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ServiceTax The rationale for the levy of Service can be traced to recommendations made in early 1990's by the Tax Reforms Committee headed by Dr. Raja Chelliah which envisaged that as the central excise duties on goods would get gradually transformed into a value added tax at the manufacturing level, service tax would get woven into that system. The Committee emphasized the importance of moving towards VAT, for making the system of indirect taxation broadly revenue neutral in relation to production and consumption and widening the tax base by covering exempted commodities. The basic objective of Service Tax is broadening the tax base, augmentation of revenue and larger participation of citizens in the economic development of the nation. It therefore did not come as a surprise when in 1994 the then Finance Minister Dr. Manmohan Singh introduced the concept of Service Tax stating thus: "There is no sound reason for exempting services from taxation, therefore, I propose to make a modest effort in this direction by imposing a tax on services of telephones, non-life insurance and stock brokers." Service Tax has been introduced in order to explore new avenues for taxation and to bring more people into the tax net. The Central Excise department administers Service Tax. A separate cell called the Service Tax Cell, under each commisssionorate, has been created for the purpose. Formerly, the entire Service Tax administration was centralized in these cells. The setup has been decentralized recently. Now various Central Excise Divisional offices, which have specific territorial jurisdiction, are empowered to administer the levy. The Service Tax assessee is the person/firm who provides the service. Hence, the Service Tax must be paid by the person/firm providing the service. The Service Tax collections have shown a steady rise since its inception in 1994. The tax collections have grown manifolds since 1994- 95 i.e. Rs. 410 crores in 1994-95 to Rs. 14196 crores in 2004-05. Service Tax revenue collection target for the year 2004-05 was fixed at Rs. 14150 crores, however on the basis of figures obtained from the Pr. C.C.A., the actual service tax revenue collection stands at Rs. 14196.19 crores. It indicates a growth of 79.93% against the actual realization Rs. 7889.97 crores during the previous year 2003-04. Till March 2005, 71 services were taxed. As of now, the number stands at 96. The list is increasing with every passing year, and it seems that all possible services might be taxed in near future. The rate of service tax has also gone up from 5 per cent in 1994 to 12 per cent today. Though the impact of service tax is increasing, the pinch is not really felt because it is an indirect tax collected as part of total value of the service. The bad news is that the finance minister said the ultimate tax rate will be 16 per cent. Value Added Tax Globally, VAT is regarded as a tax that is best levied by the Central government - a condition that is difficult to meet in a federal finance system such as ours. It is true that 123 countries have adopted VAT, but most of them have unitary systems of government. VAT is a centrally-administered tax with a revenue-sharing mechanism. It is hard to visualise VAT as a revenue-neutral measure, or one where the states will not lose out in relation to the present system, in a federal set- up. If VAT is Centrally administered, the tax base is quite wide, comprising imports, production and different stages of sales. If the base is divided between the Centre and states, the chain is broken, making tax evasion easier and affecting the states' tax base. In countries where VAT is administered by a federal government, revenue collection on imports accounts for a larger portion of total VAT revenues. In an IMF study of 22 developing countries, it was discovered that in about two-third of them, more than half the VAT revenue was collected from imports. In Pakistan and Bangladesh, VAT collection from imports was 64 per cent of the total proceeds from the tax. As tax evasion on bulk imports is difficult, it also helps in checking tax evasion at subsequent stages of the tax chain. VAT - in India VAT will replace the present sales tax in India. Under the current single-point system of tax levy, the manufacturer or importer of goods into a State is liable to sales tax. There is no sales tax on the further distribution channel. VAT, in simple terms, is a multi-point levy on each of the entities in the supply chain with the facility of set-off of input tax - that is, the tax paid at the stage of purchase of goods by a trader and on purchase of raw materials by a manufacturer. Only the value addition in the hands of each of the entities is subject to tax. For instance, if a dealer purchases goods for Rs 100 from another dealer and a tax of Rs 10 has been charged in the bill, and he sells the goods for Rs 120 on which the dealer will charge a tax of Rs 12 at 10 per cent, the tax payable by the dealer will be only Rs 2, being the difference between the tax collected of Rs 12 and tax already paid on purchases of Rs 10. Thus, the dealer has paid tax at 10 per cent on Rs 20 being the value addition in his hands. Purchase price - Rs 100 Tax paid on purchase - Rs 10 (input tax) Sale price - Rs 120 Tax payable on sale price - Rs 12 (output tax) Input tax credit - Rs 10 VAT payable - Rs 2 VAT levy will be administered by the Value Added Tax Act and the rules made there-under. VAT can be computed by using any of the three methods detailed below The Subtraction method: The tax rate is applied to the difference between the value of output and the cost of input. The Addition method: The value added is computed by adding all the payments that is payable to the factors of production (viz., wages, salaries, interest payments etc). Tax credit method: This entails set-off of the tax paid on inputs from tax collected on sales. India opted for tax credit method, which is similar to CENVAT. States such as Andhra Pradesh, Kerala, Maharashtra, Madhya Pradesh, Delhi and Haryana have experimented with VAT albeit in a limited manner, covering only limited goods. The experiments never had the full-fledged features of VAT and were only concoctions. These states have even called off their experiments owing to different reasons. Advantages of VAT In the advantages part we will first look after the broad coverage of VAT in the Indian market. Then we will consider the level of security the Indian VAT