Hear the cries from Dalal Street


A VAT on financial services would significantly streamline and organise the activities of brokers

Following the recommendations made by the FRBM Task Force towards implementing a nationwide GST, several efforts have been made in the last few months by the States and the Centre to come to an agreement to implement Value Added Tax (VAT) across India. The premise of the FRBM is the proposed implementation of the VAT principle to tax the consumption of `all goods and services' in the economy. One of the sectors which the FRBM mentioned, but has been left out so far in the debate on taxes, has been the financial services sector.

The Task Force has recommended the 'subtraction method' for determining the tax base for levy of the GST. This means that every entity in the financial services sector will subtract purchases on which VAT has already been paid from the net revenues and pay the VAT on the remaining, that is, the value added by that entity. The Task Force very correctly points out the difficulties in applying a VAT to financial services- especially in the case of insurance and banking it becomes difficult to measure the exact value added.

However, one financial services entity to which the VAT can be extended without any measurement difficulties is the brokerage industry. Several EU countries have moved towards a VAT for fee-based financial services, brokerage being one of them.

How would this work? Suppose you bought 100 shares of Reliance from Broker X at Rs 100 each. Suppose the broker charges you a 0.5% brokerage fee for her services. The contract note would then have the following three values: the total value of the transaction of Rs 10,000, the brokerage fee of Rs 50 and the GST of Rs 10 (owing to a 20% VAT on the value added, here the brokerage fee). As a customer, you would sign a cheque of Rs 10,060 to your broker. The Rs 10 is the GST that the government has collected from you. The broker would then subtract those goods and services that she has purchased on which VAT has been already paid and pay the remaining as the tax she owes to the Central Government.

Why is this better than what you pay as taxes today? If you were to go through the same transaction, you would pay the Rs 50 as brokerage fee. You would pay 10.2% of the brokerage fee (Rs 5.10) as service tax and the education cess plus stamp charges of 0.01% of the total value of the transaction i.e. Rs 10,000 (Rs 1) and another 0.075% of the total value of the transaction as the securities transaction tax (Rs 7.5). Thus a total of Rs 13.6 instead of the Rs 10 you would pay in case of a VAT.

For the brokers' community as well, a single rate VAT will replace other indirect taxes, making the process of computation and filing of taxes efficient. Recently the government has been thinking about increasing the securities transaction tax (STT). This has adverse effects on the liquidity of the market. Instead, the government should look at a flat-rate uniform VAT which will not bring in additional distortions unlike other taxes.

Over the past few years, the brokers' community has been subject to myriad tax changes and a single-rate VAT which stays for ten years will bring consistency into their operations as well as the overall tax framework. Implementation of VAT also brings in greater revenue potential for the government as there is less likelihood of leakages with this system: even if there are leakages at one stage, they are that much more likely to be collected at others.

A single-rate VAT also has the potential to drive up volumes, another factor for boosting government's tax collections.

The success of a VAT is contingent on a good IT network and given that Budget 2005 is around the corner, it will do well for the government to further lend support to strengthening and building good tax IT systems and set about implementing VAT to 'all goods and services' in the economy.

The writer is an economist.


Back up to Renuka Sane's media page.