A Primer on Goods and Service Taxes

March 15, 2013 | By | Add a Comment

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India has witnessed substantial reforms in indirect taxes over the past two decades with the replacement of State sales taxes by Value Added Tax (VAT) in 2005 marking a watershed in this regard. Prior to VAT implementation, the tax structure was considered problematic primarily due to the “cascading effect of taxes” whereby an item is taxed more than once from the production to the final retail sales stage. Exporters were also becoming less competitive in the international market due to the huge input costs involved (tax burden of a commodity increases manifold as it is taxed repeatedly) through the earlier sales tax mode – reflected in higher prices of products as compared to global competitors.

To avoid this kind of a tax structure, VAT was introduced so that taxes are paid on the “value added portion” by each producer and the hurdles of the cascading effect are done away with. But shortcomings were also noticed in the VAT structure and efforts were made to further rationalise the system. For instance, a number of Central taxes like customs duty, surcharge were not included in Central Value Added Tax (CENVAT) while indirect taxes at the State level such as entertainment and luxury taxes were left out of the purview of VAT.

The major problem with VAT is that CENVAT on certain commodities remains included in the value of goods to be taxed under State VAT. Thus, the same set of goods is taxed repeatedly –   once by the Centre and then by the State. Moreover, since VAT is applied on goods only (tax on services in India is a complicated issue due to various exemptions and definitional problems), there is also the task of calculating tax on services and adding it to the VAT on goods. The government has therefore recognised the need for harmonisation of goods and services tax so that both can be levied in a comprehensive and rational manner in a new taxation regime – Goods and Services Tax (GST).

While presenting the Union Budget 2007-08, former Finance Minister P Chidambaram had announced that GST would be introduced from April 1, 2010, in order to supplement the existing VAT system in India with a tax structure where goods and services tax can be unified in a comprehensive manner. The Empowered Committee of State Finance Ministers would work with the Central government  to prepare a road map for its roll out. The implementation of GST will, in all likelihood, be delayed beyond April 1, 2011 given that there is lack of consensus among the States and Centre on aspects relating to limiting fiscal autonomy of the States.

Filed in: Budget Primers

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