is having on our revenues. Obviously the selection of items to be covered by VAT in India will be given a bullet to think upon and at last we will check out the co-ordination VAT in India will be having with our existing direct tax system. Coverage If the tax is carried through the retail level, it offers all the economic advantages of a tax that includes the entire retail price within its scope, at the same time the direct payment of the tax is spread out and over a large number of firms instead of being concentrated on particular groups, such as wholesalers or retailers. Revenue security VAT represents an important instrument against tax evasion and is superior to a business tax or a sales tax from the point of view of revenue security for three reasons. In the first place, under VAT it is only buyers at the final stage who have an interest in undervaluing their purchases, since the deduction system ensures that buyers at earlier stages will be refunded the taxes on their purchases. Therefore, tax losses due to undervaluation should be limited to the value added at the last stage. Under a retail sales tax, on the other hand, retailer and consumer have a mutual interest in under-declaring the actual purchase price. Secondly, under VAT, if payment of tax is successfully avoided at one stage nothing will be lost if it is picked up at a later stage; and even if it is not picked up subsequently, the government will at least have collected the VAT paid at stages previous to that at which the tax was avoided; while if evasion takes place at the final stage the state will lose only the tax on the value added at that point. If evasion takes place under a sales tax, on the other hand, all the taxes due on the product are lost to the government. A significant advantage of the value added form in any country is the cross-audit feature. Tax charged by one firm is reported as a deduction by the firms buying from it. Only on the final sale to the consumer is there no possibility of cross audit. Cross audit is possible with any form of sales tax, but the tax-credit feature emphasizes and simplifies it and is likely to make firms more careful not to evade because they know of the possibility of cross check. Selectivity VAT may be selectively applied to specific goods or business entities. We have already addressed essential goods and small business. In addition the VAT does not burden capital goods because the consumption-type VAT provides a full credit for the tax included in purchases of capital goods. The credit does not subsidize the purchase of capital goods; it simply eliminates the tax that has been imposed on them. Co-ordination of VAT with direct taxation Most taxpayers cheat on their sales not to evade VAT but to evade personal and corporate income taxes. The operation of a VAT resembles that of the income tax more than that of other taxes, and an effective VAT greatly aids income tax administration and revenue collection. It is interesting to note that when Trinidad and Tobago set out to introduce VAT it chose one of its top income tax administrators as the VAT Commissioner. Capital Gains Tax A capital gain is income derived from the sale of an investment. A capital investment can be a home, a farm, a ranch, a family business, or a work of art, for instance. In most years slightly less than half of taxable capital gains are realized on the sale of corporate stock. The capital gain is the difference between the money received from selling the asset and the price paid for it. "Capital gains" tax is really a misnomer. It would be more appropriate to call it the "capital formation" tax. It is a tax penalty imposed on productivity, investment, and capital accumulation. The capital gains tax is different from almost all other forms of taxation in that it is a voluntary tax. Since the tax is paid only when an asset is sold, taxpayers can legally avoid payment by holding on to their assets--a phenomenon known as the "lock-in effect." There are many problems embedded in the current tax treatment of capital gains. One is that capital gains are not indexed for inflation: the seller pays tax not only on the real gain in purchasing power but also on the illusory gain attributable to inflation. The inflation penalty is one reason that, historically, capital gains have been taxed at lower rates than ordinary income. In fact, "most capital gains were not gains of real purchasing power at all, but simply represented the maintenance of principal in an inflationary world." Another unfairness of the tax is that individuals are permitted to deduct only a portion of the capital losses that they incur, whereas they must pay taxes on all of the gains. That introduces an unfriendly bias in the tax code against risk taking. When taxpayers undertake risky investments, the government taxes fully any gain that they realize if the investment has a positive return. But the government allows only partial tax deduction if the venture goes sour and results in a loss. There is one other large inequity of the capital gains tax. It represents a form of double taxation on capital formation. This is how economists Victor Canto and Harvey Hirschorn explain the situation: A government can choose to tax either the value of an asset or its yield, but it should not tax both. Capital gains are literally the appreciation in the value of an existing asset. Any appreciation reflects merely an increase in the after-tax rate of return on the asset. The taxes implicit in the asset's after-tax earnings are already fully reflected in the asset's price or change in price. Any additional tax is strictly double taxation. Take, for example, the capital gains tax paid on a pharmaceutical stock. The value of that stock is based on the discounted present value of all of the future proceeds of the company. If the company is expected to earn Rs.100, 000 a year for the next 20 years, the sales price of the stock will reflect those returns. The "gain" that the seller realizes from the sale of the stock will reflect those future returns and thus the seller will pay capital gains tax on the future stream of income. But the company's future Rs.100, 000 annual returns will also be taxed when they are earned. So the Rs.100, 000 in profits is taxed twice--when the owners sell their shares of stock and when the company actually earns the income. That is why many tax analysts argue that the most equitable rate of tax on capital gains is zero.
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