UNIT V

Introduction to indirect taxes: Central sales tax, objects & provisions; Interstate (Basic
problems in CST); Concept of VAT, merits and demerits of VAT (Basic problems); Tax
planning & Tax management

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Introduction to indirect taxes:
Government has to perform many functions in the discharge of its duties like infrastructure
development, health, education, defence of the country, removal of poverty, maintenance of law
and order, etc. To meet these requirements huge amount of capital is required. The government
collects money from public through a wide variety of sources i.e. fees, fines, surcharges and
taxes. Indirect Tax is a tax that increases the price of a good so that consumers are actually
paying the tax by paying more for the products. The Ministry of Finance (Department of
Revenue) through the Central Board of Excise and Customs (CBEC), an apex indirect tax
authority, implements and administers excise (central excise), customs and service tax laws.
Circulars, notifications and clarifications issued by the CBEC supplement these indirect tax laws.

1 Service Tax :
Service tax is a part of Central Excise in India. It is a tax levied on services provided in India,
except the State of Jammu and Kashmir. The responsibility of collecting the tax lies with the
Central Board of Excise and Customs(CBEC). Service Tax is a form of indirect tax imposed on
specified services called "taxable services". Over the past few years, service tax been expanded
to cover new services and recently list of negative services has been introduced. The objective
behind levying service tax is to reduce the degree of intensity of taxation on manufacturing and
trade without forcing the government to compromise on the revenue needs. For the purpose of
levying service tax, the value of any taxable service should be the gross amount charged by the
service provider for the service rendered by him.

2 Excise :
Central Excise duty is an indirect tax which is levied and collected on the goods/commodities
manufactured in India. The Central Excise Act, 1944 and other connected rules- which provide
for levy, collection and connected procedures. It is mandatory to pay Central Excise duty payable
on the goods manufactured, unless exempted eg., duty is not payable on the goods exported out
of India.

3 VAT :
“Value Added Tax” (VAT) is a tax on value addition and a multi point tax, which is levied at
every stage of sale. It is collected at the stage of manufacture/resale and contemplates rebating of
tax paid on inputs and purchases.

Central sales tax, objects & provisions

Sales tax is levied on the transaction of sale of goods. A sale of goods has various elements such
as goods, agreement to sell, transfer of property, valuable consideration, seller, buyer etc. It is
possible that each such element of sale may be distributed over more than one state.

For e.g. : the seller is in one state, the buyer is in another state, transfer takes place in the third
state, consideration may pass in the fourth state etc.

• Central Sales Tax is an indirect tax which is levied by the Central Government.
• In this case, the taxable event is ‘sale of goods inter-state’.
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 • CST applies to the whole of India including the state of Jammu & Kashmir.
• CST is payable in the state in which the movement of goods commences.
• Though it is called CST, it is actually assessed, collected & administered by the local (i.e.
State) sales tax authorities only.
• Also, the tax collected under CST is actually retained by the state (in which it is
collected).

PRINCIPLES & OBJECTS OF CST ACT, 1956

(A) Principles of Central Sales Tax Act :

Entry 92 (a) of the List-I (Union List) to the Seventh Schedule of the Constitution of India
empowers the Union Government to levy tax on the sale or purchase of goods, which takes place
in the inter-state trade or commerce.
Accordingly, the Central Sales Tax Act was enacted.

(B) Objects of the CST Act:

The objects of the Central Sales Tax Act, 1956 as given in the Preamble of the Act are as
follows:

1. To formulate principles for determining when a sale or purchase of goods takes place :
(a) In the course of interstate trade or commerce (Sec 3)
(b) Outside a state (Sec 4)
(c) In the course of import into or export from India (Sec 5).

2. To provide for the levy, collection and distribution of taxes on the sale of goods in the course
of interstate trade or commerce (Sec 9).

3. To declare certain goods to be of special importance in inter-state trade or commerce (Sec 14).

4. To specify the restrictions and conditions on the State laws imposing taxes on the sale or
purchase of such goods of special importance (Sec 15).

5. To provide for collection of taxes from companies under liquidation (Sec 16 - 18).

Inclusions in Sale Price:

• Central Sales Tax-whether or not shown separately in invoice (then back calculations
are made).

