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
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
and it seems that all possible services might be taxed in
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-
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
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
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
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.
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.
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 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.
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
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
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
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
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.