Value Added Tax (VAT): an overview

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Writuparna Kakati | 30 Apr, 2008
In this age of globalisation, international trade has been expanding at an amazing pace. With this expansion, coincided the global spread of Value Added Tax (VAT). At present, some 140 countries are using VAT as their primary or only consumption tax.

This is the reason why it has become important for SMEs to have some basic idea about VAT. Although there is a great deal of variation in the manner different countries implemented VAT, the basic intent is the same - to tax final consumption.

In simple sense, VAT (Value Added Tax) is nothing but sales tax at source. Instead of collecting it after sales (usually for or five months), state governments would collect the tax in advance. After that, set offs are allowed to the businessman.

VAT is a multi-point levy on each of the entities in the supply chain. Suppose, you purchase a product for Rs. 100 and pay a tax of Rs 10. After that you sell the product to other for Rs. 150 and a tax of Rs. 15 is charged, the VAT payable by you will be Rs. 5 [Earlier you have paid Rs.10; Rs. 15-10=5].

Example:
Rate of tax: 10% (assumed)
Purchase Price: Rs. 100
Tax paid on purchase: Rs. 10 (input tax)
Sale Price: Rs. 150
Tax payable on sale price: Rs. 15 (output tax)
Input tax credit: Rs. 10
VAT payable: Rs. 5
You pay tax to the government on the sale price of Rs.100= Rs.10
You pay net VAT on value addition after resale= Rs.5
Total tax at 10% on the last sale price= Rs.15

VAT in India

1986: VAT was first introduced in India in 1986. Originally known as Modified Value Added Tax (MODVAT), this tax system was introduced at central level with the aim to allow manufacturers to obtain reimbursement of the excise duties paid on goods. Initially the scope was confined to raw materials and components; in 1994, it was extended to include capital goods.
2000, April: MODVAT was renamed CENVAT and new recovery opportunities were introduced.
2005, April: The central government announced introduction of state level VAT system in 21 of the 29 Indian states.
2006, April: VAT was implemented in Chhattisgarh, Gujarat, Jharkhand, Madhya Pradesh and Rajasthan (Later VAT was also implemented in Tamilnadu, Pondicherry and UP).

Current indirect taxes in India
India does not have a single integrated VAT system to cover both the supply of goods and and the provision of services. The supply of goods is subject to state VAT while provision of services is subject to union tax (service tax). Moreover, CENVAT continues to be levied on all supplies of goods.

Custom Duties: Goods imported to India are subject to custom duties. They are neither subject to sales tax nor CENVAT.
Central Sales Tax (CST) and Local Sales Tax (LST): This tax is on the sales and purchase of goods that are physically moved between states. This tax is administered by the state governments and imposed by the central government under the Central Sales Tax Act. CST is not recoverable and companies engaged in business across state borders has to pay for it. The sale of goods within the same state border is subject to Local Sales Tax (LST) which is regulated by the concerned state. LST vary state to state, and as a result, many differences exist relation to exemption and derogation.
Service Tax: Service tax is imposed by the central government and it applies to 80 different service categories.

Advantages of VAT over convectional system of taxation

Both consumption of goods and services can be taxed.
It has made exporting possible without paying myriad of domestic trade taxes.
VAT implementation minimized interferences in market forces.
By providing audit trail through different stages of production and trade, VAT has made tax enforcement easier.
VAT implementation has made it easier to give concessions to goods used by common man, exported goods and goods required for manufacturing capital products.

Advantages of state level VAT

This system of taxation is simple and transparent.
After VAT implementation, 'tax rate war' among states has come to an end.
Minimized tax burden to bring down price level.
Tax diversion among states.