Design of VAT for Major States

1. Design of VAT for Major States Designed and Prepared by RTI Jammu Audit of VAT

2. Design of VAT for Major States • Empowered Committee of State Finance Ministers developed a model draft legislation on State Value Added Tax for enactment by each State, the States were given some leeway while drafting legislation for their States keeping in view the peculiar circumstances of each state and importance of certain items in the State’s economy and trade and commerce within the State. Audit of VAT

3. Design of VAT for Major States • During this session we will discuss the requirements and conditions for design of VAT legislation by States so far as their relevance and importance in audit is concerned. Audit of VAT

4. Learning Objective • At the end of the session the learner will be able to state the requirements and conditions for introducing VAT legislation in major States so far as they relate to assessment, collection and allocation of VAT. Audit of VAT

5. VAT Acts • Most of the Governments of major States, except Uttar Pradesh, adopted the Value Added Tax by 1st April 2005. The Act to levy Value Added Tax on the sales or purchases of goods in the States was (mostly) enacted and came into force with effect from April1, 2005. The Value Added Tax Acts of States replaced the respective Sales Tax Act of the States. Audit of VAT

6. Comparison of VAT with a Sales Tax • VAT (known in some countries as GST-Goods and Services Tax) differs from a conventional Sales Tax in that VAT is levied on every business as a fraction of the price of each taxable sale they make, but they are in turn reimbursed VAT on their purchases, so the VAT is applied to the value added to the goods at each stage of transaction or transfer in the course of trade. Audit of VAT

7. Comparison of VAT with a Sales Tax Sales Tax is a tax on sales and purchases, whereas Value Added Tax is a tax on value addition at each stage. Audit of VAT

8. VAT - Coverage • Ideally, VAT should cover all goods and services with very few exemptions. It should also cover all stages of production and distribution, i.e. it should reach down to the retail level subject to exemptions of those below a designated threshold. Audit of VAT

9. VAT- Rate structure • The State VAT regime is essentially based on a two rate structure of tax. A lower rate of 4% on goods of mass consumption, like drugs and medicines, and a higher rate of 12.5% on all other goods. Bullion, that is gold and silver and high vale jewelry with precious stones, is to be taxed at the rate of 1%. Besides primary agricultural unprocessed produce and some other goods of local consumption would be zero rated. Audit of VAT

10. VAT- Rate structure • In all 550 items are covered under Value Added Tax. Of these, 270 items of basic needs like medicines, drugs, industrial inputs, capital and other declared goods are charged a lower rate of 4%VAT. All other items are covered under VAT with 12.5% tax. Petrol, Diesel and lottery tickets are not covered under VAT for the present. Sugar, textiles and tobacco were initially excluded under VAT for one year. Audit of VAT

11. VAT procedure • While designing the Value Added Tax system for States, experts agreed that it is best to adopt the ‘tax credit method’ throughout. • Due to advantages, all the Sates have adopted a tax system of ‘Input Tax Credit’ system. Audit of VAT

12. Simplified system for small traders • A simplified procedure has also been prescribed for small traders below the threshold limit of registration. Small traders have been given an option to pay a turnover tax at 1 percent instead of VAT at the stipulated rate. If the dealer opts to pay the turnover tax at 1 percent, he cannot claim rebate of input taxes, which is taxes paid by him on inputs. Audit of VAT

13. Goals of VAT administration • The major goals of tax administration are: • Promote voluntary tax compliance; • Identify defaulters; • Enforce penalties on defaulters; • Keep low the cost of administration and compliance. Audit of VAT

14. Basic requirements for administering a VAT • The basic requirements for successful implementation of VAT include the following: • a suitable tax structure compliable with voluntary tax compliance; • an appropriate system for registration and tax payer identification; • a suitable system for invoicing and bookkeeping;. Audit of VAT

15. Basic requirements for administering a VAT • a simple tax collection and verification mechanism; • a system for obtaining third-party information such as on trade flows, and performance and input-output ratios by industry or broad commodity groups; • an enforcement system with strategies to deal with different kinds of non-compliance; a system for identifying unregistered potential tax payers; • a sound and effectively enforceable penalty system; Audit of VAT

16. Basic requirements for administering a VAT • a mechanism to use successful cases as means of promoting voluntary compliance; • a reliable electronic data processing system for speedy filing of tax returns by taxpayers and their examination by tax administration; • a system for selection , training and suitable placement of staff; • a system of rewarding performance and a system of punishing non-performance. Audit of VAT

