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S. Muralidhar

ONE of the prickly issues staring the auto industry in the face is the proposed implementation of the value-added tax (VAT) system by the Government. With the uncertainty associated with the new tax structure, automobile companies are worried about the possible fallout in terms of an increase in tax incidence.

The industry's view is that while VAT would be beneficial in the long run, in the short term the system could be potentially disastrous. The reason for such pessimism is that the new VAT system will not come with a foolproof, effective system of relieving the embedded taxes that such a complex manufacturing process as automobile production entails.

The Society of Indian Automobile Manufacturers (SIAM) says that unless VAT is implemented simultaneously throughout the country, it would lead to serious market distortions. On studying the VAT Bills announced by the States, the automobile industry has identified a few areas of concern, such as transitional provisions, definition and rate of tax on inputs, refund mechanism and treatment of existing incentives, which need to be addressed before VAT is made operational.

Of course, some of these issues will be ironed out, assuming that State finances will gain strength in the long run, instead of the reverse, which seems more likely. Short-term glitches in VAT implementation also include setting off of taxes already paid.

States have agreed to allow set-off of the local sales tax paid on opening stocks held as on the date of implementation of VAT. However, States such as Tamil Nadu have restricted the set-off on opening stock only to the stocks purchased in the three months preceding the date of VAT implementation.

As a result the OEMs operating in Tamil Nadu would be at a disadvantageous position vis-à-vis other States, many of which may allow set-off up to six months old stocks. The other important issue linked to this is the absence of a set-off mechanism for inputs contained in work-in-progress, finished goods and goods in transit.

The definition of industrial inputs has not been clearly given in various VAT Bills announced so far. The auto industry is suggesting that the input definition under the VAT be similar to what it is under Excise Law. This would ensure uniformity and clarity across all States. Currently, industrial inputs for automobiles attract a tax rate of four per cent. Since the inputs for automobiles have not been defined as industrial inputs in many States, they would attract the revenue-neutral rate (RNR) of 12.5 per cent. Central sales tax (CST) being four per cent, which is less than the RNR of 12.5 per cent, this would lead to a situation where sourcing within the State would be costlier than inter-State sourcing.

This would be further aggravated with the progressive reduction of CST to zero within two years from the implementation of VAT.

Automobile manufacturers are predominantly engaged in inter-State trade and will have problems of excess credit of input taxes as there is no parity in input and output tax rates. The SIAM feels that all the State Governments could follow the VAT model of the Government of Haryana — that is, with the progressive reduction of CST, industrial inputs within the State would also attract the same CST rate.

There appears to be no consensus on uniform methodology regarding the refund mechanism proposed by different States. In order to have uniformity, all States should develop a mechanism that allows automatic refund on a monthly basis.

Most of the States have announced that all exemptions be converted to deferral. Inputs, which were earlier exempt from payment of tax, would now suffer a levy of tax. Set off of this would be allowed against output tax, which can be deferred. This would lead to negative impact on most of the manufacturers as almost 90 per cent of their production is sold outside the State where production occurs.

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