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Rajendra S. Pai's SBI News Blog

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Sunday, March 13, 2005

Tax on cash from bank

Tax on cash from bank
T. Banusekar

CHAPTER VII of the Finance Bill, 2005 contains provisions relating to banking cash transaction
tax. This proposed new chapter will be applicable to whole of the country barring Jammu and
Kashmir. This chapter shall come into force with effect from June 1, 2005.

The Bill proposes to levy a banking cash transaction tax on taxable banking transactions at 0.1
per cent of the value of each such taxable banking transaction. The tax shall be payable by:

a person who withdraws cash in excess of Rs 10,000;

a person who buys a demand draft or banker's cheque or any other financial instrument for
payment in excess of Rs 10,000;

a depositor who receives more than Rs 10,000 on encashment of term deposit;

a person who withdraws sums in excess of Rs 10,000 by way of banker's cheques or a similar
exercise by the bearer of such cheques or other financial instrument.

It is also proposed to provide that no banking cash transaction tax shall be payable if the
amount of term deposit is credited to any account with the bank

The value of taxable banking transactions is as follows:

in case of cash withdrawals exceeding Rs 10,000, the amount of cash withdrawn;

in respect of purchase of a bank draft or a banker's cheques or any other financial instrument on
payment of cash exceeding Rs 10,000, the amount of cash deposited;

in respect of receipt of cash on encashment of term deposit, the amount of cash received on
encashment of term deposit.
It is proposed to provide that every scheduled bank shall collect the banking transaction tax at
the specified rate, from every person entering into a taxable banking transaction with the bank.
The bank shall pay to the credit of the Central Government the tax collected during a calendar
month by the fifteenth day of the next month.

Value Added Taxation

Value Added Taxation
(From India Infoline Website)

Value Added Taxation (VAT) has been in the news very much lately. It has been the stated
objective of several finance ministers in the last 6 to 7 years to move India from its existing
system of taxation to a VAT based system. There are several questions which arise regarding
VAT. Some of the most common ones are :-

1. What is VAT ?
2. Why is the world moving towards a VAT based system of taxation ?
3 .How will VAT help India ?
4. What steps has India taken to move towards a VAT based system ?

What is VAT ? VAT is a system of indirect taxation and is meant to be in lieu of other indirect
taxes such as excise duty, customs duty, sales tax, service tax,etc. Let us first understand how
the conventional system of indirect taxation works. Say A manufactures certain items which form
the raw material for the maufacture of another item manufactured by B who in turn sells his
production to C who will use the item as raw material. Let us assume that A's cost of production is
Rs. 90, excise duty @ 10 % is Rs. 9 and the sale price is Rs. 110 (i.e. a profit of Rs.11).

B will purchase the item for Rs. 110 from A and use it in the manufacturing process. B incurs
expenditure of Rs. 50 in the manufacturing process. Say Excise duty payable by B @ 10 % is Rs.
16 and the selling price is Rs. 200/- (i.e. a profit of Rs. 24).

C will purchase purchase the item for Rs. 200 from B and use it in the manufacturing process. C
incurs expenditure of Rs. 40 in the manufacturing process. Say Excise duty payable by C @ 10
% is Rs. 24 and sells the final product to the consumer for Rs. 300/- (i.e. a profit of Rs. 36).

What has happened in the above system is that at each of the manufacturing stages, excise duty
forms part of the cost and has inflated the cost to the final consumer. Out of the final price paid by
the consumer, Rs. 49 (i.e. 16.33 % of price) is on account of excise duty alone even when the rate
of excise duty is just 10 %. In other words, due to excise duty, there has been a cascading effect
on the price of the final product.

In order to avoid such a cascading effect of taxation, the concept of VAT was created. Under
VAT, the tax is not levied on the entire selling price of the product but only on the value addition
made at each stage of manufacturing. If VAT was followed our example, the situation would be
as follows :-

There will not be much change at the first stage of manufacture. A will pay VAT on the value
added by him i.e. cost of production plus profit ( Rs. 90 + Rs.11). VAT is Rs. 9. Selling price is Rs.
110. B purchases the item from A at Rs. 110. However, B will not pay tax on his entire cost of
production but only on his value addition, which is Rs.74 (Conversion cost of Rs. 50 plus profit of
Rs.24).VAT @ 10 % is Rs. 7.40 (Say Rs. 8). Selling price will be Rs. 192 (Rs. 110+Rs. 74+Rs. 8).
C will purchase the item for Rs. 192 and will pay VAT on his value addition of Rs. 76. VAT will be
Rs. 7.60 (say Rs. 8) and the product will be sold to the final consumer at Rs. 276.

You will notice that the price at which the final consumer can buy the product reduces from Rs.
300 to Rs. 276 without the absolute profit of the manufacturer being affected. The total excise
component in the final price is only 9 % of the final price. The rate of taxation has also been kept
constant at 10 %.

It is obvious that industry would prefer to go towards VAT system of taxation which the product
can be sold at a lower price without adversely affecting profits. Most of Western Europe and
USA have already shifted to a system of Vat. Some of the most obvious advantages of VAT are

1. VAT prevents the cascading effect of taxation on price.
2. VAT can be a substitute for a number of indirect taxes such as excise duty, sales tax, customs
duty, etc. i.e. instead of having separate levies for sales tax, excise duty, etc, one consolidated
VAT may be levied.
3. Since there will be only one administering authority for taxation, maintaining separate sets of
records will not be required. This will substantially reduce paperwork and record-keeping.