• Excise Duty- the excise duty payable is includible in ‘sale price’.

• Packing material and packing charges-sales tax is leviable on packing material as well
as packing charges (i.e. labour charges for packing goods). Sales tax is leviable on
packing charges, even if shown separately.

• Bonus discount or incentive bonus- for additional sales affected by the

distributor/dealer.
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 • Insurance charges-if the goods are insured by the seller.

• Freight and delivery charges incidental to sale only are deductible- if the goods are sold
from depot, transport charges from factory to the depot cannot be allowed as deduction.

• Design charges- in case of goods includible if charged separately in respect of goods

manufactured as per design and sold to buyer,as it is a pre-sale expense and forms part of
manufacturing cost.

• Compulsory warranty charges-includible if a manufacturer sales goods with service

warranty on which customer has no option, the charges for warranty are includible as
there is no sale without it.

Exclusions from Sale Price :

The following items shall not be a part of sale price for the calculation of sales tax liability :

• Freight / transport charges for delivery of goods- CST is not payable on freight and
transport charges. However, CST is payable on freight charges if (a)Freight Charges are
not shown separately in invoice or (b) contract is for FOR destination.

• Cost of installation if charged separately- is not to be includible.

• Cash discount for making timely payments- is not includible.

• Trade discounts-is deduction from list price to wholesalers/dealers, cannot be

considered for calculation of CST.

• Insurance on transit if incurred at the request of buyer-are not chargeable to CST.

• Goods returned within 6 months of the date of sale-Sec 8A (b) provides that if goods
are returned by buyer within six months, its sale price will be deducted from ‘aggregate
sale price’, if satisfactory evidence isproduced before sales tax authority in respect of the
same.

• Goods rejected-in such case, the period of six months is not applicable, as in case of
rejected goods, there is no ‘complete sale’ at all within the meaning of CST Act or Sale
of Goods Act, as the purchasing party has not accepted the goods. Return of goods is a
bilateral transaction brought about by consent of seller and purchaser, while rejection of
goods is a unilateral transaction, open only to purchaser.

• Government subsidy & other subsidy-is excludible from the sale price for CST.

• Deposits for returnable containers-Deposits taken for returnable bottles or tin

containers are not sales.

• Customs duty paid by Buyer-when sale is by transfer of documents.

• Taxes and fees statutorily recoverable from Buyer.

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SALE OR PURCHASE IN THE COURSE OF INTERSTATE SALE (SECTION 3)

According to Section 3 of the Central Sales Tax Act, 1956, a sale or purchase of goods shall be
deemed to take place in the course of inter-state trade or commerce if the sale or purchase :
(a) Occasions the movement of goods from one state to another; or
(b) Is effected by a transfer of documents of title to goods during their movement from one state
to another.

The essential ingredients of interstate sale are as follows :

1. The transaction should be a complete sale.

2. There should be movement of goods from one state to another state by virtue of
agreement to sale.

3. The completed sale must take place in a state different from the state in which movement
of goods commences.

4. It is not necessary that completed sale precedes the movement of goods. Sale can be
either before or after the movement of goods.

5. There must be physical movement of goods from one state to another state.

6. Where the movement of goods commences and terminates in the same state, it shall not
be deemed to be a movement of goods from one state to another by reason merely of the
fact that in the course of such movement the goods pass through the territory of any other
state.

7. The movement of goods shall commence when the goods are delivered to the carrier or
other bailee for transmission and the movement of the goods shall end when the delivery
is taken from such carrier or bailee. Thus, the transfer of documents to the title of the
goods (Lorry receipt/ Railway Receipt, Bill of Lading, Airway Bill) shall be made during
the movement of the goods from one state to another.

Exceptions to Section 3 :

1. Generally, CST is leviable on interstate sale transactions which cover movement of goods
from one state to another.

2. However, all dispatches of goods from one state to another state do not ipso facto result
in interstate sale u/s. 3 of the CST Act.

3. Only when the movement is on account of a covenant or the sale effected by a transfer of
document of title to the goods during their movement from one state to another, it will be
an interstate sale U/s 3.

