Even though Value Added Tax (VAT) is an indirect tax in the sense that the tax is
collected from someone other than the person who actually bears the cost of the
tax, VAT levied on the sale of goods and services has increasingly become
popular with many governments in many countries. In some countries like
Singapore, Australia, New Zealand and Canada, this tax is known as ‘Goods and
Services Tax (GST)’. SAFA earlier initiated ‘A Study on VAT in SAFA Countries’.
A team worked on its various aspects like the tax base, tax rates, the types of
goods and services taxed, the mode of calculation of VAT, the exemptions
allowed, etc. etc. To my knowledge the team has worked very hard on the subject
and their time-consuming job has enabled it to produce a valuable document for
reference as well as action. Mr. Ashok Chandak, Past President, SAFA, who is
very thorough and immaculate in discharging his responsibilities supported by the
team of officials of the ICAI including Mr. R. Devarajan, Additional Director and
Secretary, Fiscal Laws Committee, Ms. Priya Subramanian, Sr. Education Officer
and Ms. Mukta Kathuria, Executive Officer deserve congratulations for tackling a
difficult subject in a most professional way.
I am also extremely thankful to Mr. Sunil Goyal, Past President and Mr. Kamlesh S.
Vikamsey, current President of the ICAI for providing ICAI’s support to the study. I
am also thankful to the other member-bodies of SAFA for making available inputs
relevant to the respective countries and for the comments given on the draft, and
Dr Ashok Haldia, Permanent Secretary SAFA for his guidance to the ICAI officials
in preparation of the Study.
I am sure this Study Report is going to prove useful and helpful to all those who
would refer to it.
August 2005 Md. Nurul Hassan
1. Introduction and object of the study 1
2. Taxonomy of VAT 3
2.1 Different stages of VAT 3
2.2 Variants of VAT 8
2.3 Methods for computation of tax 10
2.4 Rate Structure under VAT 14
2.5 Merits and demerits of VAT 14
3. Federal structure and tax systems in India 19
3.1 Introduction 19
3.2 Tax structure 19
Union taxes 19
State level taxes 21
Local-level taxes 23
3.3 Collection and sharing of revenues 24
3.4 Domestic indirect taxes 24
Sales tax 25
Central Sales Tax 28
Need to reform domestic indirect taxes 29
3.5 Recommendations of various Committees on tax 29
Jha Committee 29
Technical group 30
Long-term fiscal policy 30
Chelliah Committee 30
4. VAT in Indian Federation 32
4.1 CENVAT 32
Structure of CENVAT 32
4.2 Administrative controls under CENVAT 35
4.3 Obligations under CENVAT 36
Declarative obligations 36
Accounting obligations 38
4.4 Weaknesses of the system under CENVAT 39
5. VAT in Indian States 42
5.1 Committee of State Finance Ministers 42
5.2 Expert Group on taxation of Inter-state sales 43
5.3 Committee on the draft model VAT law 44
5.4 Various models of VAT 45
Union VAT 46
State VAT 46
Dual VAT 47
5.5 Move towards VAT in States 47
5.6 Dr. Vijay Kelkar’s views 49
5.7 White Paper on State-Level VAT in India 52
5.8 Further developments and concerns 63
6. VAT in Nepal 66
6.1 Background 66
6.2 Basic features 66
Type of VAT 66
6.3 Taxable supply 68
6.4 Place and time of supply 68
Place of supply 68
Time of supply 68
6.5 Taxable value 69
6.6 Tax credit 70
In case of taxable supply 70
In case of mixed supply 70
Partial credit 71
No credit 71
6.7 Tax refund 71
Refund to exporters 71
Refund to non-exporters 71
Refund to diplomats 72
Other refunds 72
6.8 Administration 72
Taxpayer Identification Number 73
6.9 Invoicing 74
Tax invoice 74
Abbreviated invoice 75
6.10 Accounting 76
Purchase book 76
Sales book 76
VAT Account 76
6.11 Submission of return 77
6.12 Payment of tax 77
6.13 Tax assessment 78
Computer assessment 78
Management assessment 80
6.14 Collection 80
6.15 Penal provisions 80
6.16 Appeals 81
6.17 Conclusion 81
7. VAT in Sri Lanka 82
7.1 Introduction 82
7.2 Imposition of Value Added Tax (VAT) 82
Chargeability of VAT 82
Rate of VAT 82
VAT not to apply on certain wholesale or 83
retail supply of goods
Time of supply of goods 83
Time of supply of services 83
Supply in the case of instalments/hire 84
Value of taxable supply of goods or services 84
Value of goods imported 85
Zero rated goods 86
Exemption in respect of entries in First 87
Place of supply of goods or services 87
7.3 Registration 87
7.4 Returns and calculation of tax 94
Return (Section 21) 94
Credit for input tax against output tax 96
Accounting basis (Section 23) 98
Bad Debts (Section 24) 98
Adjustment of tax by credit or debit note 99
Imposition of Value Added Tax on the supply 100
of financial services by specified institutions
Monthly taxable period (Section 25B) 100
Calculation of tax (Section 25C) 100
Tax credit (Section 25D) 101
Payment of tax (Section 26) 103
Penalty for default (Section 27) 103
7.6 Assessment of tax 104
Power of Assessor to make an assessment 104
Assessor to state reason for non-acceptance 104
of a return (Section 29)
Power of Assessor to determine open 104
market value (Section 30)
Additional Assessment (Section 31) 105
Evidence of returns and assessment 105
Limitation of time for assessment or 105
additional assessment (Section 33)
ANNEXURE I FIRST SCHEDULE 112
ANNEXURE II SECOND SCHEDULE 118
8. VAT in Pakistan 121
8.1 Introduction 121
8.2 General history of sales-tax in Pakistan 121
8.3 Move towards VAT 122
8.4 Sales tax is a value added tax 123
8.5 “Excise duty” and “Sales Tax” – Distinction 123
8.6 Definitions 124
8.7 Scope of tax 129
8.8 Chargeability of sale tax 129
8.9 Conditions to levy sales tax under section 3(1)(a) 129
8.10 Sales tax is a tax on consumption 129
8.11 Sales tax a Value Added Tax 130
8.12 Rate of sales tax 130
8.13 Retail tax 130
8.14 Collection of excess tax 131
8.15 Zero rating (Section 4) 131
8.16 Change in the rate of tax (Section 5) 132
8.17 Time and manner of payment (Section 6) 132
8.18 Determination of tax liability (Section 7) 132
8.19 Levy and collection of tax on specified goods on 133
value addition (Section 7A)
8.20 Tax credit not allowed (Section 8) 134
8.21 Debit and credit note (Section 9) 134
8.22 Excess amount to be carried forward or refunded 134
8.23 Assessment of tax (Section 11) 135
8.24 Short-paid amounts recoverable without notice 136
8.25. Exemption (Section 13) 136
9. VAT in Bangladesh 137
9.1 Definitions 137
9.2 Imposition of VAT 139
9.3 Application of tax rate 140
9.4 Computation of value for charge of VAT 141
9.5 Time and method of payment (Section 6) 143
9.6 Attachment of stamp or banderol 144
9.7 Collection of VAT at source 144
9.8 Imposition of supplementary duty 145
9.9 Turnover tax (TOT) 146
9.10 Large taxpayer unit (LTU) 148
9.11 Credit of taxes 148
9.12 Correction of accounts after payment of tax 154
9.13 Settlement of excess input tax 154
9.14 Credit on input stored at the time of 154
commencement of Act (Section 12)
9.15 Drawback of tax paid on inputs used to produce or 154
manufacture of exported goods (Section 13)
9.16 Exemption 155
9.17 Books of account 156
9.18 Tax invoices 156
9.19 Period of keeping records 156
9.20 Submission of files/records etc. 157
9.21 Power of release of goods without payment of VAT 157
and drawback of VAT on some goods
9.22 Refund 157
9.23 Drawback in case of exported or imported goods 157
9.24 Drawback in case of goods used in the mean time 158
of import and export
9.25 Drawback not allowed under certain cases 158
9.26 Other Provisions 158
9.27 The Value Added Tax Act, 1991 158
Chapter – 1
Introduction and Object of the Study
VAT is the youngest member of the sales tax family. This tax was proposed for the
first time by Dr. Wilhelm Von Siemens for Germany in 1919 as an improved
turnover tax. "The improvement consisted in the subtraction of previous outlays
from taxable sales with the results that the tax base of each firm would be reduced
to the value which it added to the product." In 1921, VAT was suggested by
Professor Thomas S. Adams for the United States of America who observed
"sales tax with a credit or refund for taxes paid by the producer or dealer (as
purchaser) on goods bought for resale or for necessary use in the production of
goods for sales." VAT was also recommended by the Shoup Mission for
reconstruction of the Japanese Economy in 1949. However, the tax was not
introduced by any country till 1953. France led the way in 1954 by adopting a VAT
that covered the industrial sector alone and the tax was limited up to the wholesale
level. The tax was limited to the boundaries of France until the fifties.
VAT has, however, been spreading rapidly since the sixties. The Ivory Coast
followed France by adopting VAT in 1960. The tax was introduced by Senegal in
1961 and by Brazil and Denmark in 1967. The tax has gathered further momentum
as it was made a standard form of sales tax required for the countries of the
European Union (then European Economic Community). In 1968, France
extended VAT to the retail level while the Federal Republic of Germany introduced
it in its tax system. The Netherlands and Sweden imposed this tax in 1969 while
Luxembourg adopted it in 1970, Belgium in 1971, Ireland in 1972, and Italy, the
United Kingdom, and Austria in 1973. Of the other members of the European
Union, Portugal and Spain introduced VAT in 1986, Greece in 1987, while this tax
was adopted by Finland in 1994. Many other European countries have adopted
VAT. Similarly, many countries in North and South America, Africa and Oceania
have introduced VAT.
VAT has been spreading in the Asian region as well. The Republic of Vietnam
adopted VAT briefly in 1973. (VAT was abolished soon but it was reintroduced in
1999 in Vietnam.) South Korea introduced VAT in 1977, China in 1984, Indonesia
in 1985, Taiwan in 1986, Philippines in 1988, Japan in 1989, Thailand in 1992, and
Singapore in 1994 while Mongolia has been implementing this tax since 1998.
In the South Asian Association for Regional Cooperation (SMRC) region, VAT has
been considered in great depth in India. This country introduced VAT in a different
way under the name of modified value added tax (MODVAT) in 1986. Unlike the
VAT system of other countries, the-Indian MODVAT system is designed to correct
the excise duty. This tax is adopted mainly to avoid the disadvantages of input
taxation, such as tax cascading. The scope of MODVAT has been extended over
the years. Further, various attempts have been made to introduce a broad-based
VAT in place of several domestic trade taxes. There seems to be a broad
agreement among the Indian States to convert the State sales tax into a VAT.
Among the other members of the SAARC countries, Pakistan adopted VAT in
1990, Bangladesh in 1991, and Nepal in 1997 while Sri Lanka introduced VAT in
As VAT is less distortive and more revenue-productive, it has been spreading all
over the world. This tax had been adopted by eight countries by the end of the
1960s. Since then the tax has been introduced by at least one country each year
except 1974, 1978 and 1979. By 2000, about 120 countries have adopted VAT
and it is under consideration in many other countries. In fact, VAT has become a
popular topic for tax reform in recent years.
The objective of this study is to give an idea about the systems of VAT as are
prevalent in countries belonging to South Asian Federation namely Bangladesh,
India, Nepal, Pakistan and Sri Lanka.
Chapter – 2
Taxonomy of VAT
2.1 Different stages of VAT
The Value Added Tax (VAT) is a multistage tax levied as a proportion of the value
added (i.e. sales minus purchase) which is equivalent to wages plus interest, other
costs and profits. To illustrate, a chart of transactions is given below:
Sale price Rs.300 Sale price Rs. 400
Gross VAT Rs.37.50 Gross VAT Rs. 50
Net VAT Rs.21 Net VAT Rs.12.50
Product X Product Y
Sale price Rs. 100 Sale price Rs. 100
Sale price Rs. 500
Gross VAT Rs. 12.50 Gross VAT Rs. 4
Gross VAT Rs. 62.50
Net VAT Rs.12.50 Net VAT Rs. 4
Net VAT Rs. 12.50
(62.50 – 50)
Note: The rate of tax is assumed to be 12.5 per cent on the transactions of goods
manufactured by A.
For a manufacturer A, inputs are product X and product Y which are purchased
from a primary producer. In practice, even these producers use inputs. For
example, a farmer would use seeds, feeds, fertilizer, pesticides, etc. However, for
this example their VAT impact is not considered. B is a wholesaler and C is a
The inputs X and Y are purchased at Rs. 100 each on which tax is paid @12.5 %
and 4% respectively. The manufacturer A would, therefore, take the credit for tax
paid by him for the use of such inputs. The input price of Rs.200 plus tax would
include wages, salaries and other manufacturing expenses. To all this he would
also add his own profit. Assuming that after the addition of all these costs his sale
price is Rs.300, the gross tax (at the rate of 12.5 per cent) would be Rs.37.50. As
manufacturer A has already paid tax on Rs.200, he would get credit for this tax (i.e.
12.50+4=16.50). Therefore, his net VAT liability would be Rs.37.50 minus
Rs.16.50. Thus, manufacturer A would pay Rs.21 only (because of this he would
take the cost of his inputs to be only Rs.200).
Similarly, the sale price of Rs.400 fixed by wholesaler B would have net VAT
liability of Rs.12.50 (Rs.50-37.50= Rs.12.50) and the sales price of Rs.500 by
Retailer C would also have net VAT liability of Rs.12.50 (Rs. 62.50 - 50 =
Rs.12.50). Thus, VAT is collected at each stage of production and distribution
process, and in principle, its entire burden falls on the final consumer, who does
not get any tax credit. Thus, VAT is a broad-based tax covering the value added to
each commodity by parties during the various stages of production and
How VAT operates
The operation of VAT can be further appreciated from the following illustrations:
A is a trader selling raw materials to a manufacturer of finished products. He
imports his stock-in-trade as well as purchases the same in the local markets. If the
rate of VAT is assumed to be 12.50 per cent ad valorem, he will pay VAT as under:
(i) A's cost of imported materials (from other State) 10,000
(A will deposit Rs.1250 duty on the above. Since, this is not a 1,250
State VAT it will form a cost of input)
(ii) A's cost of local materials 20,000
(VAT charged by local suppliers Rs.2,500. Since the credit of
this would be available it will not be included in cost of input)
(iii) Other expenditure (such as for storage, transport, interest,
etc.) incurred and profit earned by A 8,750
(iv) Sales price of goods 40,000
(v) VAT on the above @ 12.50% (Approx.) 5,000
(vi) Invoice value charged by A to the manufacturer, B 45,000
I. A's liability for VAT
Tax on the sales price 5,000
Less: Set-off of VAT paid on purchases
On imported goods Nil
On local goods 2,500 2,500
Net tax payable 2,500
In the above illustration (as well as in illustrations that follows) it is assumed that
set off of VAT paid on imported goods from outside countries or other States is not
allowed. Further it is assumed that VAT is levied on goods only and not on services
rendered. If it were to be so levied, in the above illustration, assuming that A had
stored his goods in a hired godown, the owner would have levied VAT on godown
charges. Similarly, the contractor transporting A's goods for delivery to B would
have charged VAT on transport charges recovered from A. In that event A would
have been entitled to claim set-off of VAT paid on godown and transport charges.
Now B manufactures finished products from the raw materials purchased from A
and other materials purchased from other suppliers. His liability would be as under:
(i) B’s cost of raw materials 40,000
(VAT recovered by A Rs.5,000)
(ii) B’s cost of other materials
Local purchases 20,000
(VAT charged on the above Rs.2,500)
Inter- State purchases 10,400
(CST paid Rs.400)
(iii) Manufacturing and other expenses incurred and profit
earned by B 29,600
(iv) Sale price of finished product 1,00,000
(v) VAT on the above 12,500
(vi) Invoice value charged by B to the wholesaler, C 1,12,500
II. B's liability for VAT
Tax on the sales price 12,500
Less: Set-off of VAT on purchases
To A 5,000
To other suppliers 2,500 7,500
Net tax payable 5,000
When C, after repacking the goods into other packing, sells the finished product to
a retailer. The following would be the position:
(i) C's cost of goods 1,00,000
(VAT recovered by B Rs.12, 500)
(ii) Cost of packing material 2,000
(VAT charged on the above Rs. 250)
(iii) Expenses incurred and profit earned by C 18,000
(iv) Sale price of goods 1,20,000
(v) VAT on the above 15,000
(vi) Invoice Value charged by C to D, a retailer 1,35,000
III C’s liability for VAT
Tax on the sales price 15,000
Less: set-off of VAT paid
To B 12,500
To other suppliers 250 12,750
Net tax payable 2,250
When D sells the goods to the consumers, the position would be as under:
(i) D’s cost of goods 1,20,000
(VAT recovered by C Rs.15,000)
(iii) Expenses incurred and profit earned by D 20,000
(iv) Sale price of goods 1,40,000
(v) VAT on the above 17,500
(vi) Invoice value charged by D to the consumers 1,57,500
IV. D’s liability for VAT
Tax on the sale price 17,500
Less: Set-off of VAT paid to C 15,000
Net tax payable 2,500
It would be seen that in the above illustrations, at the successive stages which the
raw materials and other goods pass till they are sold to the ultimate consumers,
VAT would be collected as under:
(i) Paid by suppliers selling raw materials to A 2,500
(ii) Net tax paid by A on his sales to B 2,500
(iii) Paid by suppliers selling other materials to B 2,500
(iv) Net tax paid by B 5,000
(v) Paid by suppliers selling packing materials to C 250
(vii) Net tax paid by C 2,250
(viii) Net tax paid by D 2,500
Total recovery of revenue 17,500
Now, if tax was leviable under a sales-tax law at the last stage in a series of
successive sales (when the finished product is sold to consumers) the authorities
in the above case would have recovered the entire tax of Rs.17, 500 from D at
12.50 per cent on his sale price of Rs.1,40,000 and all earlier stages are to be
If an equal amount of tax was leviable under Sales-tax law at the first stage, in the
above illustration, it will have to be levied in the hands of 'B' only as the goods are
manufactured by him. The rate of tax will have to be determined taking into
account the amount of tax paid on raw material, etc., which will be done in the
following manner only.
Total tax amount leviable 17,500
Less: Tax recovered from ‘A’
1. On local purchases 2,500
2. On imports Nil 2,500
Less: Tax recovered from ‘B’
On other raw materials 2,500
Less: Tax recovered from ‘C’
On packing materials 250
There will be no recovery of tax from D as sale by 'D' to the consumer will be a
resale or sale of tax paid goods. Therefore, balance amount of Rs.12, 250 will have
to be recovered at the point of sale by 'B' only. The sale price of B being Rs.
1,00,000 the rate of tax will be 12.25%. Under the VAT, liability of B is only Rs.
5,000 as against Rs. 12,250 under first stage.
2.2 Variants of VAT
VAT has three variants, viz., (a) gross product variant, (b) income variant, and (c)
consumption variant. These variants, as presented in a schematic diagram given
below could be further distinguished according to their methods of calculation, viz.,
addition method and subtraction method. The subtraction method could be further
divided into :
(a) direct method
(b) intermediate method and
(c) indirect method.
Different variants of VAT
Gross product variant Income variant Consumption variant
Tax levied on all sales with Tax levied on all
no deduction for capital Tax levied on all sales sales with deduction
inputs. with set-off for for all business
Addition method Invoice method Subtraction method
Aggregating all the factor Deducting tax on inputs
from tax on sales for
payments and profit.
each tax paid
Direct subtraction Intermediate
method subtraction method
Deducting aggregate value Deducting tax inclusive
of purchase exclusive of tax value of purchases from the
from the aggregate value of sales and taxing difference
sales exclusive of tax between them.
The gross product variant allows deductions for taxes on all purchases of raw
materials and components, but no deduction is allowed for taxes on capital inputs.
That is, taxes on capital goods such as plant and machinery are not deductible
from the tax base in the year of purchase and tax on the depreciated part of the
plant and machinery is not deductible in the subsequent years. Thus, deducting
aggregate tax-exclusive value of purchase from the tax exclusive value of sales
the economic base of gross product variant is equivalent to Gross National
Product. In this variant of VAT capital goods carry a heavier tax burden as they are
taxed twice. Modernization and upgrading of plant and machinery is delayed due
to this double tax treatment.
The income variant of VAT on the other hand allows for deductions on purchases
of raw materials and components as well as depreciation on capital goods. This
method provides incentives to classify purchases as current expenditure to claim
set-off. Net investment (i.e., gross investment minus depreciation) is taxed and,
therefore, the economic base of the income variant is equivalent to the Net
National Product. In practice, however, there are many difficulties connected with
the specification of any method of measuring depreciation, which basically
depends on the life of an asset as well as on the rate of inflation.
Consumption variant of VAT allows for deduction on all business purchases
including capital assets. Thus, gross investment is deductible in calculating value
added. The economic base of the tax, therefore, is equivalent to the total private
consumption. It neither distinguishes between capital and current expenditures nor
specifies the life of assets or depreciation allowances for different assets. This
form is neutral between the methods of production; there will be no effect on tax
liability due to the method of production (i.e. substituting capital for labour or vice
versa). The tax is also neutral between the decision to save or consume.
Among the three variants of VAT, the consumption variant is widely used. Several
countries of Europe and other continents have adopted this variant. The reasons
for preference of this variant are:
First, it does not affect decisions regarding investment because the tax on capital
goods is also set-off against the VAT liability. Hence, the system is tax neutral in
respect of techniques of production (labour or capital-intensive).
Secondly, it is more in harmony with the destination principle. Hence, in the foreign-
rade sector, this variant relieves all exports from taxation while imports are taxed.
Finally, the consumption variant is convenient from the point of administrative
expediency as it simplifies tax administration by obviating the need to distinguish
between purchases of intermediate and capital goods on the one hand and
consumption goods on the other hand.
In practice, therefore, most countries use the consumption variant. Also, most VAT
countries include many services in the tax base. Since the business gets set-off for
the tax on services, it does not cause any cascading effect.
VAT is being implemented either under “origin” or “destination” principle. Under the
'origin principle', value added domestically on all goods whether they are exported
or internally consumed is subjected to tax. Consequently, tax cannot be levied on
value added abroad and this principle confines VAT only to goods originating in the
country of consumption. In short, exports are taxable under this principle while
imports are exempt. It is mostly used in conjunction with income VAT and is
unpopular for obvious reasons.
Under 'destination principle', value added irrespective of the place of origin is
taxable. All goods are taxed if they are consumed within the country. In this regime,
exports are exempt while imports are subjected to tax. Destination principle is
normally used along with consumption VAT. In a federal set-up like India,
destination principle is preferred for taxation of products consumed within the
various States of the country, Another attractive feature of this principle is that it
treats imported goods at par with domestic products unlike the origin principle
which gives indirect protection and even preference to the producers abroad, The
origin' principle amounts to unfair treatment of domestic producers which is
economically and politically inadvisable. In the EEC countries, origin principle was
once considered for eliminating border controls and problems of valuation, but was
subsequently given up as being impractical and destination principle is now
2.3 Methods for computation of tax
There are several methods to calculate the 'Value Added' to the goods for levy of
tax. The three commonly used methods are
(a) addition method,
(b) invoice method and
(c) substraction method.
This method aggregates all the factor payments including profits to arrive at the
total value addition on which the rate is applied to calculate the tax. This type of
calculation is mainly used with income VAT. Addition method does not easily
accommodate exemptions of intermediate dealers. It is also not suitable for
exempting exports and valuation of imports under the destination principle.
Another drawback of this method is that it does not facilitate matching of invoices
for detecting evasion.
This is the most common and popular method for computing the tax liability under
'VAT' system. Under this method, tax is imposed at each stage of sales on the
entire sale value and the tax paid at the earlier stage is allowed as set-off. In other
words, out of tax so calculated, tax paid at the earlier stage i.e., at the stage of
purchases is set-off, and at every stage the differential tax is being paid. The most
important aspect of this method is that at each stage, tax is to be charged
separately in the invoice. This method is very popular in western countries. In India
also-, under Central Excise Law this method is followed. This method is also called
the 'Tax Credit Method' or 'Voucher Method'. From the following illustration, the
mode of calculation of tax under this method will become clear:
Less Tax to
Stage Particulars VAT Govern-
1. Manufacturer/first seller in the State 125 - 125
sells the goods to distributor for
Rs.1000. Rate of tax is 12.50%.
Therefore, his tax liability will be
Rs.125. He will not get any VAT
credit, being the first seller.
2. Distributor sells the goods to a 150 125 25
wholesale dealer for say Rs. 1200
@ 12.50% and will get set-off of tax
paid at earlier stage at Rs. 125. His
tax liability will be Rs. 25.
3. Wholesale dealer sells the goods to 187.50 150 37.50
a retailer at say Rs. 1500. Here
again he will have to pay the tax on
Rs. 1500. He will get credit of tax
paid at earlier stage of Rs. 150. His
tax liability will be Rs. 37.50.
4. Retailer sells the goods to 250 187.50 62.50
consumers at say Rs. 2000. Here
again he will have to pay tax on Rs.
2000. He will get credit for tax paid
earlier at. Rs. 187.50. His tax
liability will be Rs.62.50.
Total 712.50 462.50 250
Thus, the Government will get tax on the final retail sale price of Rs. 2,000.
However, the tax will be paid in instalments at different stages. At each stage, tax
liability is worked out on the sale price and credit is also given on the basis of tax
charged in the purchase invoice. If the first seller is a manufacturer, he gets the
credit of tax paid on raw materials, etc. which are used in the manufacturing. From
the above illustration, it is clear that under this method tax credit cannot be claimed
unless and until the purchase invoice is produced. As a result, in a chain, if at any
stage the transaction is kept out of the books, still there is no loss of revenue. The
department will be in a position to recover the full tax at the next stage. Thus, the
possibility of tax evasion, if not entirely ruled out, will be reduced to a minimum.
However, proper measures should be implemented to prevent the production of
fake invoices to claim the credit of tax at an earlier stage.
It is said that in this method the beneficiary is the trade and industry because in the
above example, the total tax collection at all the stages is Rs.712.50 whereas tax
received by the State is only Rs. 250. The set-off available is also tax paid. If the
profit margin is to be kept at the constant level then the set-off will have to be
considered to avoid cascading effects of taxes.
While the above-stated invoice or tax-credit method is the most common method
of VAT, another method to determine the liability of a taxable person is the cost
subtraction method, which is also a simple method. Under this method, the tax is
charged only on the value added at each stage of the sale of goods. Since the total
value of goods sold is not taken into account, the question of grant of claim for
set-off or tax credit does not arise. This method is normally applied where the tax is
not charged separately. Under this method for imposing tax, 'value added' is
simply taken as the difference between sales and purchases. The following
illustration will make the working of this system clear:
Particulars for tax
No. @ 12.50%
First seller sells the goods to a distributor 1,125 125
at say, Rs. 1125 inclusive of tax
Distributor sells the goods to a whole-seller 225 25
2. at say, Rs.1,350. Here taxable turnover will
be Rs.1,350 - Rs.1,125
Wholesaler sells the goods to a retailer at 337.50 37.50
3. say, Rs 1,687.50. Here taxable turnover
will be Rs. 1,687.50 - Rs. 1,350
Retailer selling the goods at say, Rs. 2250. 562.50 62.50
Taxable turnover will be' Rs.2250 - Rs.
Tax is calculated by the formula T×R
100 + R
T = Taxable turnover, R = Rate of Tax
Thus, under this system also, the incidence of tax is at each stage and the
incidence of tax on the final sale price to the consumer will remain the same as in
the earlier method. However, this holds good till the time the same rate of tax is
attracted on all inputs, including consumables and services, added at all the stages
of production/distribution. If the rates are not common, then the final tax by the two
methods may differ. The method is being objected to by arguing that under this
method, tax is levied on income. The value addition at each stage may not be only
due to profit but may be partly due to freight/transportation and other services. The
incidence of tax is on the sale of goods. However, the mode of calculation of
taxable turnover is value added. Therefore, the method cannot be said to be
imposing tax on income/profit.
2.4 Rate Structure under VAT
VAT can operate either with a single rate or with multiple rates. When multiple
rates are used, in addition to zero-rate, lower rates are prescribed for granting
concessions. Multiple rates conveniently allow preferential treatment to certain
commodities, firms or sectors and a zero rate is normally applied to exempt mass
consumption Articles. Generally, luxuries are taxed at a rate higher than the
normal rate to curb consumption and make the tax structure more progressive.
Such a rate of differentiation can achieve the objective of tax policy only at the
retail level in tax credit method when the commodity or service is finally passed on
to the consumer. Multiple rates have no impact if they are applied at earlier stages
as they only make the producer or wholesaler pay lesser tax on the value addition.
The retailer subsequently gets a smaller tax credit against the standard rate which
is invariably higher than the tax liability at earlier stages.
Under the subtraction method, it is possible to apply different rates at each stage of
transaction. With multiple rates, there is a heavy burden on the retailer as he is
required to maintain a complete account of exempted goods, goods having
concessional rates, standard rates, source of purchase, etc. which increases the
cost of compliance and even induces unintended evasion. Therefore, it is
suggested that a single rate of tax is preferable despite its inherent regressivity.
However for varied reasons, this is not possible. More than half of the total number
of VAT operating countries now use two to four rates.
2.5 Merits and demerits of VAT
It has been explained earlier that when compared to the other systems of imposing
sales tax on a transaction of sale, VAT has an edge over them. The working of VAT
is quite simple. This is one of the reasons as to why a host of other countries
adopted the system. The other merits of VAT are explained below. However it
should be carefully noted that the following merits will accrue in full measure only
under a situation where there is only one rate of VAT and VAT applies to all
commodities without any question of exemptions whatsoever. Once concessions
like differential rates of VAT, composition schemes, exemption schemes,
exempted category of goods etc. are built into the system, distortions are bound to
occur and the fundamental principle that VAT will totally eliminate cascading
effects of taxes will also be subject to qualifications.
The greatest advantage of the system is that it does not interfere in the choice of
decision for purchases. This is because the system has anti-cascading effect. How
much value is added and at what stage it is added in the system of
production/distribution is of no consequence. The system is neutral with regard to
choice of production technique, as well as business organisation. All other things
remaining the same, the issue of tax liability does not vary the decision about the
source of purchase. VAT facilitates precise identification and rebate of the tax on
purchases and thus ensures that there is no cascading effect of tax. In short, the
allocation of resources is left to be decided by the free play of market forces and
competition. A significant factor in the importance attached to VAT in the EU
countries is its ability to treat intra-community trade as also trade with other
countries with complete neutrality, that too without any distortion by taxation. This
is possible when the VAT is applied where the goods are consumed and not at a
place where goods are produced. In the federal structure of India in the context of
sales-tax, so long as Central VAT is not integrated with the State VAT, it will be
difficult to put the purchases from other States at par with the State purchases.
Therefore, the advantage of neutrality will be confined only for purchases within
Certainty and transparency
The VAT is a system based simply on transactions. Thus there is no need to go
through complicated definitions like sales, sales price, turnover of purchases and
turnover of sales. The tax is also broad-based and applicable to all sales in
business, thus there is little room for different interpretations. Similarly, due to the
basic feature that it gives credit of tax paid on earlier stage, the buyer will always
ask for invoice. Thus the scope of tax avoidance or evasion will be much less. The
disputes will also be fewer. Thus, this system brings certainty to a great extent. So
also, the buyer knows, out of the total consideration paid for purchase of material,
what is tax component. Thus, the system ensures transparency also. Besides, this
transparency will enable the State Governments to know as to what is the exact
amount of tax coming at each stage. Thus it will be a great aid to the Government
while taking decisions with regard to rate of tax etc.
Harmonized system of taxation
VAT became popular because of its built-in advantage of harmonizing the tax
structure. It leaves very small room for interpretation. Even the entries prone to
varied interpretations, under 'VAT, do not make any difference either to dealers or
the Government. Ideally under VAT, there should be only one basic rate. In any
case, typically, VAT involves lowering the number of tax slabs/rates resulting in
reduction of litigation.
