What is VAT?
through a system of deductions
whereby taxable persons (i.e., VAT-
registered businesses) can deduct
from their VAT liability the amount
of tax they have paid to other taxable
persons on purchases for their
business activities. This mechanism
- Sameer Bagul ensures that the tax is neutral,
product is resold or when ‘value’ has regardless of the number of
he decision of
T been added. transactions involved.
implementing the Value
The mechanism of VAT is such To understand the mechanism
Added Tax (VAT) in this
that, for goods that are imported and easily, let’s study the present system
year’s budget has churned immense
consumed in a particular state, the and VAT.
interest in the common man,
first seller pays the first point tax, In the present system, the
perhaps much more than the
and subsequent sellers pay tax only
turbulence it created within the manufacturer or the wholesaler
on the value addition done by purchases the goods or raw
trading community. There are many
them - leading to total tax burden materials without payment of any
apprehensions about how the tax
exactly equal to the last point tax. tax, but against the statutory forms.
will affect them? Will the prices of
Since the tax is collected from the
goods increase? Is this a political In the new VAT system, the
seller at each stage as he adds value manufacturer or wholesaler has to
gimmick? Why are the traders
to the product or goods, hence it is pay tax on his purchases also. This
opposing it when manufacturers
the Value Added Tax. tax is paid locally and called Input
have welcomed this move and
It is charged as a percentage of tax credit. Since this tax paid will be
politicians call it the most rational
prices at each stage, which means set off against his total Central Sales
that the actual tax burden is visible Tax liability, it is called as Tax credit.
Let us examine the basics of VAT
at each stage of the production and The impact of VAT is that instead
and its implications.
distribution chain. of paying tax directly on the sales as
Value Added Tax (also referred to
VAT is collected by the in the present system, the
as input tax or turnover tax) is an
government of destination state (i.e. manufacturer or wholesaler pays tax
indirect tax levied at every economic
the state in which the final consumer
stage from the manufacturer to the in two stages one at the time of
is located), on consumer purchase and other at the time of
expenditure. Hence it is a sale.
One of the definitions of VAT
consumption tax because it is borne In order to set off the tax credit,
provided by the European Union
ultimately by the final consumer. It
says that, it is a general tax that the traders now will have to make
is not a charge on companies. sure that the vendor, from whom
applies, in principle, to all
It is collected fractionally, they are buying goods or raw
commercial activities involving the
production and distribution
of goods and provision of Example
Lets analyse the situation in a case of a distributor for Colour TVs to understand
This means VAT is
the concept better.
collected in stages
In a quarter, the wholesaler purchases 10 CTVs @ of Rs.9000/- i.e. goods worth
(instalments) rather than at
Rs. 90000/-. Lets assume he has to pay 5% local tax on this.
one point (e.g. Sales Tax) for
So the Input Tax Credit is Rs. 90000 x 0.05 = Rs. 4500/-
sale of goods. Now, the wholesaler sells all the 10 CTVs @ Rs. 10000/- i.e. the invoice will show
a sale of Rs. 100000. Lets assume that his Central Sales Tax (CST) liability is 10% on
Though value added tax
the sales he has to pay Rs. 10000.
is similar to sales tax,
Since the wholesaler has paid Input tax of Rs.4500/- earlier, now he has to pay
instead of implementing
one tax of a certain only the remaining tax, which is known as VAT.
i.e. VAT = Total Tax Liability – Input Tax Credit
percentage at the time of
VAT = 10000 – 4500 = Rs. 5500/-
retail sale, there is a smaller
tax added each time the
Advanc'edge MBA / May 2003
materials, has paid tax to the government. The major would oppose VAT.
implication of this exercise is that the onus of paying taxes In such cases the officials are not clear about the
is shifted from the government to the traders themselves. interstate implementation of the new taxation system
But given the inefficiencies of tax departments traders when a non-VAT state transacts with a VAT implemented
are quite apprehensive about the entire process and fear state.
losing more money in the By definition of this tax, the
form of double taxation and customers are the sufferers as
bribe, as evading tax would the prices of the goods would
be difficult now. increase and traders and
The most important manufacturers would have a
exercise for the government tough time dealing with the
now would be to train and situation as VAT would
educate their officials and actually cut into their profit
the traders for effective margins during the initial
implementation of the new stages.
tax regime. As India moves further into
This would also lead to the process of globalisation the
abolition of the direct implementation of VAT
control on taxes by would lead to creation of a
individual states, octroi, sales tax and even custom duties. “Single market” with free movement of the goods without
Some of the tax-haven states like Daman & Diu and the state boundaries affecting business. It would
Pondichery may lose their zero tax status and the eventually lead to healthy competition with
companies registering their offices in these places will rationalisation of prices as in the longer run the prices of
not enjoy the benefits anymore. goods would come down and traders would better
Though the implementation of VAT is pending over margins. Though a few states in the country have agreed
last several years, we have a hope of at least a few states to VAT, with the trading community’s fear, inefficient
adopting it. But given the political scenario in the country, bureaucracy and grim political scenario, an efficient VAT
especially with the elections coming up, BJP ruled states regime is still a distant reality.
Advanc'edge MBA / May 2003