4. The following are the instances where goods move from one state to another but do not
amount to interstate sales :

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 a. A movement of goods from one state to another will not amount to interstate sales
unless the seller had the responsibility to deliver the goods outside that state or the
movement was as a result of a covenant or incident of contract of sale.

b. Stock transfer between head office & branch office will not amount to interstate
sales as the basic elements of sale i.e., the presence of a buyer & seller;
consideration & transfer of ownership etc. are not present.

c. Sale or purchase in the course of export/ import does not attract levy of CST since
these have been specifically covered u/s 5 of the CST Act, 1956.

d. Sale through commission agent / on account sales will not amount to interstate
sales as the agent only acts on behalf of the seller and he does not acquire any
ownership of the goods. The agent is only entitled to receive commission on the
sales effected by him and will also get reimbursement of the expenses incurred by
him.

Concept of VAT, merits and demerits of VAT (Basic problems)

Tax on sale within the State is a State subject. Over the period, many distortions had come in
taxation. Following were some of the problems –

• Unhealthy competition among States by giving sales tax incentives to new industries.
When one State gave incentives, others also had to give. This ruined State finances.
• ‘Tax rate war’ started to attract more revenue to State. Often, goods from the State were
sent to another State on stock transfer basis and brought back in the same State to show
as Inter-State Sale.
• States introduced ‘first point sale’ to avoid cascading effect of State sales tax. This made
tax evasion easy.
• Cascading effect of tax due to Central Sales Tax.

VALUE : • Value means value of the commodity. i.e. the utility relating to the user. e.g.
Material, labour, Profit etc. As the use increases, Value of the product increases.

ADDED: •Addition in the Value •i.e. Product is purchased and some work performed for
increasing it's Value.

TAX: • Taxation on such Value Addition.

=
VAT

VAT system not same in all States - The VAT system as introduced is result of deliberations of
committee of representatives from 29 States. Each State has its own views and peculiarities.
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Hence, having uniform nationwide VAT is very difficult and some compromises/adjustments are
inevitable.

VAT law not uniform in all States - Each State has made changes as per their needs. Though
basic concepts are same in VAT Acts of all States, provisions in respect of credit allowable,
credit of tax on capital goods, credit when goods are sold interstate are not uniform. Even
definitions of terms like ‘business’, ‘sale’, ‘sale price’, ‘goods’, ‘dealer’, ‘turnover’, ‘input tax’
etc. are not uniform. Schedules indicating tax rates on various articles are also not uniform,
though broadly, the schedules are expected to be same.

HISTORY OF VAT
• VAT is a broad based tax levied at multiple stages with tax on input credit against taxes
on output.
• VAT was first introduced in France in 1954.
• Later was introduced in Brazil in Mid 1960 then it was slowly spread in European
Countries by the end of 1970s and now almost more than 130 nations are under it’s
coverage.
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HISTORY OF VAT in INDIA

• In India most of the State including Union Territories implemented VAT w.e.f. 1st April
2005 which substituted local sales tax laws.

• But VAT had already laid its stone way back in 1986 as it had been introduced under
Central Excise Law & in 2002 in Service Tax Law.

• VAT in India is not comparable to that of other countries because it is replacement of

State level sale tax and not entire indirect tax structure.

• VAT in India is a State subject.

• The States of Madhya Pradesh & Maharashtra introduced the concept of tax on Value
Addition way back in 90’s but could not succeed in implementing the same in the desired
manner.

• With the joint effort of Central & State government, VAT was implemented by a
majority of States with effect from 1st April 2005.

• The power to levy tax on sale transactions in the form of VAT is drawn from entry
number 54 in List II of Seventh Schedule of Constitution of India by the S.G.

• Under the VAT every transaction taking place in the course of business is taxed enabling
the S.G. to collect revenue on the Value Addition on every stage.

Earlier Sales Tax System VAT System

1. Tax was levied at the stages of first sales or at the Tax is levied and collected at every point of sale.
final stage. Thus it was levied at single stage. Thus, it is a multi – stage tax.

2. Successive sales (resale) of goods on which tax is Tax is collected at every point of sale and the tax
already paid did not attract tax. already paid by dealer at time of purchases of
goods will be deducted from the amount of tax paid
at the next sale.

3. Dealers reselling tax paid goods did not collect Dealer reselling tax-paid goods will have to collect
any tax on resale and file NIL return VAT and file return and pay VAT at every stage of
sale (Value Addition).