Better revenue collection and stability
The Government will receive its due tax on the final consumer/retail sale price.
There will be a minimum possibility of revenue leakage, since the tax credit will be
given only if the proof of tax paid at an earlier stage is produced. This means that if
the tax is evaded at one stage, full tax will be recoverable from the person at the
subsequent stage or from a person unable to produce proof of such tax payment.
Thus, in particular, an invoice of VAT will be self enforcing and will induce business
to demand invoices from the suppliers. Another attribute of VAT is that it is an
exceptionally stable and flexible source of government revenue. The stability of
VAT as a revenue source stems from the fact that if consumption is less volatile the
income system provides a flexible instrument of taxation, since it is collected on a
current basis. The decision about revenue can also be taken correctly as variance
in rate of tax has direct relation with revenue collection.
Better accounting systems
Since the tax paid on an earlier stage is to be received back, the system will
promote better accounting systems.
Effect on retail price
A persistent criticism of the VAT form has been that since the tax is payable on the
final sale price, the VAT usually increases the prices of the goods. However, there
appears to be no intrinsic reason as to why VAT should have any inflationary
impact if it merely replaces the existing equal yield tax. It is possible that the final
price under the VAT system may not be more than the price under the sales tax
system. A survey of the price effect of introducing VAT in more than 130 countries
resulted in a conclusion that in more than 80% countries it did not alter the rate of
inflation. It may also be pointed out that with the introduction of VAT, the tax impact
on raw material is to be totally eliminated. Therefore, there may not be any
increase in the prices. So far India is concerned what happened to the prices of
goods in the several States where State-Level VAT was introduced is worthy of
serious consideration and debate because it has created a negative psychological
impact in the minds of the general public.
Cost of administration to State
Another point which needs consideration is the question of the cost of
administration to the State. Because of introduction of VAT, the administration cost
to the State can increase significantly as the number of dealers to be administered
will go up significantly. However, this increase is required to be evaluated against
the likely gains under the VAT.
Compliance cost to the dealers
It is argued that for compliance with the VAT provisions, the accounting cost will
increase. The burden of this increase may not be commensurate with the benefit to
traders and small firms. Though under sales-tax laws, it may be stated that a
transaction of sale is liable to tax, but for the purposes of liability, the purchase
nucleus is required to be found out. If the purchases are from a registered dealer, it
will be a resale. If purchases are from outside the State, the sale will be a first sale.
Therefore, even without the introduction of VAT, for taxation of a sale transaction,
the source of purchase has to be considered. Under the VAT also, a detailed
account of the purchase will have to be maintained. Therefore, there may not be
significant increase in the cost as compared with the present cost. In any case, the
inherent benefit of simplicity of the system will overcome this difficulty.
Increase in working capital requirement
Another possible weak point in the introduction of VAT, which will have an adverse
impact on it is that, since the tax is to be imposed or paid at various stages and not
on last stage, it would increase the working capital requirements and the interest
burden on the same. In this way it is considered to be non-beneficial as compared
to the single stage-last point taxation system. This position may depend upon the
facts of each case. But the experience of MODVAT under excise law shows that,
as a whole a full VAT is likely to bring in much more cash flow benefit. The credit for
tax paid on goods lying in stock at the year end but sold in the next year may be
used for paying the tax on sale.
VAT is a form of consumption tax. Since the proportion of income spent on
consumption is larger for the poor than for the rich, VAT tends to be regressive.
However, this weakness is inherent in all the forms of consumption tax. While it
may be possible to moderate the distribution impact of VAT by taxing necessities
at a lower rate, it is always advisable to moderate the distribution considerations
through other programmes rather than concessions or exemptions which create
complications for administration and compliance with uncertain
Chapter – 3
Federal Structure and Tax Systems in India
India has a government that combines the features of both a unitary and a federal
system. There are three tiers of government - the union government, the state
government and the local government - and all the three tiers are empowered to
levy taxes. These powers are enshrined in the Constitution of India. The Indian
Constitution assigns the powers of taxation more precisely and in greater detail
than most federal countries.! There are also provisions under which the legislature
of a state may authorize the local governments (panchayat or municipality) to levy,
collect and appropriate taxes, duties, tolls and fees in accordance with such
procedure and subject to such limitations as may be specified by law.
3.2 Tax structure
Tile main taxes included in the union list are personal and corporate income taxes
(except on income from agricultural land), taxes on wealth (except on agricultural
land), customs duties, and central excises (except excises on liquor and narcotics
and medical and toilet preparations that include alcohol). The union government is
also empowered to levy taxes on inter-state sales. Finally, the central government
has also the residual powers not otherwise assigned. The existing structure of the
union tax system, together with the major developments that have taken place in
the 1990s, is outlined below.
The union government currently levies income tax (individual and corporate
income taxes), tax on interest earnings, wealth tax, gift tax, customs duties, central
excises, central sales tax (CST) and service tax. For the purpose of income tax,
income is divided into five categories - salary, income from house property, profits
or gains from business or profession, capital gains, and income from other
sources. Also, companies are classified into two categories, domestic companies
(registered under the Indian Companies Act) and other companies.
The rate structure of both the individual income tax and the corporate income tax
has been rationalized considerably in the 1990s. For example, the top rate of
personal income tax for an individual, a Hindu undivided family; an association of
persons and bodies of individuals was reduced from 40 per cent in 1990-91 to 30
per cent by 1997-98. Similarly, the rate of corporate income tax for domestic
companies was reduced from 50 per cent in 1990-91 to 35 per cent by 1997-98
while the rate of corporate income tax for foreign companies was reduced from 65
per cent in 1990-91 to 48 per cent by 1997-98.
A minimum alternative tax (MAT) was introduced in the fiscal year 1996-97 in the
case of companies whose total income as computed under the Income-tax Act is
less than 30 per cent of the book profits as per the accounts prepared in
accordance with the Companies Act 1956. Such companies have to pay a 30 per
cent tax on the book profit. A system of presumptive income tax exists for specified
small income earners. The interest tax is levied on credit institutions on interest
earned on their loans at the rate of percent.
The wealth tax is levied on net wealth, which is the excess of assets over debts.
Net wealth up to Rs. 1,500,000 is exempt from tax, while the net wealth exceeding
Rs. 1,500,000 is subject to tax at a rate of 1 per cent.
The gift tax is levied on gifts, defined as transfers by one person to another of an
existing movable or immovable property made voluntarily and without
consideration in money or money's worth. It is levied not in respect of every gift but
in respect of the total taxable gifts made by a person during the year. Gifts up to
Rs.30, 000 are exempt and the rest is taxed at the rate of 30 per cent.
The union government levies customs duties on a large number of goods ranging
from industrial raw materials, machinery and equipment, to final goods like income
tax, customs duties have been rationalized considerably in recent years. The
numbers of rates have been reduced and the levels lowered in line with the liberal
economic policy adopted since the early 1990s. It was recognized by the
government that the dual objectives of protecting infant industries and raising
revenues have, over time, led to a customs duty structure where import duties on
certain items had reached as high as 300 per cent. It was proposed in 1991-92 to
reduce the ad valorem rate of basic plus auxiliary duties of customs to a
maximum of 150 percent. Rates of customs duties were reduced further over the
years and as per the 1997-98 budget, the peak rate of import duties has been fixed
at 40 per cent.
In addition, the central government levies countervailing duties equivalent to the
domestic excises on those goods that are subject to excise taxes if produced
domestically. These duties have also been rationalized over time as per changes
in the central excise duties. .
The union government also levies central excises on a wide range of commodities.
These are levied on both inputs as well as final products when they are removed
from factory premises, irrespective of whether they are immediately sold or stored
for future use. Central excises have been rationalized considerably in the recent
years and a movement towards a Modified Value Added Tax (MODVAT) is an
important step in the reform of excise duties because it allows for the rebate of
excises on inputs.
The service tax is levied at the rate of 5 per cent on the service charges collected
by the transporters of goods by road, consulting engineers, customs route agents,
steamer agents, air travel agents, clearing and forwarding agents, outdoor
caterers, manpower recruiting agencies/ consultants, tour operators including car
rentals, advertising agencies, the telegraph authority and the courier services.
The union government is empowered to levy a central sales tax on inter-state
trade, with a maximum rate of 4 percent on the purchases by registered vendors
and 10 percent by unregistered vendors. The revenue from this tax, however, goes
to the state collecting this tax. Similarly, the union government is also authorized to
collect additional excise duty in lieu of state sales tax on sugar, textiles and
tobacco products. This was adopted mainly as a tax harmonizing measure.
State level taxes
The main taxes in the state list are sales tax, excises on liquor and drugs,
agricultural income tax, land revenue and land registration fees. However, not all
states or union territories levy all the taxes assigned to them under the
Constitution. Sales tax is the most important tax at the state level. There is,
however, no uniformity among the states and union territories regarding the
structure and operation of the taxes they levy. This may be illustrated by
comparing the tax systems adopted by the Uttar Pradesh and the West Bengal
The Uttar Pradesh government levies a single-point sales tax, called 'trade tax'.
Tax points, however, differ depending upon the nature of the taxable commodity.
The tax is largely levied at the first point on the sale of importers and
manufacturers. However, in the case of a few items such as footwear, sweets,
confectionery, gold and silver ornaments, raw wool, tea and coffee, the trade tax is
levied on the last sale. On the other hand, it is levied on the first purchase in the
case of a few selected items, mainly agricultural products (food grains, cereals,
pulses, ghee, butter, cheese, jute, khandsari sugar, oil seeds, oil cake and rice
bran). All importers are required to register for the purpose of this tax, irrespective
of the level of turnover. It is mandatory to register for manufacturers with annual
turnover above Rs. 100,000 and traders with turnover above Rs. 150,000. Tax
rates range from 1.5 per cent (light commercial vehicles) to 26 per cent. The
general rate is 8 per cent, applicable to all items that are not specifically mentioned
in the Schedule. There is a 25 per cent surcharge on the existing rates.
The West Bengal government levies sales tax on the sale by manufacturers,
processors or importers. It also levies a tax at the last point with multi-point taxation
at low taxes on intermediate sale transactions. This means that the full rate of tax is
not levied on the intermediate stages. Under this system, if the buyer gives the
declaration form to the seller, then the seller may charge a reduced rate of 2 per
cent for most of the items. This is meant to provide an incentive for registration and
to minimize disadvantages of multiple taxation, including cascading. Vendors have
to register for sales tax when their gross turnover exceeds the taxable quantum
within an accounting year. The taxable quantum specified for different categories
of dealers is as follows: Rs. 30,000 for importers, Rs. 100,000 for manufacturers or
producers, and Rs. 500,000 for retailers. There are eight rates, ranging from 2 to
20 per cent (2, 3, 4, 5,7,12,15 and 20 per cent).
The Uttar Pradesh government levies a sugar purchase tax on the purchase of
sugarcane while the West Bengal government levies a coal cess. Uttar Pradesh
levies a luxury tax on hotels and an entertainment tax on the entrance fees to
cinema halls with permanent structure, subscription fees of cable TV and other
means of entertainment, such as horse-riding, dance, singing, sailing, musical
parks, amusement parks, video libraries, video game parlours, etc., West Bengal
also levies a similar tax under the name of amusement tax.
State governments also levy excise duties. These duties are levied on such items
as liquor; spirit, opium, ganja, bhang, hashish, beer and tax rates vary from
commodity to commodity. States are empowered to levy taxes on goods and
passengers. The passenger tax, in its pure form, is to be levied .on passenger
fares paid for commercial transport services. The goods tax is to be levied as a
percentage of the freight paid by a consignor to the transport agency which, in turn,
remits the tax collected to the concerned tax authorities. The rate is 10 per cent.
This tax can also be paid as a compounded levy at the option of the taxpayer.
Taxes and duties are also levied on the sale and use of electricity. The electricity
board collects the tax and passes it on to the state government. The rates are the
highest on commercial use, lower on domestic consumption and the lowest on
agricultural use. State governments also levy vehicle taxes on various types of
vehicles, the tax rates depending upon the type, weight and capacity of the
State governments are also empowered to levy land revenue, stamp duty and
registration fees land revenue has been the traditional source of revenue of the
state governments in India. In general, land revenue rates have not been revised
for a long time. Stamp duty is levied on the instruments of transactions, while
registration fees are levied on transactions relating to movable and immovable
property. Registration fees are on top of the stamp duty. Stamp duty is a tax and it
comes under the sovereign power of the state, while registration fees are the
charges for services rendered by the state. States are also empowered to levy a
tax on agricultural income. This tax has' not been generally effective. A tax on
professions, trades, vocations and employment is levied on persons engaged in
employment and the employers deduct it from the salary or wages.
Local governments are also empowered to levy taxes. For example, Calcutta and
Lucknow Municipal Corporations levy taxes on property, trades, professions and
vocations, advertisement, carts, carriages and vehicles. Both these municipal
corporations generate the bulk of their revenues from the property-based taxes. In
Calcutta, property tax is known as the 'consolidated rate on lands and buildings,
while in Lucknow it is known as the general tax. In Calcutta Municipal Corporation,
this tax is levied on the annual value of the land and buildings, generally based on
the rental values. The Lucknow Municipal Corporation also levies property tax on
the annual rental value at the rate of 30 per cent.
Both the Calcutta and the Lucknow Municipal Corporations levy taxes on
advertisements and vehicles (cart and carriage). The Lucknow Municipal
Corporation levies tax on hotels, lodges, restaurants, sweet shops, small teas
hops, slaughterhouses and ponds while Calcutta Municipal Corporation, with the
approval of the State Government, levies a toll on vehicles at rates fixed by the
3.3 Collection and sharing of revenues
The Indian Constitution has detailed provisions for the sharing and distribution of
revenues generated from various taxes. Some taxes are collected by the union
government and the revenues are used entirely by the union government itself
(customs duties) while some taxes are levied and collected by the central
government and tax proceeds are shared between the union and the states
(personal income tax and union excises). There are some duties levied by the
union but collected and appropriated by the states, such as central sales tax.
Customs duties are an important source of revenues for the union government
while sales tax is the major source of revenue of state governments. Of the other
state level taxes, state excises, stamp duties and registration fees are more
important from the point of view of revenue. As in many developing countries, the
overall tax/GDP ratio for the country is comparatively low.
It is important for India to enhance its resource mobilization and increase the
tax/GDP ratio in the years to come. Additional revenues have to be generated in
such a way that the industry and trade sectors do not become less competitive.
While there may be some scope for the mobilization of additional resources
through direct taxes, the country will have to depend more on indirect taxes. As
there is a trend to lower the levels of customs duties in line with the liberal
economic policies, the relative importance of customs duties as a source of
revenue is likely to decline. This means that the major focus of tax reform in the
country must be on domestic indirect taxation.
3.4 Domestic indirect taxes
As outlined above, central excise duties are major form of domestic indirect taxes
levied by the union government. Unlike many countries that levy excise duties on a
few selected items, generally tobacco products and alcoholic beverages, India
levies central excises on a wide range of commodities. Excise duties are levied on
both inputs as well as final products. India has, perhaps, one of the most
comprehensive excise tax systems in the world. The constitutional exclusion of
sales tax from the federal tax base might have led to the proliferation of excises to
a much wider base than originally envisaged. While the rates of the excises have
been rationalized considerably in the recent years, their structure is still very
complex. In addition, the union government levies a service tax on specified
services and a sales tax on inter-state trade. It is also empowered to collect sales
tax in lieu of the additional excise duty on three commodities, namely sugar,
textiles and tobacco products.
Sales tax, including sales tax on motor spirit and purchase tax on such items as
sugarcane, is the most important tax levied by the States and Union Territories.
Sales tax revenue accounts for about 60 per cent of the states' own tax revenue.
The structure and operation of the sales tax varies considerably among the states
regarding point of collection, coverage, tax incentives and rate structure.
Point of levy
Sales taxes are collected at various stages in different states. For example,
Karnataka and Kerala levy multi-point tax on a few commodities. Gujarat has
adopted a double-point sales tax. Under this system, the tax is levied both at the
first sale as well as at a semi-wholesale stage of sale on some commodities.
Maharashtra had adopted a similar sales tax system before it adopted a VAT in
1995. Under the previous system, the tax was levied at the manufacturing/import
point on a large number of commodities and at the last point on a few commodities,
such as precious stones, imported liquor and natural gas.
The sales tax, however, is collected generally at a single point. The bulk of the
revenue is collected at the first point, probably on administrative grounds, bearing
in mind the large number of vendors who may not maintain proper accounts. Under
the first point sales tax system, bulk of the revenues can be collected from a small
number of large dealers and their records can be thoroughly scrutinized. On the
other hand, the returns of the small dealers who make only a marginal contribution
to revenues can be summarily assessed. Under this system, the costs of collection
and compliance are lower and administration is easier and more effective.
However, the first-point tax suffers from several theoretical limitations and practical
problems. For example, since the first-point tax has a lower taxable base than the
last-point tax, i.e. retail sales tax (RST) or VAT, it has to be levied at a higher rate
for collecting the same amount of revenues. Higher rates make the tax system
more costly to the economy. Such a tax system encourages taxpayers to change
the methods of doing business and some firms have shown the tendency to push
functions and, thereby cost, beyond the point of impact of the tax. Also, there is a
possibility of tax being levied upon tax under the first-point levy. When the tax is
levied both on inputs and outputs it leads to cascading. In this case, even the cost
of holding inventories may go up leading to higher interest payments and
additional cascading. Furthermore, the first-point tax without the provision of
set-off encourages vertical integration of firms. This works against the goal of
promoting ancillaries in the economy. The first-point tax also leads to pyramiding of
taxes wherein the application of percentage markups on tax-inclusive prices raises
the prices paid by consumers by more than the amount of tax. The first-point levy is
not desirable from the point of view of foreign trade as well since the export prices
contain tax elements, thereby making these goods less competitive in the
The first-point tax is also not always easy from an administrative point of view. For
example, it gives an incentive for under valuation and smuggling of goods. Beside,
the first-point tax also has made tax administration more complex through the
establishment of the checkpoints. In order to ensure that the tax has been paid on
the first transaction, most states have established checkpoints on their borders
with neighbouring states where vehicles are required to stop and provide evidence
of payment of tax on commodities being carried. This often leads to delays,
increase in costs, harassment and corruption. These checkpoints are sometimes
justified on the ground that they serve the purpose of monitoring the flow of goods
into the state. This is not necessarily true. A complete checking of all trucks is not
practical and it is possible to avoid the check posts altogether. Also, rail shipments
are usually not checked when they enter the State. Finally, the first point tax invites
pressure from interested groups for the exemption of their products from the tax
due to its high rates.
The first-point levy also is criticized on equity grounds. Since the proportion of
value added at later stages and at earlier stages of production differ from commodity
to commodity, the first-point tax is biased against those commodities, which have
larger value, added at the earlier stages of production. In particular, there is an
unintended bias in favour of such commodities as consumer durables that
generate a substantial value-added at stages beyond the tax impact point. Thus,
the first-point sales tax may tend to encourage the consumption of luxury goods.
Coverage of sales tax
State governments levy sales taxes on a large number of commodities, including
raw materials and other inputs. Input taxes, however, suffer from several
limitations. To begin with, input taxes are cascading in nature and promote vertical
integration. They cause distortion in choice of inputs and thus lead to inefficiency.
A tax element remains in the export prices, thereby making domestic products less
competitive in the international markets. They also cause pyramiding of prices
from application of percentage markups. Further, input taxes give rise to
uncontrolled and unintended incidence of taxation on various goods. Taxes on
inputs tend to be inequitable as well.
On the other hand, a large number of goods are exempt from sales taxes in different
states on various grounds, including social, cultural and religious. Exemptions,
however, are not effective in achieving their objectives but bring several undesirable
results. They narrow the tax base, thereby making it necessary to levy higher rates
on taxable items. Higher rates, in turn, give an incentive for tax evasion. Exemptions
also create loopholes for tax evasion. Since tax exemptions affect the choices of
both the producers and consumers, they bring inefficiency both in production and
consumption. A plethora of exemptions also complicates tax administration and
increases both costs of collection and compliance costs.
There is a tendency among the states to lower their tax rates in order to lure
businesses. Often, very generous concessions are provided to industrial units set
up in backward areas or small industries in rural areas through tax holidays and
deferral of tax payment This leads to loss of revenues, creates inequity and causes
problems for both enforcement and compliance. As the base becomes narrow due
to different kinds of concessions, the tax rates have to be higher in order to collect
the same amount of revenue. This creates further incentive for evasion.
On the other hand, tax incentives have not proved to be effective measures for
promoting industries. Other means of encouragement, such as subsidies and
sub-venation (a type of subsidy to support industry) rather than exemption from
sales tax, may be more suitable. This has also been the finding of several
committees appointed by the government of India from time to time. .
The state governments have usually applied multiple rates of sales tax on various
grounds, including social justice in some cases. For example, there are eight
different rates of sales tax in West Bengal. Maharashtra levied sales tax with over
20 rates before its replacement by VAT in 1995. Further, with each state having
different lists of exemptions, providing a variety of incentives and applying varying
standards of enforcement of the tax, the effective tax rates are widely different
among the states.
Such rate differences cause resource misallocation. This leads to migration of
capital from high-tax to low-tax regions over time. It may also result in cost
escalation due to reallocation of resources among states contrary to their own
endowments and involve avoidable transportation costs of raw materials and
finished products. Further, multiple rates make tax administration more
complicated since, under this system, goods are classified into different groups
according to their rates. Taxpayers have to keep separate records and tax officials
have to check them. It increases both administrative and compliance costs. It may
also be inequitable since a dealer may charge different rates on the same goods
sold to different categories of buyers. There is also the possibility of a dealer
charging a higher rate for an item subject to lower rate and vice versa, either
knowingly or out of ignorance.
Thus, multiple rates tend to bring economic and administrative inefficiency and
may result in considerable revenue loss.
As stated earlier, the central government is empowered to levy sales tax on
inter-state trade. This tax is levied on declared goods (goods of. importance to
inter-state trade such as iron and steel, hide and skins, jute and coal) by the CST
Act. According to a government report, the CST was initially intended to ensure
that some revenue accrues to exporting states without raising unduly the burden
on consumers in the importing state. Since this provision authorizes a given state
to tax citizens of other states, it was considered necessary to keep the rate very
low (1 per cent). However, the original purpose of CST was forgotten over the
years. The rate has been raised in stages to 4 per cent on registered dealers and
10 per cent on unregistered dealers in order to generate more revenue from this
CST suffers from several limitations. It is clearly a' hindrance to the free flow of
trade across state borders. Also, when the goods are subsequently sold in the
importing state, the tax of that state applies. As a result, the inter-state transactions
are taxed more heavily compared to the transactions within the state. In effect, the
operation of the domestic common market is disrupted.
CST also allows the manufacturing states to burden consumers in the less wealthy
States, which means that resources are transferred 'from poor to rich States.
Because of these disadvantages of CST, the Jha Committee recommended the
reduction of CST from 4 per cent to 1 per cent. Something needs to be done about
the CST to make the tax system neutral to trade and business decisions, externally
and internally, by removing the distorting elements and moving towards a
free-market regime. Traders discovered various means of escaping CST on
inter-State sales by establishing distribution units in the importing States, and
sending goods to them on consignment basis.
Need to reform domestic indirect taxes
The structure of the domestic indirect taxes is highly distortive and leads to
cascading of tax, it has become confusing and complex. It is necessary to
establish a tax system that is simple, transparent and neutral, and that facilitates
free movement of goods. To this end, it would be necessary to evolve a tax system
with minimum rate differentiation. Also, the point of levy should be moved closer to
consumption rather than production. The tax burden on inputs should be reduced
and eventually removed altogether.
3.5 Recommendations of various Committees on tax reforms
One option that has been considered for quite some time is the introduction of
some form of a VAT in place of several indirect taxes. Many tax reform
committees, institutions and individual researchers have recommended VAT in
order to avoid the problems of multiple taxation and also to rationalize the whole
domestic indirect tax system of India. Important views of various committees on
domestic indirect taxes, including introduction of VAT, are briefly summarized
The Indirect Taxation Enquiry Committee of 1976 (Jha Committee) examined the
various aspects of VAT and the possibility of introducing this tax in India. While the
committee recognized that a VAT in place of the existing systems would have
several economic advantages, it also pointed out two main problems in its
implementation first, there is a political problem. A general VAT in place of various
commodity taxes (including the state level sales taxes) requires an amendment of
the Constitution and would undermine the fiscal autonomy of the State
governments. Second, there might be an administrative problem, as the
wholesalers and retailers would find it difficult to cope with the accounting
requirements of VAT. The committee, therefore, recommended a manufacturing
level VAT (MANVAT). According to the committee, the main advantage of
MANVAT would be that it would altogether eliminate cascading on account of
taxation of raw materials and other inputs. The tax levied on a final product would
be the total tax on it and the tax on inputs at earlier stages will not affect its cost or
A Technical Study Group on Central Excise Tariff was set up in 1985 in order to
examine the cascading effect of indirect taxes and explore the measures to
mitigate them. This group examined various schemes adopted to avoid multiple
taxation and came to the conclusion that the general extension of the Proforma
credit procedure to all excisable goods, including packing materials and
consumables, would lead to a virtual adoption of VAT at the manufacturing level.
The general extension of Proforma credit procedures would prepare the ground for
the introduction of MANVAT.
Long-term fiscal policy
A long-term fiscal policy was announced in November 1985. This policy
emphasized the simplification of the multitude of rates and exemptions under the
excise system and undertaking of major strides in relieving the taxation of inputs in
production through different measures, including the adoption of a MODVAT.
The Tax Reforms Committee, 1991, set up under the chairmanship of Professor
Raja J. Chelliah further examined VAT. This committee "underlined the need for
making the system of indirect taxation broadly neutral in relation to production and
consumption, widening the tax base by covering exempted commodities and
making a beginning with the taxation of services. The ultimate objective of the
reform of the central excise is to move towards a full-fledged VAT system at the
central level covering almost all commodities other than raw produce of agriculture
and many, if not most, services. In order to prepare the ground for introducing the
genuine VAT system at the manufacturing level, the committee had suggested
reduction in the multiplicity of rates of excise duties to two or three rates, say at 10,
15, or 20 per cent." This tax could be supplemented by a selective excise duty on
non-essential commodities or commodities injurious to health.
According to the Chelliah Committee, the ideal solution would be to have a single
VAT at the central level, reaching down to the retail stage in replacement of most
indirect taxes like the state sales taxes, the municipal octroi, the goods and
passengers tax and the electricity duty while sharing the proceeds of the VAT
among the three levels of government. In the interim period the scope of MODVAT
was to be extended in order to establish a genuine VAT at the manufacturing level.
The committee recommended several measures, such as conversion of specific
rates of excises into ad valorem rates, abolition of exemptions, and inclusion of
selective services into the tax net for the successful implementation of a VAT. This
committee went one step further than the Jha Committee by recommending an
extension of VAT to the wholesale stage. The wholesale level VAT could be
administered by the state, and the revenue collected could be retained by the state
where it is collected.
Chapter – 4
VAT in Indian Federation
India's indirect tax system is unique in that under the Constitution, the Central
government has the authority to impose a broad spectrum of excise duties on
production or manufacture while the States are assigned the power to levy sales
tax on consumption. In addition, States are empowered to levy tax on many other
goods and services in the form of entry tax, octroi, entertainment tax, electricity
duty, motor vehicles tax, passengers and goods tax and so on. Due to this
dichotomy of authority under the Constitution, India has been rather slow in the
adoption of VAT. Also, it has created an obstacle in introducing the European-style
VAT in India, although over the years, tax reform committees have recommended
that central excise duty, sales tax, and other' domestic trade taxes be replaced by
a comprehensive VAT that could tax all commodities and services.
At the Central level, at the time of Independence, India inherited a system of
commodity taxes in which Union excise duties (UEDs) were levied on about a
dozen articles yielding a small proportion of total tax revenue to the Centre.
Following Independence, the rates were raised, the base was enlarged, and more
and more items were brought into' its net. Over time, there was a speedy extension
of UEDs. It was not only levied on finished goods but also covered raw materials,
intermediate goods and capital goods.
Structure of CENVAT
As of now, the Central Government levies basic UEDs on all goods manufactured
or produced in the country. The prevailing structure includes (i) CENVAT (also
called UEDs), (ii) special excise duty (SED), (iii) additional excise duty in lieu of
sales tax [AD(ST)]; (iv) additional duty of excise on textiles and textile articles [AD
(T&TA), and (v) cesses on specified commodities.
The additional duty of excise in lieu of sales tax [AD(ST)] is levied on tobacco,
textiles and sugar. This is a tax rental arrangement between the Centre and the
States. According to this arrangement the central government levies additional
excise duty in lieu of sales tax and the States refrain from levying sales tax on
these items. The net proceeds of this duty were being distributed among the States
until the Report of the Eleventh Finance Commission, which has recommended its
inclusion under the sharable taxes.
Cesses on specified commodities and. additional excise duty on textiles and textile
articles are primarily meant to raise resources for the development of concerned
industries. The revenue department administers it but some other departments
also contribute in this endeavour.
With effect from March 1, 1986 MODVAT was introduced under the union excise
duty as a system of giving credit for excise duty on inputs. Initially, it was
introduced for a selected number of commodities. The coverage was limited to 37
chapters out of a total of 91. Over time, MODVAT was extended and finally
replaced by Central VAT, known as CENVAT in the Budget 2000-01. CENVAT has
in general a single rate of 16% with some variations for select commodities. The
coverage of CENVAT has been extended to all commodities except high-speed
diesel (HSD), motor spirit (petrol) and matches. In addition to general rate, there
are three rates of special excise duty (SED) of 8%, 16% and 24% on specified
Most of the items under SED are final products but some of the items also fall in the
category of intermediate goods.
The CENVAT Scheme allows instant credit for excise duty, special excise duty
(SED), ADE and countervailing duty (CVD) paid on inputs and capital goods
received in a factory for the manufacture of any dutiable final products (except
matches). The credit could be utilised to pay excise duty on any final product. That
is, all raw materials or inputs are covered except high-speed diesel and motor
spirit. Similarly, credit could be availed of on capital goods including pollution
control equipment, components, spares, accessories, moulds and dyes and
paints, packaging material and greases/coolants.
Through the introduction of CENVAT credit could be availed of by the
manufacturer immediately on receipt of eligible and duty paid goods in the factory.
There is no need for the manufacturer to file any declaration or obtain any
permission. For capital goods, however, only 50% of the duty paid on the goods
can be availed of in a financial year; the remaining credit can be availed of in the
next financial year, provided the goods are still in use (except for spares and
components). Further, no depreciation should be claimed by the manufacturer
under section 32 of the Income-tax Act, 1961 on that part of the value of these
capital goods, which is equal to the duty, paid on the goods. A manufacturer who
manufactures only exempt final products is not allowed to take this credit.
However, the manufacturer producing both dutiable and exempted final products
in the same factory is eligible to avail of its benefits. This is subject to certain
conditions viz., maintenance of separate records in respect of inputs used to
manufacture exempted products or payment of 8% of the total price (excluding
taxes) of the exempted final products or in the case of a few specified items, on
reversal of the credit availed. Similarly, credit can be availed of on capital goods if
not used exclusively for the manufacture of exempted final products.
The scheme of CENVAT, interalia, provides the following facilities:
(i) Removal of inputs or capital goods as such on payment of excise duty as
if such goods had been manufactured in the factory;
(ii) Removal of goods to job-workers for processing, testing, reconditioning
or for any other purpose provided that the goods are received back within
180 days or are removed from the premises of the job worker if permitted
by the Commissioner of Central Excise;
(iii) Refund of credit accumulated due to export under bond of the final
products is also permissible;
(iv) Unutilised CENVAT credit can be transferred on account of shifting of a
factory to another site or due to change in ownership by sale, merger,
amalgamation, lease or transfer to a joint venture wherein liabilities are
also transferred; and
(v) A special dispensation has been made in the case of goods
manufactured in specified areas of the North-East.