17. Tax system and voluntary compliance • Some of the factors which contribute to voluntary compliance are: • simplicity of tax structure; • reasonable level of taxation; Audit of VAT

18. Tax system and voluntary compliance • equity in taxation; • simplicity of administrative procedures; • adequacy of taxpayer awareness; • adequacy of services to the taxpayer; • credibility of tax administration. Audit of VAT

19. Registration and taxpayer identification • Registration of all taxable persons is a must for successful implantation of a tax. The VAT Act should clearly include: • who is required to register; • how and where to register; Audit of VAT

20. Registration and taxpayer identification • from whom to obtain and where to submit registration form; • what information is to furnished at the time of registration; • what are the obligations and privileges of registered taxpayers. Audit of VAT

21. Measures to promote registration • The tax administration must take the following steps for facilitating registration by potential registrants: • adequate publicity; • mailing blank application forms to potential registrants; Audit of VAT

22. Measures to promote registration • efficient taxpayer services to respond to taxpayers queries; • setting up of registration counters in major business centres for about a week, every year; • visit by tax officials to the premises of potential registrants; Audit of VAT

23. Taxpayer identification number • Each taxpayer should be allotted a unique taxpayer identification number (TIN). A TIN is a code to identify a taxpayer. It has two main objectives: (1) to facilitate computer applications, such as detecting short filers and delinquent accounts; (2) to help cross check information on taxpayer compliance, for example, the selective cross checking of sales and purchases among tax payers. Audit of VAT

24. Taxpayer identification number • A TIN should comprise four parts, (i) the State code, (ii) a biographical character, (iii) a sequential number and (iv) a check digit. . Audit of VAT

25. Taxpayer identification number • Certain other characteristics that a TIN should satisfy are: • each taxpayer must be given a unique and reliable TIN. A unique TIN if applied to all taxes would facilitate cross verification across tax departments; Audit of VAT

26. Taxpayer identification number • The TIN must not include taxpayer characteristics that may change over time, like economic activity, type (natural person or legal entity), and location (address) of taxpayer within the State. Inclusion of such characteristics creates problems, because a change in such a characteristic of a taxpayer would call for a change in his TIN; • Each company (including branches within the State) should be assigned only one TIN. For conglomerates, a separate TIN should be assigned to each separate legal entity; Audit of VAT

27. Taxpayer identification number • The TIN should be only as long as is necessary for identifying taxpayers. Eleven digits are sufficient to identify the entire world population; • In the composition of TIN, use of alphanumeric numbers should be avoided. Some computer devices cannot process alphanumeric inputs. Also, alphanumeric keyboards slow down keying in information and increase the chances of error. Use of ‘I’ and ‘O’ of English alphabet give the additional problems because they are confused with the numeric numbers ‘1’ and ‘0’. Audit of VAT

28. Economic activity code • Knowledge about economic activity codes of taxpayers is useful in producing statistical information for economic analysis, evaluating performance of tax system and auditing the taxpayers. Each taxpayer should be assigned an economic activity code that should be recorded in the taxpayer’s master file. Audit of VAT

29. Invoice requirements • There are two types of invoices, tax invoices and final consumer invoices. The tax invoices are required to register sales and purchases among VAT taxpayers, while the final consumer invoices are used to register sales to unregistered persons (final consumers). Audit of VAT

30. Tax invoice • The tax invoices are crucial for VAT control. They establish both the tax liability of the seller and the amount of deduction allowed to the registered purchaser. A tax invoice should be issued only by the VAT taxpayer and it should contain the following information: Audit of VAT

31. Tax invoice • Name and address and VAT registration number of the seller; • Date of issue of the invoice; • Serial number of the invoice; • Quantity and description of goods (and services) sold; • Unit price and amount charged, excluding VAT; • VAT charged; and • Name, address and registration number of the buyer. Audit of VAT

32. Final consumer invoice • This is a simplified type of invoice for registering sales to unregistered persons who should be considered as final consumers under the VAT. On this invoice, price may be shown inclusive of VAT, while the name and address of the buyer may be omitted. Only one copy of the invoice is necessary. Audit of VAT

33. Bookkeeping requirements • VAT law should prescribe minimum number of records to be kept. These record books and accounts should be kept updated and be available for inspection at any time. Since preserving old records involves costs, these should be required to be preserved only for a short period. In the context of India, these may be required to be preserved initially for a period of seven years. The period may be reduced to five years on gaining experience in the administration of VAT. Audit of VAT

