Understanding VAT

Every day, I learn something new at the place where I work. This is an attempt to educate the world about what I am doing! :) [Assuming that the world is interested! ;)]

VAT - Value Added Tax
This is a relatively new concept introduced by the Government of India for reducing the burden of taxes on manufacturer. Any manufacturer adds value to a commodity, making it marketable/sellable. The manufacturer, therefore, has to pay tax for this value addition [foolish, isn't it? You are punished for improving something] Hence, the name Value Added Tax. However, it is not as simple as that. Value Addition can also mean an increase in price. This can be illustrated by the following case study:

Chandu is a trader who buys biscuit packets from Brittania. He in turn, sells them to a local distributor, Pandu. Pandu then sells the biscuit packets to the local shops, which sell them to the customer. One local shop is Rasiklaal General Stores, where you are the customer [or consumer, pun unintended! :)]

Consider the previous system of sales tax, where sales tax was levied at a flat rate for the first sale, and thereafter, no tax was collected. In this case, if Brittania sells the packet at Rs. 11.00 (inclusive of tax @ 10% i.e. cost of Rs. 10 and tax @ 10% on sales price) M/s. Chandu, Pandu and Rasiklal are free to add their own profits to the cost price of the bisucit packet and they need not worry about being taxed. And you, the customer, ends up bearing the brunt of the Rs. 20/- biscuit packet!

Now, under the current system of VAT, Brittania will sell the biscuit at the normal price. If Chandu adds his profit of Re. 1 to the biscuit, he has to pay VAT on the increment i.e. on the Re. 1 price increase. This implies that higher the price increase, the greater the tax he has to pay. Similarly, the same is true for Pandu and Rasiklal. This ensures that there taxation at multiple points as opposed to a single point. Although, the revenue for the Government may reduce, it ensures a larger tax "net" wherein there are money inputs from many places.

I may not have been able to explain the finer details of VAT explicitly here. I am providing links for readers interested in further reading.

Similarly, there exists a concept of CENVAT, wherein each person in a chain can claim against taxes the amount he/she has paid as tax for his/her purchase. This is valid only in the case of Excise duties, certain import duties [known as Countervailing Duties and Special Additional Duty] and Service Tax,

Some reading material:

1. http://dateyvs.com/salestax_vat.htm
2. http://finance.indiamart.com/taxation/central_vat.html
3. http://finmin.nic.in/law/CENVATcreditrules2004.pdf

VAT - prevention of cascading effect of tax

Transaction without VAT Transaction With VAT Details A B A B Purchases - 110 - 100 Value Added 100 40 100 40 Sub – Total 100 150 100 140 Add Tax 10% 10 15 10 14 Total 110 165 110 154