The manufacturer should take reasonable steps to ensure that the appropriate
duty has been paid on inputs or capital goods on which credit is availed, as
indicated in the documents accompanying the goods.
The structure and procedures under CENVAT, as given above, indicates that the
new procedure results in transparency of the tax burden under the UEDs. In
addition, it reduces cascading effect of input taxation as well as the pyramiding
effect of the tax. Also, it generates a mechanism to check evasion of tax through
self-policing. The empirical studies on impact of introduction of CENVAT show that
there is a definite positive effect. In fact, the industrial units have been able to save
on interest (ranging between 0.5 and 1 percent of the total duty paid). Also, the
overall effect has been revenue neutral and has not caused any price effect.
In addition, the reforms implemented under UEDs during last ten years have
simplified its structure especially through CENVAT. While previously there were
large number of rates, over the years it has been brought down considerably. As of
today, the general rate of CENVAT is 16%. However, in many cases the actual
duty paid on inputs could be less than tariff rate through exemption notifications. In
addition, there are three rates category (viz., 8, 16, and 24 percent) of special
excises. These also are given credit for tax paid on inputs 13. Apart from
rationalisation of rate structure, exemption notifications have also been curtailed
and the specific rates are converted into ad volrem rates. Further, the rate
structure of CENVAT is linked to the Harmonized System of Nomenclature
(HSN), at present in vogue in more than 130 countries for providing help in
4.2 Administrative controls under CENVAT
The administrative controls under the UEDs (or the CENVAT) fall in some
categories, described below:
(a) Physical control:
This is the oldest form of control under the Union excise duty. Under this control,
there is an assessment of tax by the Central Excise Officer, posted at the factory,
before the removal of goods. Thereafter, the goods are moved under his
supervision and under the cover of an invoice countersigned by him. This system
is now restricted to cigarettes only.
(b) Self-Assessment procedure:
This was previously known as self-removal procedure (SRP). Under this
procedure; the assessee files a classification declaration for his goods in
quadruplicate under Rule 173B to inform the department of the claimed rate of duty
applicable to his goods. If the rate of duty is ad volrem and the assessee sells
goods to a related person or he has factories manufacturing similar goods in
different Central Excise Divisions or Commissionerates or he removes goods for
captive consumption etc., he should also file before the Assistant Commissioner a
price declaration under Rule 173C in the prescribed form in advance. The
assessee himself assesses the duty due on the excisable goods intended to be
removed and pays duty on a fortnightly basis.
(c) The compounded levy scheme:
This procedure is meant for small scale decentralized sector and at present covers
embroidery, marble slabs, stainless steel Pattis/Pattas and aluminium circles.
Under this scheme the duty for a specified period is fixed on the basis of the
number and the type of machines. Payment of tax under this procedure absolves
the manufacturer from observing day-to-day formalities of CENVAT regarding
maintenance of accounts and removal of goods etc.
(d) Collection of duty at the point of consumption:
The duty under this system is confined to Khandsari Molasses going for
manufacture of alcohol, whether for potable or industrial use. The duty is paid by
the distilliers on the date of receipt of Khandsari Molasses. The CENVAT credit is
admissible on Khandsari Molasses to the extent it is used for manufacture of
dutiable excisable goods.
(e) Levy of excise duty on the basis of capacity of production:
A new Section 3A introduced in the Central Excise Act through the Finance Act
1997 enables the Government to levy a duty at the notified rate on the notified
commodity on the basis of production capacity as determined by an officer not
below the rank of Assistant Commissioner of Central Excise, in place of actual
production. The assessee has, however been given the right to represent on the
basis of evidence of actual production being lower and in that case the proper
office will determine the quantum of actual production to be taxed after observing
the principles of natural justice. The scheme is at present applicable to
independent textile processors only.
4.3 Obligations under CENVAT
As in the case of dealers under VAT in other countries, CENVAT has also
introduced VAT procedures under the-new system. It has placed some obligations
on the part of the dealers paying CENVAT.
The administration of CENVAT requires various declarative obligations as given
(a) Tax payer registration:
Every manufacturer of excisable goods (except small-scale manufacturer) is
required to get himself registered before the commencement of production.
Registration is valid for the premises it is granted. That is, a manufacturer having
more than one premises must obtain a separate registration for each of the
premises from the respective Range Superintendent having jurisdiction over the
premises, may it be a factory or a depot/branch office. If a manufacturer desires to
start production of a new product he should get his registration duly endorsed to
this effect. There is no fee for registration and there is no need for its renewal. In
addition to the manufacturer, since 1994, even wholesalers (i.e. dealers who
intend to pass CENVAT credit to its buyers), could be registered. This system has
been introduced to help small manufacturers.
(b) Issue of invoices:
With effect from 1st April 1994, invoice has replaced the gate pass (GP-I) as the
clearance document. It is prescribed that an invoice must accompany the
consignment, each time the goods are transported from the factory to the godown
of the manufacturer. To keep track of the clearance of goods from the factory, each
accompanying page of the invoice book should be pre-authenticated by an
authorised officer of the assessee and be serially numbered in the book and the
numbers intimated to the Assistant Commissioner in advance. Manufacturer
paying duty exceeding Rs.10 crores have been exempted from intimation and
authentication. Invoices are required to be issued in quadruplicate. In the case of
petroleum products, there is a provision for removal of dutiable goods from the
factory to warehouse without payment of tax. In such cases subsidiary gate pass
(GP-2) is required to be issued. The subsidiary Gate Pass called certificate in lieu
of GP-I is issued when the consignment of duty paid inputs moves first to another
consignee or destination and thereafter a part of it is supplied to a manufacturer
availing CENVAT. It is provided that the CENVAT credit could be taken through the
invoices issued by the first and the second stage dealers of excisable goods only.
The credit cannot be taken on the basis of the invoices that are issued by the third
and the subsequent stage dealers. Thus, the scheme of invoices has the following
(i) The first stage dealer is defined as one receiving the inputs
directly from a manufacturer or his depot under the cover of an
invoice issued under Rule 52A.
(ii) The second stage dealer is one who purchases from the first
(iii) No credit can be availed on the strength of an invoice issued by
the second stage dealer unless the invoice is authenticated or
countersigned by the proper officer having jurisdiction over the
second stage dealer.
(iv) Both the first stage and the second stage dealers should be
registered with the central excise department.
(c) Monthly return:
The manufacturer is required to pay CENVAT on fortnightly basis and submit a
monthly return (RT12) to the Superintendent of the Central Excise by the 10th of
the month following the month during which duty was paid. Manufacturers availing
of the small-scale exemption, based on value or quantity of clearances during a
financial year, need to file his return only on a quarterly basis. The return must
• Particulars of goods manufactured and cleared and amount of
excise duty paid;
• Particulars of inputs received during the month and the amount of
duty taken as credit; and
• Information on total duty paid through PLA (account current) and
CENVAT credit giving details of disposal of inputs and utilization
of the credit.
(d) Other documentary obligations:
In addition to the monthly return, at the time of clearance the manufacturer is
required to submit the extracts of PLA and CENVAT accounts to the
Superintendent of the Range.
With the introduction of CENVAT, maintenance of statutory accounts has been
done away with. That is, the manufacturer on his own shall 'maintain his records
regarding receipt, disposal, consumption and inventory of the goods containing
relevant information If CENVAT credit is taken or utilised wrongly, the same, along
with interest, will be recovered and, if the same involves fraud, willful
miss-statement, collusion, suppression of facts or contravention of the provisions
of the Act or the Rules, mandatory penalty and interest will also be attracted.
For this purpose a Personal Ledger Account (PLA) is also maintained. The duty is
paid fortnightly/monthly. The amount of duty payable is recorded in daily stock
account under rule 53 before clearance.
The manufacturers to pay duty on the final products cleared by them could use
PLA account or the CENVAT credit.
In addition to the already existing powers under section 14 of the Central Excise
Act (to summon persons to give evidence and to produce documents), the excise
department is empowered to go into the cost structure of the goods manufactured
through a cost audit so as to decide whether there is under-invoicing; The new
sections 14A and 14AA make provision for special audit in certain cases. These
sections envisage an audit within a limited period with some important conditions
Stipulated. As far as the department IS concerned, the cost audit report would
prevail to determine the assessable value, notwithstanding any cost audit done in
the unit under any law viz. the Companies Act, 1956. The expenses including the
fee for the cost accountant are borne by the department. It is important to note that
the powers under section 14A is exercised by the Chief Commissioner of Central
Excise and under 14M is exercised by the Commissioner of Central Excise. In
other words, the provisions of these two sections are invoked only under
extraordinary circumstances and not as a matter of routine.
4.4 Weaknesses of the system under CENVAT
The existing structure of CENVAT (i.e. UED) and the procedures for its
administration calling for specified obligations are characterised by the following
First, the existing procedures for physical controls are outmoded. In the context of
the liberalized economy it is immaterial whether the tax is levied through UED or
CENVAT, the physical control should have no place in the administrative system. It
needs to be replaced by self-assessment procedure.
Second, the provision of registration of wholesalers has created plethora of
loopholes in the system to avoid payment of tax. While it does help small dealers to
claim set-off for the tax on their inputs, the practice has created additional
work-load for the department to cross check their sales and purchases with the
claim of set-off by the small manufacturers. The resulting cases of evasion are also
large. Earlier, when MODVAT provisions were liberalized and dealers in excisable
goods were also permitted to register themselves under Rule 174 of the Central
Excise Rules, 1944, any dealer of excisable goods could register himself with the
Superintendent of Central Excise in charge of the Range in which he had
premises. Under the liberalized procedure there was no distinction between a
manufacturer, a first stage dealer, second stage dealer or a subsequent stage
dealer. This led to fraud at a large scale when fictitious dealers were issuing
modvatable invoices said to cover duty paid excisable goods, on the basis of which
MODVAT credit was being taken, fraudulently by various manufacturers. Detection
of such fictitious invoices and fraudulent dealers became difficult, because cross
verification could not be done either instantly through a computerized network or
within a reasonable time through correspondence. As a result, a number of
fictitious invoices said to cover duty paid excisable- goods were floating in the
system resulting in enormous amount of loss of revenue. When this was detected,
the MODVAT credit was restricted to the manufacturers, the first stage dealers and
the second stage dealers. This has reduced fraud and issue of fictitious invoices to
some extent. In fact, this could be further reduced if this facility is restricted to only
the first-stage dealers and all the Central Excise Ranges and Divisions in the
country are linked through a computer network.
Third, the coverage of CENVAT, as noted above, has not been extended to all the
commodities. Initially (under MODVAT), half the revenue was being derived
through the commodities covered under it. Over the years the coverage has been
expanded. Now it accounts for approximately 92% of the revenue through
commodities under CENVAT. The time is ripe to incorporate other excises also
into the ambit of CENVAT.
Fourth, there is a special provision related to deemed credit. Under this facility, a
manufacturer takes CENVAT credit at specified rates for certain inputs without
producing documents related to the payment of duty. Deemed credit is available
only in respect of commodities where chain of various processes is broken due to
some exempted goods that are used. For example, there is no duty on grey fabrics
but CENVAT credit on yam is allowed through deemed credit. Since in such cases,
duty payment documents may not be available, it is felt that CENVAT credit at
specified rates may be allowed. The inputs so specified are deemed to be duty
paid unless they are clearly recognizable as non-duty paid. The deemed credit
facility which was initially (i.e. in March 1986) given to the small manufacturers was
extended to all the units after a month. Later on, it was restricted to items under the
category of steel, ingots and re-rollables, certain flat products of steel, unwrought
aluminum, copper, lead and zinc and waste/scraps of copper. However, with effect
from 1st April 1994 it is applicable to iron and steel roller only. Also, it has of late
been withdrawn on ingots and re-rollable materials of iron and steel when the
clearances of the re-rollers exceed Rs. 7.5 million in a financial year. In the context
of extension of CENVAT scheme to processed textile fabrics, through the Budget
1996-97 the government has declared final products in respect of which the
deemed credit for the duty paid on inputs is available on such notified outputs.
Chapter – 5
VAT in Indian States
In order to evolve a policy for the introduction of an integrated VAT system for India
as a whole, in 1993 the National Institute of Public Finance and Policy (NIPFP) was
entrusted with the job of preparing the design of a possible VAT system.
Accordingly, a study team was set up. The team examined various aspects of VAT
and came up with a feasible scheme of reform of VAT within the existing
constitutional framework that could be implemented in the near future.
Under the above mentioned scheme the following proposals were made:
(i) Central excise duties should be converted into a full-fledged
manufacturer-level VAT, covering all goods produced, manufactured or
imported (and a few selected services), with immediate credit of input tax.
(ii) There should be not more than three rates in the beginning, and
eventually a uniform rate should be adopted.
(iii) The State-level sales tax should be converted into a VAT based on the
destination principle with tax credit mechanism. It should be broad-based,
with not more than three rates, zero rate on exports, and a minimum
exemption of such products as unprocessed food.
(iv) The VAT should be introduced with an annual turnover threshold.
(v) A model law should be developed which the States can adopt with
suitable changes while retaining the basic structure. There must be a
persistent effort to harmonize VATs of different States. A VAT council of
States may be set up, a massive taxpayer education programme may be
launched and the tax should be introduced only after good preparation.
5.1 Committee of State Finance Ministers
The Union Finance Minister called a meeting of the State finance ministers in May
1994 in order to discuss the various aspects of VAT and a committee of State
finance ministers was constituted on sales tax reform following this meeting. The
committee had to examine all aspects of sales tax reform, including the
introduction of VAT.
The committee recommended several measures to rationalize the existing sales
tax with the ultimate aim of introducing VAT at the State level. The major
recommendations include simplification of the rate structure, minimization of the
exemptions and enhancement of transparency. To this end, the committee
(i) The adoption of four general floor rates (0, 4, 8, 12) and two special floor
rates (1 and 20) in place of the existing multiple rates being levied in
(ii) Keeping the exemptions to a minimum;
(iii) Preparing a list of exempt goods and fixing a target date beyond which no
State/Union Territory should exempt goods other than those mentioned in
the list, and;
(iv) Doing away with sales tax incentives for industrialization. No new tax
incentives should be given after 1 April, 1997, and the existing ones
should be allowed to lapse in due course.
The committee also recommended several preparatory steps to be taken for the
implementation of a full-fledged State-level VAT. They included a massive
taxpayers education programme, computerization of sales tax administration, and
preparation of model VAT legislation.
5.2 Expert group on taxation of inter-State sales
In the beginning of 1996, a group of experts and officials was set up by the
government for studying the problem of taxation of Inter-State sales. This group
submitted its report at the end of 1996. The main recommendations of this group
were as follows:
(i) The central sales tax rate should be reduced from 4 per cent to 2 per cent
in three annual phases.
(ii) The central sales tax should be extended to consignments and branch
(iii) Half of the central sales tax revenue should be retained by the exporting
State and the other half should be pooled for sharing among the States
on an agreed formula.
(iv) In the beginning, the importing State should allow a 50 per cent rebate of
central sales tax paid by a registered vendor outside the State. It should
ultimately be extended to 100 per cent.
(v) Local rates should be levied on Inter-State sales to unregistered dealers.
5.3 Committee on the draft model VAT Law
A committee was set up to draft a model VAT law for the States. This committee
prepared the first draft of a ‘Manual for Value Added Sales Tax’ in 1998. It is
basically a Statute to provide State governments with a model for imposition and
collection of VAT, which will replace the existing taxes on sales or purchases of
goods levied by the States. The manual makes provisions relating to various
structural and operational aspects of the State-level VAT including the list of goods
subject to various rates.
The Union Finance Minister convened a conference of all State Chief Ministers in
November, 1999 and decided on the following course of domestic tax reforms :
(i) Implementation of floor rates of sales tax by all States and Union
Territories and discontinuation of grant of sales tax based incentives from
1st January, 2000.
(ii) Implementation of VAT from 1 st April, 2001 which was first extended to 1 st
April, 2002 and again postponed to 1st April, 2003.
Empowered Committee comprising of nine State Finance Ministers was
constituted on 17th July, 2000 to monitor the decisions taken in the Chief Ministers’
Empowered Committee decided to rationalize the future rate structure under VAT
to 5 rates i.e. :
• NIL for certain goods
• 1% for gold, silver and precious stones
• 4% for certain essential goods and industrial inputs
• 20% for liquor and some petroleum products, and
• A revenue neutral rate (RNR) of 10 to 12.5% for other goods.
Subsequent decision taken in February, 2003 is that all States should adopt a
uniform RNR rate of 12.5%.
The Finance Act, 2002, amended the Central Sales Tax Act, 1956 to allow the
State Governments to impose tax on sale of declared goods at more than one
stage. This amendment is keeping in mind the proposed implementation of VAT
being a multi point tax.
One of the important concerns of the State Governments was the probable loss of
revenue if VAT is implemented in the States. Perhaps this is the major obstacle in
the implementation of VAT in States. The Central Government has agreed to
compensate the States for loss due to implementation of VAT. The compensation
package is 100% in the first year, 75% in the second year and 50% in the third
year. However, the modalities of raising the resources for the purpose have yet to
be worked out.
The Constitution (Ninety Second Amendment) Act, 2003 has inserted a new Article
268A entitled Service tax levied by Union and collected and appropriated by the
Union and the States. It provides that taxes on services shall be levied by the
Government of India and such tax shall be collected and appropriated by the
Government of India and the States in accordance with such principles of
collections and appropriations as may be formulated by Parliament by law. The
Amendment Act has also inserted a new entry “92C”. Taxes on Services” in the
Now the introduction of VAT has been postponed to 1st April, 2005. This
postponement is due to various reasons such as divergent views on treatment of
existing sales tax incentives already granted by the States, treatment of Central
Sales Tax (CST) under VAT, lack of commitment by the Central Government at
that time on compensating the States for loss in revenue etc. For example different
States, for the progress of trade and the industry are extending various incentives
like grant of loan equal to the liability of sales tax, deferment of tax liability for a
particular period and full tax exemption. The industry is very much concerned that
once VAT is implemented these incentives would be withdrawn by the State
Governments and that would go against the principle of estoppel. The industry
wants the incentives to continue side by side along with the facility of credit for
VAT. Another reason for postponement is lack of preparedness by the States.
5.4 Various models of VAT
There are various models of VAT for a. country where the powers of indirect
taxation are divided between different levels of government. Some of the models
are briefly described below.
From an economic point of view, the ideal solution would be to levy a VAT at the
central level in place of various domestic indirect taxes levied by different levels of
governments. It simplifies the domestic indirect tax system considerably by
avoiding the inter-state differentiation and multiple taxation. Such a tax may be
accompanied by a few selective non-deductible excises. The revenue could be
distributed to different levels of governments on the basis of a formula. In
Germany, VAT is a central tax but collected by the State Governments, and
revenue is distributed among the Centre and the State Governments. The federal
VAT is fully harmonized across states.
The federal VAT in place of various domestic indirect taxes levied at various levels,
including the sales tax would, however, greatly reduce the fiscal autonomy of the
states. It also requires a constitutional amendment, which may not be politically
feasible. There will be less incentive to generate revenues at the central level since
large part of the revenue will be distributed to the lower levels.
The second option is to levy a VAT at the State level, supplemented by the
non-deductible central excises on limited items. State VATs may be more or less
harmonized with each other and look like the European VAT system. VAT at the
State level in a federal context raises the basic issue of treatment of cross-border
trade. If it is not treated properly, there is a possibility of multiple taxation, thereby
interfering with free functioning of the domestic market.
Burgess, Howes and Stern recommend three ways to handle inter-state trade
problem. "In all three, interstate exports to non-VAT-registered agents would be
taxed. Under the first proposal, all other interstate exports would be zero rated.
Under the second, all other interstate exports would be taxed at the same rate as
exports to non-VAT-registered agents, but would be rebatable by the importing
state government. The second approach differs from the third one in that the
exporting government would be made responsible for the payments of rebates via
the establishment of a clearinghouse. The zero-rating of export arrangement
would be particularly simple to implement, as its main requirement would be a
single change in the CST for registered trade from its current 4 per cent to zero. In
this case some compensation for the 'producing' states may be needed. The
Finance Commission would achieve this. As a transitional measure the CST could
be initially reduced to 2 per cent say, rather than being immediately abolished."
The third option would be a dual VAT both at the central and the state levels. Under
this system, the central government is allowed to levy VA1 at the manufacturing
level and state governments levy VAT at the distribution stages. In this context, it
will be necessary to examine the following issues in a greater detail.
• Central VAT and State VAT on a common base or separate bases, Same
rate or different rates, centrally or jointly controlled rates,
• One administration or separate administration, with credit or without credit,
• It will be necessary to have a close harmonization between the Union and
State VATs. In the absence of such harmonization, a dual VAT would be
complex to operate and comply with. It will also offer scope for game playing
between governments and evasion among firms. However, harmonization
would cause a reduction in states' autonomy.
5.5 Move towards VAT in States
With the objective to introduce State-Level VAT in India in 1992 the Government of
India constituted a Tax Reform Committee headed by Dr. Raja J. Chelliah. In 1993,
the committee recommended VAT in place of existing tax system. Thereafter, the
Government appointed NIPFP (National Institute of Public Finance and Policy),
New Delhi as the Nodal Agency to work out the modalities of VAT.
The first preliminary discussion on State-Level VAT took place in a meeting of
Chief Ministers convened by Dr. Manmohan Singh, the then Union Finance
Minister in 1995. In this meeting, the basic issues on VAT were discussed in
general terms and this was followed up by periodic interactions of State Finance
Ministers. Thereafter, in a significant meeting of all Chief Ministers, convened on
November 16, 1999 by Shri Yashwant Sinha, the then Union Finance Minister the
following important decisions were taken.
(i) Before the introduction of State-Level VAT, the unhealthy sales-tax rate
"war" among the States would have to end and sales-tax rates would
need to be harmonized by implementing uniform floor rates of sales-tax
for different categories of commodities with effect from January 1, 2000.
(ii) In the interest of harmonization of incidence of sales- tax, the sales- tax
related industrial incentive schemes would also have to be discontinued
with effect from January 1, 2000.
(iii) On the basis of the achievement of the first two objectives, steps would
be taken by the States for the introduction of State-level VAT after
For implementing the above decisions, an Empowered Committee of State
Finance Ministers was set-up.
Thereafter, this Empowered Committee met regularly, attended by the State
Finance Ministers, and also by the Finance Secretaries and the Commissioners of
Commercial Taxes of the State Governments as well as senior officials of the
Revenue Department of the Ministry of Finance, Government of India. Through
repeated discussions and collective efforts of the Empowered Committee, it was
possible within a period of about a year and a half to achieve remarkable success
in the first two objectives on harmonization of sales-tax structure through
implementation of uniform floor rates of sales-tax and discontinuation of
sale-tax-related incentive schemes. As a part of regular monitoring, whenever any
deviation was reported from the uniform floor rates of sales- tax, or from decision
on incentives, the Empowered Committee took up the matter with the concerned
State and also the Government of India for necessary rectification.
After reaching this stage, steps were initiated for the systematic preparation for the
introduction of State-Level VAT. In order to avoid any unhealthy competition
among the States which may lead to distortions in manufacture and trade,
attempts have been made from the very beginning to harmonize the VAT designs
in the States, keeping also in view the distinctive features of each State and the
need for federal flexibility. This has been done by the States collectively agreeing,
through repeated discussions in the Empowered Committee, to certain common
points of convergence regarding VAT, and allowing at the same time certain
flexibility for the local characteristics of the States.
Along with these measures at ensuring convergence on the basic issues on VAT,
steps have also been taken for necessary training, computerization and interaction
with trade and industry, particularly at the State levels. This interaction with trade
and industry is being specially emphasized.
The conference of State Chief Ministers presided over by Shri Atal Behari
Vajpayee, the then Prime Minister, held on October 18, 2002 at which Shri
Jaswant Singh, the then Finance Minister was also present confirmed the final
decision that all the States and the Union Territories would introduce VAT from
April 1, 2003. The Empowered Committee of State Finance Ministers on February
8, 2003 again endorsed the suggestion that all the State legislations on VAT
should have a certain minimum set of common features. Most of the States came
out with their draft legislations; Shri Jaswant Singh the then Union Finance Minister
also announced the introduction of VAT from 1st April 2003 in his 2003-2004
budget speech made on February 28, 2003. An extract from his speech is
"The coming year will be historic with the States switching over to a Value
Added Tax (VAT). The Central Government has been a partner with the
States, in the highest tradition of cooperative federalism, in this
path-breaking reform. This will also involve an amendment to the
Additional Excise Duty Act. Second, it is proposed to make 2003-04 the
year when a long-overdue constitutional amendment to integrate services
into the tax net in a comprehensive manner is enacted and implemented.
This will give a boost to revenues, and help implement VAT"
Owing to some unavoidable circumstances VAT could not be implemented w.e.f.
April 1, 2003 or on the revised date June 1, 2003. Despite all obstacles, Haryana
stood first to implement VAT w.e.f. April 1, 2003.
5.6 Dr. Vijay Kelkar’s views
The report submitted by Dr. Vijay Kelkar, Advisor to the Union Finance Minister, in
the year, 2002 on direct and indirect taxes have far-reaching implications. He has
made significant observations on the issue of VAT. At the very outset he stated
that VAT eliminates the cascading effect of taxes; it promotes competitiveness of
exports, it has a simple and transparent culture and it improves compliance.
Economists have generally shared the view that VAT is best suited as a Federal or
Central tax and not at the State level. However, States and provinces in a few large
Federal countries like Brazil and to a lesser extent Canada, have adopted VAT
with varying degrees of success.
Dr. Vijay Kelkar has made the following recommendations in regard to State-Level
(i) A publicity awareness programme should be started jointly with the
Central Government and the State Governments and the former should
extend financial support for this, if required. It is also necessary that the
publicity awareness programme should be implemented at the earliest.
(ii) An attempt should be made towards uniformity of all State legislations,
procedures and documentation relating to VAT.
(iii) The issue of compensation to States must be primarily tackled through
mutually acceptable mechanism of additional resource mobilization
through service tax and not through budgetary support.
(iv) With the introduction of VAT all other local taxes should be discontinued
and the same should be taken into account in determining the Revenue
(v) Whereas additional duties of excise may continue for textiles up to 2005,
it may continue even thereafter for cigarettes, which should not be
subjected to VAT.
(vi) The VAT schemes should provide for grant of credit of duty by the
importing States for the duty paid in the exporting State, in the course of
inter-State movement of goods.
(vii) For the stability and continuity of VAT, the setting up of a VAT Council or
a permanent suitable alternative vested with adequate powers to take
steps against discriminatory taxes and practices and eliminate barriers to
free flow of trade and commerce across the country should be explored.
In the meeting of the Empowered Committee on June 18, 2004 when Shri P.
Chidambaram the Union Finance Minister, was present, all the States excepting
one, once again categorically renewed their commitment to the introduction of VAT
from April 1, 2005. Accordingly, the Ministry of Finance published a White Paper
on State-Level VAT in January, 2005. This paper consists of three parts. In Part I
the Committee considered the justification of VAT and the background.
In the existing sales-tax structure there are problems of double taxation of
commodities and multiplicity of taxes, resulting in a cascading tax burden. In the
VAT, a set off is given for input tax as well as tax paid on previous purchases. With
the introduction of VAT all other State taxes and the Central sales-tax will be
gradually phased out. VAT encourages self-assessment by the dealers. Thus,
under a system of VAT overall tax burden will be rationalized and prices will
generally fall. Extensive as well as in-depth consultations were made among the
State Finance Ministers. There were critical issues like re-imbursement of loss of
revenue arising out of introduction of VAT, substitution of central sales-tax by
another suitable system etc. The Union Finance Ministers and the Central
Government played a supportive and understanding role in the whole process,
which paved the way for the implementation of the system.
The State-Level VAT has been worked out, striking a federal balance between the
common points of convergence regarding VAT and flexibility for the local
characteristics of the States. The essence of VAT is in providing set-off for the tax
paid earlier, and this is given effect through the concept of input tax credit/ rebate.
The VAT is based on the value addition to the goods, and the related VAT liability
of the dealer is calculated by deducting input tax credit from tax collected on sales
during the payment period. This input tax credit will be given for both
manufacturers and traders for purchase of input/ supplies meant for both sales
within the State as well as to the other States irrespective of when these will be
utilized/ sold. If the tax credit exceeds the tax payable on sales in a month, the
excess credit will be carried over to the end of the next financial year. If there is any
excess unadjusted input tax credit at the end of the second year then the same will
be eligible for refund. For all exports made out of the country, tax paid within the
State will be refunded in full. Tax paid on inputs procured from other States through
inter-State sale and stock transfer will not be eligible for credit. All tax- paid goods
purchased on or after April 1, 2004 and still in stock as on April 1,2005 will be
eligible to receive input tax credit subject to submission of requisite documents.
This entire design of VAT with input tax credit is crucially based on documentation
of tax invoice, cash memo or bill. Registration of dealers with gross annual
turnover above Rs. five lakhs will be compulsory. There will be provision for
voluntary registration. It is also proposed to give Tax Payer’s Identification
Number. There will be simplified forms of returns. The VAT liability will be
self-assessed by the dealers themselves in terms of submission of returns upon
setting- off the tax credit. Correctness of self-assessment will be checked through
a system of departmental audit. There will be no need for any provision for
concessional sale under the VAT Act since the provision for set-off makes the input
zero-rated. Hence, there will be no need for a declaration form, which will be a
further relief for the dealers. In general, all the goods including declared goods will
be covered under VAT and will get the benefit of input tax credit.
There will be only two VAT rates of 4% and 12.5 % plus a specific category of tax
exempted goods and a special VAT rate of 1 % only for gold and silver ornaments
etc. VAT system will stop the unhealthy tax–rate war and trade diversion among
the States, which had adversely affected the interests of all the States in the past.
The States will duly effect changes in their VAT Acts or draft VAT Acts and the
relevant rules to align the position with the principles explained in the White Paper.
The Finance Minister Shri P.Chidambaram in his Budget 2005-2006 speech made
on February 28, 2005 submitted the VAT proposal as under:
"In a remarkable display of the spirit of cooperative federalism, the States
are poised to undertake the most important tax reform ever attempted in
this country. All States have agreed to introduce the value added tax
(VAT) with effect from April 1, 2005. VAT is a modern, simple and
transparent tax system that will replace the existing sales-tax and
eliminate the cascading effect of sales-tax. It is in force in more than 130
countries ranging from Sri Lanka to China. India too has a VAT at the
Central level (CENVAT), but only for goods.
In the medium to long term, it is my goal that the entire
production–distribution chain should be covered by a national VAT, or
even better, a goods and services tax, encompassing both the Centre
and the States.
The Empowered Committee of State Finance Ministers, with the solid
support of the Chief Ministers, has laboured through the last 7 years to
arrive at a framework acceptable to all States. The Central Government
has promised its full support and has also agreed to compensate the
States, according to an agreed formula, in the event of any revenue loss.
I take this opportunity to pay tribute to the Empowered Committee, and
wish the States success on the introduction and implementation of VAT."
The White Paper brought out on State-Level VAT was a result of collective efforts
made by the Government of India, all the States and support from trade
organizations, Chambers of Commerce and Industry and many other agencies.
5.7 White Paper on State-Level VAT in India
This White Paper on State-level Value Added Tax (VAT) is presented in three
parts. To begin with, the justification of VAT and its background have been
mentioned (Part 1). In Part 2, the main design of VAT, as evolved on the basis of a
consensus among the States through repeated discussions in the Empowered
Committee, has been elaborated. While doing so, it is recognized that this VAT is a
State subject and therefore the States will have freedom for appropriate variations
consistent with the basic design as agreed upon at the Empowered Committee.
Finally, in Part 3, the other related issues have been discussed for effective
implementation of VAT.