34. Purchase book of accounts • Each registered person under VAT should be required to maintain a purchase book of accounts for recording the following information: • Tax-exempt and taxable purchases separately; • Imports and domestic purchases separately; • Purchases subject to different VAT rates, separately; and • The date, invoice number, name of supplier, TIN of the domestic supplier, value of purchases and VAT credit. Audit of VAT

35. Sales book of accounts • Each registered person under VAT should be required to maintain a sales book of accounts. The sales book should have provision for recording the following information: • Exempt sales, zero rated sales and sales subject to different rates of VAT separately; Audit of VAT

36. Sales book of accounts • Sales to registered taxpayers and final consumers separately; and • The date, invoice number, name of buyer, value of sales and VAT charged, if the buyer is a registered tax payer. Name and TIN of the buyer are not needed if the buyer is an unregistered taxpayer. Audit of VAT

37. Credit notes • Where credit notes are issued, they should contain the same information as the tax invoices and, in addition, the date and serial number of the tax invoice on which the VAT was originally charged and brought to account and the reasons for giving the credit. However, for credit notes issued to clear the books of bad debts, no credit of VAT should be allowed in the VAT accounts. Audit of VAT

38. Tax collection and verification • Generally the tax administrations are organized along functional lines reflecting four main functions. These are: • taxpayer information and registration; • tax accounting and data processing; Audit of VAT

39. Tax collection and verification • tax collection including pursuing stop filers, and delinquent accounts; and • audit, inspection and control. • The collection division is mainly connected with: • the payment of tax and filing of returns by registered persons; and • identification of non-filers, stop filers and delinquent taxpayers; Audit of VAT

40. Schedule of payment of tax and filing of tax returns • The VAT Acts should specify the periodicity of payment of tax and filing of tax returns. It may be monthly for large and medium tax payers and quarterly for small tax payers. Audit of VAT

41. Identification of stop filers and delinquent taxpayers • The simplest way to identify and punish stop filers and delinquent taxpayers is through quick and intensive action based on computerized system. Computerized list of stop filers and delinquent taxpayers should be produced every month or quarter, as the case may be. Audit of VAT

42. Tax return forms • A tax administration uses the tax return forms to obtain data from taxpayers for enforcing tax laws and for economic analysis. In the case of VAT, the administration’s ability to convert data promptly into usable information is a basic requirement. Audit of VAT

43. System of tax assessment • An assessment system that is conducive to voluntary assessment is the self-assessment system that is the backbone of modern tax administration. Audit of VAT

44. Characteristic of a self-assessment system • Under self-assessment system, a taxpayer is responsible for determining his own tax liability (self-assessment) and accurate and timely reporting and payment of his tax. Self-assessment places more responsibility on the taxpayers. There is no regular intervention by tax administration at the time return is filed to check that each return filed is correct. Audit of VAT

45. Requirements of self-assessment system • In order to make the self-assessment system success and to protect revenues, the following conditions are required: • procedures must be simple; • a strong but fair system of penalties must be applied to the defaulters; and • effective audit and enforcement programme must be introduced. Audit of VAT

46. Identification of tax evasion and fraud • Tax evasion and fraud are practiced by several taxpayers under any tax system, including VAT. Under VAT tax evasion may take place through over reporting of purchases, under reporting of sales, and misclassification of sales and/or purchases. Tax fraud may take place through altering or counterfeiting documents. Audit of VAT

47. Strategy to identify evaders • The level of non-compliance with tax laws depends mainly on the probability of detection and severity of penalty. The ways to increase probability of detecting and punishing VAT evaders is to develop a strategy based on broad and swift audit. Audit of VAT

48. Selection of taxpayers for audit (by tax administration) • Audit by tax administration should be selective but should cover all categories of taxpayers. Success of an audit programme depends, besides other factors, on the choice of cases for audit. A consideration of the following strategy will be useful for selection of cases for audit: • depending upon the capacity of tax administration, 10% to 20% of VAT taxpayers may be selected for audit; Audit of VAT

49. Selection of taxpayers for audit (by tax administration) • the larger cases to the extent of 10% of total number of cases to be audited should be included in the audit cases; • about 75% of audit cases may be selected on the basis of risk analysis, that is high-risk taxpayers Risk analysis involves some mathematical formula which assigns risk-score to a taxpayer, based on the characteristics (such as ratio of sales to purchases, the ratio of sales in excess of purchases to purchases and the growth rate of sales) in comparison to some pre-determined norms; Audit of VAT

50. Selection of taxpayers for audit (by tax administration) • about 15% of audit cases may be selected through a stratified random sample. This ensures presence of the tax department in the whole universe of taxpayers that imparts efficiency to audit strategy. Audit of VAT