Value Added Tax Scams and Introduction of the GST
Which is a challenging factor in the Indirect Taxation system?
1. Horizontal equity in the distribution of tax burden and broadening of the tax base form the two main purposes of indirect taxation.
2. But in administering indirect taxes, determine the “point of levy” has been challenging.
3. The commonly observed practice is to levy and collect the tax at a single point in the commodity value chain. Ad Valorem Sales tax in India is an example.
4. But the concept of single point levy has its weakness.
a) Due to cascading effect of tax, the burden of taxation could be shifted disproportionately on the final consumers.
b) In Developing and Transitional economies, a high concentration of informal economic activities at the consumption point leaves a little scope for recovery fo tax.
c) It has been a major reason for tax evasion.
d) Indirectly it also leads to creation of a parallel economy.
What role did Value Added Tax (VAT) system play?
1. VAT helped in overcoming the problems of single point levy system by shifting to the multipoint tax regime.
2. VAT is levied on each transaction node and also neutralizes the cascading effect of tax by giving input tax credit.
3. It also ensures compliance through market-driven checks and balances. In a B2B transaction, purchaser and the seller will have opposite approach towards their respective tax liabilities. This ensures the incidence of taxation at every stage of the transaction.
4. As it covers all nodes/entities in the chain, it gives rise to the formal economy.
Why VAT system failed?
1. Carousel Fraud:
a) Also referred to as “missing trader fraud”, it is a very significant part of the value-added tax fraud. Organized groups usually exploit VAT exemption on the intracommunity supply of goods.
b) Absence of a single integrated chain from production to consumption and functioning of multiple authorities in their respective section makes the system vulnerable to this fraud.
2. Split up in the value chain:
a) The entire process of tax on commodity value chain in India is broadly split up into the “production” and the “distribution” parts. While the production part is monitored by Centre, the latter is monitored by States.
b) this disconnect between two operating VAT systems leads to manipulation of the system itself.
c) Large number of bogus firms are created to manipulate the tile of goods and to make fake transactions to evade VAT.
3. Identity Fraud:
a) This term was coined by the International Monetary Fund (IMF) in relation to VAT.
b) Organization for Economic Co-operation and Development (OECD) points out that VAT-related fraud not only leads to evasion but also large-scale money laundering.
c) The manipulators operate through fake firms opened in the name of pseudo-entities, by theft of identity.
4. Shopkeepers also delink their actual trading activity from accounting procedures by not issuing bills/invoice per transaction.
5. There is also little scope for detection fo VAT frauds related to false declarations.
Where the impact of VAT evasion is felt?
1. It results in uneven business competition and informalizaiton.
2. It also leads to an influx of “dirty money” through pseudo operators.
3. By changing or hiding the title of goods, the sellers of items of mass consumption also escape the need for maintenance of quality index.
How the Goods & Service Tax (GST) system provides a solution?
1. To cover the existing lacunae, hosts of small and ad hoc taxes had to be introduced, which will lead to a multiplicity of taxes and higher consumer price.
2. GST integrated operational VAT at both production and distribution part.
3. The destination-based GST and input tax credit set up helps in cutting through multiple tax authorities.
4. It also helps in locating the transaction entity and that of the item, whereby the process of racketeering can be reined-in to an extent.
5. It also helps in the formalization by increased use of information technology tools.