1. Justification of VAT and Background
1.1 In the existing sales-tax structure, there are problems of double taxation
of commodities and multiplicity of taxes, resulting in a cascading tax burden. For
instance, in the existing structure, before a commodity is produced, inputs are first
taxed, and then after the commodity is produced with input tax load, output is taxed
again. This causes an unfair double taxation with cascading effects. In the VAT, a
set-off is given for input tax as well as tax paid on previous purchases. In the
prevailing sales-tax structure, there is in several States also a multiplicity of taxes,
such as turnover tax, surcharge on sales-tax, additional surcharge, etc. With
introduction of VAT, these other taxes will be abolished. In addition, Central
sales-tax is also going to be phased out. As a result, overall tax burden will be
rationalized, and prices in general will also fall. Moreover, VAT will replace the
existing system of inspection by a system of built-in self-assessment by the
dealers and auditing. The tax structure will become simple and more transparent.
That will improve tax compliance and also augment revenue growth. Thus, to
repeat, with the introduction of VAT, benefits will be as follows:
Ø a set-off will be given for input tax as well as tax paid on previous
Ø other taxes, such as turnover tax, surcharge, additional
surcharge, etc. will be abolished
Ø overall tax burden will be rationalised
Ø prices will in general fall
Ø there will be self-assessment by dealers
Ø transparency will increase
Ø there will be higher revenue growth
The VAT will therefore help common people, traders, industrialists and also the
Government. It is indeed a move towards more efficiency, equal competition and
fairness in the taxation system.
1.2 For these beneficial effects, a full-fledged VAT was initiated first in Brazil
in mid 1960’s, then in European countries in 1970’s and subsequently introduced
in about 130 countries, including several federal countries. In Asia, it has been
introduced by a large number of countries from China to Sri Lanka. Even in India,
there has been a VAT system introduced by the Government of India for about last
ten years in respect of Central excise duties. At the State-level, the VAT system as
decided by the State Governments, would now be introduced in terms of Entry 54
of the State List of the Constitution.
1.3 The first preliminary discussion on State-level VAT took place in a
meeting of Chief Ministers convened by Dr. Manmohan Singh, the then Union
Finance Minister in 1995. In this meeting, the basic issues on VAT were discussed
in general terms and this was followed up by periodic interactions of State Finance
Ministers. Thereafter, in a significant meeting of all Chief Ministers, convened on
November 16, 1999 by Shri Yashwant Sinha, the then Union Finance Minister,
three important decisions were taken. First, before the introduction of State-level
VAT, the unhealthy sales-tax rate “war” among the States would have to end and
sales-tax rates would need to be harmonized by implementing uniform floor rates
of sales-tax for different categories of commodities with effect from January 1,
2000. Second, in the interest again of harmonization of incidence of sales-tax, the
sales-tax-related industrial incentive schemes would also have to be discontinued
with effect from January 1, 2000. Third, on the basis of achievement of the first two
objectives, steps would be taken by the States for introduction of State-level VAT
after adequate preparation. For implementing these decisions, an Empowered
Committee of State Finance Ministers was set-up.
1.4 Thereafter, this Empowered Committee has met regularly, attended by
the State Finance Ministers, and also by the Finance Secretaries and the
Commissioners of Commercial Taxes of the State Governments as well as senior
officials of the Revenue Department of the Ministry of Finance, Government of
India. Through repeated discussions and collective efforts in the Empowered
Committee, it was possible within a period of about a year and a half to achieve
nearly 98 per cent success in the first two objectives on harmonization of sales-tax
structure through implementation of uniform floor rates of sales-tax and
discontinuation of sales-tax- related incentive schemes. As a part of regular
monitoring, whenever any deviation is reported from the uniform floor rates of
sales-tax, or from decision on incentives, the Empowered Committee takes up the
matter with the concerned State and also the Government of India for necessary
1.5 After reaching this stage, steps were initiated for systematic preparation
for the introduction of State-level VAT. In order again to avoid any unhealthy
competition among the States which may lead to distortions in manufacturing and
trade, attempts have been made from the very beginning to harmonize the VAT
design in the States, keeping also in view the distinctive features of each State and
the need for federal flexibility. This has been done by the States collectively
agreeing, through repeated discussions in the Empowered Committee, to certain
common points of convergence regarding VAT, and allowing at the same time
certain flexibility for the local characteristics of the States.
1.6 Along with these measures at ensuring convergence on the basic issues
on VAT, steps have also been taken for necessary training, computerization and
interaction with trade and industry, particularly at the State levels. This interaction
with trade and industry is being specially emphasized.
1.7 It may be noted that while such preparation was going on, the Chief
Ministers of all the States in an important meeting on State-level VAT convened by
the Prime Minister on October 18, 2002, when Shri Jaswant Singh, the then Union
Finance Minister was present, clearly Stated their intention of introducing VAT
from April 1, 2003. About 29 States and Union Territories had expeditiously sent
their Bills to the Ministry of Finance, Government of India for prior vetting. The
Union Ministry of Finance had considered these Bills of States and Union
Territories, and sent their comments/suggestions to the States and Union
Territories in line with the decisions of the Empowered Committee of the State
Finance Ministers for incorporating the same in VAT Bills to be placed in the State
legislatures and subsequent transmission to the Government of India for
Presidential Assent. At this stage, there were certain developments, which delayed
the introduction of VAT. Despite these developments, most of the States remained
positively interested in implementation of VAT. Madhya Pradesh VAT Bill had
already been accorded Presidential Assent in November 2002. One State, namely,
Haryana, has already introduced VAT on its own with good results on revenue
growth. It is important to note that in the meeting of Empowered Committee on
June 18, 2004 when Shri P. Chidambaram, the Union Finance Minister, was
invited and was kindly present, all the States, excepting one, once again
categorically renewed their commitment to the introduction of VAT from April 1,
2005. Even for this particular State with certain problems, a positive interaction has
recently been organized with that State to resolve certain genuine ground-level
problems. Now nearly all the States have either finalized their VAT Bills and are in
the process of obtaining Presidential Assent, or will reach that stage very soon.
2. Design of State-Level VAT
2.1 As already mentioned, the design of State-level VAT has been worked
out by the Empowered Committee through several rounds of discussion and
striking a federal balance between the common points of convergence regarding
VAT and flexibility for the local characteristics of the States. Since the State-level
VAT is centred around the basic concept of “set-off” for the tax paid earlier, the
needed common points of convergence also relate to this concept of set-off/input
tax credit, its coverage and related issues as elaborated below.
Concept of VAT and Set-off / Input Tax Credit
2.2 The essence of VAT is in providing set-off for the tax paid earlier, and this
is given effect through the concept of input tax credit/rebate. This input tax credit in
relation to any period means setting off the amount of input tax by a registered
dealer against the amount of his output tax. The Value Added Tax (VAT) is based
on the value addition to the goods, and the related VAT liability of the dealer is
calculated by deducting input tax credit from tax collected on sales during the
payment period (say, a month).
If, for example, input worth Rs. 1,00,000/- is purchased and sales are worth Rs.
2,00,000/- in a month, and input tax rate and output tax rate are 4% and 10%
respectively, then input tax credit/set-off and calculation of VAT will be as shown
(a) Input purchased within the month : Rs. 1,00,000/-
(b) Output sold in the month : Rs. 2,00,000/-
(c) Input tax paid : Rs. 4,000/-
(d) Output tax payable : Rs. 20,000/-
(e) VAT payable during the month : Rs. 16,000/-
after set-off/input tax credit
[(d) – (c)]
Coverage of set-off / input tax credit
2.3 This input tax credit will be given for both manufacturers and traders for
purchase of inputs/supplies meant for both sales within the State as well as to
other States, irrespective of when these will be utilized/sold. This also reduces
immediate tax liability.
Even for stock transfer/consignment sale of goods out of the State, input tax paid in
excess of 4% will be eligible for tax credit.
Carrying over of tax credit
2.4 If the tax credit exceeds the tax payable on sales in a month, the excess
credit will be carried over to the end of next financial year. If there is any excess
unadjusted input tax credit at the end of second year, then the same will be eligible
Input tax credit on capital goods will also be available for traders and
manufacturers. Tax credit on capital goods may be adjusted over a maximum of 36
equal monthly instalments. The States may at their option reduce this number of
There will be a negative list for capital goods (on the basis of principles already
decided by the Empowered Committee) not eligible for input tax credit.
Treatment of exports, etc.
2.5 For all exports made out of the country, tax paid within the State will be
refunded in full, and this refund will be made within three months. Units located in
SEZ and EOU will be granted either exemption from payment of input tax or refund
of the input tax paid within three months.
Inputs procured from other States
2.6 Tax paid on inputs procured from other States through inter-State sale
and stock transfer will not be eligible for credit. However, a decision has been
taken for duly phasing out of inter-State sales-tax or Central sales-tax. As a
preparation for that, a comprehensive inter-State tax information exchange system
is also being set up.
Treatment of opening stock
2.7 All tax-paid goods purchased on or after April 1, 2004 and still in stock as
on April 1, 2005 will be eligible to receive input tax credit, subject to submission of
requisite documents. Resellers holding tax-paid goods on April 1, 2005 will also be
eligible. VAT will be levied on the goods when sold on and after April 1, 2005 and
input tax credit will be given for the sales-tax already paid in the previous year. This
tax credit will be available over a period of 6 months after an interval of 3 months
needed for verification.
Compulsory issue of tax invoice, cash memo or bill
2.8 This entire design of VAT with input tax credit is crucially based on
documentation of tax invoice, cash memo or bill. Every registered dealer, having
turnover of sales above an amount specified, shall issue to the purchaser serially
numbered tax invoice with the prescribed particulars. This tax invoice will be
signed and dated by the dealer or his regular employee, showing the required
particulars. The dealer shall keep a counterfoil or duplicate of such tax invoice duly
signed and dated. Failure to comply with the above will attract penalty.
Registration, small dealers and composition scheme
2.9 Registration of dealers with gross annual turnover above Rs. 5 lakh will
be compulsory. There will be provision for voluntary registration. All existing
dealers will be automatically registered under the VAT Act. A new dealer will be
allowed 30 days time from the date of liability to get registered.
Small dealers with gross annual turnover not exceeding Rs. 5 lakh will not be liable
to pay VAT. States will have flexibility to fix threshold limit within Rs. 5 lakh.
Small dealers with annual gross turnover not exceeding Rs. 50 lakh who are
otherwise liable to pay VAT, shall however have the option for a composition
scheme with payment of tax at a small percentage of gross turnover. The dealers
opting for this composition scheme will not be entitled to input tax credit.
Tax Payer’s Identification Number (TIN)
2.10 The Tax Payer’s Identification Number will consist of 11 digit numerals
throughout the country. First two characters will represent the State Code as used
by the Union Ministry of Home Affairs. The set-up of the next nine characters may,
however, be different in different States.
2.11 Under VAT, simplified form of returns will be notified. Returns are to be
filed monthly/quarterly as specified in the State Acts/Rules, and will be
accompanied with payment challans. Every return furnished by dealers will be
scrutinised expeditiously within prescribed time limit from the date of filing the
return. If any technical mistake is detected on scrutiny, the dealer will be required
to pay the deficit appropriately.
Procedure of self-assessment of VAT liability
2.12 The basic simplification in VAT is that VAT liability will be self-assessed
by the dealers themselves in terms of submission of returns upon setting off the tax
credit. Return forms as well as other procedures will be simple in all States. There
will no longer be compulsory assessment at the end of each year as is existing
now. If no specific notice is issued proposing departmental audit of the books of
accounts of the dealer within the time limit specified in the Act, the dealer will be
deemed to have been self-assessed on the basis of returns submitted by him.
Because of the importance of the concept of self-assessment in VAT, provision for
“self-assessment” will be Stated in the VAT Bills of the States.
2.13 Correctness of self-assessment will be checked through a system of
Departmental Audit. A certain percentage of the dealers will be taken up for audit
every year on a scientific basis. If, however, evasion is detected on audit, the
concerned dealer may be taken up for audit for previous periods. This Audit Wing
will remain delinked from tax collection wing to remove any bias. The audit team
will conduct its work in a time bound manner and audit will be completed within six
months. The audit report will be transparently sent to the dealer also.
Simultaneously, a cross-checking, computerised system is being worked out on
the basis of coordination between the tax authorities of the State Governments and
the authorities of Central Excise and Income Tax to compare constantly the tax
returns and set-off documents of VAT system of the States and those of Central
Excise and Income Tax. This comprehensive cross-checking system will help
reduce tax evasion and also lead to significant growth of tax revenue. At the same
time, by protecting transparently the interests of tax-complying dealers against the
unfair practices of tax-evaders, the system will also bring in more equal
competition in the sphere of trade and industry.
2.14 There will be no need for any provision for concessional sale under the
VAT Act since the provision for setoff makes the input zero-rated. Hence, there will
be no need for declaration form, which will be a further relief for dealers.
2.15 Under the VAT system, the existing incentive schemes may be continued
in the manner deemed appropriate by the States after ensuring that VAT chain is
2.16 As mentioned earlier, all other existing taxes such as turnover tax,
surcharge, additional surcharge and Special Additional Tax (SAT) would be
abolished. There will not be any reference to these taxes in the VAT Bills. The
States that have already introduced entry tax and intend to continue with this tax
should make it vatable. If not made vatable, entry tax will need to be abolished.
However, this will not apply to entry tax that may be levied in lieu of octroi.
2.17 Penal provisions in the VAT Bills should not be more stringent than in the
existing Sales-tax Act.
Coverage of goods under VAT
2.18 In general, all the goods, including declared goods will be covered under
VAT and will get the benefit of input tax credit.
The only few goods which will be outside VAT will be liquor, lottery tickets, petrol,
diesel, aviation turbine fuel and other motor spirit since their prices are not fully
market determined. These will continue to be taxed under the Sales-tax Act or any
other State Act or even by making special provisions in the VAT Act itself, and with
uniform floor rates decided by the Empowered Committee.
VAT rates and classification of commodities
2.19 Under the VAT system covering about 550 goods, there will be only two
basic VAT rates of 4% and 12.5%, plus a specific category of tax-exempted goods
and a special VAT rate of 1% only for gold and silver ornaments, etc. Thus the
multiplicity of rates in the existing structure will be done away with under the VAT
Under exempted category, there will be about 46 commodities comprising of
natural and unprocessed products in unorganised sector, items which are legally
barred from taxation and items which have social implications. Included in this
exempted category is a set of maximum of 10 commodities flexibly chosen by
individual States from a list of goods (finalised by the Empowered Committee)
which are of local social importance for the individual States without having any
inter-State implication. The rest of the commodities in the list will be common for all
the States. Under 4% VAT rate category, there will be the largest number of goods
(about 270), common for all the States, comprising of items of basic necessities
such as medicines and drugs, all agricultural and industrial inputs, capital goods
and declared goods. The schedule of commodities will be attached to the VAT Bill
of every State. The remaining commodities, common for all the States, will fall
under the general VAT rate of 12.5%.
In terms of decision of the Empowered Committee, VAT on AED items relating to
sugar, textile and tobacco, because of initial organisational difficulties, will not be
imposed for one year after the introduction of VAT, and till then the existing
arrangement will continue. The position will be reviewed after one year.
Effects of the VAT system
2.20 This design of the State-level VAT has been carefully worked out by the
Empowered Committee after repeated interactions with the States and others
concerned and striking a balance between the needed convergence and federal
flexibility as well as ground-level reality. If now all the components of the VAT
design are taken together, then it will be seen that the total effect of this VAT
system will be to rationalise the tax burden and bring down, in general, the price
level. This will also stop unhealthy tax-rate “war” and trade diversion among the
States, which had adversely affected interests of all the States in the
past. Moreover, this VAT design will also significantly bring in simplicity and
transparency in the tax structure, thereby improving tax-compliance and eventually
also the revenue growth, as mentioned in the beginning.
3. Steps taken by the States
3.1 It is now of significance to note that most of the States, after collective
interaction in the Empowered Committee, have either already modified or agreed
to modify their VAT Bills by incorporating these common points of convergence
including flexibility as mentioned in the VAT design above, and are also taking
other preparatory steps towards introduction of VAT from April 1, 2005.
3.2 As a part of the preparatory steps, the States have started the process of
preparing the draft of VAT Rules, including Books of Accounts to be maintained.
The objective will be to keep these as simple as possible so that it becomes easy
for a small trader to comply with the requirements.
3.3 Moreover, the States have initiated, and in many cases also completed,
steps for computerisation upto the levels of assessing officers and also at the
check posts. This process will continue since this is extremely important for
document-based verification and integration with Taxation Information Exchange
System as well as with information of the Central excise and income tax systems
as indicated earlier.
3.4 It may be mentioned here that appropriate Central funds for VAT-related
computerisation in the North-Eastern States are also being released by the
Government of India.
4. Related issues
4.1 While the States have thus taken several steps towards introduction of
VAT, certain supporting decisions were critically needed at the national level for
more effective implementation of VAT from April 1, 2005.
4.2 It needs to be carefully noted that although introduction of VAT may, after
a few years, lead to revenue growth, there may be a loss of revenue in some
States in the initial years of transition. It is with this in view that the Government of
India had agreed to compensate for 100 per cent of the loss in the first year, 75 per
cent of the loss in the second year and 50 per cent of the loss in the third year of
introduction of VAT, and the loss would be computed on the basis of an agreed
formula. This position has not only been reaffirmed by the Union Finance Minister
in his Budget Speech of 2004-05, but a concrete formula for this compensation has
also now been worked out after interaction between the Union Finance Minister
and the Empowered Committee.
4.3 As mentioned earlier, there is also a need, after introduction of VAT, for
phasing out of Central Sales-tax (CST). However, the States are now collecting
nearly Rs. 15 thousand crore every year from CST. There is accordingly a need of
compensation from the Government of India for this loss of revenue as CST is
phased out. Moreover, while CST is phased out, there is also a critical need for
putting in place a regulatory frame-work in terms of Taxation Information Exchange
System to give a comprehensive picture of inter-State trade of all commodities. As
already mentioned, this process of setting up of Taxation Information Exchange
System has already been started by the Empowered Committee, and is expected
to be completed within one year. The position regarding CST will be reviewed by
the Empowered Committee during 2005-06, and suitable decision on the phasing
out of CST will be taken.
4.4 It is also essential to bring imports into the VAT chain. Because of the
set-off, this will not result in any tax cascading effect, but will only improve tax
compliance. A proposal for VAT on imports, including the collection mechanism
with adequate safeguards for the protection of interest of land-locked States, is
being discussed with the Government of India.
4.5 Similarly, discussion between the Empowered Committee and the
Government of India is going on for an early decision on the question of collection
and appropriation of service tax by the Centre and the States.
If decisions on VAT on imports and service tax are taken expeditiously at the
national level, then these two important spheres of taxation can be integrated,
along with the AED items as mentioned earlier, into the VAT system of the States
from the second year of introduction of VAT.
4.6 It may be noted that this VAT design has been worked out carefully by the
Empowered Committee to strike a balance not only between the common points of
convergence and federal flexibility, but also a balance between what can be done
to begin with and what should be incorporated subsequently for further perfection
of the VAT system.
4.7 For successful implementation of State-level VAT, close interaction with
trade and industry is specially important. The Empowered Committee has
therefore also set up a Consultative Committee with one representative from each
of the national level trade organisations and national level chambers of commerce
and industry. This Committee has already started interacting with the Empowered
Committee. This process of interaction will continue regularly to discuss issues
and sort out problems of implementation of VAT. Such Consultative Committees
will also be set up at the level of each State, and interaction with the State
Government will take place in a similarly regular manner.
4.8 In course of discussion with representatives of trade and industry,
reference has often been made to the earlier VAT Bills of some of the States. It
should be clearly noted, as already mentioned before, that all the States have
agreed to amend their earlier VAT Bills so as to conform broadly to the common
design as elaborated in this White Paper. This process of amendment has also
already started. The point of reference on VAT should therefore be this design of
VAT as explained in this White Paper. It should also be mentioned that there are
some important points on the ground-level implementation of VAT which have
been raised by the representatives of trade and industry. Many of the points will be
taken care of in the VAT rules of the States, with changes where necessary.
4.9 Finally, a comprehensive campaign on State-level will be launched to
communicate in simple and transparent manner the benefit of VAT for common
people, traders, industrialists and also the State Governments. This campaign will
then be launched first at the national level on the basis of necessary coordination
between the States and the Centre. This will then be simultaneously followed up at
the level of every State and also in districts of the States. This campaign will be
based on written materials as well as publicity through all media. The purpose of
this campaign will be a two-way interaction between the Government and the trade
and industry as well as the common people.
There is now only looking forward to the introduction of State-level VAT by all the
States and Union Territories from April 1, 2005. We seek cooperation of all
sections of people in the country.
5.8 Further developments and concerns
With effect from April1, 2005 a majority of the Indian States have introduced VAT
legislations in their respective States. This is indeed a signal achievement of the
Empowered Committee of State Finance Ministers, which brought around the
States to agree on a minimum common denominator. The various State VAT
Legislations are based on the fundamental principles of State Level VAT contained
in the White Paper. However, there are significant variations in the list of goods,
which are subject to varying rates of taxes. It is enough to say that this is only a
beginning in the implementation of the State-Level VAT. There is a long way to go
before an efficient system of State- Level VAT is put in to operation.
There are several areas of contention and concern as between the Central and the
State Governments. The following are the most significant among them:
1. Under the Constitution of India the Central Government and the State
Governments have been allocated powers of taxation. While till now
sales-tax was the major revenue earner for the States, there are other
avenues of taxation like octroi, entertainment tax, luxury tax and a few
other minor levies. While the States have accepted giving input tax credit
by implementing State-Level VAT, they are fighting shy of giving up their
other powers of taxation. Therefore, in several States these auxillary
levies continue to exist side by side with State-Level VAT contributing to
the cascading effect.
2. Computerization and maintenance of proper invoices is the bed rock
upon which a successful VAT system has to be build. However,
computerization particularly in the State Governments is extremely
unsatisfactory and the various States are not geared up for this huge
3. The traders and the business community do not appreciate the scientific
basis of VAT. In a large section of the business particularly belonging to
non-corporate sector proper books of accounts are not maintained
reflecting purchases and sales. For them, to install computerized systems
for maintenance of documents is a costly proposition. Further, a VAT
system will require proper disclosure of purchases of various eligible
inputs which will ultimately enable the Assessing Officer to arrive at the
correct turnover of the trader. This is one more hindrance in the way of
implementation of VAT.
4. Central sales-tax which was introduced to prevent double taxation of the
same transaction by two different States on the principle of nexus theory
still continues to exist. The While Paper on State-Level VAT envisages a
new system to tackle this issue. However, complex issues of allocation of
tax between different States will arise while formulating the system.
5. The intention of introduction of State-Level VAT is to remove all trade
barriers to enable the smooth flow of trade and commerce throughout the
country. In other words it should lead to the abolition of all check-posts
and levy of octroi at different boarder points. In practice this is not
happening. The continuance of CST is a contributory factor.
6. Several States are of afraid of loosing the revenue because of the
eligibility of the input credit. In fact the State of Maharashtra has already
come out with a claim of loss. Compared to this in States like Haryana,
VAT revenue has registered an increase and the number of units has
shown a remarkable increase after the introduction of VAT. In some other
States revenue increase has been recorded. However, knowledgeable
observers feel that the euphoria of increased collection will fade away
after a few months.
7. The issue of incentives prevalent in several States in respect of
deferments or waiver of sales-tax is another thorny issue to be resolved.
The industry having enjoyed the incentives over a long period of time is
pressing for the continuance of the incentives in one form or another.
This, if accepted and implemented, will complicate the State-Level VAT.
8. To ensure that the States realize the proper VAT revenue it is necessary
to subject the accounts of the traders and business to proper scrutiny.
This scrutiny or audit has been given to chartered accountants by several
States. The ICAI on its parts has done pioneering work in State-Level
VAT and there is a broad consensus that chartered accountants can
contribute for streamlining the account keeping and for the proper
realisation of the revenue by the Government.
9. The various States Government have realized the difficulties of the
traders and the business community in switching over to a VAT system by
maintaining proper documentation. In order to help small traders, various
States have come out with the composition schemes by which the traders
will be freed from the hassles of record keeping.
10. The Empowered Committee of States Finance Ministers is addressing
huge task of bringing uniformity in the various States-Level VAT
The ultimate vision of the Indian policy planners is to bring an integrated VAT
system comprising of excise, customs, service-tax and sales-tax. The natural
result of this uniform VAT would be the abolition of all other taxes. Thus, an
integrated tax on goods and services throughout the country will operate.
However, given the federal structure of the Indian Union and the demands of the
various States for more autonomy particularly in the finance area, this is going to
be a big economic challenge for India.
Chapter - 6
VAT in Nepal
The framework of the Nepalese VAT system is specified in the VAT Act and
Regulations. The VAT system is also governed to some extent by the Finance Act,
1999. Some procedural matters relating to VAT are also introduced through
operating manual. The government also has introduced some notifications relating
to the VAT system. Similarly, the VAT Department has issued several circulars on
various procedural matters from time to time.
6.2 Basic Features
Type of VAT
Nepal has adopted a consumption type VAT system. Under this system tax is
levied on value added at each stage in the process of production and distribution.
Practically speaking, however, value added is never calculated directly; but the
same result is obtained indirectly through the input tax credit mechanism, i.e. VAT
is levied on output and a credit is allowed for the full amount of the tax paid on the
business input, including capital goods, at previous stages. The end result is that
each and every VAT registrant pays VAT on its value added only.
VAT is based on the destination principle. It is levied on the goods and services
where the place of supply is in Nepal and importation of goods and services into
Nepal. Exports of goods and services are zero-rated. This means that the tax base
is domestic consumption.
VAT is a broad-based tax, which applies to all business turnovers through to the
retail stages, with a few exceptions. It is levied on a large number of goods and
services other than those specifically exempt by law, particularly on administrative
and social grounds.
Exempted goods and services are included in Schedule 1, which is given at the
end of the VAT Act. This schedule can be changed by the government and does
not require parliamentary approval.
Currently, the following goods and services are exempted from VAT:
• Basic agricultural products such as paddy, rice, wheat, green and fresh
vegetables, fresh fruits, fresh eggs, unprocessed cereals, oil seeds,
unprocessed food, etc., but excluding food held out for sale by hotels;
restaurants, cafes and similar establishments.
• Goods of basic needs such as piped water, fuel wood, coal and kerosene.
• Live animals and animal products.
• Agricultural inputs such as seeds, manure, fertilizer, soil conditioners,
agriculture hand implements and pesticides
• Medicines, medical and health services.
• Educational services.
• Books, newspapers, etc.
• Artistic and cultural goods and services.
• Transportation services.
• Specified personal or professional services.
• Other goods or services such as postal services, financial and insurance
services, bank notes, and cheque books, gold and silver, land and building,
betting, casinos, lotteries.
VAT for a fiscal year is levied at a single positive rate as specified in the Financial
Act made for that year . A few transactions or goods and services are zero-rated,
which are given in Schedule 2 of the VAT Act. Like Schedule 1, which is related to
exemptions, the government, without a parliamentary approval, also can change
Zero-rating means some items are taxed at zero rate. This further means that no
VAT is payable on them, but they are otherwise regarded as taxable. Therefore, a
registered person making zero-rated sales may take full credit for the VAT paid on
the taxable inputs to his business.
At present, the following supplies are zero-rated:
• Export of goods.
• Goods or stores taken on board an aircraft, provided that the goods are
taken on board an aircraft on flight to a destination outside Nepal for
delivery to another country and fuel is used by the aircraft on a flight to a
destination outside Nepal.
• Goods that have been shipped for use as stores on a flight to a destination
• Imports of goods and services' by accredited diplomats.
• Goods or services purchased or imported by His Majesty the King, Her
Majesty the Queen, His Majesty the Crown Prince, and other members of
the royal family.
6.3 Taxable supply
VAT is levied on a 'taxable supply', which is defined as the process of selling,
exchanging or delivering goods or services; or the grant of permission thereto or a
contract thereof for a consideration. To be a taxable supply the consideration can
be in money or money's worth.
6.4 Place and time of supply
Place of supply
Under the Nepalese VAT system, the place of supply is defined as follows:
• For moveable goods, the place where the goods were sold or transferred.
• For immovable goods, the place where the goods are located.
• For imported goods, the customs point where the goods first enter Nepal.
• For goods supplied by a vendor to himself, the place where the vendor or
producer of the goods resides.
• For services, where the benefit of service is received.
Time of supply
The time of supply is important under VAT in order to establish the tax liability. For
most practical purposes, the time of supply will be the date of the invoice, but it is
important to bear in mind that there may be an alternative date of supply. Under the
Nepalese VAT, system the time of supply is defined as the earlier of the following:
• The time of supply of the goods or service;
• The time of issue of an invoice; or
• The time of receipt of payment for the goods or services.
In the case of supply of services, the time of supply is defined as the time when the
services are performed.
For certain goods and services, special provisions are made as follows:
• The time of supply for continuously provided services such as telephone is
the time an invoice is issued for the part of the service provided; and
• Where partial payment is made for goods or services, the time of supply
shall be the earliest day on which the payment is made.
6.5 Taxable value
VAT is levied on the taxable value of each transaction, which is the total price
charged by the seller (including all- related charges). The taxable value does not
include the VAT itself, and takes into account any price adjustments (such as
discounts or rebates) in effect at that time of the sale. Adjustment that becomes
necessary after the time of sale (such as for goods returned) is to be made in
subsequent determination of the tax or credits.
The taxable value of a transaction is the price paid, which is also consideration for
the goods or services, by the recipient to the supplier, provided that the supplier
and recipient are independent of each other. The price charged must include all
related expenditure borne by the supplier, for example, transport costs, if the
goods are delivered to the recipient, or any taxes other than VAT, chargeable on
the goods or services.
In the case of imported goods, the tax base is the sum of import value, freight,
transport costs, insurance, commission, import duties plus any charges paid by the
In the case of a transaction taking place between associated persons, or goods
being exchanged or bartered, or at any time when the value declared is lower than
the prevailing market value, the taxable value of the transaction shall be the market
value of the goods or services, which shall be taken as the consideration in money
agreed between independent sellers and buyers for the supply of goods or
services. If a tax officer is satisfied that the declared value is substantially below
the market value, he may determine the value of the disputed transaction to the
best of his ability.
6.6 Tax credit
In case of taxable supply
Tax credit is an important element of VAT. Under this system VAT registrants
making taxable supplies, including the zero rated supplies, are entitled to claim
input tax credit. It is, however, allowed to the extent that the purchased/imported
goods and services are used for goods and services sold in taxable transactions,
including exports. Since, only VAT registrants are allowed to claim input tax, small
vendors falling below the registration threshold and not registered for VAT are
required to pay VAT on their purchases but cannot claim an input tax credit.
It is necessary to meet the following conditions for the entitlement of an input tax
• The goods or services supplied to the VAT registrant must be solely for use
in his business of making taxable sales;
• The registrant must hold and be able to produce a valid tax invoice for the
goods or services for which credit is claimed; and
• The claim for deduction must be made within one year of the date of invoice.
In case of mixed supply
A person involved in mixed transaction (i.e. making both taxable and tax-exempt
transactions) is entitled to claim input tax credit on the purchases related to the
making of taxable sales only, but not purchases related to his exempt sales.
The VAT registrant is allowed to claim the tax on purchases which he can clearly
identify as being for taxable sales. A VAT registrant will have overheads, such as
diesel or telephone charges or stationary, which will be used by both his taxable
and his exempt sales.
A VAT registrant is authorized to claim a proportion of his input tax. The proportion
to be claimed is the proportion that his taxable sales bear to his total sales.
Some goods are used for both the purpose of the business and for personal use. In
such cases, it is very difficult to ascertain the proportion used in the taxable and
tax-exempt transactions. These include such items as computers and cars. In
these cases, only partial input tax credit can be taken. For example, 40 per cent of
input tax credit may be claimed on aeroplanes and automobiles and 60 per cent
may be claimed on computers.
