Fine Print Wrecked Modvat

Too much left to interpretation, says 

Excise is a tax on production. If it is collected at each stage of production, the cumulative effect of the tax on the ultimate price is much more than the total tax. The world over, therefore, tax systems intend to mitigate the effect of cascading, that is tax on tax. Which is why more than 100 countries have adopted the value-added tax. Simply put, it means collecting tax on value added at each stage. A comprehensive kind of VAT permeates each stage of production and distribution. Services are also brought into its net.

It is the Indirect Taxation Enquiry Committee (Jha Committee, 1976) that seems to have recorded the adverse effect of the cascading of excise for the first time. The committee also recommended the adoption of the manufactured value-added tax (Manvat) in lieu of excise. The Tax Reforms Committee (Chelliah Committee, 1991) also discussed it at considerable length. VAT is the buzzword now. Some feel that it is the panacea for all the ills of excise and sales tax.

In recent times never has a taxation topic received so much attention as VAT Industry associations vie with each other to organise seminars and workshops as to how to prepare for the switch over. The oft-given advice is like this: replace Modvat with VAT. After all Modvat has been there for long. But has Modvat any lessons to offer?

At the time of its inception in 1986, Modvat was extended only to a few chapters of the Excise Schedule and a comprehensive coverage was left to the future. It is, however, important to examine as to how the Modvat scheme worked in its actual implementation.

It is said that what matters for practical purposes is the legal text and not the legislative policy intention. Many feel that the Modvat scheme is one perfect example of a huge gap between intention and application. The Modvat scheme, as a legal text, shrouded itself with a vast number of rules, conditions and procedural obligations. Nothing wrong in it, per se.

However, the operation of the Modvat scheme became a victim of interpretation of rules and procedures. The truth is that it engulfed the entire gamut of assessees, small and big, and the departmental officials at all levels. The industry claims that many on the official side suffered from the phobia of "revenue loss". On the other hand, quite a few officials complain that several of the unscrupulous would take credit when not due and reverse it only after the stage of legal wrangles was over, thus delaying it as far as possible. Evidence lies on the side of both.

Part of the problem was with regard to the implementation of the Modvat procedures. The battle lines were clearly drawn. While the officials followed the Modvat rules and procedures in letter, the assessees rushed to the tribunal and the courts to demand benefits of the Modvat scheme even if procedures were flouted. The former asserted its authority to deny credit on procedural infringement, the latter claimed it almost as a matter of right. As a result, disputes and litigation filled the entire environment.

Not surprisingly, the number of disputes on the Modvat scheme alone surpassed the total number of disputes on all other counts in the administration of excise duties. Legal journals cited at great length case laws on each rule and proviso of the Modvat scheme. Naturally, Modvat became much maligned.

In several cases the disputes did not get settled below the Supreme Court. With each side taking fastidious positions, such an outcome was inevitable. Raise a doubt and a dispute ensued.

Here are some examples: Does the Modvat credit become ineligible if taken on the original copy of the invoice and not on the duplicate copy as prescribed in the rules? Does a manufacturer lose the benefit of credit if the goods are not returned by the job worker within a period prescribed? If the Modvat rules allowed credit up to two endorsements, does it override the substantive provision?

The Modvat scheme continued its uneven journey. Changes in the Modvat scheme were made from time to time. But they were more to find quick remedies for immediate problems rather than looking for symptoms of the disease. The battle for sticking to a strict interpretation of rules and procedures by officials continued unabated. At the same time the tribunal allowed relief liberally on the theory of "substantive compliance with law". According to some officials, the tribunal made a mockery of Modvat procedures.

What did this situation lead to? The officials are bound to follow the decisions of the tribunal in compliance with judicial decisions. In fact, the industry claims that even this dictum had to be enforced through a Supreme Court judgement. Consequently, the Assistant Commissioners and Commissioners (Appeals) allowed the credit in several situations, may be much against their own view and perception.

However, all these cases landed up in the tribunal in the form of second appeals and their fate is not difficult to guess. The tribunal disposed of them to the benefit of the assessees, simply relying upon its earlier decisions in similar cases. The department did not succeed in quite a many cases. Who gained? Only the advocates and consultants.

The Modvat scheme was hospitalised more than once. The last operation carried out on it was to transform it into the Cenvat scheme. And to be sure, Cenvat is not a mirror reflection of the Modvat scheme. There are certain significant departures. See the important ones. First, declaration of inputs or capital goods has been done away with. Second, reinstallation of capital goods for taking credit abolished. Third, job work obligations simplified. And fourth, the number of rules and sub-rules reduced drastically.

The different nature of excise duties, albeit levied for different purposes, also makes the scheme operationally complex. But this cannot be avoided for different duties are meant for disbursement for different purposes. All these and other similar constraints have taken it further from the ideal. And the ideal should comprise only one basic rule: Tax paid on any input can be utilised towards payment of tax on output. No ifs and buts.

Many of these irritants will be wiped out if VAT replaces excise. Much of the problem will be resolved if exemptions are pruned and replaced by "zero-rating" of few essential commodities.

The Modvat scheme has suffered torture by design. It was also afflicted with complexity on the ground that excise applies only when "manufacture" takes place. At each stage the test of "manufacture" is to be satisfied.

The Modvat scheme has, however, left several lessons for introduction of a value-added tax, whenever it comes. First, the coverage should be comprehensive right from the beginning. Second, it must be remembered that VAT and exemptions are virtually incompatible. Third, the procedure should not become a victim of interpretation and should be viewed as a tool of operational monitoring.

Training and mindset should also be given significant importance in designing a value-added tax system. The assessees also ought to be apprised of their obligation and responsibilities for a successful implementation of VAT. Much of the impact is lost by perceptions and rigidities. Spending money and time on training would prove a useful investment. Leaving from experience over time may prove more costly.

(T R Rustogi is joint secretary in the ministry of finance. The views expressed are his own)