4. Computation of tax liability was complex It is transparent and easier.

5. Sale Tax was not levied at the time of purchases VAT dispenses with such forms and sets off all tax
against statutory forms but there was misuse of paid at the time of purchase from the amount of
such forms resulting in tax evasion. tax payable on sale.

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6. Return and Challans were filed separately and the The return and the challans are filed together in a
dealers had to give numerous details. simple format after self-assessment.

7. A large number of form were required At the most a few forms are required.

EXEMPTED GOODS

Under exempted goods category, the empowered committee has listed about 50 commodities
comprising of:

• Natural products
• Unprocessed products
• Items which are legally barred from taxation and
• Items which have social implication

Further 10 commodities out of commodities listed in the exempted category will be flexibly
chosen by individual State which are of local importance for the individual
State example:

• Books, periodicals and journals including maps, charts and globes

• Blood including blood components
• Fresh vegitable and fruits
• Earthern Pot
• Electricity energy
• Course grains other than paddy, rice and wheat
• Fresh plants, saplings and fresh flowers
• Kum Kum, Bindi, Sindur etc.
• All bangles except those made of previous metels
• Curd, Lassi, Butter milk and separated milk
• Betel leaves
• Animal driven or manually operated agricultural implements their spare parts, components and
accessories.

BASIC PRINCIPLE OF VAT

VAT (Value Added Tax) is a tax on final consumption of goods and services.

VAT works on the principle that when raw material passes through various manufacturing stages
and manufactured product passes through various distribution stages, tax should be levied on the
‘Value Added’ at each stage and not on the gross sales price. This ensures that same commodity
does not get taxed again and again and there is no cascading effect. In simple terms, ‘value
added’ means difference between selling price and purchase price. VAT avoids cascading effect
of a tax.

Basically, VAT is multi-point tax, with provision for granting set off (credit) of the tax paid at
the earlier stage. Thus, tax burden is passed on when goods are sold. This process continues till
goods are finally consumed. Hence, VAT is termed as ‘consumption based’ tax. It is tax on
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consumption of goods and services. VAT works on the principle of ‘tax credit system’.
Distinction between sales tax and VAT - Basic distinction between VAT and sales tax is that
sales tax is payable on total value of goods while VAT is payable only on ‘value addition’ at
each stage.

Advantages of VAT are as follows :

• Tax burden is only at the last i.e. consumption stage. This is useful for taxation structure based
on ‘destination principle’.

• It becomes easier to give tax concessions to goods used by common man or goods used for
manufacture of capital goods or exported goods.

• Exports can be freed from domestic trade taxes.

• It provides an instrument of taxing consumption of goods and services.

• Interference in market forces is minimum.

• Simplicity and transparency.

• Aids tax enforcement by providing audit trail through different stages of production and trade.

• Thus, it acts as a self-policing mechanism resulting in lower tax evasion.

• Tax rates can be lower as tax is levied on retail price and not on wholesale price.

DISADVANTAGES AND PITFALLS IN VAT:

One major disadvantage of VAT is tremendous paper work and record keeping. VAT system can
work only if record keeping is proper and reliable. The elaborate record keeping is not possible
to small businesses. Hence, exemption is granted to tiny businesses whose turnover is below
prescribed limits. In case of small businesses, a composition scheme is provided where tax is
paid on gross value of sales at a fixed rate.

Some major problems in VAT are –

• Bogus Invoices on which tax credit is availed, i.e. invoice without actual purchase of goods.
• Acquisition fraud (missing trader fraud).
• Carousel Fraud (missing trader fraud).

Acquisition fraud - The acquisition fraud is based on the fact that goods imported are tax free. A
dealer imports goods and makes sale within the country. The dealer either has his own VAT
registration number or he hijacks other’s VAT number. He collects the tax from buyer and then
disappears without paying the collected tax to Government. The buyer is usually innocent and is
not aware that the seller is not going to pay tax to Government. This is ‘missing trader fraud’ of
one type.

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In Indian context, this fraud is possible when CST rate is Nil or is reduced to 1%. A dealer can
purchase goods inter-state and make sale within the State. He will collect tax and then disappear.
He may use someone else’s vat number in his invoices or may himself get registered with
address of some temporary rented premises.

