Vat In India

BASIC CONCEPT OF VAT

VAT works on the principle that when raw material passes through various manufacturing stages and manufactured product passes through various distribution stages, tax should be levied on the Ð''Value Added' at each stage and not on the gross sales price. This ensures that same commodity does not get taxed again and again and there is no cascading effect. In simple terms, Ð''value added' means difference between selling price and purchase price. VAT avoids cascading effect of a tax.

Basically, VAT is multi-point tax, with provision for granting set off (credit) of the tax paid at the earlier stage. Thus, tax burden is passed on when goods are sold. This process continues till goods are finally consumed. Hence, VAT is termed as Ð''consumption type' tax. VAT works on the principle of Ð''tax credit system'.

Generally, any tax is related to selling price of product. In modern production technology, raw material passes through various stages and processes till it reaches the ultimate stage e.g., steel ingots are made in a steel mill. These are rolled into plates by a re-rolling unit, while third manufacturer makes furniture from these plates. Thus, output of the first manufacturer becomes input for second manufacturer, who carries out further processing and supply it to third manufacturer. This process continues till a final product emerges. This product then goes to distributor/wholesaler, who sells it to retailer and then it reaches the ultimate consumer.

If a tax is based on selling price of a product, the tax burden goes on increasing as raw material and final product passes from one stage to other. For example, let us assume that tax on a product is 10% of selling price. Manufacturer Ð''A' supplies his output to Ð''B' at Rs. 100. Thus, Ð''B' gets the material at Rs. 110, inclusive of tax @ 10%. He carries out further processing and sells his output to Ð''C' at Rs. 150. While calculating his cost, Ð''B' has considered his purchase cost of materials as Rs. 110 and added Rs. 40 as his conversion charges. While selling product to C, B will charge tax again @ 10%. Thus C will get the item at Rs. 165 (150+10% tax). As stages of production and/or sales continue, each subsequent purchaser has to pay tax again and again on the material which has already suffered tax. This is called cascading effect.

Cascading effect of conventional system of taxes Ð'-

A tax purely based on selling price of a product has cascading effect, which has the following disadvantages Ð'-

(a) Computation of exact tax content difficult

(b) Varying Tax Burden as tax burden depends on number of stages through which a product passes

(c) Discourages Ancillarisation

(d) Increases cost of production

(e) Concessions on basis of use is not possible

(f) Exports cannot be made tax free.

VAT was developed to avoid cascading effect of taxes. In the aforesaid example, Ð''value added' by B is only Rs. 40 (150Ð'-110), tax on which would have been only Rs. 4, while the tax paid was Rs. 15. In VAT, the idea is that B will pay tax on only Rs 40 i.e. value added by him. Then, it makes no difference whether a product passes through 5 or 10 stages or even 100 stages, as every person will pay tax only on Ð''value added' by him to the product and not on total selling price.

VAT removes these defects by tax credit system. Under this system, credit is given at each stage of tax paid at earlier stage.

Illustration - In the example we saw above, Ð''B' will purchase goods from Ð''A' @ Rs. 110, which is inclusive of duty of Rs. 10. Since Ð''B' is going to get credit of duty of Rs. 10, he will not consider this amount for his costing. He will charge conversion charges of Rs. 40.00 and sell his goods at Rs. 140. He will charge 10% tax and raise invoice of Rs. 154.00 to Ð''C'. (140 plus tax @ 10%). In the Invoice prepared by Ð''B', the duty shown will be Rs. 14. However, Ð''B' will get credit of Rs. 10 paid on the raw material purchased by him from Ð''A'. Thus, effective duty paid by Ð''B' will be only Rs. 4. Ð''C' will get the goods at Rs. 154 and not at Rs. 165 which he would have got in absence of Cenvat. Thus, in effect, Ð''B' has to pay duty only on Rs 40, which is the value added by him.Following example will illustrate the tax credit method of VAT.

Transaction without VAT Transaction With VAT

Details A B A B

Purchases - 110 - 100

Value Added 100 40 100 40

SubÐ'-Total 100 150 100 140

Add Tax 10% 10 15 10 14

Total 110 165 110 154

Note - 'B' is purchasing goods from 'A'. In second case, his purchase price is Rs 100/- as he is entitled to Cenvat credit of Rs 10/- i.e. tax paid on purchases. His invoice shows tax paid as Rs 14. However, since he has got credit of Rs 10/-, effectively he is paying only Rs 4/- as tax, which is 10% of Rs 40/-, i.e. 10% of 'value added' by him.

In Consumption Type VAT, Ð''Value Added' is considered by deducting all purchases, raw materials and capital items. Consumption type VAT is popular and it is adopted by most of the countries for following reasons : (a) Administration control is easy due to Ð''credit method' that can be adopted (b) It makes no distinction between capital intensive and labour intensive activities (c) Tax avoidance by classifying capital goods purchases as revenue purchases is avoided. (d) It is in harmony with the 'destination principle' (e) It simplifies tax administration as there is no need to distinguish between purchase of capital goods and consumption goods.

It is obvious that tax revenue will go down in VAT system, if same rate of tax is maintained. Hence, VAT rate will have to be suitably increased to ensure that tax revenue does not reduce. This rate is termed as Ð''Revenue Neutral rate' (RNR). It is the VAT rate at which tax revenue remains same despite