With certain goods and services it is very difficult to ascertain whether they have
been used for the purpose of the business or for personal use. These include such
items as business entertainment, beverages, alcohol or alcohol mixed beverages,
such as liquor and beer, and light petroleum (petrol) fuel for vehicles. In these
cases no input credit can be taken.
6.7 Tax refund
Tax refund is another important element of the VAT system. It generally happens
in the case of zero-rated supplies such as exports. This is because exporters of
taxable goods do not have to collect tax on their exports but are entitled to claim
tax paid on the inputs of exports. Tax refund may arise in other situations also.
Refund to exporters
The VAT Act provides immediate refund for exports. Since, exports sales are
zero-rated there is no tax due on such sales. This means that exporters are most
likely to have large excess credits. A person is defined as an exporter for any
month if his export sales for that month are more than half of his total sales. An
exporter may make application for refund of VAT to the concerned VAT office. This
office will process the refund, claim and forward it to the VAT refund section of the
VAT department for the final approval and issuance of the refund cheque.
Refund to non-exporters
There is also a situation where it will be necessary to refund in the case of a
registrant who is not an exporter. A registrant may have excess credits even if he is
not an exporter. In this case he can carry forward his excess credit. He can claim
for a refund if he has excess credits for a continuous period of six months or more.
Such a situation may arise in the case of a new business, an inventory building up
or the purchase of large capital asset.
If a registered person remains in credit for a period of six consecutive months, he
may submit an application for refund of VAT to the concerned VAT office. After
being processed, refund applications are to be forwarded to the VAT refund
section of the VAT department that is responsible for approval.
Refund to diplomats
Refund is also provided to the accredited diplomats on a reciprocal basis. In the
case of importation, they do not have to pay tax since their imports are zero-rated.
In the case of domestic products, they have to pay VAT first and claim for refund.
Other officials of international organizations that are accredited by the Ministry of
Finance also are entitled to claim for refund. Similarly, the projects under bilateral
or multilateral agreements also enjoy this facility.
There are also situations where VAT may be collected by mistake, for example on
a product that is either zero-rated or exempt. There is a provision for the refund of
this tax to the person who has paid the tax.
Suppliers of taxable goods and services are required to register under the VAT Act
and collect this tax. It is, however, not necessary for them to register if they deal
with only tax exempt goods and services. Similarly, small vendors falling below the
registration threshold are also not required to register for VAT.
The existing level of threshold is Rs.2 million. In the case of imports, traders having
annual commercial imports below Rs.200,000 are not required to resister. Traders
dealing with the mixed supply also will have to register only when the transaction of
taxable supply exceeds the registration threshold. However, vendors filling below
the registration threshold can register voluntarily.
There is no system of group registration under the Nepalese. VAT system.
Similarly, the Nepalese VAT Act does not allow branch or divisional registration
The registration process is as follows:
• Fill in VAT registration application form.
• In case of partnership, fill also another form designed for partnership firms.
• Attach copies of business and income tax registration certificates.
• Submit it to the concerned VAT office. On receipt, the VAT office gives a
temporary certificate and allocates Taxpayer Identification Number (TPIN)
and forwards the details to the VAT department.
• VAT department processes the information and prints out a VAT certificate
with TPIN assigned by the VAT office to the taxpayer on it and forwards it to
the concerned VAT office.
• The VAT office hands over the certificate to the concerned taxpayer.
• Taxpayer has to display the original certificate at his main place of business
and certified copies at other places.
• Taxpayer has to furnish information within 15 days, in case of changes in
the information mentioned in the VAT application form.
Apply for de-registration under the following conditions:
• In the case of an incorporated body, if the incorporated body is closed
down, sold or transferred, or if the incorporated body otherwise ceases to
• In the case of a partnership firm, if it is dissolved.
• In the case of individual ownership, if the owner dies. If a registered person
ceases to be engaged in taxable transactions.
• If person is registered in error.
Taxpayer Identification Number
The VAT administration issues a unique registration number to the VAT
registrants. It consists of nine digits with a cheque digit. No suffix or prefix is
attached to it. The TPIN does not represent anything like geographical area, nature
of transaction, ownership, etc. The VAT department allocates the blocks of TPINs
to various VAT offices. If all TPINs assigned to a particular VAT office are used,
this office demands for new block of TPINs. VAT department maintains records of
Taxpayers are required to mention TPINs in the following documents:
• Tax invoice/abbreviated invoice;
• Purchase and sales books;
• Correspondence to the VAT office;
• Documents relating to income tax;
• Documents relating to customs duties;
• Documents relating to the exports/imports; and Documents relating to
obtaining a loan from a bank or financial institution exceeding Rs. 100,000.
If a taxpayer is deregistered, his TPIN becomes ineffective. This number is not
given to any other taxpayer. If he is reregistered, he is given this number (i.e. the
original number) again.
VAT is an invoice-driven system. Under this system, each registrant is required to
issue a tax invoice or an abbreviated invoice.
A VAT registrant is required to issue a tax invoice in the prescribed form whenever
a transaction takes place. The format is prescribed in the VAT regulations, which
requires the following information:
• A sequential identifying number.
• The date of the transaction.
• The date of issue of the invoice, if different from the date of the transaction.
• The name, address and TPIN of the vendor.
• The name, address and, where applicable, TPIN of the buyer.
• The type of transaction (e.g. sale, hire, rental or exchange).
• A description to identify the goods or services supplied. The quantity of the
goods or the extent of the service for each description.
• The rate of VAT and the amount payable, excluding VAT, for each
description of goods or services.
• The value of any goods or services provided in part exchange.
• The total amount payable, excluding VAT.
• The rate and amount of any discount offered.
• The total tax charged.
• The total amount charged, inclusive of VAT.
A minimum of three copies of each invoice must be prepared. The first copy must
be given to the buyer and the vendor must retain the remaining two copies. These
must be made available at all reasonable times for inspection by a tax officer. The
invoices must be issued in sequential numerical order. However, the invoices can
be prepared with different serial numbers for branches or different sections (such
as restaurants, bars, laundry, etc., in the case of hotels) with prior approval of the
VAT registrants may make application to use an abbreviated invoice and the
concerned tax officer may allow its use subject to the following conditions:
• The recipient of goods or services for which an abbreviated invoice is
issued shall not be entitled to input tax credit on that purchase.
• The abbreviated invoice shall not be used for transactions exceeding Rs.
5000, including VAT.
• The registered person must keep a daily record of sales.
• Any till rolls or cash rolls used by the retailer must be totalled daily and
retained for inspection at any reasonable time.
The following information must be recorded on the abbreviated invoice:
• An identifying number issued in sequential order.
• The name, address and registration number of the vendor. The date of the
• A description to identify the goods or services supplied. The total amount of
money paid, including VAT.
In the case of sales under the abbreviated invoice, VAT is calculated by multiplying
the sales by the VAT quotient. The VAT quotient is found by dividing the rate of
VAT by 100 plus the rate of VAT.
VAT registrants are required to maintain purchase and sales books and list all
sales and purchases in these books. They are also required to prepare a VAT
VAT registrants are required to maintain an account of their business purchases
for VAT purpose. They have to record of purchases by invoice. At the end of each
accounting period VAT registrant must total the amount of taxable purchase/
imports, tax exempt purchase/imports and the tax paid on purchases/imports.
Similarly, VAT registrants are required to maintain account of their sales for VAT
purpose. Like purchases, sales also are to be recorded per invoice basis. At the
end of each accounting period VAT registrants are required to total the amount of
taxable (standard-rated and zero-rated) and tax exempt sales they have made in
the period and the tax collected on sales. If they make both taxable and exempt
purchases and sales they are then required to calculate the proportion of input tax
they are entitled to the tax period.
VAT registrants are also required to maintain the VAT account. It is a monthly
summary of taxable purchase and sales and VAT paid on purchases and charged
VAT registrants can maintain their business accounts on computer with prior
approval of VAT administration.
VAT registrants must make their accounts available at all reasonable times for
inspection by the VAT officer. In most instances, they will be produced at the VAT
registrants' premises, but their production can be demanded at any place. The
VAT officer may take possession of accounts at any reasonable time and they may
be removed, copied or taken possession of, as necessary.
All documents and accounts relating to the business must be retained for a period
of six years.
6.11 Submission of return
A VAT registrant must complete a VAT return and submit it to the concerned VAT
office within 25 days of the month following the end of the accounting period. In the
case of compulsory registrants, it is necessary to submit VAT return every month
but the voluntary registrants have to submit returns on a trimester basis.
The head office is required to submit tax returns for the transactions carried out by
it and its branches and sub branches, if any. There are no special rules, for
example for seasonal business or others. Even if there is no transaction, it is
necessary to submit a zero return.
Returns could be debit returns, credit returns or zero-returns. There is no need to
attach purchase and sales invoices or any other documents relating to the tax with
If a taxpayer does not submit return within stipulated time, he will be subject to a
penalty of 0.05 per cent of payable tax per day or Rs. 500, whichever is higher.
6.12 Payment of tax
If a registrant's output tax liability is greater than his input tax credit, he is required
to remit the difference to the government with 25 days from the close of the month
in which the tax liability occurred. Compulsory registrants have to pay tax every
month while voluntary registrants will have to pay tax on a trimester basis.
There are some circumstances that are beyond the control of a taxpayer, which
can prevent paying the tax .due within the prescribed time. Natural disasters such
as floods, and unfortunate circumstances such as a fire or death in the family
are-some of those incidents that could cause a delay. The law grants the authority
to the Director General to waive the payment of the penalty under such
On the other hand, if the input tax credit is greater than the output tax liability, the
balance of credit is to be carried forward for the next month. If a VAT registrant has
more than 50 per cent of his sales as exports, he can apply for refund instead of
carry forward of the excess credit.
The VAT Act makes provision for the additional charges as late payment penalties.
The rate of such penalty is 10 per cent of the VAT payable in the first month, an
additional 10 per cent in the second month, and then no further action. There is
also a provision for interest on non-payment. The current rate of interest is 15 per
cent. Interest on overdue is charged on a calendar month basis.
6.13 Tax assessment
VAT is a self-assessed tax. Taxpayers determine their tax liability themselves and
pay tax. Under this system, a taxpayer determines his tax liability and files his
return to the VAT office. However, not all taxpayers may file their return and- pay
tax within the specified time. Similarly, not a1l taxpayers may file the correct
returns and pay correct amount of tax. There could be different situation as follows:
• Tax return is not filed;
• Tax return is late;
• Tax return contains incomplete information; or
• The tax administration has reason to believe the tax is otherwise than as
In such cases, VAT officials may have to make a tax assessment. Such
assessment could be computer assessment or management assessment, as
If a taxpayer does not assess his income himself and does not file his return within
the specified time, he is termed as non-filer. Computer prints out the list of
non-filers after 45 days of the expiry of the tax period. The VAT office gives the
non-filers a notice. If they do not file returns within the specified period even after
the issuance of the notice of non-filing, the computer makes a monthly or trimester
assessment, depending upon the status of a particular taxpayer.
The process regarding computer assessment is designed in the following way:
(i) Find out highest amount declared by the taxpayer in his tax returns during
the previous 12 months from the VAT payable.
(ii) If a taxpayer has not filed any return, find the turnover figure stated on the
registration application. Divide this by the number of filing periods in a
year, and then multiply by the VAT rate.
(iii) Pick the highest figure in (i) or (ii) above.
(iv) Increase the number found in (iii) by 30 per cent to get the assessment
• Such assessments are stored in an assessment verification file for
review. The assessed tax is not recorded in the taxpayers' account at the
time of computer assessment.
• Tax assessment notice is sent to the Collection Section of the VAT
department for management review.
• The Collection Section makes a verification of the computer assessment;
particularly to be sure whether or not the taxpayers have submitted their
returns for the period for which the computer assessments have been
• The Collection Section cancels the computer assessments in the case of
those taxpayers whose return have already been received and accepts
• The Collection Section provides this information to the computer system
without any delay.
• On the receipt of such information, the Computer Section posts the VAT
in the taxpayer's account (Le. transfers data from assessment verification
file to the taxpayers account).
• The Computer Section prints computer assessment.
• The VAT officer signs such computer assessments. If he does not agree
with the computer assessment, he makes management assessment by
correcting figures printed by the computer.
• Assessment orders are issued and distributed to the concerned parties.
The tax officers do management assessment when a taxpayer receives updated
information after submitting his returns and informs it to the tax officer or in the
case of those taxpayers where tax officers find errors during the tax audit.
The management assessment process is explained below:
• The tax officer assesses tax, and determines interest and penalties.
• The tax officer creates management assessment on a trimester basis in
the case of voluntary registrants and monthly basis in case of others.
• Management assessment must be batched and submitted to the
Computer Section. .
• VAT assessments will only normally extend back four years from the time
the taxpayer is given the notice of assessment.
VAT administration collects tax dues through the following methods:
• Tax officers are empowered to recover tax dues from the credit in a VAT
debtor's account. .
• Tax officers also can issue to a third party who is indebted to the
VAT debtor a demand for the payment of the money owed by the third
party to the VAT debtor. Tax officers are also authorised to suspend the
transaction of a VAT debtor.
• Tax officers also can withhold export/import of VAT debtor.
• Tax dues also can be realized by seizing and selling the property of the
• Tax officers can collect tax arrears within six years of such arrears
6.15 Penal provisions
Penal provisions have been made for any non-compliance. For example,
a vendor will be required to pay liable tax plus up to Rs.10,000 or a 10 per
cent of payable tax, whichever is higher, if he fails to register before the
commencement of his business.
Penalty for non-issuance of invoice is Rs.500 each time whereas the
corresponding figure for failure to keep the required information in
account is up to Rs. 10,000 each time. Similarly, a taxpayer who has
committed fraud or tax evasion will be charged with a penalty not
exceeding 100 per cent of the amount of tax, or six months jail, or both.
A taxpayer may file an appeal to the Revenue Tribunal within 35 days
against a tax assessment or a penalty order by a tax officer or an order by
the Director General relating to the suspension of his place of transaction.
Before filing an appeal, the taxpayer must deposit the, disputed amount
of the assessed tax due; the rest of the amount of the tax due plus the
whole amount of the fine shall have to be deposited or a bank guarantee
of the same has to be provided.
Nepal has adopted a destination-based consumption-type VAT with tax
credit mechanism extending right through the retail level. The rate of tax
is 10 per cent combined with zero, rate on exports. The exemption list is
rather long and the registration threshold is Rs. 2 million (Rs. 200,000 for imports).
Taxpayers are required to issue invoices of their supplies and maintain
purchase and sales books. The tax period is trimester for voluntary
registrants, and one month for others. The VAT Act makes provision for
the additional charges as the late payment penalties. The rate of such
penalties is 10 per cent of the VAT payable in the first month, an
additional 10 per cent in the second month, and then no further action.
Late payment penalties are based on one calendar month from the due
date. There is also a provision for interest on non-payment. The current
rate of interest is 1 5 per cent.
VAT is based on the principle of self-assessment. Tax officials, however,
can assess VAT when a taxpayer does not submit a return, or submits an
incorrect or fraudulent return; Tax officers are authorized to recover tax
dues by various means, including retention of tax credit, deduction from
debtors, closing the business, and seizing and selling property of the VAT
Chapter – 7
VAT in Sri Lanka
The Value Added Tax Act (No.14 of 2002) as amended by the (hereinafter referred
to as VAT Act) provides for the imposition and collection of a value added tax on
goods and services supplied in Sri Lanka or imported into Sri Lanka. It also
provides for the abolition of the national security levy and the goods and services
tax. It was certified on 26th July, 2002 and came into operation on August 1, 2002
7.2 Imposition of Value Added Tax (VAT)
Chargeability of VAT
Section 2 provides for the chargeability of VAT. Accordingly, VAT will be charged
at the time of supply, on every taxable supply of goods or services, made in a
taxable period, by a registered person in the course of the carrying on, or carrying
out, of a taxable activity by such person in Sri Lanka or on the importation of goods
into Sri Lanka, by any person.
Rate of VAT
VAT will be charged at the rate of 10% on the value of such goods or services
referred to in the Second Schedule, which is given in the Annexure 1 of this Study.
An increased rate of 20% is applicable on the value of all other taxable goods and
services. However, the above rates are not applicable to zero rated supplies.
Where the consideration is inclusive of VAT, the tax payable is to be calculated on
the basis of a tax fraction. For example, if the consideration includes VAT collected
at the rate of 10%, the tax fraction applicable would be 1/11. For VAT collected at
the rate of 20% forming part of the consideration, the tax fraction would be 1/6.
No VAT is collectible in respect of garments sold locally under certain
circumstances. The collection of VAT will be deferred in case of tea supplied to a
broker in a tea auction for export purposes.
It is significant to note that VAT on importation of all goods will be treated on par
with the customs duty. However, no VAT would be charged on any goods which
entered into a customs bonded area, or on any fabric imported by any person for
the purpose of manufacture of garments for export, or on any fabric imported by
any person, who has registered with the Board of Investment of Sri Lanka as a
Trading House for the purpose of manufacture of garments for export through
other garment manufacturers, or on any fibre, yarn, grey cloth, finished cloth,
chemicals and dyes used for the manufacture of fabric imported by any Fabric
manufacturer or on any ship imported on or before 31.12.2002.
VAT not to apply on certain wholesale or retail supply of goods
Section 3 provides that VAT shall not be charged on the wholesale or retail supply
of goods. However, if a manufacturer or an importer of such goods or a supplier
who is unable to satisfy the Commissioner-General as to the source from which the
goods supplied by him were acquired, supplies these goods on a wholesale or
retail basis, VAT would apply.
Time of supply of goods
Section 4 provides that the supply of goods shall be deemed to have taken place at
the time of the occurrence of anyone of the following whichever, occurs earlier :-
(a) the issue of an invoice by the supplier in respect of the goods; or
(b) a payment for the goods including any advance payment received by the
(c) a payment for the goods is due to the supplier in respect of such supply; or
(d) the delivery of the goods have been effected.
Time of supply of services
The supply of services shall be deemed to have taken place, at the time, of the
occurrence of any of the following whichever, occurs earlier :-
(a) the service was performed; or
(b) a payment is received for the services rendered or for future services; or
(c) a payment is due for the services rendered or for future services; or
(d) an invoice is issued in respect of the services rendered.
Supply in the case of instalments/hire purchase
In the case of supply of goods on for which the consideration is payable in
installments, the supply shall be deemed to take place when the payment is due or
when the payment is received, whichever is earlier. Where goods are supplied
under a hire purchase agreement, the supply shall be deemed to take place at the
time the agreement is entered into.
Value of taxable supply of goods or services
Under section 5, the value of a taxable supply of goods or services would be
determined as follows -
(a) where the supply is for a consideration in money, then the value would be
such consideration less any tax chargeable under this Act. However,
such value should not be less than the open market value;
(b) where the supply is not for a consideration in money or not wholly in
consideration of money, the value would be the open market value of
(c) Where a supply of goods or services is made by an employer, to his
employee as a benefit from employment, the consideration in money for
the supply shall be the open market value of such supply. However,
where the open market value of such supply cannot be ascertained, the
consideration in money of such supply shall be the cost of a similar
benefit enjoyed by any other employee, as may be determined by the
(d) Where a supply of services is made under any lottery, or any taxable
activity of entering into or negotiating a wagering contract or any business
of like nature, the value of such supply shall be the total amount of money
receivable in respect of such supply, less the consideration of the prizes
or winnings awarded in such lottery, wagering contract, or any business
of like nature, as the case may be.
(e) The value of the supply of goods under a hire purchase agreement shall
be the cash price determined in accordance with the provisions of the
Consumer Credit Act, No. 29 of 1982, and shall not be less than the open
(f) The value of supply of land and improvements thereon, shall be the value
of such supply less the value of land at the time of supply and the value of
any improvements on the land as at March 31, 1998 which shall not be
less than the open market value of such supply excluding the value of
such land at the time of supply and the value of any improvements on
such land as at March 31, 1998.
(g) Where goods or services are supplied either on the issue of a ticket or by
the deposit of money, the value of such supply shall be the amount paid
for such ticket less the tax payable under this Act or the amount deposited
less the tax payable under this Act, not being any amount which is
refundable, as the case may be.
(h) Where any goods supplied under a lease agreement is subsequently
transferred to the lessee at the termination of such agreement for a
consideration not exceeding ten per centum of the total consideration of
the lease agreement, such consideration shall be deemed to be a lease
rental recovered under such agreement. Further, where such
consideration is more than ten per centum of the total consideration of the
lease agreement such supply shall be deemed to be a separate supply.
(i) Where the consideration in respect of a supply of goods or services
relates to a taxable supply and a supply which is not taxable, the
consideration for such taxable supply shall be deemed to be such part of
the consideration as is attributable to such taxable supply and shall not be
less than the open market value of such taxable supply.
(j) Goods may be manufactured or produced or a service may be provided
by using other goods or services which may be provided by the supplier
or any other person. Such other goods or services shall be deemed to be
used in the manufacture or production of goods or the provision of service
as the case may be. The value of the supply of the goods so
manufactured or produced and the supply of services in connection with
such manufacture or production or the supply of the service shall be the
open market value or the sum received as consideration for such supply,
whichever is higher:
However, where it is proved to the satisfaction of the Assessor that the supply of
goods, and the supply of services are two separate supplies, each such supply
shall be treated as a separate supply by such Assessor.
Value of goods imported
Under section 6, the value of goods imported, shall be the aggregate of the value
of the goods determined for the purpose of customs duty; and the amount of any
customs duty payable, in respect of such goods with the addition of any surcharge,
cess and any excise duty payable under the Excise (Special Provisions) Act.
No.13 of 1989 on such goods.
Zero rated goods
1. Under section 7, a supply of goods shall be zero rated where the supplier
of such goods has exported such goods; and
2. A supply of services shall be zero rated where the supply of such services
are directly connected with –
(i) any movable or immovable property outside Sri Lanka;
(ii) the repair of any foreign ship or aircraft, refurbishment of marine
cargo containers or any other goods imported for the purpose of
(iii) a copyright, patent, licence, trade mark or similar intellectual
property right, to the extent that such right is for use outside Sri
(iv) the international transportation (including transshipment) of
goods or passengers as are specified by the
Commissioner-General by a Notification published in the
(v) computer software development, in respect of software
developed by the developer for use wholly outside Sri Lanka,
and for which payment is received in foreign currency through a
bank if, and only if, documentary evidence is produced to the
satisfaction of the Commissioner-General of the supply of such
(vi) client support services provided, on or after April 1, 2001 over
the internet or the telephone by an enterprise set up exclusively
for the provision of such services to one or more identified
clients outside Sri Lanka, for which payment is received in
foreign currency, through a bank;
(vii) any other services consumed outside Sri Lanka to the extent
that the payment for such services is received in foreign
currency, through a bank in Sri Lanka.
3. Where a registered person supplies any goods or services which is zero rated -
(a) no tax shall be charged in respect of such supply;
(b) the supply shall in all other respects be treated as a taxable
supply and accordingly the rate at which tax is charged on the
supply shall be zero.
Exemption in respect of entries in First Schedule
Under section 8, no tax shall be charged on the supply of goods or services and
the importation of goods specified in the First Schedule to this Act as such supplies
and imports are not taxable unless zero-rated under section 7.
Place of supply of goods or services
Under section 9, goods or services shall be deemed to be supplied in Sri Lanka
where the supplier carries on or carries out a taxable activity in Sri Lanka and the
goods are in Sri Lanka at the time of supply or the services are performed in Sri
Lanka by the supplier or his agent.
Who should register?
Under section 10, every person who, on or after August I, 2002 carries on or
carries out any taxable activity in Sri Lanka shall be required to be registered under
(a) Threshold limit for taxable period -
If at the end of any taxable period of one month or three months, as the case may
be, the total value of his taxable supplies of goods or services or goods and
services made in Sri Lanka in that taxable period has exceeded rupees five
hundred thousand (Rs.5 lakhs); or
(b) Threshold limit for a year -
If in the twelve months period then ending, the total value of his taxable supplies of
goods or services or goods and services made in Sri Lanka has exceeded one
million and eight hundred thousand rupees (Rs.18 lakhs); or
(c) Threshold limit for the next taxable period/year -
If at any time, there are reasonable grounds to believe that the total value of his
taxable supplies in Sri Lanka of goods or services or goods and services in the
succeeding one month or three months taxable period, as the case may be, is
likely to exceed five hundred thousand rupees (Rs.5 lakhs) or in the succeeding
twelve months period is likely to exceed one million and eight hundred thousand
rupees (Rs.18 lakhs).
(d) Exclusion of single isolated transaction -
Where the Commissioner-General is of the opinion that the supply of goods relates
to a single isolated transaction, the value of such supply may be excluded in
calculating the total value of taxable supplies for the purposes of this section.
(e) Application for registration -
Every person who is required to be registered under should make an application
for registration in the specified form to the Commissioner-General not later than
fifteen days from the date on which he is so liable to be registered.
(f) Exclusion of wholesale or retail trade -
For the purpose of this section the total value of taxable supplies shall not include
the supplies of any wholesale or retail trading activity excluded from the payment
of tax under section 3.
Importers of goods to notify Commissioner-General
Section 11 provides that every person who is an importer of goods into Sri Lanka
should notify the Commissioner-General not later than fourteen days prior to the
clearing of such goods that he has imported such goods. He should obtain from the
Commissioner General an identification number for the clearing of such goods.
However, certain specified categories of persons are exempted from this
Under section 12, any person who supplies goods or services and carries on or
carries out a taxable activity or imports any taxable goods may make an
application in the specified form to the Commissioner-General for registration
under this Act.
The Commissioner-General may refuse registration –
(i) after affording the applicant an opportunity of being heard; and
(ii) having regard to -
(a) the nature of the business carried on or carried out by such
(b) the value of the taxable supplies made by such applicant in the
two preceding taxable periods and
(c) the probability that the value of his taxable supplies will not
exceed the value referred to in section 10.
Power to call for information
For the purpose of registering a person under section 14, Section 13 confers
power to the Commissioner-General to call for any information from such person at
any time relating to any taxable activity carried on or carried out by such person.
Procedure for registration
Under section 14, the Commissioner-General shall register a person under the
following circumstances -
(a) where an application has been made by any person for registration under
section 10 ;
(b) where an application for registration under section 12 has been made and
such application has not been refused by the Commissioner-General; or
(c) where an application for registration, has not been made but the
Commissioner-General is of opinion having regard to the nature of the
activities carried on or carried out by such person, that such person is
required to be registered under this Act. Such person should be afforded
an opportunity of being heard.
Certificate of registration -
(a) Section 15 provides that the Commissioner-General shall issue to a
person registered under this Act upon such registration under section 14 -
(i) a tax registration number; and
(ii) a certificate of registration.
(b) The Certificate of registration shall set out the name and other relevant
details of the registered person, the date on which registration comes into
effect, and the tax registration number of such person.
(c) The person to whom a certificate of registration is issued should display
such certificate at a conspicuous place in the place where he carries on or
carries out the taxable activity. Copies of such certificate may be
displayed in the event of there being more than one place of business.
(d) Every registered person who makes an exempt supply specified in the First
Schedule shall display the categories of such goods and services supplied
by him as given in the First Schedule at each such place of supply.
(e) Where any person fails to comply with the above provisions the
Commissioner-General may -
(i) impose on such person a penalty of a sum not exceeding fifty
thousand rupees and give notice in writing to such person of the
imposition of such penalty;
(ii) by notice in writing require such person- -
(a) to pay such penalty; and
(b) to comply with the said provisions within such period as
may be specified in such notice.
(f) The Commissioner-General may reduce or annul any penalty imposed on
any person if such person proves to the satisfaction of the
Commissioner-General that his failure to comply with the provisions of
subsection (3) or (4) was due to circumstances beyond his control and
that he has subsequently complied with such provisions.
Cancellation of registration
(a) Under section 16, where a registered person has ceased to carry on or
carry out a taxable activity or the total value of his supplies during any
taxable period has not exceeded the value set out in section 10, he may
make an application to have his registration cancelled at any time after the
lapse of a period of twelve months following the date of registration, either
under this Act or under the Goods and Services Tax Act No. 34 or 1996.
(b) The Commissioner-General, on receipt of an application made under
subsection (1), may at any time, cancel the registration subject to
satisfaction of any of the following conditions -
(i) the applicant or any registered person, as the case may be, has
ceased to carry on or carry out a taxable activity; or
(ii) that the total value of his taxable supplies does not exceed the
value referred to in section 10; or
(iii) the facilities under the Customs Ordinance in respect of him
have been suspended by the Director-General of Customs; or
(iv) that the continuation of such registration may impede the
protection of revenue.
(c) The Commissioner-General may refuse to cancel the registration of any
person where he is of the opinion that such person has not ceased to
carry on or carry out a taxable activity or that it is necessary and
expedient to continue with his registration for the protection of revenue.
(d) Where the Commissioner-General cancels the registration of a registered
person he shall inform such person of the date of cancellation of the
registration by registered post.
(e) With effect from the date of cancellation of the registration, any goods or
services then forming part of the assets of a taxable activity carried on or
carried out by that person shall be, deemed to be supplied by that person
in the course of carrying on or carrying out a taxable activity at a time
immediately prior to the date of cancellation, unless the taxable activity
(inclusive of all such assets) is carried on or carried out by another
person, who is a registered person.
Registered person to return certificate of cancellation
(a) Under section 17, where the registration of a registered person has been
cancelled by the Commissioner-General, such person shall return to the
Commissioner-General the certificate of registration issued to him not
later than fourteen days from the last day of the last taxable period during
which the registration was valid.
(b) Such person should not display in any place where such taxable activities
were carried on or carried out, the certificate of registration or a copy
(c) Such person should not issue any tax invoice, tax debit note or tax credit
note as the case may be.
(d) Where any person fails to comply with the above provisions, the
Commissioner-General may –
(i) impose on such person a penalty of a sum not exceeding fifty
thousand rupees, and give notice in writing to such person of the
imposition of such penalty;
(ii) by notice in writing require such person to pay such penalty and
comply with the provisions of this section within such period as
may be specified in such notice.
(e) The Commissioner-General may reduce, or annul any penalty imposed
on any person under this section if such person proves to the satisfaction
of the Commissioner-General that his failure to comply with the
provisions was due to circumstances beyond his control and that he has
subsequently complied with such provisions.
Liability of a registered person
Under section 18, notwithstanding the cancellation of registration under section
16, a registered person shall be liable for any act done or omitted to be done while
he remained a registered person in respect of the taxable supplies made by such
person under this Act or under the Goods and Services Tax Act, No. 34 of 1996.
Notification of change
Every registered person shall notify the Commissioner-General in writing of any
(a) in the name, address and place at which any taxable activity is carried on
or carried out by such person;
(b) in the nature of the taxable activity carried on or carried out by such
(c) in the person authorized to sign returns and other documents; and
(d) in ownership of the taxable activity,
not later than fourteen days after the occurrence of the change.
Tax invoice (Section 20)
Issuance of tax invoice - A registered person who makes a taxable supply shall
issue to the person to whom such supply is made, a tax invoice within twenty eight
days after the time of such supply. However, the person to whom the supply is
made has to make a written request for issuance of a tax invoice within fourteen
days from the time of supply stating that he is a registered person under this Act or
is deemed to be a registered person under this Act.
Contents of tax invoice - The tax invoice should set out the following -
(a) the name, address and the registration number of the supplier;
(b) the name and address of the person to whom the supply was made;
(c) the date on which the tax invoice was issued and its serial number;
(d) the date of supply and the description of the goods or services;
(e) the quantity or volume of the supply;
(f) the value of the supply, the tax charged and the consideration for the
(g) the words "TAX INVOICE" at a conspicuous place in such invoice.
Customs goods declaration to be treated as tax invoice - Where goods have
been imported into Sri Lanka, the customs goods declaration or any other
document authenticated by the Director-General of Customs shall he treated as a
tax invoice under this Act. Any customs goods declaration or any other document
authenticated by the Director-General of Customs and issued under the Goods
and Services Tax Act, No. 34 of 1996 prior to August 1, 2002 shall also be treated
as a tax invoice.
