The reasons why Value Added System (VAT) scores over any other system of indirect taxation are twofold. First, it eliminates cascading effect on the assessable value of goods and services by rendering such value tax-neutral. Second, by providing a credit chain from origin to end, the system sets up a self-corrective mechanism by substantially reducing, if not eliminating, the risk of tax evasion. To be precise, if tax is evaded by unaccounted clearance, the credit chain automatically gets snapped and at the next accountable stage, whether manufacturing, wholesale, or retail, the full tax burden with cascading effect would have to be discharged for want of credit. If tax is evaded by under-valuation, the buyer-assessee would get a lesser credit and incur consequently a higher tax liability. Hence, it is assumed that the trade would not gain by attempting to evade tax in an ideal VAT or GST regime. The question is, do we have an ideal VAT regime at the centre and the states.
As for the states, in the absence of inter-states credit operability, credit in State-VAT does not run along the supply chain that may originate in one state and terminate in another. Therefore, the current system has an inherent lacuna which can only be plugged with the introduction of GST when credit chain will in all likelihood be operable in inter-state transactions. In Central VAT (CENVAT) also, for reason of high threshold limit for levy on goods (Rs. 1.5 crores annually) and also for restricting the levy to manufactured goods only, a large number of transactions are kept outside the purview of CENVAT thereby providing an incentive for tax evasion.
The case in point is the manufacture of ingots, rods and wires of copper, steel, Aluminium etc. out of market scraps and waste procured by the unorganized sector, mostly from dealers, without any proof of duty payment, and hence without an input credit. Since value-addition in respect of those productions, particularly of copper and aluminium, is minimal, the duty incidence on wiring and re-wiring units becomes almost prohibitive in the absence of input credit. This explains why those manufacturing units in unorganized sector pay only a fraction of the CENVAT that is actually payable, primarily to survive in a competitive market where large units invariably utilize CENVAT credit on recycled scraps and waste generated in the course of manufacturing process. As a logical corollary, the unaccounted production and clearances by the unorganized sector to evade 16% CENVAT lead to simultaneous evasion of 4% State VAT, and eventually a minimum of 33% corporate tax as well, leaving those activities outside the ambit of GDP reckoning. And the evasion continues up to the finished stage in which it reaches the ultimate consumer. The only remedy to the above evasion-prone, distorted market condition lies in the revival of ‘deemed credit’ that once co-existed with the MODVAT (Modified VAT) scheme from its very inception (1986), but was later rescinded by an Order of the ministry of Finance (Department of Revenue), dated 1.3.94, purportedly in consideration of gross misuse.
The misuse was primarily of two types. First, some inputs were suspected to be non-duty-paid or exempt in which event deemed credit was not admissible. Second, there were instances of forgery and tampering of invoices to enhance the quantum of deemed credit, and to reduce the net duty liability. However, the cure by way of rescission of the scheme of Deemed Credit was worse than the disease itself as it led to massive unaccounted production and clearances to evade not only CENVAT, but State VAT and corporate tax also, besides having its corrupting influence on tax officers.
What then is the remedy? Should we suggest revival of the old scheme of ‘Deemed Credit’ to remove current distortions in CENVAT and VAT where a large number of transactions remain unaccounted? To revive a two decades old concept sans modification would certainly be anachronistic.
The modification that is worth our consideration is to allow deemed input credit at the exit stage rather than at the entry stage, after ensuring duty liability of inputs in question. Currently, under indirect subtractive computation method, an assessee is permitted to pay entire duty from CENVAT credit account, till it is exhausted. In the proposed scheme, the assessee shall not be permitted to pay entire duty from Deemed Credit account, at any given time, so that his credit utilization does not exceed the percentage fixed, during any assessment period. Once this is done, all transactions of the rolling and re-rolling units are likely to enter into books of account, boosting central as also state revenue considerably. At the same time, prices of wires, cables etc. are likely to stabilize at a lower level once cascading effect is removed and the cost of evasion eliminated.
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