A Promising Experiment

There is a move to bring about major reforms in both the direct and indirect taxes fronts. These are intended to radically simplify the tax system which, over the years, has become complex and discriminatory. In the field of indirect taxation, an important step in this regard is said to be the replacement of the present system by a broader structure which would simplify administration, increase economic efficiency and improve distributional equity.

In the quest for improvement in this front, the central and state governments have introduced value added tax (VAT), on a full or limited scale. It is perhaps one of the most sophisticated indirect tax systems in the world. A complete VAT extends through to the final sale by the retailer and is collected at each stage of the production or the distribution process. Unlike a multi-stage turnover tax, which is applied to the full value of a product each time it is sold, VAT is assessed at each stage only on the basis of increment in the value added to the product since the last taxable transaction. The total base of a complete VAT is, therefore, exactly the same as that of retail sales tax.

 

Services are included within the scope of the VAT. In Brazil and Ecuador, services are subject to a separate gross receipts tax, which in Brazil is imposed by the municipalities. In the countries which apply the VAT, all services are covered unless specifically exempt. A number of exemptions exist. However, the most common among them are real property rentals, transport and communications services, and financial services. Liberal professions are universally exempt.

However, the tax treatment of financial institutions in various countries is not uniform. Some countries exclude banking, insurance and other financial activities whereas some tax these at concessional rates. It is generally agreed that a VAT is not well adapted to financial services, especially banking and insurance. The value added by banks and insurance companies is difficult to calculate under the indirect substractive (tax credit) method, although it would be feasible to employ the additive method and to the total payrolls and profits after depreciation allowances.

The hire-purchase system also falls under the category of financial services and the issue of subjecting this service to VAT has been considered in Maharashtra. The broad features of this tax are:

As on date, VAT on hire-purchase is not allowed to be recovered. However, suitable amendments to the Act are expected to be made, whereby it will be allowed to be legally passed on to the hirer.

A reduced rate of 1 per cent is applied only on vehicles and plant and machinery used for production of goods for sales. The reduced rate of 1 per cent will now be applied to all capital assets eligible for depreciation under the Income Tax Act, 1961, thereby widening the scope of benefit of reduced rates and its uniform levy on all assets.

The Association of Leasing and Financial Services Companies took up the issue relating to levy of VAT on hire-purchase transactions, and it appears that the commissioner of sales tax, Maharashtra, tentatively, agreed to grant the following concessions to this sector:

The receipts related to hire-purchase transactions prior to the Act coming into force will not be subject to tax, as 1 per cent tax is non-recoverable and the same would not have been considered as part of expense, when the agreement was entered into by finance companies. Hence, the receipts related to only those transactions where the delivery of goods has taken place after October 1, 1995, will be subject to tax.

Since there is no provision to calculate set off on pro-rata basis, the tax rate of 1 per cent will be unconditionally and uniformly applied to all capital assets without any conditions attached thereto.

As regards goods bought from outside Maharashtra and delivered in Maharashtra and inter-state lease, till the Supreme Court clarifies the matter, the Maharashtra government will continue to follow the situs principle and continue to tax these goods.

One of the conditions attached in the notification dated March 6, 1996 is that the dealer should be a leasing or finance company.

The association said that the word leasing or finance company has been used loosely. There is no way by which such a company can be identified, as most finance companies are in other businesses also. Strictly speaking, a bank is not a leasing company, nor is a state industrial development corporation like Sicom. There could not have been any intent to deny the benefit of the rate-reduction in such cases. Hence, it was suggested that such a condition be replaced by a more meaningful condition reading: The dealer is engaged in the business of selling goods on hire-purchase or installment sales.

VAT on hire-purchase transactions is a new concept and is expected to settle down soon. In the taxation of services, VAT does offer one advantage. Many services are rendered for both production and consumption purposes; under the usual structure of a retail sales tax, there is no means of excluding services that are inputs to a business activity since no sale for resale is involved in them. The only feasible method of exclusion is to allow registered purchasers to make all purchases of services tax-free. They can account themselves for tax only on services acquired for taxable purposes. This method is not difficult, and can be given a try.