Copy of tax invoice to be retained by supplier- The original of the tax invoice
shall be issued to the person to whom the supply was made and the duplicate of
such invoice shall be retained by the person who makes such supply for a period of
five years after the expiry of the taxable period in which such invoice was issued.
Issue of duplicate tax invoice - It shall not be lawful to issue more than one tax
invoice for each supply. If a registered person claims to have lost the original tax
invoice the person who makes the supply may issue to such registered person a
copy clearly marked "copy only".
Where recipient is an unregistered person - Where a registered person makes
a taxable supply and the recipient of such supply is not a registered person such
supplier shall issue an invoice giving the total consideration of such supply
including the tax charged. Where the supplier has not kept adequate records on
such supplies covered by such invoices all such supplies shall be considered as
supplies made under the standard rate or tax. An invoice issued under this
subsection shall not be considered as a tax invoice for the purposes of this Act.
Exception – Supply to Government agencies etc.
However, a tax invoice shall be issued by such registered person who makes such
taxable supply to any Government institution, Provincial Council, Local
Government institution, or any public corporation, for any taxable supply made to
such institution, Council or such corporation, as the case may be, whether or not
such institution, Council or corporation is registered under this Act.
Consequences of contravention – Any person who contravenes the provisions
of sub-section (1) shall be guilty of an offence and shall be liable on conviction,
after summary trial before a Magistrate, to a fine not less than Rs.25,000 and not
exceeding Rs.2,50,000. In case of continuing offence after conviction, to a fine of
Rs.500 for each day thereof.
Closure of business – Where any person convicted of an offence continues to
commit such offence beyond a period of fourteen days from the date of his
conviction, the court may order the closure of such business upon an application
for closure of the business being made by the Commissioner-General or any
Non-compliance with the order for closure – Where a person fails to comply
with the closure order issued under sub-section (8), the Magistrate shall forthwith
order the fiscal of the court or any police officer authorized by him to close the
business. Such order shall be sufficient authority for the said fiscal or any police
officer authorized by him in that behalf to enter the premises in which the business
is carried on or carried out with such assistants as the fiscal or such police officer
shall deem necessary to close such business.
7.4 Returns and calculation of tax
Return (Section 21)
Time limit for furnishing of return –
Every registered person shall furnish to the Commissioner-General not later than
the last day of the month after the expiry of each taxable period, a return of his
supplies during that taxable period, Every such return should be in the specified
form and should contain all such particulars as may be required to be set out in
Notice to an unregistered person –
An Assessor may, by notice in writing, require any person who is not a registered
person but in his judgment is a person chargeable with tax, to furnish, a return in
the specified form within the time specified in such notice.
Notice to get information –
The Assessor can issue notice to any person for obtaining full and relevant
information in respect of the supply of goods or services made by any person and
also to ensure attendance for the purpose of being examined regarding the taxable
activity carried on or carried out by that person. Under section 21(5), for the
purposes of this Act, a Deputy Commissioner may also issue similar notice.
Retention of documents –
A Deputy Commissioner or an Assessor with the approval of a Deputy
commissioner can retain books of accounts, documents in order to very the entries
Inadequate return/information –
The Assessor, in case he feels that the return or information furnished is
inadequate, can issue a notice to get comprehensive information or return.
Consequences of non-compliance –
Where any person fails to file a return or furnish the relevant information either by
himself or in response to a notice issued to him he is liable to pay a penalty not
exceeding Rs.50,000 as imposed by the Commissioner-General. He may also be
required to furnish the relevant return.
Condoning payment of penalty –
The Commissioner-General can reduce or annul any penalty imposed on any
person if such person proves to the satisfaction of the Commissioner-General that
his failure to comply with the relevant provisions was due to circumstances beyond
his control and that he has subsequently complied with such provisions or
In cases where the Commissioner-General does not impose a penalty, every
person who has contravened the relevant provisions would be guilty of an offence
under this Act and would be liable to a fine not exceeding Rs.50,000 or an
imprisonment of either description for a term not exceeding six months or both.
Credit for input tax against output tax (Section 22)
A registered person shall, in respect of any taxable supply made by him, account
for and pay the tax by reference to such taxable period at such time and in such
manner as may be specified in this Act.
A registered person shall be entitled, at end of each such period, to the credit for so
much of his input tax as is allowable under this Act. This input tax can be deducted
from any output tax that is due from him. However, any person adopting a payment
basis of accounting shall be entitled to claim credit on so much of his input tax as is
allowable under this Act, only in respect of a supply for which the payment of the
tax has been made by such person.
Where a supply of goods or services received by a registered person, or goods
imported by such person are used or are to be used partly for the purposes of a
taxable activity and partly for other purposes, only so much of the tax on such
supplies or importation as is referable to his taxable activity shall be counted as his
However, in the case of a person providing leasing facilities under the Finance
Leasing Act. No. 56 of 2000, the input tax on goods supplied under a leasing
agreement for a period less than three years shall be counted at the rate of ten per
centum or less, even if the tax charged on such goods is more than ten per
Where any return is furnished and if at the end of any taxable period to which the
return relates, the amount of the input tax exceeds the amount of the output tax,
the excess of the input tax shall, subject to the provisions of section 58 be
Where such excess is not so refunded, the Commissioner-General shall pay
interest at the rates prescribed under section 59 on such amount, for the period
commencing on the expiration of two months from the end of the taxable period in
which such refund became due and ending on the date of the refund.
Where an unregistered person leases out his land and buildings in terms of a
tenancy agreement, to a registered person, such registered person would be
entitled to claim input tax for the expenses incurred by him in connection with the
services provided on such land for the duration of such tenancy agreement on
providing sufficient evidence to the satisfaction of the Commissioner-General.
Such evidence should establish the existence of a tenancy agreement in respect of
such land and building. It is significant to note that this benefit is available to the
lessee, being a registered person, even if the lessor, being an unregistered person
(i.e. lessor) is not entitled to claim any input tax.
Any input tax attributable to the supply: of goods or services received shall not be
deducted under sub-section (2) in respect of the following:-
(i) if the supply is in respect of motor vehicles other than motor cycles,
bicycles, motor coaches provided by an employer for the transportation of
his employees, motor vehicles used for excursion tours, or for the
transportation of tourists or transportation of goods or hiring cars, or
motor vehicle forming part of any stock in trade of any taxable, activity;
(ii) if the supply of goods or services received is not connected with the
(iii) if the supply of goods or services received is not supported by -
(a) a valid tax invoice; or
(b) a custom's goods declaration or other authenticated document
issued by the Director-General of Customs' under this Act or
under the Goods and Services Tax Act, No. 34 of 1996,
and received within twelve months from the end of the relevant taxable
period in respect of which such tax invoice was issued or from the date of
importation goods, as the case may be;
(iv) if the input tax on such tax invoice or customs goods declaration, as the
case may be, has not been deducted from the output tax for any taxable
period ending before the lapse of six months from the last day of the
taxable period in which such tax invoice or customs goods declaration
However, any registered person who has obtained a licence under the Electricity
Act and engages in the distribution of electricity may be allowed input tax on the
purchase of electricity for such distribution.
Where input tax disallowed in respect of any motor vehicle referred to in paragraph
(i) may be allowed up to a limit of fifty percent of such input tax for any taxable
period commencing on or after January 1, 2003, subject to the provisions of
subsection (3), where such vehicle is partly or wholly used in any taxable activity.
Any refund in excess of the amount due, or any excess amount or input tax
claimed under this Act or the Goods or Services Tax Act No. 34 of 1996 shall be
assessed by an Assessor on the registered person to whom the refund has been
made or making such claim, as the case may be, and such amount shall be
deemed to be a tax in default on the first day of the taxable period in which the
excess of input tax first arose. For this purpose, input tax claimed in a return by the
persons mentioned hereunder shall be deemed to be an excess amount of input
tax claimed by such person.
(a) Any person who has not commenced any commercial operation within or
on completion of the project implementation period
(b) Any person who has obtained approval under subsection (7) or
sub-section (6) of section 22 of the Goods and Services Tax Act, No.34 of
1996 and has not commenced business of making taxable supplies as
stated in the undertaking given by such person prior to obtaining such
Accounting basis (Section 23)
Section 23 provides that every registered person shall account for tax on an
invoice basis. However, the Commissioner-General may direct such person to
account for tax on a payment basis on such conditions as may be specified by him
on an application made in that behalf by a registered person.
Bad debts (Section 24)
In ascertaining the amount of tax payable in any taxable period, there shall be
deducted an amount of tax corresponding to any bad debt incurred in the taxable
activity of a registered person on a debt created on or after April 1, 1998 and which
has become bad during such taxable period. The amount of tax deductible shall
not exceed the amount paid as tax in a previous taxable period in respect of the
bad debt, which is to be written off:
However, where any amount written off as bad debt before or after the
commencement of this Act is received in any taxable period by that person, then,
notwithstanding the provisions of section 33, the amount received shall be treated
as a taxable supply during the taxable period under this Act or the Goods and
Services Tax Act, No. 34 of 1996 in which it was received and shall be liable to tax:
Further, where any amount of tax corresponding to a bad debt has been deducted
by any person, the amount so deducted shall be an output tax for the
corresponding period of the person in respect of whom the bad debt was incurred,
if he is a registered person.
Adjustment of tax by credit or debit note (Section 25)
Where a registered person has issued a tax invoice and accounted for an incorrect
amount of tax by undercharging or overcharging tax on a supply made to another
person, he shall be entitled to issue to such other person, a tax debit note or a tax
credit note, as the case may be, for the purpose of adjusting the amount of tax so
undercharged or overcharged.
Upon the issue of the tax debit note or tax credit note, as the case may be, in
respect of a supply and in relation to the period in which such note was issued -
(a) the supplier should –
(i) pay as output tax, such amount of the tax chargeable in respect
of the supply as is in excess of the amount that was accounted
(ii) deduct as input tax, such amount accounted for as output tax as
exceeds the amount of tax chargeable; and
(b) the person, being a registered person, to whom the supply was made
(i) pay as output tax, such amount of the tax deducted by him as
input tax, as exceeds the proper amount that should have been
(ii) deduct as input tax, such amount deductible as exceeds the
actual amount deducted by him.
Imposition of Value Added Tax on the supply of financial services by
Charge of VAT on the supply of the financial services by specified institutions
A Value Added Tax would be charged with effect from January I, 2003, on the
supply of financial services in Sri Lanka, made by any specified institution, which
carries on a business of supplying such financial services.
Every specified institution, carrying on the business of supplying any financial
service in Sri Lanka, should be registered if the value of such supply for a period of
three months exceeds Rs.5,00,000 or for a period of twelve months exceeds
Rs.18,00,000, as the case may be.
Every specified institution required to be registered shall make an application for
registration in the specified form to the Commissioner-General not later than ten
days from the date of commencement of this Act. However any institution
registered under this Act and which is a specified institution within the meaning of
this Chapter, shall be deemed for all purposes to be a registered specified
The Commissioner General can issue, upon registration, to such registered
specified institution –
(a) a tax registration number; and
(b) a certificate of registration:
Monthly taxable period (Section 25B)
The taxable period of every registered specified institution shall be one month and
a return in the form specified shall be furnished for each month before the end of
the following month.
Calculation of tax (Section 25C)
Every registered specified institution under this Chapter shall be liable to tax for
each taxable period on its total value addition of such institution which includes the
net profit or loss, as the case may be, before payment of income tax on such profit
computed in accordance with the accepted accounting standards, subject to an
adjustment for economic depreciation, determined by the Minister having regard to
the interest of the economy by order published in the Gazette, and the emoluments
payable to all the employees of such institution:
However, where the amount of profits for each taxable period cannot be accurately
ascertained, such amount may be estimated on the basis of available information.
The estimated amounts shall be adjusted to reflect the actual amount on half
Emoluments paid to all the employees shall include-
(a) in the case of "specified employees" under Chapter XIV of the Inland
Revenue Act, No.38 ,of 2000, the gross remuneration payable to such
employees and reflected in the pay sheet maintained under the Inland
Revenue Act; and
(b) in the case of an employee other than a "specified employee", the gross
remuneration paid to such employee reflected in the pay sheet
maintained under sub-section (2).
Every registered specified institution shall maintain a pay sheet in respect every
employee, other than a specified employee, in the manner set out by the
Commissioner General under section 110 of the Inland Revenue Act, No. 38
The amount of tax payable for each month shall be ten per centum of the value
additions specified in subsection (1).
Tax credit (Section 25D)
Section 25D provides that where any registered specified institution has paid any
tax under any other provision of this Act, other than this Chapter, a tax credit shall
be allowed on an amount equal to such tax paid against the tax payable under this
Chapter. This provision is applicable where in the opinion of the
Commissioner-General there is no material difference in the recognition of receipts
of such institution for the calculation of profits for the purposes of this Chapter and
for the purposes of the calculation of taxable supplies under any other provisions of
this Act: However, only fifty per centum of any such tax paid under any other
provision of this Act other than under this Chapter, in relation to tax calculated as
provided in section 22 at the standard rate shall be deducted against the tax
payable under this Chapter.
Meaning of “Supply of financial services”
According to section 25F “supply of financial services” means -
(a) the operation of any current, deposit or savings account;
(b) the exchange of currency;
(c) the issue, payment, collection or transfer of ownership of any note, order
for payment, cheque or letter of credit;
(d) the issue, allotment, transfer of ownership, drawing, acceptance or
endorsement of any debt, security, being any interest in or right to be paid
money owing by any person;(???)
(e) the issue, allotment, transfer of ownership of any equity security or a
(f) underwriting or sub-underwriting the issue of any equity security, debt
security or participatory security;
(g) the provision of any loan, advance or credit;
(h) the provision
(i) of the facility of installment credit finance in a hire purchase
conditional sale or credit sale agreement for which facility a
separate charge is made and disclosed to the person to whom
the supply is made;
(ii) of goods under any hire purchase agreement or conditional sale
which have been used in Sri Lanka for a-period not less than
twelve months as at the date of such agreement;
Specified institution means-
(a) a licenced commercial bank within the meaning of the Banking Act, No.
30 of 1988;
(b) a finance company registered under the Finance Companies Act,
No. 78 of 1988 ;
(c) a licenced specialized bank within the meaning of the Banking Act, No. 30
Payment of tax (Section 26)
The tax in respect of any taxable period should be paid not later than the last day of
the month following the end of that taxable period. Any tax not so paid shall be
deemed to be in default and the person by whom such tax is payable or where any
tax is payable by more then one person, each such person shall be deemed to be
a defaulter for the purposes of this Act.
The Commissioner-General has powers to defer the due date for the payment of
tax in certain cases, under an appeal against such assessment where -
(a) a request in writing has been made to the Commissioner-General for a
(b) it has been proved to the satisfaction of the Commissioner-General that
the tax due on the alleged supplies on which the assessment has been
made has not been charged by such person:
However, such deferred tax or part thereof shall become payable on the settlement
of the appeal or withdrawal of the deferment by the Commissioner-General, and
shall be deemed to be tax in default from the original due date of such tax.
Penalty for default (Section 27)
Section 27(1) provides that where any tax is in default, the defaulter shall, in
addition to such tax in default pay as penalty -
(a) a sum equivalent to ten per centum of the amount in default; and
(b) where the amount in default is not paid before the last day of the month
succeeding the first month in which such tax was in default, a further sum,
equivalent to two per centum of the amount in default in respect of each
period ending on the last day of each succeeding month or part of such
period during which it is in default.
However, the total amount payable as penalty under this sub-section shall in no
case exceed one hundred per centum of the tax in default and any such amount
may be waived or reduced if the Commissioner-General is satisfied that the
reasons for default are just and equitable.
If there is any change in the amount of tax due on determination of an appeal, the
penalty has to be calculated on the revised amount.
7.6 Assessment of tax
Power of Assessor to make an assessment (Section 28)
The Assessor shall assess the amount of the tax which, in the judgment of the
Assessor, ought to have paid for that taxable period and shall, by notice in writing,
require the persons mentioned hereunder in the circumstances mentioned therein,
to pay such amount forthwith -
(a) any registered person, who, in the opinion of the Assessor is chargeable
to tax, but fails to furnish a return for any taxable period; or
(b) any registered person chargeable to tax, who furnishes a return in
respect of any taxable period but fails to pay tax for that taxable period; or
(c) any person requesting the Commissioner-General in writing to make any
alteration or addition to any return furnished by such person for any
The amount so assessed in respect of any person for a taxable period shall be
deemed to be the amount of the tax payable by him for that taxable period.
Assessor to state reason for non-acceptance of a return (Section 29)
Where an Assessor does not accept a return furnished by any person under
section 21 for any taxable period and makes an assessment or an additional
assessment on such person for such taxable period under section 28 or under
section 31, as the case may be, the Assessor shall communicate to such person
by registered letter sent through the post as to why he is not accepting the return.
Power of assessor to determine open market value (Section 30)
The Assessor can determine the open market value of a taxable supply, if is of the
(a) that a registered person has made a taxable supply for a value less than
the open market value of such supply or for no value; or
(b) the transaction, in respect of which the taxable supply has been made, is
between two associated persons,
The Assessor should determine the open market value of such supply having
regard to the circumstance of the transaction and the time of supply.
Additional assessment (Section 31)
Where it appears to an Assessor that a person chargeable with tax has paid tax
which is lower than the tax payable by him for that taxable period, or chargeable
from him for that taxable period, he may assess such person at the additional
amount at which, according to the judgment of such Assessor, tax ought to have
been paid by such person. The Assessor shall give such person notice of the
assessment. The amount so assessed shall be deemed to be tax in default for that
taxable period and accordingly such person shall, from the date on which such
person ought to have paid the tax for that taxable period be liable to the penalty in
respect of such amount.
Evidence of returns and assessment (Section 32)
The production of any document under the hand of the Commissioner-General
purporting to be a copy of or extract from any return or assessment made under
this Act shall be admissible in all courts and shall be sufficient evidence of the
Limitation of time for assessment or additional assessment (Section 33)
Section 33 provides that where any registered person has furnished a return under
section 21(1) in respect of a taxable period or has been assessed for tax in respect
of any period, it shall not be lawful for the Assessor to make an assessment or
additional assessment, after the expiry of three years from the end of the taxable
period in respect of which the return is furnished, or the assessment is made, as
the case may be.
However, where the Assessor is of the opinion that a person has willfully or
fraudulently failed to make a full and true disclosure of all the material facts
necessary to determine the amount of tax payable by him for any taxable period, it
shall be lawful for the Assessor to make an assessment or additional assessment,
within a period of five years from the end of the taxable period to which the
The definitions of the terms used in the Act is given in section 83 of the Act
(i) "Associated persons" means –
(a) any two or more companies which consist of the same
shareholders or are managed and controlled by the same
(b) any company and any shareholder, where such shareholder or
the spouse or child of such shareholder or any trustee of such
shareholder or any trustee of the spouse or the child of such
shareholder hold jointly or severally twenty- five per centum or
more of the paid up capital or twenty -five per centum or more of
the nominal value of the allotted shares of that company; or
(c) any two individuals one of whom is the spouse or child of the
other or is a trustee for such spouse or child; or
(d) a partnership and an individual where such individual is
related to any partner of such partnership; or
(e) a joint venture and any person who is related to a member of
such joint venture; or
(f) any two persons one of whom is a trustee for the other;
(g) any two individuals related to each other; or
(h) any two or more persons carrying on any activity separately or
jointly which has resulted in the supply of identical goods or
services which cannot be produced by any other person or
(ii) "body of persons" means any body corporate or unincorporate, provincial
Council, local authority, any fraternity, fellowship, association or society
of persons, whether corporate or unincorporate, any partnership, and
includes any Government department or any undertaking of the
Government of Sri Lanka or any co-ownership of immovable property.
(iii) "books" shall not include diaries, cheque books, exercise books or ledger
(iv) "Commissioner-General" means the Commissioner-General of Inland
Revenue appointed under the Inland Revenue Act, No. 38 of 2000 and
includes a Commissioner and a Deputy Commissioner specially
authorized by the Commissioner-General either generally or for a specific
purpose to act on behalf of the Commissioner-General;
(v) "Company" means any company incorporated or registered under any
law in force in Sri Lanka or elsewhere;
"customs bonded area" means
(a) a bonded warehouse approved under section 69 of Customs
(b) a bonded warehouse approved under section 84A of Customs
(c) a warehouse of the Republic as defined in section 167 of
(d) a Free Trade Zone declared 'by the Board of Investment of Sri
Lanka which is subject to monitoring by the Department of Customs.
(vi) "Construction contractor or sub contractor" means any person who has
entered into a contract with another person and provides services in Sri
Lanka in constructing of a building, road, bridge, water supply systems,
drainage systems, sewerage systems, electricity generation or
transmission system or any other infrastructure for that other person.
(vii) "Director" means a director as defined in the Companies Act, No. 17 of
1982 and includes a working director;
(viii) "Educational establishment" means -
(a) a higher educational institution established under the
Universities Act No.16 of 1978 or the Buddhist and Pali
University Act No. 74 of 1981 ;
(b) any recognized institution providing vocational training or
training for persons engaged in any trade, profession, or
employment and includes an incorporated examination body;
(ix) "Educational services" means the provision of services by any
educational establishment in relation to education, vocational training or
(x) "executor" includes an administrator;
(xi) "goods" means all kinds of movable or immovable property but does not
(b) computer software made to customers special requirements
either as unique programme or adaptation for standard
programme, inter company information data and accounts,
enhancement and update of existing specific programmes,
enhancement and update of existing normalized programmes
supplied under contractual obligation lo customers who have
bought the original programme or where the value of contents
separately identifiable in a software such vale of contents;
(xii) "incapacitated person" means any minor, lunatic, idiot or person of
(xiii) "importation" includes the bringing into Sri Lanka of goods from outside
Sri Lanka by any person or goods received from a custom bonded area
the purchase of goods on a sale by the Director-General of Customs, the
Sri Lanka Ports Authority or the Commissioner-General, for the levy of
the tax and other dues;
(xiv) "input tax" in relation to a registered person, means -
(a) the tax charged by another registered person on any goods or
services to be used by such registered person in carrying on or
carrying out a taxable activity;
(b) the tax paid by him or tax deferred under the proviso to
subsection (3) of section 2, on the importation or purchase of
goods or purchase of services which arc used by such person
for the purpose of making taxable supplies under this Act or
Goods and Services Tax Act, No. 34 of 1996.
(xv) "international transportation" means any service directly related to the
transportation of goods or passengers -
(a) from a place in Sri Lanka to a place out side Sri Lanka;
(b) from a place outside Sri Lanka to a place in Sri Lanka up to the
point of landing unless such services are carried out under a
specified carriage contract according to the Documents of
carriage issued by a freight forwarder who is registered with the
Central Bank of Sri Lanka.
(c) from a place outside Sri Lanka to another place outside Sri
(xvi) "manufacture" means the making of an article, the assembling or joining
of an article by whatever process, adapting for sale any article,
packaging, bottling, putting into boxes, cutting, cleaning, polishing,
wrapping, labeling or in any other way preparing an article for sale other
than in a wholesale or retail activity;
(xvii) "output tax", in relation to any registered person, means the tax
chargeable in respect of the supply of goods and services made or
deemed to be made by such person under this Act or Goods and
Services Tax Act ,No. 34 of 1996.
(xviii) "open market value" in relation to the value of a supply of goods or
services at any date means, the consideration in money less any tax
charged under this Act, which a similar supply would generally fetch if
supplied in similar circumstance at that date in Sri Lanka, being a supply
freely offered and made between persons who are not associated
(xix) "person" includes a company, or body of persons;
(xx) "standard rate" means the rate specified under subsection (I) of section 2,
applicable to the supply of taxable goods and services other than such
supplies of goods and services and imports specified in the Second
(xxi) "supply of goods" means the passing of exclusive ownership of goods to
another as the owner of such goods or under the authority of any written
law and includes the sale of goods by public auction, the transfer of goods
under a hire purchase agreement, the sale of goods in satisfaction of a
debt and the transfer of goods from a taxable activity to a non-taxable
(xxii) "supply of services" means any supply which is not a supply of goods but
includes any loss incurred in taxable activity for which an indemnity is
(xxiii) "supplier", in relation to any supply of goods and services, means the
person making the supply;
(xxiv) "taxable period" means
(a) a period of one month.
(i) where the value of taxable supplies of any person has
exceeded thirty million rupees during the preceding
twelve months; or where the value of taxable supplies
of any person for the period of the succeeding twelve
months is estimated to exceed thirty million rupees; or
(ii) where any person makes zero rated supplies;
(iii) where any person has entered into an agreement with
the Board of Investment of Sri Lanka referred to in
items (XXVII) or (XXVIII) of the Schedule to the Goods
and Services Tax Act No. 34 of 1996 prior to April 1,
2001, during the project implementation period;
(iv) where any person has commenced a business or
started a project and undertakes to comply with the
requirements of sub-section (7) of section 22 under this
Act or subsection (6) of section 22 under this Act or
Goods and Services tax Act, No. 34 of 1996.
(v) where any person has entered into any such
agreement with the Board of Investment of Sri Lanka,
as referred to in item (XXVIII) of the Schedule to the
Goods and Services Tax Act, No. 34 of ] 996 and such
person could not commence making taxable supplies
under the project to which the agreement relates, by
March 31, 2001.
(b) a period of three months commencing respectively on the first
day of January, the first day of April, the first day of July and the
first day of October of each year in respect of a registered
person who is not referred to in paragraph (a) or who opts to
submit quarterly returns on the approval by the
(xxv) "Taxable activity" means
(a) any activity carried on as a business, trade, profession or
vocation other than in the course of employment or every
adventure or concern in the nature of a trade;
(b) the provision of facilities to its members or others for a
consideration and the payment of subscription in the case of a
club, association or organization;
(c) anything done in connection with the commencement or
cessation of any activity or provision of facilities referred to in (a)
(d) the hiring, or leasing of any movable property or the renting or
leasing of immovable property or the administration of any
(e) the exploitation of any intangible property such as patents,
copyrights or other similar assets where such asset is registered
in Sri Lanka or the owner of such asset is domiciled in Sri Lanka.
(xxvi) "Taxable supply" means any supply of goods or services made or
deemed to be made in Sri Lanka which is chargeable with tax under this
Act and includes a supply charged at the rate of zero percent other than
an exempt supply.
(i) The supply or import of
(a) unprocessed agricultural products other than, potatoes, onions,
chillies, all other grains (other than rice and paddy) and planting
(b) unprocessed horticultural products;
(c) unprocessed animal husbandry products other (than any variety
of meat and live birds. including day old chicks;
(d) unprocessed fishing products;
(e) unprocessed forestry products other than timber,
(i) Cardamom, cinnamon, cloves, nutmeg, pepper,
desiccated coconuts, rubber, paddy and seed paddy;
(ii) The supply or import of rice, rice flour, wheat, wheat
flour and eggs
(iii) The supply or import of bread of any description;
(iv) The supply or import of liquid milk (not made out of
powdered milk or any grain) and infants powdered
(v) The-supply or import of air crafts, helicopters and
temporary import of any plant, machinery, equipment
which are re-exported with twelve months from the
date of such import;
(vi) The supply of educational services by an educational
establishment or government schools or schools
funded by the government;
(vii) The supply or import of any books other than
chequebooks, periodicals, magazines, news papers,
diaries, ledger books or exercise books;
(viii) The supply or import of kerosene, bunkerfuel and
(ix) The supply of public library services by the
Government, a Provincial Councilor a local authority;
(x) The supply or import of crude petroleum oil;
(xi) The supply of the following financial services :
(a) the operation of any current, deposit or
(b) the exchange of currency;
(c) the issue, payment, collection or transfer of
ownership of any note, order for payment,
cheque or letter of credit; .
(d) the issue, allotment, transfer of ownership,
drawing, acceptance or endorsement of any
debt security, being any interest in or right to
be paid money owing by any person;
(e) the issue, allotment, transfer of' ownership of
any equity security or a participatory security;
(f) underwriting or sub -underwriting the issue of
an equity security, debt security or
(g) the provision of' any loan, advance or credit;
(h) the provision
(a) of the facility of instalment credit
finance in a hire purchase conditional sale or
credit sale agreement for which facility a
separate charge is made and disclosed to the
person to whom the supply is made;
(b) of goods under any hire purchase
agreement or conditional sale agreement
which have been used in Sri Lanka for a
period not less than twelve months as at the
date of such agreement;
(i) life insurance, 'Agrahara' Insurance and crop
and livestock insurance;
(xii) The import or supply of goods and services to the mission of any
State or any organization to which the provisions of the
Diplomatic Privileges Act, No.9 of 1996 applies, or to any
diplomatic personnel of such mission or organization, or entitled
to these benefits provided that reciprocal benefits are available
to their counterparts from Sri Lanka and identified as such by the
Commissioner - General, including the import under a
temporary admission carnet for re-export. Such identifications
under Goods and Services Tax Act, No. 34 of 1996 will be
remained valid under this Act.
(xiii) The import and supply of goods at duty free shops for payment
in foreign currency;
(xiv) The import or supply of unused postage or revenue stamps of
the Government of the Democratic Socialist Republic of Sri
Lanka or of a Provincial Council;
(xv) The import of any article entitled to duty free clearance under the
Passenger's Baggage (Exemptions) Regulations made under
section 107 of the Customs Ordinance, or any article cleared
duty free re-importation certificate as provided in Schedule A
under the Customs Ordinance, or any article cleared ex-bond for
use as ship stores;
(xvi) The import of goods by any organisation approved by the
Minister, where he is satisfied that such goods are gifts from
persons or organisaitons abroad or the supply of goods directly
funded by any foreign organisaiton for the relief of sudden
distress caused by natural or human disasters.
(xvii) The supply of public passenger transport services (other than air
or water transport or transport of tourists by way of excursion
tours or taxi services) or the provision of leasing facilities for
such motor coaches with seating capacity not less than twenty
eight passenger scats and used for such public passenger
(xviii) The supply of electricity no exceeding 30 kwh per consumer as
defined under the Electricity Act (Chapter 205) per month;
(xix) The import by any person who has entered into an agreement
(a) prior to May 16. ] 996; or
(b) prior to April 1, 1998 in respect of a project the total
cost of which is not less than Rs.500 Million.
with the Board of Investment of Sri Lanka under section 17 of
Board of Investment of Sri Lanka Law. No.4 of 1978, of any
article which is prescribed as a project related article to be
utilized in the project specified in the agreement during the
project implementation period of such project as specified in
such agreement or up to the date of completion of such project,
which ever is earlier;
(xx) The import by any person who has entered into an agreement
with the Board of investment of Sri Lanka under section 17 of
Board of Investment of Sri Lanka Law No.4 of 1978 of any article
which is prescribed as a project related article to be utilized in
the project specified in the agreement, who will be making only
exempt supplies after completion of the project
(a) for a period of two years from August 1, 2002 ; or
(b) until the completion of the project which ever is earlier.
(xxi) The supply of services at a restaurant situated beyond the
immigration counter at the Bandaranaike International Air Port;
(xxii) The supply of services by a person in Sri Lanka to another
person to be consumed or utilized by such other person outside
Sri Lanka, where the payment is made in rupees;
(xxiii) The supply, lease or rent of residential accommodation other
than the supply, lease or rent of residential accommodation by
an enterprise which has entered into an agreement with the
Board of Investment of Sri Lanka, under section 17 of the Board
of Investment of Sri Lanka Law, No 4 of 1978, on or after April I,
2001 and the total cost of the projects which such agreement
relates is not less than ten million United States of America
dollars or its equivalent in any other currency and the project
relates exclusively to the aforesaid supply, lease or rental;
(xxiv) The supply of all health care services provided by medical
institutions or professionally qualified persons providing such
care, other than the supply of health care services by a medical
institution which has entered in to an agreement with the Board
of Investment of Sri Lanka under section 17 of the Board of
Investment of Sri Lanka Law No.4 of 1978, on or after April J..