With so many benefits attached to VAT, one would wonder why is VAT not being implemented
immediately in India ? The reason for this is that there are several issues to be sorted out. One
cannot have part of the taxation system based on VAT and part on conventional taxation. The
entire tax system for all products must be made VAT compatible. Another important issue is that
currently excise and customs fall under the Central Government whereas Sales Tax falls under
the State Government. Each State Government has its own laws for sales tax. Implementing VAT
would mean that either State Governments forego their rights to collect Sales Tax or to make the
rates of Sales Tax in all States for all products uniform. Due to several such reasons, it may not
be possible to immediately shift to a VAT based system of taxation.

However, this does not mean that India has not made any move towards moving to a VAT
based system. India has introduced the system of MODVAT (Modified Value Added Taxation)
which is a combination of conventional taxation and VAT system of taxation. MODVAT works in
the following manner :-

In our earlier example, under MODVAT, there will not be much difference between conventional
taxation and MODVAT at the first stage of manufacturing. A's cost of production will be Rs. 90,
excise duty @ 10 % is Rs. 9 and the sale price is Rs. 110 (i.e. a profit of Rs.11).

B will purchase the item for Rs. 110 from A and incurs expenditure of Rs. 50 in the manufacturing
process. Say Excise duty payable by B @ 10 % is Rs. 16. However, B will take credit for the
excise duty paid by A and borne by him in the cost of his raw material purchase. Consequently,
he will pay excise duty in cash of only Rs. 7 (i.e. Rs 16 less Rs. 9). This is known as claiming
modvat credit. The selling price in this case without affecting his profit will be Rs. 191.

Similarly, C will purchase the item for Rs. 191 from B and incur expenditure of Rs. 40 in the
manufacturing process. Say Excise duty payable by C @ 10 % is Rs. 27 (191+40+36). C will
claim modavt credit of Rs. 16 (Rs. 7+ Rs. 9) and pay excise duty of Rs.11. The selling price of the
final product will be Rs. 278 without affecting profit.

The price at which the final consumer can buy the product reduces from Rs. 300 to Rs. 278 under
MODVAT even when the rate of tax is kept constant at 10 %.

The greatest disadvantage of MODVAT is that it leads to a lot of paper work in the form of
maintaining records of MODVAT obtained and claimed as credit. Besides, unscrupulous
manufacturers often use illegal purchase invoices in order to obtain MODVAT which is later
claimed against excise duty payable.

MODVAT can be regarded as a stepping stone towards full movement to a full VAT based
taxation system where there is only one levy is prevalent instead of the multiple taxes currently
levied. There is only one tax collecting department which the tax payers deal with instead of
separate departments for each type of indirect tax. Besides, VAT implies fewer rates of duties
as opposed to several different rates. This leads to a simplification of the tax structure and
improves administration of the law. VAT can also lead to better financial control of the
expenditure of various States since the tax can be collected by the Center and can be disbursed
to States depending on their financial prudence. Internationally, the system of taxation has
moved towards VAT and in this age of globalisation, India cannot afford to become
uncompetitive on account of out-dated taxation practices.

Pritesh Mehta
Chartered Accountant

SBI chairman says credit growth unprecedented

SBI chairman says credit growth unprecedented
(Business Standard)
Our Banking Bureau / Mumbai March 12, 2005

The State Bank of India (SBI) is witnessing unprecedented growth in its loan book.

With the advances growth being "not normal", the largest bank in the country, is planning to raise
tier II capital worth Rs 3,000-4,000 crore to support its growth.

"The credit growth we are seeing now is unprecedented and across sectors," said SBI chairman
A K Purwar today on the sidelines of the annual conference organised by the Fixed Income
Money Market and Derivatives Association of India (Fimmda).

The rate of credit growth till February 2005 on a year-on-year basis is 20 per cent. The rate of
loan growth on the retail front (particularly home loans, consumer durables loans and personal
loans) and agriculture loans is 30 per cent. The incremental credit-deposit ratio is over 100 per

"The credit growth is going to be substantial in the next fiscal (2005-06) in all sectors. Therefore,
the bank is exploring the option to raise capital through tier II bonds worth Rs 3,000-4,000 crore to
support the credit growth," said Purwar. The SBI chairman did not indicate the time-frame in which
the bonds would hit the market. The bonds are likely to have a five year maturity period.

At the same time Purwar did not rule out an equity issue. "I will not rule out the possibility of going
for a public offering as the current market is very attractive," he said.

The chairman also said the bank would comply with the US-GAAP accounting norms by the end
of this fiscal, which is a pre-requisite if a bank wants to go for an American depositary receipts

Purwar expects the demand from the retail and the services segments to continue well into the
next fiscal.

SBI in the first half of this fiscal had recorded a credit growth of 24 per cent and the chairman had
then indicated that the growth rate was unsustainable.

The bank then revised upwards its credit growth target for the current year up to 18-20 per cent
from 16 per cent.