Tax planning & Tax management

While tax planning and tax management correlate with each other, the two aspects of taxes have
several differences. The primary difference between tax planning and tax management is the
time frame in which each part is conducted. The tax planning takes place ahead of time, while
the tax management is the implementation of the plan.

The first primary difference between tax planning and tax management is the requirements.
While tax planning is not a requirement for either a business or individual, tax management is a
requirement.

The second primary difference between tax planning and tax management is about tax liability.
When a business or individual goes through the tax planning process, they are trying to minimize
the tax liability of the entity by planning deductions, purchases and expenses ahead of time. Tax
management, however, involves making sure that when the tax plan is implemented, that it is
according to the tax laws and regulations.

The third difference between tax planning and tax management pertains to liabilities. Tax
planning involves taking the actions necessary to minimize the tax liabilities of the business or
the individuals. Tax management on the other hand is about avoiding the payment of interest or
fees for not abiding by the tax laws and regulations.

The fourth difference between tax planning and tax management is the time frame. Tax planning
is an action that is taken in the present but relates to the future. Tax management, on the other
hand, encompasses the past, present and future. this includes tracking past sales, deductions,
assets and more, making current tax payments and preparing tax documents for any future
payments that must be made.

While there are plenty of differences between tax planning and tax management, there is also one
primary similarity. The primary similarity between tax planning and tax management is that tax
planning is a subset, or a part, of tax management. When an individual or business is in the
process of tax planning, they are also taking into account all of the aspects of tax management,
including tax deductions, proper auditing of the accounting files and records, putting together
and filing the tax return documents on time and planning for tax scenarios that may come up
during that particular tax year.

Tax Planning

The word ‘tax planning’ connotes the exercise carried out by the taxpayer to meet his tax
obligations in proper, systematic and orderly manner availing all permissible exemptions,
deductions and reliefs available under the statute as may be applicable to his case. To illustrate,
assessee software company setting up assessee software technology park in assessee notified area
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to avail benefits of section 10A of the Act is assessee legally allowable course. Planning does not
necessarily mean reduction in tax liability but is also aimed at avoiding controversies and
consequential litigations.

Tax Planning involves planning in order to avail all exemptions, deductions and rebates provided
in Act. The Income Tax law itself provides for various methods for Tax Planning, Generally it is
provided under exemptions u/s 10, deductions u/s 80C to 80U and rebates and relief’s. Some of
the provisions are enumerated below :

• Investment in securities provided u/s 10(15) . Interest on such securities is fully exempt
from tax.
• Exemptions u/s 10A, 10B, and 10BA
• Residential Status of the person
• Choice of accounting system
• Choice of organization.

For availing benefits, one should resort to bonafide means by complying with the provisions of
law in letter and in spirit.

Where a person buys a machinery instead of hiring it, he is availing the benefit of depreciation. If
is his exclusive right either to buy or lease it . In the same manner to choice the form of
organization, capital structure, buy or make products are the assesse’s exclusive right. One may
look for various tax incentives in the above said transactions provided in this Act, for reduction
of tax liability. All this transaction involves tax planning.

Every taxpayer is expected to voluntarily make disclosures of his incomes and tax liabilities
through legal compliance. When a tax payer deliberately or consciously do not furnish material
particulars or furnishes inaccurate or false particulars or defrauds the State by violating any of
the legal provisions, it shall be termed as ‘tax evasion’. It is also illegal, but also unethical and
immoral.

Tax Planning should be done by keeping in mine following factors :

• The Planning should be done before the accrual of income. Any planning done after the
accrual income is known as Application of Income an it may lead to a conclusion of that
there is a fraud.
• Tax Planning should be resorted at the source of income.
• The Choice of an organization, i.e. Taxable Entity. Business may be done through a
Proprietorship concern or Firm or through a Company.
• The choice of location of business , undertaking, or division also play a very important
role.
• Residential Status of a person. Therefore, a person should arranged his stay in India such
a way that he is treated as NR in India.
• Choice to Buy or Lease the Assets. Where the assets are bought, depreciation is allowed
and when asset is leased, lease rental is allowed as deduction.
• Capital Structure decision also plays a major role. Mixture of debt and equity fund should
be balanced, to maximize the return on capital and minimize the tax liability. Interest on
debt is allowed as deduction whereas dividend on equity fund is not allowed as deduction