200 I and the total cost of the project to which such agreement
relates is not less than ten million United States of America
dollars or its equivalent in any other currency;
(xxv) The supply or import of pearls, diamonds, natural or synthetic
precious or semi-precious stones, diamond powder, precious
metals or metals clad with precious metal, and gold coins;
(xxvii) The supply or import of artificial limbs, crutches, hearing aids,
accessories for such aids or other appliances which are worn or
carried or implanted in the human body to compensate for a
defect or disability;
(xxviii) The supply or import of wheel chairs, prepared culture media for
development of micro organisms, diagnostic or laboratory
reagents, surgical gloves, contact lenses, X-ray tubes, white
canes for the blind and Braille typewriters and parts;
(xxix) The supply of services in relation to burials and cremations by
the government, a Provincial Council, a local authority or any
(xxx) The supply of free or subsidized meals by an employer to his
employees at their places of work;
(xxxi) The supply of transport free or at a subsidized rate by an
employer to his employees using a vehicle on which the input
tax has been disallowed or a motor coach provided by such
employer to transport employees to and from their homes and
their place of work;
(xxxii) The import of personal items and samples in relation to business
worth not more than Rupees 10,000/- through parcel post or
(xxxiii) The supply or import of pharmaceutical products (other
than cosmetics) and raw materials for such products;
(xxxiv) The supply or import of ayurvedic preparations which belong to
the Ayurveda pharmacopoeia or Ayurveda preparations (other
than cosmetic preparations) or unani, siddha or homeopathic
preparations (other than cosmetic preparations) and raw
materials for such preparations.
(xxxv) The supply or import of agriculture tractors;
(xxxvi) The supply or import of agricultural machinery.
(i) The supply of electricity exceeding 30 kwh per consumer as defined
under the Electricity Act, (Chapter 205) per month, and the supply of
electricity in bulk to the national grid;
(ii) The supply of services by construction contractors or
(iii) The supply of services by hotels, guest houses, restaurants or similar
institutions and travel agents in relation to inbound tours;
(iv) The supply of cinematic films, other than video films, other produced in
Sri Lanka or imported into Sri Lanka import of such films, exhibition of
such films and theatrical productions;
(v) The supply of educational services other than services referred to in item
(vi) of the First Schedule;
(vi) The supply or import of coconut poonac, prawn feed, and poultry feed.
(vii) The supply or import of tea, coconut oil, potatoes, onions, chillies, copra,
vegetable seeds (other than seed paddy), planting materials, live birds,
day old chicks, dressed chicken including chicken parts and any other
variety of unprocessed meat;
(viii) The supply or import of magazines and journals;
(ix) The supply or import of powdered milk (other than infants powdered milk),
condensed milk and dhall;
(x) The supply or import of sugar, jaggery and sakkara;
(xi) The supply or import of dried fish, maldive fish, fertilizer including rock
phosphate and water;
(xii) The supply or import of petrol, diesel and liquefied petroleum gas;
(xiii) The supply or import of motor coaches and chassis or bodies of motor
coaches with twenty eight or more seating capacity, used for public
passenger transport as described under item (xvii) of the First Schedule;
(xiv) The supply or import of photo voltaic, solar batteries, energy, efficient
compact fluorescent lamps and spare parts for such lamps and Solar
(xvi) The supply of services in relations to the fees collected by the Sri Lanka
Bureau of Foreign Employment from prospective migrants;
(xvi) The supply or import of industrial machinery other than fans and parts, air
conditioners, refrigerators, cabinets for refrigerators, dish washing
machines (house hold type), personal weighing machines, lawn or sports
ground rollers and spares, lawn movers and parts, household washing
machines, household type sewing machines, but including electric
motors and generators, electric generating sets and rotary converters
and parts for such motors, generators, generating sets and converters;
(xvii) The supply of services in the course of carrying on a profession or
vocation either singly or jointly with another person or persons, if all such
persons are qualified members of a recognized professional body or
carrying on a vocation in the fields of literature, art, music or any other fine
(xviii) Supply of finance leasing facilities by a person registered under the
Finance leasing Act. No. 560 of 2000, other than any receipt of an
advance payment on account of the asset to he given on lease or in
relation to such leasing transaction or any payment for the early
settlement of the amount payable under the lease agreement which
exceeds ten per centum of the total agreement value;
(xix) The supply of land transport services to transport goods;
(xx) The collection of membership fee or similar charges from the members of
a society, club or association;
(xxi) The supply or import of bicycles and motor bicycles;
(xxii) The supply of services by professional conference organizers, registered
with the Sri Lanka Convention Burau in organizing seminars or other
(xxiii) The supply or import of textiles and handloom products;
(xxiv) The supply or import of ships;
(xxv) The supply or import of any jewellery;
(xxvi) the supply or import or maize;
(xxvii) the supply or import or machinery; medical and surgical instruments,
apparatus or accessories including medical and dental equipment,
ambulances for the provision. “Health services and surgical dressings”;
(xxviii) the supply, lease or rent of residential accommodation other than
supplies specified in the First Schedule;
(xxix) the supply of all health care services provided by medical institutions
other than supplies specified in the First Schedule;
(xxx) the supply of land and improvements.
Chapter – 8
VAT in Pakistan
Pakistan is a country with population of Rs.149.03 million and GDP of Rs.40,18,112
million. The per capital income in that country is Rs.28,933. The total revenue from
both tax and non-tax sources is Rs.701.60 million. The total tax revenue is
Rs.458.90 million, out of which the revenue from collection of direct taxes is Rs.145
million and from collection of indirect taxes is Rs.313.90 million. Thus, indirect taxes
contribute 68.40% of total tax revenue as against the contribution of 31.60% by way
of direct taxes. The pattern of sectoral contribution to GDP shows that the service
sector contributes over a half (50.7%) of the GDP, and the remaining half is
contributed almost equally by agriculture (23.6%) and industry (25.7%).
The types of indirect taxes in Pakistan are customs duty, central excise duty and
sales tax. The apex authority for levy and collection of indirect taxes is the Central
Board of Revenue. The customs duty is levied by the Customs Act, 1969. The
excise duty is regulated by the Central Excise Act, 1944. The Sales Act, 1990 is
the relevant legislation governing the levy of imposition of sales tax in the country
and incorporates in itself a system of Value Added Tax. This is an act to
consolidate and amend the law relating to the levy of a tax on the sale, importation,
exportation, production, manufacture or consumption of goods.
8.2 General history of sales-tax in Pakistan
Under the Government of India Act, 1935 the sales tax was a Provincial subject.
After Independence the Government of Pakistan adapted the Government of India
Act. 1935. The Federal Government decided to take over the sales tax, enacted a
law to this effect on 31st March, 1948 viz. the Pakistan General Sales Tax Act,
1948 which came into force on the 1st day of April, 1948. The standard rate under
this Act was six pies per rupee. This tax was leviable at every stage whenever a
sale was effected. However the dealers having annual turnover upto Rs.5,000/-
were exempt from this levy.
Later, on the representations of the trade against the multiple point tax system, the
Government appointed a Sales Tax Committee to study the whole situation and
make suggestions. On the recommendations of the said Committee, the
Government enacted the present Sales Tax Act. This Act was assented by the
Governor General of Pakistan on 20th April, 1951 but put into force on 1st July, by
Notification No.5, dated 27th June, 1951.
The administration of the Sales Tax, as regards final assessment, remained with
the Income Tax Department upto 24th April, 1981. The administration of the Sales
Tax was transferred to the Central Excise and Customs Department on 25th April,
1981 when necessary amendments were made in the Sales Tax Act, 1951 by the
Sales Tax (Amendment) Ordinance, 1981. Since then the administration of the
Sales Tax is with the Central Excise and Customs Department.
Sales tax, under the Act as it stood before its amendment made in 1960, could not
be charged on importation and exportation of goods but on consumption. The
lacuna was however removed by the Taxation of Goods (Sales and Purchase)
Order, 1960 dated 30th June, 1960, by virtue of which the power to impose taxes
on the sales, purchase, consumption, importation, manufacture and production of
goods, was conferred since 31st March, 1948. The enactment was made
retrospective ever since the sales tax became a Federal subject.
8.3 Move towards VAT
Lastly in order to achieve the higher role of revenue generation, the Federal
Government drafted a new Sales Tax Act the draft of which was circulated among
the public for seeking their opinions and suggestions. There was resistance
against the proposed draft by the trade which also threatened the Government of
general strikes as they were of the view that the draft which the Government was
going to enact was leading towards value added system that is to say a tax on
each stage of transactions.
The Government brought the enactment relating to value added tax in a very novel
way which is a unique exercise in Pakistan's legislative history where a completely
new enactment except the "Preamble" of the old Act No. III of 1951 has been
legislated as a part of the Finance Act, 1990.
The Finance Act received the assent of the President on 30th June, 1990 enforcing
the Finance Act, 1990 with effect from 1st July, 1990 subject to the declaration
under the Provisional Collection of Taxes Act, 1931 as appended to the Finance
Bill presented in the National Assembly on 7th June, 1990. By virtue of the
provisions of section 13 of the Finance Act, 1990, the Sales Tax (Amendment) Act,
1990 did not come into force from first day of July, 1990 when the Finance Act,
1990 itself came into force as provisions have been made for bringing into force
the Sales Tax (Amendment) Act, 1990 (Third Schedule of the Finance Act, 1990)
from such date as may be notified by the Federal Government under section 1(3)
of the said Act. The Federal Government through its Notification No.S.R.O.
1100(I)/90, dated 28th October, 1990, appointed the 1st day of November, 1990 as
the date on which the Sales Tax (Amendment) Act, 1990 came into force. After
enforcement of the Sales Tax (Amendment) Act, 1990, its name was changed as
Sales Tax Act, 1990 by the Finance Act, 1991.
8.4 Sales tax is a value added tax
Sales tax is charged, levied and paid only when taxable supply is made in the
course or furtherance of “taxable activity”. Definition of “taxation activity” lays down
in clear and unambiguous terms that it involves in whole or in part the supply of
goods to any other person, which is the condition precedent for the levy of sales
tax. Provisions of sales Tax Act, 1990 showed that it was a value added tax, which
was levied at every stage, the value addition took place at the time of supply, it
was, therefore, no more a one point levy.
8.5 “Excise duty” and “Sales Tax” – Distinction
Duty of excise is a tax on goods produced or manufactured in the taxing country
and intended for home consumption which is levied upon a manufacturer or
producer in respect of his goods. The sales tax on the other hand is levied upon a
vendor in respect of sales. Both the taxes seem to overlap each other, but in law
there is no overlapping. The taxes are of separate and distinct imposts. If in fact
they overlap that may be because the taxing authorities imposing a duty of excise
find it convenient to impose that duty at the moment when the excisable goods
leave the factory, for the first time upon the occasion of its sale. But that method of
collecting the tax is an accident of administration, it is not of the essence of the duty
of excise which is attracted by the manufacture itself. All that can be said is that
subject to the provisions of the statute a duty of excise is a tax on goods produced
or manufactured in the taxing country, and it ought normally not to be confused
with a tax which is a turnover or sales tax. In Pakistan the sales tax is levied on the
value of supply of taxable goods and on value of imported, exported goods. The
value for sales tax purpose is duty paid value that is to say value of the goods plus
duty, if any, whether excise or customs.
The following definitions are worth noting.
(1) "associated persons" means any two or more persons who are close
relatives to each other or who are interconnected with each other in the
following way, namely:-
(i) if the persons, being companies or undertakings, are under
common management or control or one is the subsidiary of the
(ii) if a person who is the owner or partner or director of a company
or undertaking, or who, directly or indirectly, holds or controls
twenty per cent shares in such company or undertaking, is also
the owner, partner or director of another company or
undertaking, or, directly or indirectly, holds or controls twenty
per cent shares in that company or undertaking;
Explanation.- For the purpose of this clause, the expression
"close relatives" mean the family, parents, brothers, sisters and
dependents of registered person;
(2) "distributor" means a person appointed by a manufacturer, importer or
any other person for a specified area to purchase goods from him for the
further supply and includes a person who in addition to being a distributor
is also engaged in the supply of goods as a wholesaler or a retailer;
(3) "input tax" in relation to a registered person, means the tax-
(i) levied under this Act on the supply of goods received by that
(ii) levied under this Act on the goods imported, entered and
cleared under section 79 or section 104 of the Customs. Act, by
(iii) levied under the Sales Tax Act, 1990 of Pakistan as adapted in
the State of Azad Jammu and Kashmir, on the supply of goods
received by that person; and
(iv) chargeable as duties of excise under section 3 of the Central
Excises Act, 1944 (I of 1944), on such excisable goods or
services as are notified by the Federal Government under the
third proviso to subsection (1) thereof and on which such duties
are charged, levied and paid as if it were a tax payable under
section 3 of this Act;
(4) "manufacture" or "produce" includes-
(i) any process in which an article singly or in combination with
other articles, materials, components, is either converted into
another distinct article or product or is so changed, transformed
or reshaped that it becomes capable of being put to use
differently or distinctly and includes any process incidental or
ancillary to the completion of a manufactured product;
(ii) process of printing, publishing, lithography and engraving; and
(iii) process and operations of assembling, mixing, cutting, diluting,
bottling, packaging, repacking or preparation of goods in any
(5) "open market price" means the consideration in money which that
supply or a similar supply would generally fetch in an open market;
(6) "output tax" in relation to any registered person means the tax charged
under this Act in respect of a supply of goods made by that person and
shall include duties of excise chargeable under section 3 of the Central
Excises Act, 1944 (I of 1944) on such excisable goods or services as are
notified by the Federal Government under the third proviso to subsection
(1) thereof and on which such duties are charged, levied and paid as if it
were a tax payable under section 3 of this Act;
(7) "retail price", with reference to the Third Schedule, means the price
fixed by the manufacturer or the importer, inclusive of all charges and
taxes (other than sales tax at which any particular brand or variety of any
article should be sold to the general body of consumers or, if more than
one such price is so fixed for the same brand or variety, the highest of
(8) "retail tax" means tax levied under section 3AA;
(9) "supply" includes sale, lease (excluding financial or operating lease) or
other disposition of goods carried out for consideration and also
(i) putting to private, business or non-business use of goods
acquired or produced or manufactured in the course of
(ii) auction or disposal of goods to satisfy a debt owed by a person;
(iii) possession of taxable goods held immediately before a person
ceases to be a registered person.
Provided that the Federal Government, may by notification in
the official Gazette specify such other transactions which shall
or shall not constitute supply.
(10) "tax" means the sales tax, retail tax or enlistment tax, and includes
additional tax or any other sum payable under any of the provisions of this
Act or the rules made thereunder;
(11) "taxable activity" means any activity which is carried on by any person,
whether or not for a pecuniary profit, and involves in whole or in part, the
supply of goods or rendering of services on which sales tax has been
levied under the respective Ordinance and use of goods acquired for
private purposes or for the manufacture of exempt goods without making
supply to any other person, whether for any consideration or otherwise,
and includes any activity carried on in the form of a business, trade or
(12) "tax fraction" means the amount worked out in accordance with the
100 + a
('a' is the rate of tax specified in section 3);
(13) "taxable goods" means all goods other than those which have been
exempted under section 13;
(14) "tax invoice" means a document required to be issued under section 23;
(15) "taxable supply" means a supply of taxable goods made by an importer,
manufacturer, wholesaler (including dealer), distributor or retailer other
than a supply of goods which is exempt under section 13 and includes a
supply of goods chargeable to tax at the rate of zero per cent under
(16) "time of supply" a supply shall be deemed to have taken place at the
earlier of the time of delivery of goods or the time when any payment is
received by the supplier in respect of that supply;
Provided that where any part payment is received-
(i) for a supply in a tax period, it shall be accounted for in the return
for that tax period; and
(ii) in respect of an exempt supply, it shall be accounted for in the
return for the tax period during which the exemption is
withdrawn from such supply:
Provided further that -
(a) where any goods are supplied by a registered person to an
associated person and the goods are not to be removed, the time of
supply shall be the time at which these goods are made available to the
(b) where the goods are supplied under hire purchase agreement,
the time of supply shall be the time at which the agreement is
(17) "value of supply" means,-
(a) in respect of a taxable supply, the consideration in money
including all Federal and Provincial duties and taxes, if any,
which the supplier receives from the recipient for that supply but
excluding the amount of tax:
Provided that -
(i) in case the consideration for a supply is in kind or is
partly in kind and partly in money, the value of the
supply shall mean the open market price of the supply
excluding the amount of tax;
(ii) in case the supplier and recipient are associated
persons and the supply is made for no consideration or
for a consideration which is lower than the open market
price, the value of supply shall mean the open market
price of the supply excluding the amount of tax; and
(iii) in case a taxable supply is made to a consumer from
general public on installment basis on a price inclusive
of mark up of surcharge rendering it higher than open
market price, the value of supply shall mean the open
market price of the supply excluding the amount of tax.
(b) in case of trade discounts, the discounted price excluding the
amount of tax; provided that the tax invoice shows the
discounted price and the related tax and the discount allowed is
in conformity with the normal business practices;
(c) in case where for any special nature of a transaction it is difficult
to ascertain the value of a supply, the open market price;
(d) in case of imported goods, the value determined under section
25 of the Customs Act, including the amount of customs-duties
and central excise duty levied thereon;
(e) in case where there is sufficient reason to believe that the value
of a supply has not been correctly declared in the invoice, the
value determined by the Valuation Committee comprising
representatives of trade and the Sales Tax Department
constituted by the Collector and
(f) in case the goods other than taxable goods are supplied to a
registered person for processing, the value of supply of such
processed goods shall mean the price excluding the amount of
sales tax which such goods will fetch on sale in the market:
(g) in case of a taxable supply, with reference to retail tax, the price
of taxable goods excluding the amount of retail tax, which a
supplier will charge at the time of making taxable supply by him,
or such other price as the Board may, by a notification in the
Official Gazette, specify.
Provided that, where the Central Board of Revenue deems it
necessary, it may, by notification in the official Gazette, fix the
value of any taxable supplies or class of supplies and for that
purpose fix different values for different classes or description of
same type of supplies:
Provided further that where the value at which the supply is
made is higher than the value fixed by the Central Board of
Revenue, the value of goods shall (unless otherwise directed by
the Board) be the value at which the supply is made.
(18) "wholesaler includes a dealer and" means any person who carries on,
whether regularly or otherwise, the business of buying and selling goods
by wholesale or of supplying or distributing goods, directly or indirectly, by
wholesale for cash or deferred payment or for commission or other
valuable consideration or stores such goods belonging to others as an
agent for the purpose of sale; and includes [a person supplying taxable
goods to a person whose income is not liable to tax under the Income Tax
Ordinance, 2001 (XLIX of 2001) but has deducted income tax at source
under section 153 of the said Ordinance and a person who in addition to
making retail supplies is engaged in wholesale business; and
(19) "zero-rated supply" means a taxable supply which is charged to tax at
the rate of zero per cent under section 4.
8.7 Scope of tax
Section 3 is the charging section which creates a charge on all taxable supplies
made in Pakistan by a registered person in the course or furtherance of any
taxable activity carried on by him and on all goods imported. In other words under
section 3 of the Sales Tax Act, 1990 sales tax is chargeable on value of:-
(1) Taxable supplies
8.8 Chargeability of sale tax
Chargeability of sale tax is provided under section 3 of the Act which enunciate that
there shall be charge levied and paid a tax known as sale tax at the rate of 15% of
the value of taxable supplies made in Pakistan by a registered person in the course
or furtherance of any taxable activity carried on by him and goods imported into
8.9 Conditions to levy sales tax under Section 3(1)(a)
Section 3(1)(a) reveals that as per clause (a) of sub-section (1) of section 3 of the
Act two conditions are essential to levy sales tax 'namely the taxable supplies and
taxable activities. In order to create the charge of sales tax, inter alia, two
conditions must be fulfilled independently, i.e. the transaction of sale must
constitute a "taxable activity" and it should also be a “taxable supply". Even if one
condition is missing the charge of sales tax would not be leviable.
8.10 Sales tax is a tax on consumption
It will be seen that charging provisions of section 3 of the Act provided for the
charge and levy of a tax known as Sales Tax. This charge is "subject to the
provisions of this Act". Sub-section (3) of section 3 goes to state that liability to pay
tax shall be, in the case of supply of goods in Pakistan, of the person making the
supply. These provisions are to be seen in the perspective of over all scheme and
the definition of word "input tax" as given in section 2(14), the word "output tax" as
given in section 2(20) and the "taxable activity" and "taxable supply" as defined in
section 2(35) and 2(41) of the Act respectively. If nothing else, sub-section (1) and
sub-section (3) of section 3-B make it clear that the incidence of tax charged under
section 3 has to pass on to the consumer ultimately. The provisions regarding input
as well as out put tax as defined in the definition clause of the Act read with
sections 7 and 8 thereof are only the modalities prescribed to protect the interest of
the exchequer against any pilferage, evasion or fraud. Every maker of a taxable
supply is an agent of the exchequer to receive the amount on its behalf and then to
pass it on to the next supplier till finally the consumer bears the brunt.
8.11 Sales tax a Value Added Tax
Provisions of Sales Tax Act, 1990 show that it is a value added tax, which was
levied at every stage, the value addition took place at the time of supply, it is
therefore, no more a one point levy. Sales tax payable under Sales Tax Act, 1990
is a value added tax as distinguished from the Sales Tax Act, 1951, where it was a
one point levy this distinction, however, does not necessarily lead to the inference
that only such activities as may amount to sale of goods in common parlance
would fall within the tax net.
8.12 Rate of sales tax
Sub-section (1) prescribes the rates of Sales Tax @ 15%. This rate of sales tax is
also called standard rate of sales tax.
8.13 Retail tax
Section 3AA provides that there shall be charged, levied and paid retail tax at the
rates specified in section 3 by a retailer who is making taxable supplies in the
course or furtherance of any taxable activity carried on by him. All the provisions of
this Act shall apply to the charge, levy, deduction of input tax, payment, collection
and enforcement of the retail tax as if it were sales tax under section 3. The
application for registration as tax payer of retail tax shall be made to the Collector
in such form and manner as may be specified by the Board.
8.14 Collection of excess tax
Under section 3B any person who has collected or collects any tax or charge,
whether under misapprehension of any provision of this Act or otherwise, which
was not payable as tax or charge or which is in excess of the tax or charge actually
payable and the incidence of which has been passed on to the consumer, shall pay
the amount of tax or charge so collected to the Federal Government.
Any amount payable to the Federal Government under sub-section (1) shall be
deemed to be an arrear of tax or charge payable under this Act and shall be
recoverable accordingly and no claim for refund in respect of such amount shall be
The burden of proof that the incidence of tax or charge has been or has not been
passed to the consumer shall be on the person collecting the tax or charge.
8.15 Zero rating (Section 4)
The following goods shall be charged to tax at the rate of zero per cent:-
(a) goods exported, or the goods specified in the Fifth Schedule;
(b) supply of stores and provisions for consumption aboard a conveyance
proceeding to a destination outside Pakistan as specified in section 24 of
the Customs Act, 1969 (IV of 1969);
(c) such other goods as the Federal Government may, by Notification in the
Official Gazette, specify;
Zero rating shall not apply in respect of a supply of goods which -
(i) are exported, but have been or are intended to be re-imported
into Pakistan; or
(ii) have been entered for export under section 131 of the Customs
Act, 1969 (IV of 1969), but are not exported; or
(iii) have been exported to a country specified by the Federal
Government, by Notification in the Official Gazette.
The Federal Government has the power to restrict the amount of credit for
input tax actually paid and claimed by a person making a zero rated
supply of goods otherwise chargeable to sales tax.
It may be noted that goods which are exempt from sales tax under section
13 cannot be zero rated under section 4 on their export.
8.16 Change in the rate of tax (Section 5)
If there is a change in the rate of tax –
(a) a taxable supply made by a registered person shall be charged to tax at
such rate as is in force at the time of supply;
(b) imported goods shall be charged to tax at such rate as is in force,-
(i) in case the goods are entered for home consumption, on the
date on which a bill of entry is presented;
(ii) in case the goods are cleared from warehouse, on the date on
which a bill of entry for clearance of such goods is presented.
Where a bill of entry is presented in advance of the arrival of the
conveyance by which the goods are imported, the tax shall be
charged as is in force on the date on which the manifest of the
conveyance is delivered.
If the tax is not paid within seven days of the presenting of the
bill of entry the tax shall be charged at the rate as is in force on
the date on which tax is actually paid.
8.17 Time and manner of payment (Section 6)
The tax in respect of goods imported into Pakistan shall be charged and paid in the
same manner and at the same time as if it were a duty of customs payable under
the Customs Act, 1969 [and the provisions of the said Act.
The tax in respect of taxable supplies made during a tax period shall be paid by the
registered person at the time of filing the return in respect of that period.
The tax due on taxable supplies shall paid by any of the following modes, namely:
(i) through deposit in a bank designated by the Board and
(ii) through such other mode and manner as may be specified by the Board.
8.18 Determination of tax liability (Section 7)
For the purpose of determining his tax liability in respect of taxable supplies made
during a tax period, a registered person shall be entitled to deduct input tax paid or
payable during the tax period for the purpose of taxable supplies made, or to be
made, by him from the output tax that is due from him in respect of that tax period
and to make such other adjustments as are specified in section 9.
The taxpayer may adjust input tax paid on the purchases in the immediate three
preceding tax periods from the output tax subject to the condition that the taxpayer
specifies the reasons for such delayed input tax adjustment in the revised sales tax
return for such period or in the return for the immediately succeeding tax period.
A registered person shall not be entitled to deduct input tax from output tax
(i) in case of a claim for input tax in. respect of a taxable supply made, he
holds a tax invoice in his name and bearing his registration number, in
respect of such supply for which a return is furnished;
(ii) in case of goods imported into Pakistan, he holds bill of entry or goods
declaration in his name and showing his sales tax registration number,
duly cleared by the customs under section 79 or section 104 of the
Customs Act, 1969 (IV of 1969);
(iii) in case of goods purchased in auction, he holds a treasury challan in his
name and bearing his registration number, showing payment of sales tax
The Federal Government has power to allow a registered person to deduct input
tax paid by him from the output tax determined or to be determined as due from
him under this Act.
8.19 Levy and collection of tax on specified goods on value addition
The Federal Government may specify, by notification in the official Gazette, that
sales tax chargeable on the supply of goods of such description or class shall, with
such limitations or restrictions as may be prescribed, be levied and collected on the
difference between the value of supply for which the goods are acquired and the
value of supply for which the goods, either in the same state or on further
manufacture, are supplied.
The Federal Government may, by notification in the official Gazette, and subject to
the conditions, limitations, restrictions and procedure mentioned therein, specify
the minimum value addition required to be declared by certain persons or
categories of persons, for supply of goods of such description, or class as may be
prescribed, and to waive the requirement of audit or scrutiny of records if such
minimum value addition is declared.
8.20 Tax credit not allowed (Section 8)
A registered person shall not be entitled to reclaim or deduct input tax paid on -
(a) the goods used or to be used for any purpose other than for the
manufacture or production of taxable goods or for taxable supplies made
or to be made by him;
(b) any other goods which the Federal Government may, by a notification in
the official Gazette, specify;
(c) the goods under sub-section (5) of section 3;
(d) fake invoices; and
(e) purchases made by such registered person, in case he fails to furnish the
information required by the Board notification issued under subsection (5)
of section 26.
If a registered person deals in taxable and non-taxable supplies, he can reclaim
only such proportion of the input tax as is attributable to taxable supplies in such
manner as may be specified by the Board.
No person other than a registered person shall make any deduction or reclaim
input tax in respect of taxable supplies made or to be made by him.
8.21 Debit and credit note (Section 9)
Where a registered person has issued a tax invoice in respect of a supply made by
him and as a result of cancellation of supply or return of goods or a change in the
nature of supply or change in the value of the supply or some such event the
amount shown in the tax invoice or the return needs to be modified, the registered
person may, subject to such conditions and limitations as the Board may impose
issue a debit or credit note and make corresponding adjustment against output tax
in the return.
8.22 Excess amount to be carried forward or refunded
If in relation to a tax period, the total deduction of input tax and other adjustments
as specified in section 9 exceed the output tax, the excess amount shall be carried
forward by the registered manufacturer, importer, wholesaler or retailer to the next
tax period and shall be treated as input tax for that tax period:
Such excess amount of tax carried forward, from the previous tax period may be
refunded to the registered person subject to such conditions, restrictions and
limitations as the Board, may by notification in the official Gazette, specify.
The refund of tax charged on the acquisition of plant and 'machinery shall also be
admissible to the registered person who, at the time of taking delivery of taxable
plant and machinery, its components and spare parts is not making taxable
supplies, subject to the condition that he shall, within the period specified by the
Board, by notification in the official - Gazette, commence taxable supplies and
complies with such other conditions as are specified therein.
The input tax incurred in connection with a zero-rated supply shall be refunded not
later than thirty days of filling of return in such manner and subject to such
conditions as the Board may, by notification in the Official Gazette, specify.
If a registered person is liable to pay any tax, additional tax or penalty payable
under any law administered by the Board the refund of input tax shall be made
after adjustment of unpaid outstanding amount of tax or, as the case may,
additional tax and penalty.
Where there is reason to believe that a person has claimed input tax credit or
refund which was not admissible to him, the provisions regarding time limit shall
not apply till the investigation, including the verification of the deposit of tax claimed
as refund, is completed and the claim is either accepted or rejected.
8.23 Assessment of tax (Section 11)
Where a person who is required to file a tax return fails to file the return for a tax
period by the due date or pays an amount which, for some miscalculation is less
than the amount of tax actually payable, an officer of Sales Tax shall, after a notice
to show cause to such person, make an order for assessment of tax, including
imposition of penalty and additional tax in accordance with sections 33 and 34.
Where a person required to file a tax return files the return after the due date and
pays the amount of tax payable in accordance with the tax return alongwith
additional tax and penalty, the notice to show cause and the order of assessment
Where a person has not paid the tax due on supplies made by him or has made
short payment or has claimed input tax credit or refund which is not admissible
under this Act, an officer of Sales Tax shall make an assessment of sales tax
actually payable by that' person or determine the amount of tax credit or tax refund
which he has unlawfully claimed and shall impose a penalty and charge additional
tax in accordance with sections 33 and 34.
No order under this section shall be made by an officer of Sales Tax unless a
notice to show cause is given to the person in default specifying the grounds on
which it is intended to proceed against him and the officer of Sales Tax shall take
into consideration the representation made by such person and provide him with
an opportunity of being heard.
An order under this section shall be made within ninety days of issuance of show
cause notice or within such extended period as the Collector or, as the case may
be, Collector (Adjudication) may, for reasons to be recorded in writing, fix provided
that such extended period shall in no case exceed ninety days.
Where a registered person fails to file a return, an officer of Sales Tax Department,
not below the rank of Assistant. Collector, shall subject to such conditions as
specified by the Central Board of Revenue, determine the minimum tax liability of
the registered person.
8.24 Short-paid amounts recoverable without notice
Where a registered or enrolled person pays the amount of tax less than the due tax
as indicated in his return, the short-paid amount of tax shall be recovered without
giving a show cause notice to such person provided that no additional tax or
penalty shall be charged unless a show cause notice is given to such person.
8.25. Exemption (Section 13)
Supply of goods or import of goods specified in the Sixth Schedule shall, subject to
such conditions as may be specified by the Federal Government, be exempt from
tax under this Act.
Where a person does not desire to avail any tax exemption, he may, after voluntary
registration, opt to pay sales tax at the rate applicable to such supplies under the
provisions of section 3 subject to condition that he shall not thereafter be
deregistered till the expiry of two years from the date of such registration.
Chapter – 9
VAT in Bangladesh
The levy of VAT in Bangladesh is governed by the Value Added Tax Act, 1991.
Section 2 of the said Act contains the definitions. Following definitions are relevant
for the purpose of our study:
(a) “Exempted” means any exempted goods or services under this Act.
