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A Primer on VAT in India

-R.S.Ramesh

The origin of VAT can be traced back to 1918. France is the first country to introduce
VAT in 1954. Since then 125 countries have adopted the system in modified form. In
India, the VAT was introduced 0n 1st April 2005 with the following objectives:

• There was an urgent need for major reform in domestic sales taxes to meet the
Challenges of globalization
• to improve tax administration
• to create congenial atmosphere for tax compliance and concern or diminishing tax
revenue

What is VAT?
VAT is a method of taxing in stages i.e. it is levied on the value added at each stage and
not on the gross turnover of the dealer of goods. This is levied on the difference between
sales and purchases at each stage. Primarily VAT is a multi point tax that seeks to tax
goods in the consuming state, while avoiding the taxation of inputs. Thus the basic
concept of VAT is:

i) It is collected on each sale and resale


ii) no body will be exempted from the chain of transaction
iii) Registered dealers are allowed a credit of rebate of tax paid on purchase for
use in the taxable activities

Why VAT?
- It is a simple structure that reduces evasion of tax.
- Under the VAT system, no tax fresh tax is incorporated into the cost of inputs
used by the dealers for their commercial activities.
- It is anti-cascading in the sense that the tax is levied only on the value added by
allowing a rebate of tax paid on the purchases.
- the rates of tax is comparatively low so that both dealer and the consumer of
goods must not be unnecessarily taxed.
- The incidence of tax is quite transparent in the sense that it shows how much
value is added at what stage.
- It is a self-regulatory, i.e., it compels the dealer to demand for a bill to claim
refund of the tax paid on his purchases and thus leaves auditing work for the
department.

How VAT is levied?


We know that a commodity passes through various stages from the point of
manufacturing to the point of actual consumption. The VAT as the name implies is a tax
which is levied on the value added by the business or the firm at each stage. The value
added may be seen as the value of sales less the value of the purchased inputs.

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Thus, the net VAT liability is the difference between the total amount of VAT shown on
all sale bills and the total amount of VAT shown on the purchases invoices. The same
value added is never taxed twice i.e., there is no scope for cascading or double
imposition. Thus VAT is a tax on the value added to goods in the process of production
and distribution. For eg when a bookseller buys a book from publisher for Rs. 200 and
sells it for Rs. 250, he has added Rs. 50 to the value of the book. In other words the value
of the booksellers’ service is Rs. 50. Bookseller may calculate the VAT in two ways,

a) subtract the cost of goods purchased from sales;


b) Add together the various elements that make up the VAT like payment of wages,
rent interest and profit.

Thus the greatest merit of VAT is that it eliminates the cascading effect of tax burden on
both the business community and the consumers. It helps in competitive costing of goods
which in turn, will influence the pricing pattern. It encourages exports since VAT is fully
rebated on exports. Goods under VAT are exported tax – free and are therefore, more
competitive internationally.

Limitations of VAT
There are, however, some basic difficulties in the application of VAT in India. Firstly, the
collection of VAT demands that all concerned-producers, distributors, traders, etc., have
to maintain proper accounts of their transactions. They are required to undertake calculate
the gross revenue, assess the tax already paid and calculate the tax liability. It thus calls
for certain accounting discipline. Unfortunately this exercise leaves much to be desired as
these are some how managed by bribing the bureaucrats in the department.

The small traders opine that the VAT procedure is rather too complicated and beyond
their comprehension. To make it more focused, the VAT system needs to be simplified so
that the tax incidence will be effective.