in many States from April 1,2005. The column had mentioned the likelihood of VAT encouraging sub-contracting to SSIs and the advantage that application of VAT to capital goods offered to manufacturers,including SSIs.
Given the fact that a few major States have abstained from implementing VAT and given the continuing indifference of SSIs to the issue, it may be worthwhile elaborating the basic advantages that the VAT system offers to manufacturers and the economy as a whole, beyond the two aspects mentioned earlier.
The most important advantage of the VAT system is that it prevents what is known as the "escalation" effect of taxes being levied on the full value of goods including the tax paid on inputs (in the case of manufacture) or purchases (in the case of trade). This results in avoidable price increases and thus acts as a restraint on the expansion of the market for any product. In the case of manufacture, this aspect has long since been dealt with in India by the introduction of Central value added tax in place of Central Excise. The CENVAT regime is characterised by setting off the taxes paid on inputs against the tax payable on the output and a movement towards a single excise rate, from a plethora of rates. Apart from avoiding tax on tax (escalation), VAT also reduces the profit margin or interest which a manufacturer (or trader)tends to charge on his investment in working capital (a phenomenon which some economists call pyramiding).
When it comes to the trading chain (in which goods do not undergo any transformation while being passed from manufacturers, to distributors, wholesalers and final retail outlets), `escalation' would occur when (under a multipoint sales tax system) ST is levied on the whole value of goods, including the cost of transportation, storage, packing, repacking etc, at every stage of transfer of ownership. The advantage of VAT in the sales chain has not been appreciated in India because most States had switched over to the single-point ST system, where the escalation is not seen. But the fact is that the actual ST rate fixed for commodities under the single point ST system takes into account the revenue that is targeted to be collected from any sector and thus tends to be high.
Once VAT is introduced, the rate need not be high, because tax is collected on the value added - but only on the value added -- at every point of sale. There is also less scope for evasion of tax through underinvoicing.
The Indian State VAT system has fixed a low rate of four per cent on raw materials or inputs, and even on this, setoff is given to the manufacturer (who is a registered dealer) against the tax payable on his final product. Thus VAT is a superior method of taxation that would lead to cost reduction and higher demand
Another advantage is said to be the `neutrality' of VAT to technologies. Since under the VAT system, taxes paid on inputs are given a set off and there is normally a single rate on inputs, manufacturers will tend to be guided solely by techno-economic considerations in the choice of technologies and not be influenced in the choice by differential tax rates on possible alternative inputs.
In many cases, VAT could lead to new investment opportunities for small entrepreneurs. If a certain product, inclusive of VAT, costs much more to consumers in a location far away from the place of manufacture as a result of value added by transportation, storage and trade chain margins, this would make it attractive for entrepreneurs to start a production facility near the last point of consumption and gain a share of the existing market.
It can be said with confidence that SSIs have a vested interest in pushing for VAT in States that have not fallen in line.
SSIs : A review