(b) “Output tax” means VAT imposed under this Act.
(c) “Input” means.
(i) all sorts of raw materials, fuel, packages, service, machinery
and its parts but does not includes labor, land, building, office
equipment and vehicles.
(ii) imported, purchased, acquired or collected goods by any means
for the purpose of conducting business, sales, exchange or
hand over of that goods.
(d) Input tax: means Vat paid or payable on input, which is purchased or
imported by/from any registered person.
(e) Tax period: means the duration of one month or any duration as
determined by the Government, by Notification in Official gazette.
(f) Taxable goods: means any goods not included in the first schedule.
(g) Taxable services: means any service not included in the Second
(h) Turnover : means all money received or receivable by a person in a
particular period from the supply of taxable goods or services produced
(i) Prescribed Date: means 10th of the month after the tax period for the
purpose of submission of return.
(j) Price: means total money or measurable with money received or
receivable against supply of goods or services.
(k) Goods: all movable goods except share, stock, coin, security and
(l) Manufacturer/Producer: means a person who undertakes-
(i) any process by combining different materials or components so
that the product produced is identically usable;
(ii) to carry on any auxiliary process to produce the same;
(iii) to carry on any process of printing, publishing etc,;
(iv) to carry on any process of packaging or repackaging,
assembling, mixing, cutting, liquidating etc,.
(v) any act done by the Official Assignee or Receiver on behalf of a
manufacturer who have become insolvent; and
(vi) to carry on any process by using the material and component of
another person as a subcontract by utilizing his own plant and
(m) Commercial Importer: means such person who sells or otherwise
transfers goods except those mentioned in the First Schedule to other
person without changing the shape, nature, characteristics or quality after
importation of the goods by him.
(n) Commercial Document: means books of accounts or records or papers
maintained by any person for keeping records of his business
transactions or financial position and it also includes other documents
such as debit voucher, credit voucher, cash memo, purchase-sales day
book, cash book, journal book, document for bank account & related
records, trail balance, ledger, financial statements & analysis, profit &
loss account, profit & loss appropriation account, bank reconciliation,
balance sheet and audit reports.
(o) Trader: any person who sells or transfers by any means to any person
without changing the shape, nature or quality of the goods which is
imported, purchased, acquired or collected by any means.
(p) Large Taxpayer Unit or LTU: means Large Taxpayer Unit established
under section 8D.
(q) Person: includes any business organization, association of persons and
(r) Zero taxable goods or services: means goods or services exported or
deemed to be exported goods or services or food or other goods
mentioned under section 3(2) on which no VAT and Supplementary Duty,
as applicable, shall no be imposed and all taxes and duty paid on input
used in making the above goods, shall be refunded, except advance tax
and duty specified in Official Gazette.
(s) Gross Receipt: is the money received or receivable [with commission or
charge] excluding VAT or Advance Tax by service provider in
consideration of service provided.
(t) Supply: means sales, handover, lease or settlement by any other means
of goods in consideration of price by producer for his produced goods (or
by business person for imported, purchased, acquired or collected goods
and the following are also considered as supply:
(i) Usage of goods acquired while conducting business or
produced. In respect of personal, business related or
non-business related purpose,
(ii) Auction or settlement of goods for repayment of loan.;
(iii) Possession of taxable goods immediately before cancellation of
(iv) Remove or release of goods from production place thereof;
(v) Any other transaction which is determined by SRO.
9.2 Imposition of VAT
Section 3 deals with the imposition of VAT. As per the said section VAT is
determined and payable at 15% on the value as mentioned in Sec. 5 of all goods or
services except the goods as specified in Section 1 and services as specified in
VAT will be charged at zero rate on the following:
(i) Goods or services exported or deemed to be exported from Bangladesh
(ii) Foods and other goods exported for consumption abroad as per the
section 24 of the Customs Act.
However, in the following situations VAT will be imposed normally and not
at zero rate –
(a) goods those are exported with an intention of re-import; and
(b) goods are not exported within 30 days of submission of bill of
export or within such date extended by the commissioner.
As per Subsection (3) of section 3 VAT shall be payable by -
(a) the importer in case of import;
(b) supplier in case of goods manufactured in Bangladesh;
(c) The person rendering services; and
(d) in any other case; the supplier.
In case of any imported or other goods the classification of goods under the
Customs Act will apply for the calculation of payment of VAT.
For the purpose of achieving the goals of this section the Board for public interest,
by notification in the Government gazette may -
(a) declare any taxable goods as taxable services or any taxable services as
taxable goods; and
(b) explain to determine the scope of any taxable services.
9.3 Application of tax rate
Section 4 of the Value Added Tax Act of Bangladesh provides for the application of
tax rates. The said section requires that the tax shall be payable at the time
specified in section 6(2) or (3).
Sub-section (2) of section 4 provides that the tax shall be charged at existing rate:
(a) In case of import on the date of placing the bill of entry under the Custom
Act for releasing goods for consumption in the country; or if the bill of
entry is submitted before arriving of the vehicle carrying the goods then
on the date of submission of manifest, or
(b) When the said goods is delivered from warehouse under section 104 of
the Custom Act.
9.4 Computation of value for charge of VAT
Section 5 of the Act provides for the method of computation of value for the
purpose of section 2 dealing with imposition of tax, which is laid as under:
Imports: In case of imports, the value shall be the transaction value as determined
under section 25 or 25A of the Custom Act plus import duty, supplementary duty
except advance tax.
Goods supplied: Sub- Section (2) provides that in case of goods supplied, the
price shall be the consideration receivable from buyer by the producer or business
person, which will include purchase price of materials and all expenditure incurred
by the manufacturer and also commission, charges, fees and all supplementary
duty excluding VAT and profit.
Provided that in case of imported input used for producing taxable goods or selling,
exchanging, the value shall be based on the amount as determined under section
25 or 25A of the Custom Act, for taking VAT credit under section 9 of the VAT Act.
Further provided that in order to determine base for computing VAT, the Board can
fix through notification in official gazette VAT rate and amount/quantity in respect
of certain goods or class of goods.
Sub section (2A) provides that if any registered person sells goods directly in his
own brand name of from own sales center or through distributor or commission
agent after collecting the same by way of contract or sub-contract from other
producer VAT will be determined on the price received by the owner from the buyer
and the price will be equal to amount as mentioned in sub-section (2).
Sub-section (2B) further provides that if any producer or importer wants to
supply goods at uniform price in the form of printing on the body or container or
packet of the goods, he can do that in the procedure prescribed through the rule on
production level by the producer and at import level by the importer.
Rule relevant for supply of goods is as follows:
Rule-3B: Procedure of supply of goods at uniform price by producer or
In case of supply of goods by any producer at production level or importer at import
level at uniform price in the form of printing on the body or container or packet of
the goods, following procedure is to be followed, namely-
(a) Before the supply of taxable goods, the producer or importer shall declare
the price according to the method stated in rule 3 for the purpose of
imposition of value added tax or, where applicable, value added tax and
Provided that in case of the above price declaration, he shall show
separately in Form VAT-1 the declaration at production level and all the
costs, profit and commission at the level of final supply of the goods;
(b) The producer or importer shall submit such undertaking that the declared
uniform price shall be printed on the body or container or packet of the
goods with the indelible ink in a visible part and the goods shall be
supplied at the said uniform price throughout the country;
(c) All the required supporting documents are to be submitted with the
undertaking mentioned in clause (b) while submitting it in the Board;
(d) A specimen of the good containing the imprint of “Mushak paid” or where
applicable “VAT paid” by the said or below or above the price printed on
the body or container or packet of the goods, shall be submitted at the
time of submitting documents under clause(c);
(e) On receipt of the approval of the Board, the Divisional Officer will intimate
the concerned producer or importer and the stated goods can be supplied
from the date specified by him;
(f) During the supply or sale through own sales center or distributor or dealer
or agent, goods shall be supplied or sold after giving a seal containing the
words “Total VAT at source” in the VAT-11 Challan
As per sub-section (3) of section 5 the Government shall, through Official
Gazette determine price of the goods, which is sold at retail price. Here
the manufacturer/producer shall determine the retail price with the
approval of the concerned authority. Such retail price shall include all
expenses, commission, charges, duty and taxes. The selling price and
brand or symbol has to be printed on each packet or bag noticeably.
Services: Sub-section 4 provides for the valuation in case of service. VAT shall be
charged on total money receipts. The Board may also determine value or rate for
this purpose by notification in official gazette. This notification allows another
truncated basis VAT collection.
Goods supplied by a registered dealer: In case of goods supplied by a
registered person or person eligible to be registered, VAT shall be charged on the
total money received/receivable on the goods in a specific period as determined
by the rule.
Rule 3(6) lays down the provision in respect of transactions involving trade
discounts. It is reproduced as under:
Rule 3(6) - The person giving trade discount has to give advertise in national daily
and inform related divisional officer of VAT regarding original price, discounted
price and discount period. Rate of discount cannot be more than 15% and discount
period cannot be more than 30 days within 12 months.
9.5 Time and method of payment (Section 6)
In case of imported goods the method of payment of VAT and supplementary duty,
as the case may be, will be same as customs duty as per the Customs Act.
Section 4 of the Value added tax Act of Bangladesh requires that the tax shall be
payable at the time specified in section 6(2) or (3).
Section 6(2) requires that in case of goods produced by a registered person, VAT
shall be payable on the happening of the following events, which occurs first;
(a) when the goods are delivered;
(b) issuance of invoice, relating to the goods supplied;
(c) at the time when goods are transferred for personal or the use of others;
(d) receipt of part or full payment.
Section 6(3) provides that in case of services rendered by registered person, VAT
shall be payable on the happening of the following events, which occurs first-
(a) services rendered;
(b) issuance of invoice;
(c) receipt of post or full payment.
However, the Board may, in accordance with the prescribed rules, direct any
method and time for payment and system for VAT, supplementary duty including
advance payment in respect of any goods, class of goods or service.
9.6 Attachment of Stamp or banderol
Notwithstanding anything contained in section 4, the Board may, by Official
Gazette, attach any stamp or banderol of specific price with security system on any
goods or any class of goods from the time mentioned in the gazette in order to
collect VAT and supplementary duty. The Board will also determine the mark or
design of the stamp and banderol and also the procedure of its uses, distribution,
reservation, supervision, observation, record keeping and packaging, etc.
Stamp and Banderol means security instrument with specific colour, design, size.
9.7 Collection of VAT at source
Notwithstanding anything contained in this Act, payable Value Added Tax for
services which is ascertained by Government notification in official gazette for this
purpose will deduce or collect at source according prescribed manner by order of
the Board, at the time of payment of service value or commission by concerned
service receiver or commission payer.
Provided that, where a service renderer being foreign aided project have already
paid all above mentioned VAT and deposited it properly to Government Treasury,
the any sub-contractor, agent or any other person employed to perform the
purposes of the project, will not have to pay the VAT again and so on. Here it is
notable that, in this ground, the project (main service provider) or its sub-contractor
or its agent will have to submit all necessary documents regarding payment of
such VAT at primary stage and its deposition to Government Treasury.].
A certificate, mentioning the following, of deduction or collection of VAT shall be
given by the person collecting or deducting VAT to the person rendering services:-
(a) Registration number of VAT payer;
(b) total amount of payment for service;
(c) the value of service/commission on which VAT is impossible;
(d) the amount of VAT deducted or collected ; and
(e) any other information warranted by rules.
As per sub-section (4c) if the person concerned fails to deduct VAT -
(a) he shall pay interest @ 2% per month with the original amount due
(b) the amount deducted and paid shall be deemed to be paid by the party
from which deduction has been made.
(c) Notwithstanding in clause (a) if VAT is not deposited within 2 months from
the date of its collection/deduction the person responsible shall be
penalized up to Rs. 25,000/- by the Commissioner.
Sub-section (5) of section 6 provides that VAT payable for goods supplied
or services rendered (except payable at import stage) will be paid through
return and current account in accordance with the methods prescribed
9.8 Imposition of supplementary duty
As per section 7 supplementary duty shall be charged @ 2.50% to 3.50% on the
goods or services. Such duty is charged for sake of public interest by discouraging
import and production of luxury, non-essential, socially undesirable and other
goods or services listed in the third schedule.
For the purpose of calculating supplementary duty, the value of goods and
services shall be-
(a) In case of import
The value on which the import duty is imposed under section 25 or 25A of
the Custom Act and after adding the import duty with the said value.
(b) In case of goods produced in Bangladesh
The value received by the producer. The Supplementary Duty and VAT
will be excluded from the value received.
(c) In case of service
The total bill which will exclude VAT & Supplementary Duty.
(d) In case of goods sold in retail price
The price fixed under section 5(c).
Sub-section (3) of the said section provides that the method and time of
payment of supplementary Duty shall be same as VAT specified in
9.9 Turnover tax (TOT)
As per section 8 every producer or businessperson or service renderer for taxable
products or services, who is not required to be registered under section 15 shall
pay turnover Tax @4%.
Relevant rules are laid down as under:
Rule-4 : Payment of Turnover Tax
If annual turnover is below 20 lakhs then the above persons will pay turnover tax @
4% on his annual turnover. All proceedings relating to the turnover tax shall be
prescribed by the Rules.
The persons liable to pay TOT shall be enlisted with Superintendent for payment of
TOT. For such enlisting application to Superintendent in the form VAT-6 shall be
made. If satisfied, Superintendent will enlist him within 7 days and provide a
After enlistment, a declaration has to be given about estimated turnover and
system of payment of tax in the form of VAT Mushok-2B for approval of
Superintendent. If declared turnover is not accepted to Superintendent on specific
and logical ground he may determine the turnover within 30 working days after
giving opportunity of being heard.
TOT has to be paid from the date immediately after the enlistment.
TOT can be paid in one installment by the enlisted persons. However, such
payment will be subject to fulfillment of certain conditions.
TOT can also be paid in monthly or quarterly installment subject to fulfillment of
Enlisted person can appeal to Commission for determining his turnover.
After considering appeal and hearing, as applicable, the commission can
determine turnover and TOT and inform him in writing. The commission will also
send the copy of the order to the local commissioner and divisional officer within 7
working days for implementation.
Commission can reassess turnover if different information comes to the hand of
commissioner and divisional officer. Reassessment of turnover can also be done
even if the taxpayer wishes to change amount of turnover.
Annual payable TOT determined by commission will be payable as per rule 4(4).
After submission of application of declaration or investigation by the commission if
turnover is found excess over the minimum amount which is determinant factor for
being registered, the commission will send the application to commissioner or
divisional officer for registering the person under VAT.
On default of payment as per rules (4) or (5) of determined TOT, enlisted person
will be fined by superintendent for not more than Tk. 5,000 and additional monthly
interest @ 2% on uppaid amount.
Any dues to Government on account of TOT will be collected following the
procedures under section 56.
Excess paid TOT will be refunded in same procedures as mentioned under
Form VAT-17A has to be filled in for maintaining accounts of goods or service
transferred and enlisted number must be mentioned clearly in cash memo.
This rule is applicable for the person registered under section 17 and for the goods
and services mentioned in and order under section 8(4).
If actual turnover of the person is excess over the amount as mentioned under 4(1)
after elapse of one year from enlistment then he has to apply for canceling
enlistment and apply in the form VAT-6 for registration under section 15.
Superintendent will send a copy of information on enlistment and collection of
Divisional officer can examine information of TOT of enlisted person at any time
and order superintendent necessary directions.
As per section 8 (3) the Board may for public interest exempt any item from
turnover tax. However such exemption will be subject to prescribed conditions and
limitations specified by the order.
The Board may in public interest and after proper investigation, order any person
who is engaged in supplying goods or rendering services to get registered under
section 15 irrespective of amount of turnover and pay VAT.
9.10 Large taxpayer unit (LTU)
As per section 8D the Board, through notification in the official Gazette, can
establish required number of Large Taxpayer Unit or LTU for the purpose of
collection and supervision of value added tax from whole areas of the country or
any fixed outer limits of a prescribed area or a stated class of taxpayers.
9.11 Credit of taxes
Sub-section (1) of section 9 provides that the supplier, traders of taxable goods or
services shall get tax credit on output tax. However, no tax credit on output tax will
be available in respect of the following:
(a) Raw Materials used for producing exempted products;
(b) Raw Materials purchased from Turnover Tax units;
(c) Supplementary Duties;
(d) Multiple usable packing materials except for the first time;
(e) Tax paid on-
§ BMRE of any building, infrastructure or establishment,
§ Repairs & purchase of furniture, stationeries, air-conditioner, fan,
lighting, generators etc.
§ Payments for architecture, designing and other products associated
with such products and services.
(f) Value added tax paid in addition to value added tax prescribed by rules
on production or supply of taxable goods or provision of taxable services
and paid on various goods and services.
Previous provision under clause (f) above, now under new sub-rule (1A) of rule 19
in a revised way [see below]:
The following services on which 60% of the Total VAT paid will be allowed as
§ Tele printer
§ Freight forwards, clearing & forwarding agent,
§ Audit & Accounting Firm,
§ Procurement provider,
§ Security services,
§ Legal advisor,
§ Transport contractor
§ L/C service and
§ Electricity distributor.
(g) VAT paid on Traveling, Entertainment, Employee Welfare etc;
(gg) VAT paid on that input which not fulfill the taxable base of amount as per
section 5(2) and input tax paid on purchased input according to second
proviso of section 5(2).
(h) Service provider paying VAT on a Truncated Base under section 5(4);
(hh) Input tax paid on that input which purchased by business holder
according to the section 5(4a).]
(i) Supplier paying VAT on Tariff Value under section 5(7);
(j) Input tax mentioned in the bill of entry or Chalan containing registration
number except the registration number of the supplier of goods, trader or
provider of services;
(k) VAT paid on materials still under someone else’s control or custody.
Provided that credit must be taken within 30 days from the entry of input
at the production, supply or service rendering place.
Rule-19: System of VAT Credit
Rule 19 lays down the provisions relating to VAT credit.
Rule 19(1): Any registered person can take credit under section 9 & 13 for the
VAT, other tax and excise duty paid on the input against the output tax on taxable
goods or services within the tax period.
Rule 19(1A): Notwithstanding contained anything in sub-rule (1), credit can be
taken at the following rate on the following services used in any place,
establishment or premises related to production or supply of goods or provision of
(a) 80% of VAT paid on:
§ Gas and
§ Electricity distribution,
(b) 60% of VAT paid on:
§ Freight forwards, clearing and forwarding agent,
§ Audit and Accounting Firm
§ Procurement provider,
§ Security Services,
§ Legal advisor,
§ Transport contractor, and
§ Letter of credit (L/C) service]
Rule 19(2): In case if supply of taxable goods, the registered person will write
down input tax paid on inputs in “Credit” column shown in the Current Account in
the Form VAT-18 after entering the whole amount of inputs into the production or
business place including the bill of entry or Chalan containing the inputs
purchased, the registration number.
Rule 19(2A) & (5): In case of taxable goods and service the input tax can be
adjusted by writing down in the current A/C with output tax of the period in which
the related output entered in the production or business place. If the output tax
exceeds input tax the excess amount has to be deposited to Government Treasury
in cash and if the input tax exceeds output tax then the excess will be carried
forward in the balance column of current A/C for adjusting with output tax of the
Rule 19(3): The registered person, who supplies both taxable and tax exempted
goods, will take credit of the input tax (VAT) on the purchased input by recording
and adjusting in “credit” column of the current account. At the end of the related tax
period, the input tax paid on the input used for tax exempted goods will be shown in
the “payable” column of the current account.
Rule 19 (4) & (5A): The registered person, who supplies both taxable goods and
services and also exports the same for which input tax and other taxes and excise
duties have been paid, can take tax credit of input tax (VAT) paid on the input with
the supply of taxable of goods or services rendered by recording and adjusting in
“Credit” column of the current A/C. At end of the period supplementary duty, import
duty, excise duty and all other duties and taxes paid except advance income taxes
will be recorded recording in “Credit” column of the current A/C.
Rule 19(6): The registered person, who renders both taxable and tax exempted
services, will take credit of the those input tax (VAT) on the purchased input which
has been used to render taxable services.
Sub-section (1A) of section 9 provides that tax credit shall be determined on the
basis of tax rules in case of capital equipment.
Rule 20: Credit Input VAT in respect of Capital Machinery
(1) After importing any machinery, any registered person producing taxable
goods or rendering taxable services can release the same without paying
any VAT from excise station on submission of bond in the form of
(2) The Divisional Officer will give order to Commissioner of excise station to
annul the aforesaid bond if the registered person is able to erect the
machine within 6 months form date of aforesaid release, failing to do so
the person can apply to the Commissioner to extend the period for
another 3 months.
(3) After procuring machinery from Bangladeshi producer any registered
person producing taxable goods or rendering taxable services or
engaged in export can get the supply the machinery without paying any
VAT on submission of bond in the form of VAT–14A. Upon satisfactory
findings after the due investigation of erection of the machine within 6
months from date of aforesaid supply the Divisional Officer will give order
to annul the aforesaid bond. If the person fails to do so then he can apply
to the Commissioner to extend the period for another 3 months.
(4) If the capital machinery as mentioned in (i) & (ii) is sold by the registered
person to another registered person, then seller has to refund or adjust
with current A/C or return the credit received to the Government Treasury
in the following way:
1 year – 100% of the VAT credit
2nd year- 65% of the VAT credit
3rd year- 45% of the VAT credit
4th year – 15% of the VAT credit
(5) If a registered person purchase any capital machinery according sub-rule
(1) and (3), he will gain credit as per following schedule:
1 year – 100% of the VAT to bill of entry
2nd year- 65% of the VAT to bill of entry.
3rd year- 45% of the VAT to bill of entry.
4th year –15% of the VAT to bill of entry.
Section 9(2) states that any person who has obtained tax credit without having the
eligibility as stated in sub-section (1), notwithstanding anything in section 37 the
concerned Officer will be able to cancel the credit. The concerned officer can also
order to adjust the same with the current account or tax return.
Section 9(2a) was inserted by the Finance Act, 2003. The said section overrules
other provisions of the Act and states that, if any person who is aggrieved by any
order served by concerned officer according to sub-section (2), he may furnish a
written complain before any VAT officer whose designation is not below than
aforesaid concerned officer.
According to the sub-section (2a), the officer can dispose off the submitted written
complain, if any, by giving a reasonable opportunity of being heard to the applicant
within seven working days from the date of application. The order passed by that
officer in this regard is final.
(3) If the supplier uses the inputs for both taxable and tax exempted products
and services he shall be allowed tax credit proportionately.]
(4). Where within the duration of preserved taxable goods become damage at
the place of input at the production, service or business, in that case the concerned
suppliers or renderer of services or business holder shall pay the input tax of those
in the manner prescribed by the rule.]
9.12 Correction of accounts after payment of tax
As per section 10 if goods sold by a registered person are subsequently cancelled
or returned, the VAT and Supplementary Duty paid, as the case may be, relating to
the said goods can be adjusted through the next return and the current account.
9.13 Settlement of excess input tax
Section 11 provides that if tax paid on input entitled for credit is in excess of
payable output tax in any tax period then the registered person will be given credit
for the next tax period in the current account for the amount paid in excess and that
amount will be determined as input tax of the following period.
9.14 Credit on input stored at the time of commencement of
Act (Section 12)
Any registered person will get input tax credit against output tax payable at the rate
and procedure mentioned in rules, with the permission of concerned officers for the
§ Input stored in hand before the commencement of this Act when it is
• Under the Excises and Salt Act, 1944 (1 of 1944) on which excise duty is
• Under the Sales Tax Ordinance, 1982 (XVIII of 1982) where sales tax is
impossible on input or,
§ Input stored in hand after the commencement of this Act, which will be used
to produce or manufacture and goods, on which VAT is paid under newly
included in VAT Act.
9.15 Drawback of tax paid on inputs used to produce or
manufacture of exported goods (Section 13)
(1) Notwithstanding any thing contained in chapter VI of the Custom Act,
1969 any person will get drawback if he paid VAT, Supplementary Duty,
Import Duty, other Excises Duty and taxes except Advance Taxes and
such Supplementary Duties as mentioned by SRO in Government
gazette if these are paid on inputs which –
§ Is used to produce or manufacture exported goods or services, or
§ Is deemed as exported goods or services, or
§ Is used in foods or any goods mentioned in section 3(2).
Provided that the above drawback will not be allowed if it is not claimed
within six months from the date of export or deemed to be exported and at
the date of last export in case of partial on the condition of confirm and
irrevocable L/C or local back to back to L/C or local or international
For the purpose of this sub-section date of export means date of
submission of “bill of export” of goods or services by owner thereof under
section 131 of the Custom Act.
(2) Any exporter can adjust output tax on goods or service, which is supplied
in Bangladesh by the exporter.
(3) The Board, by an order in official gazette can allow drawback of input tax
paid as mentioned in sub-section (1) on the basis of invoice for actual
export or on the basis of flat rate after determining of input-output
co-efficient of exported goods.
(4) The Board, by an order in official gazette can allow drawback of VAT and
supplementary duty paid on the goods or services produced locally which
is used for implementing any international contract on conditions as
mentioned in the order.
Section 14 contains the provisions relating to exemptions.
(1) Government by notification in official gazette, from time to time, may
subject to the prescribed limitations and conditions, exempt any import or
supply goods or class of goods or services from VAT and Supplementary
(1A) The Board by special order may, exempt any goods imported or supplied
or services for the implementation of any international or bilateral
Contract on the reciprocal basis, subject to the limitation & condition
mentioned in that order.
(2) Board by special order, specifying the causes for each case, exempt any
taxable goods or services from VAT and Supplementary Duty.
9.17 Books of account
As per the provisions of section 31 every registered person has to maintain the
following books and records in the manner mentioned in the rules for the tax period
in order to facilitate in determination tax liability in respect of goods purchase or
supplied or service rendered:
(a) Statement of purchases together with the invoices of taxable or exempted
goods or services.
(b) Statement of taxable or exempted goods or services supplied or
statement of such goods or services exported and copies of the related
(c) Current Account,
(d) Statement of money deposited in the Treasury or in any approved bank of
the Government for this purpose in payment of any Value Added Tax
(e) Statement of stocks of inputs and produced and manufactured goods,
(ee) commercial documents of taxable and exempted goods and services:
Provided that Board through Government Gazette notification reserves the right to
determine the methods and kinds of books and records to be preserved by any
9.18 Tax invoices
Section 32 requires that every registered person shall, at the time of supply of
taxable goods or services or export of goods or services or sale of taxable
imported goods, give an renumbered invoice in the prescribed form or any other
form approved for this purpose by the Board by the notification of the official
gazette subject to the following conditions:
(a) Not more than one invoice can be issued for each transaction; and
(b) If the original invoice of a customer is lost he can issue a duplicate copy
marked as “only duplicate”.
9.19 Period of keeping records
Section 33 deals with the provisions relating to the period of record keeping. It
states that every registered person who is required to keep records under section
31 shall keep these records and commercial papers, etc. in Bangladesh for not
less than 4 years after the end of the related tax period. Where any case is pending
under this law against a registered person, then he has to keep records of related
tax period until settlement of that case.
9.20 Submission of files/records etc.
Section 34 deals with provisions relating to submission of records etc. A registered
person shall at any time on a requisition by a tax officer, submit the records,
commercial documents possessed or controlled by him.
9.21 Power of release of goods without payment of VAT and
drawback of VAT on some goods
Section 66 provides that the Board subject to imposition of suitable condition,
limitation or commandment and prohibition for general matter determined under
the provision or special matter under special order in line with the section 21 of the
Custom Act may allow release of goods without payment of VAT and drawback of
VAT on some goods.
Section 67 deals with the provisions relating to refund.
(1) The tax payer can claim a refund of excess VAT or Supplementary Duty
or Turnover Tax paid due to carelessness or wrong explanation and the
above excess tax will be refunded in line with the method as mentioned in
Provided that the claim has to be made within six months of such
payment otherwise no claim will be allowed.
(2) According to section 81 of the Customs Act the said 4 months period shall
be calculated from the date of adjustment after final assessment.
9.23 Drawback in case of exported or imported goods
Section 68 provides that subject to the provision of Chapter-VI of the Custom Act
the person shall get a drawback of VAT or supplementary Duty paid on imported
goods identifiable easily at the time of exporting the same for consumption abroad.
9.24 Drawback in case of goods used in the mean time of
import and export
As per section 69 notwithstanding anything contained under section 68, VAT or
Supplementary Duty paid on the goods during time of import and export, drawback
will be made under the drawback rule.
9.25 Drawback not allowed under certain cases
As per section 70 without prejudice the section 13 and notwithstanding anything
contained in the section 68 and 69, drawback is not allowed in the case where
section 39 of the Custom Act is applicable.
9.26 Other Provisions
The following is a brief summary of the provisions dealing with other relevant
matters relating to the imposition of VAT and the procedures for registration,
Assessment and collection:
9.27 The Value Added Tax Act, 1991
Rule-11A: Registration of Commercial Importer
Sec.-16: Exemption from Registration
Sec.-17: Self Registration
Rule-9: Procedure of Registration
Sec.-18: Change of Information Relating to Registration
Sec.-19: Cancellation of Registration
Rule 15: Cancellation of Registration
Sec.-20: Appointment of Value Added Tax Officers
Sec.-22: Assignment of Power
Sec.-23: Duties imposed on other Government Officers of VAT Officers
Sec.-24: Assistance of VAT Authority
Sec.-24A: Assistance given by VAT Officer
Powers of VAT Authorities
Sec.-25: Power to serve Summon
Sec.-26: Officers’ Power to Enter into Place of Production, Place of Providing
Services, Place of Business to Inspect Stocks, Services and Inputs and to
Examine Accounts and Files
Sec.-26A: Giving Order of Audit by Empowered Official or Appointment of Auditor
by the Board
Sec.-26B: Provision regarding Supervised Supply, Inspection and Monitoring
Sec.-27: Seizure of Forfeitable Goods
Sec.-28: Management of Seized Goods
Sec.-29: Settlement of Money of Receipt of Sale and Sale of Goods
Sec.-30: Management of Forfeited Goods
Sec.-35: Submission of Return
Rule-24: Procedure Relating to Return How to Submit
Sec.-36: Examination of Return
Sec.-37: Offences and Penalties
Sec.-39: Limitation of Forfeiture (Extent)
Sec.-40: Power of Adjudication
Sec.-41: Imposition of Penalty Instead of Forfeiture
Sec.-43: Power of the Board to Call for the Records and Initiate Proceedings
Sec.-44: Board’s Power to Rectify Mistakes, etc.
Sec.-45: Revisional Power of Government
Sec.-46: Presence by Empowered Representative and VAT Counselor etc.
Sec.-47: Power of the Government for Calling for the Records and Examination
Sec.-48: Power to Search
Sec.-48A: Delegate the Power of Magistrate VAT Officer
Sec.-49: Power of Arrest
Sec.-50: Arrest is Prohibited Without any Warrant for Certain Crimes
Sec.-51: Procedure for Search and Arrest
Sec.-52: Management for Arrested Person
Sec.-53: Method of Procedures to be Followed of Officer in Charge of a Thana
Sec.-54: Method of Investigation of the Person Sent Under Section 52 by a VAT
Sec.-55: Recovery of Other Duty-Tax Including Un-recovered and Deficit VAT
Sec.-56: Recovery of Dues by Government
Sec.-57: Circulation of Order, Decision etc.
Sec.-58: No Claim of Damage Otherwise Negligence or Whimsical
Sec.-59: Transfer of Ownership
Sec.-60: Applications of Other Laws on VAT
Sec.-61: Prohibition of Jurisdiction of the Court
Sec.-62: Protection of Activity Done Believing in Good Faith
Sec.-63: Asset of Deceased Person
Sec.-64: Liability of Insolvent Person
Sec.-65: Elimination of Problem
Sec.-71A: Power to Write off Arrear to Government
Sec.-71AA: Reward for Revelation of Tax Evasion, Violation of Law etc.
Sec.-72: Power to Make Rules
Sec.-73: Repeal and Preservation