What are CENVAT and VAT?
Under CENVAT (the Central Value Added Tax), the Centre levies a tax on the value added at each stage of
manufacture. In a VAT system, the tax paid on all inputs can be deducted from the excise paid on the output;
in effect, therefore, tax is paid only on the value addition that takes place at each stage.

Pioneered in France to eliminate the cascading effect of several levies from the stage of raw material to final
product, it is now levied in more than 40 countries. The advantage of VAT over any other indirect tax is that it
shifts the tax base towards the point of final consumption rather than first point sale thereby ensuring `tax
neutrality' of production decisions. Since each producer up the value chain would like to claim the benefit of
set-off, there is automatic pressure on the producers down the value chain to pay their tax. Moreover, since
tax collection takes place in stages, evasion at any one stage is automatically compensated at a later stage.

What was wrong with the existing system of excise tax?
Under the existing law, the central government is empowered to levy excise duty on goods manufactured in
the country. Over time, the excise system has become very complex. Rate differentiation was taken to absurd
lengths as it became very difficult to establish which item fell into which tax slab and disputes often lingered in
courts for years. Multiple rates and complicated tax regime increase the cost of compliance. Excise tax,
moreover, suffered from the problem of cascading, with tax levied on both inputs and output. MODVAT or
modified VAT scheme was devised as an alternative to do away with the cascading by introducing VAT
provisions like set-off and deduction. Under MODVAT, central excise on most manufactured goods was modified
to incorporate credit for the tax paid on various inputs. But with multiplicity of rates, problems of classification
and of disputes continued. Thereafter, the Tax Reforms Committee recommended a comprehensive VAT to
replace the existing system of Central excise, states sales tax and other indirect taxes. Unfortunately, we have
not been able to go this far.


How is CENVAT better?
CENVAT is a single rate of excise to eliminate complexity by having a single basic rate, i.e. the 16 % CENVAT
and making all inputs (with single basic rate) eligible for a set-off/deduction. Except HSD and petrol, tax paid
on all inputs can be set off. Therefore, CENVAT is a VAT up to the manufacturing stage. Tax paid on capital
goods is also eligible for set off with it being spread over a two-year period. Besides there are three special
excise rates — of 8, 16 and 24 % — which cannot be set-off. While the basic CENVAT rate of 16 % is applicable
to almost all goods subject to excise, special excise is levied only on certain finished goods. As most finished
goods are sold to consumers, the question of a set-off does not arise — here the special excise is akin to a
sales tax.