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Methods of Tax Planning

Various methods of Tax Planning may be classified as follows :

1. Short Term Tax Planning : Short range Tax Planning means the planning thought of
and executed at the end of the income year to reduce taxable income in a legal way.
Example : Suppose , at the end of the income year, an assessee finds his taxes have been too high
in comparison with last year and he intends to reduce it. Now, he may do that, to a great extent
by making proper arrangements to get the maximum tax rebate u/s 88. Such plan does not
involve any long term commitment, yet it results in substantial savings in tax.

2. Long Term Tax Planning : Long range tax planning means a plan chaled out at the
beginning or the income year to be followed around the year. This type of planning does not help
immediately as in the case of short range planning but is likely to help in the long run ;
e.g. If an assessee transferred shares held by him to his minor son or spouse, though the
income from such transferred shares will be clubbed with his income u/s 64, yet is the income is
invested by the son or spouse, then the income from such investment will be treaded as income of
the son or spouse. Moreover, if the company issue any bonus shards for the shares transferred ,
that will also be treated as income in the hands of the son or spouse.

3. Permissive Tax Planning : Permissive Tax Planning means making plans which are
permissible under different provisions of the law, such as planning of earning income covered
by Sec.10, specially by Sec. 10(1) , Planning of taking advantage of different incentives and
deductions, planning for availing different tax concessions etc.

4. Purposive Tax Planning : It means making plans with specific purpose to ensure the
availability of maximum benefits to the assessee through correct selection of investment, making
suitable programme for replacement of assets, varying the residential status and diversifying
business activities and income etc.

Tax Management

Planning which leads to filing of various returns on time, compliance of the applicable
provisions of law and avoiding of levy of interest and penalties can be termed as efficient tax
management. In short, it is an exercise by which defaults are avoided and legal compliance is
secured. Through proper tax planning and management, the penalty of upto Rs.100000 for delay
in furnishing of tax audit reports u/s 44AB can be avoided. Similarly by applying for Permanent
Account Number (PAN), the penalty under the Act can be avoided. The borrowal of loan
otherwise than by way of an account payee cheque or bank draft attracts 100% penalty and this
can be avoided by conscious planning of the execution of loan transactions.

Planning is a perception conceived on legitimate grounds and achieved through genuine

transactions within the framework of law e.g. contribution to Public Provident Fund and
claiming rebate u/s 88 of the Act. The filing of the returns with all proper documentary evidence
for the various claims, rebates, reliefs, deductions, income computations and tax liability
calculations would also be termed as tax management.

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Tax management is also an important aspect of tax planning. Assessee is exposed to certain
unpleasant consequences if obligations cast under the tax laws are not duly discharged. Such
consequences take shape of levy of interest, penalty, prosecution, forfeiture of certain rights, etc.
Therefore, any effort in tax planning is incomplete unless proper discharge of responsibilities is
not made.

The objective of Tax Management is to comply with the provisions of Income Tax Law and its
allied rules. Tax Management deals with filing of Return in time, getting the accounts audited,
deducting tax at source etc. Tax Management helps in avoiding payment of interest, penalty,
prosecution etc.

Tax Management relates to Past Present, Future.

Past – Assessment Proceedings, Appeals, Revisions etc.
Present – Filing of Return, payment of advance tax etc.
Future – To take corrective action

Tax management includes:

1. Compiling and preserving data and supporting documents evidencing transactions,

claims, etc.
2. Making timely payment of taxes e.g. advance tax, self assessment tax, etc.
3. TDS and TCS compliance
4. Following procedural requirements e.g. payment of expenses or acceptance of loans or
repayment thereof, over Rs.20,000 by account payee bank cheque or bank draft, etc.
5. Compliance with the prescribed requirements like tax audit, certification of international
transactions, etc.
6. Timely filing of returns, statements, etc.
7. Responding to notices received from the authorities.
8. Preserving record for the prescribed number of years.
9. Mentioning PAN, TAN, etc. at appropriate places.
10. Responding to requests for balance confirmation from the other assessees.

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