Whether you’re a businessman or just a consumer, you might recall the days of navigating through multiple taxes before the era of GST began in 2017. One of those various taxes is the VAT, a taxation method with significant global prevalence.
Contrary to popular belief, VAT hasn’t disappeared in India after the introduction of GST. Goods not covered under GST, such as alcohol and petroleum products (hence their varying prices from one state to another), are still subject to VAT. Intrigued? Read on to delve deeper into this crucial indirect tax.
What is VAT?
VAT full form is Value Added Tax. VAT is a consumption tax levied on consumers by the government for the sale of goods. VAT is collected at every value-adding step, from the production to the sale of goods. Let’s understand this in steps:
- A product cycle begins at manufacturing and ends at its sale, consisting of various developmental steps in between.
- The product’s value increases at each developmental step, and VAT is levied on this value.
- The final sale price consists of the cumulative VAT levied at each developmental step, including the final step, i.e., the product’s sale.
- The business collects the VAT from the customer, deducts the VAT paid over the cycle and gives the difference to the government.
This cascading effect of VAT, where the customer bears the entire tax amount, is one of the main reasons GST replaced VAT for most goods and services.
Apart from VAT meaning and VAT definition, the history of VAT in India is quite interesting and can be divided into two eras:
- Before 2017: Before 2017, India had multiple taxes, including VAT, central excise duty, service tax, and various state taxes. This led to administrative burden, cascading effect on customers where they were required to pay a higher price and unethical business decisions.
- After 2017: On 1 July 2017, the multiple tax system was abolished, and all these taxes were subsumed into the Goods and Services Tax (GST), which is applicable across the country.
GST retains some core principles of VAT, such as tax credits and value addition. Further, VAT is still applicable on goods not covered under GST.
Types of VAT
Now that you understand VAT full form and what is value added tax, let’s take a look at the different kinds of VAT prevalent across the world. These include:
- Standard VAT: This type of VAT is most common, where a standard rate is applied for all goods and services.
- Multi-rate VAT: In some countries, different VAT rates are applied for different categories of goods and services, giving rise to a multi-rate VAT system.
- Zero-rate VAT: In most countries, certain services like healthcare, exports or education can be exempt from VAT for social reasons.
Calculation of VAT
Now that the value added tax meaning and value added tax definition are clear, let’s look at how VAT is calculated in practice. To understand VAT calculation, we need to understand input tax and output tax.
1. Input Tax
This is the tax the dealer pays on purchasing goods and services. Remember the production cycle where VAT is charged at each developmental step? The dealers pay the VAT for which they can claim tax credits from the government.
2. Output Tax
The consumer pays Output Tax to the dealer on the product’s final selling price.
The VAT to be paid by the dealer to the government can then be calculated as:
VAT=Output Tax-Input Tax
For example, imagine a dealer purchases some material to develop a product for Rs. 100, on which the government levies a 10% tax. The dealer pays Rs. 10 to the government. This is the input tax. The dealer sells the final product to you for Rs. 150, on which, again, 10% VAT is levied. Hence, the dealer gets Rs.15 as VAT from you, which is the output tax. The VAT to be paid by the dealer to the government is 15-10=Rs. 5.
Advantages and Disadvantages of VAT
The advantages of VAT for government, businesses and consumers are as follows:
- Reducing VAT lowers the cost of goods for consumers.
- For businesses, a uniform VAT rate can enhance business as customers can assess tax quickly.
- For the government, the administrative burden of calculating taxes is reduced, and it can focus on collection as the businesses can self-assess their taxes.
The disadvantages of VAT include:
- Businesses can face higher costs due to VAT.
- Due to VAT, the risk of tax evasion can increase as businesses look to make more profit. Additionally, the government has to deploy additional resources to prevent tax evasion.
- Businesses can pass on the VAT costs to the end consumer, leading to higher prices.
Closing Thoughts
This brings us to the end of the discussion on VAT. VAT full form is Value Added Tax and it is a consumption tax levied on each step of the production cycle from manufacturing to final sales. It is one of the most prevalent taxation methods in the world. In India, VAT on most goods is now subsumed under GST. However, VAT is still applicable on items not covered under GST. Understanding VAT gives businesses and consumers a meaningful glimpse into the complicated taxation structures.
FAQs
VAT is levied at each production step where value is added. The VAT is calculated at each step as the difference between the tax amount obtained by applying VAT on increased value and the amount already paid as VAT on the value at the previous production step.
The formula for VAT calculation in India is:
VAT=Output Tax-Input Tax
The consumer pays output tax on the final price of the product. The manufacturer pays input tax in the course of developing the product.
The differences between VAT and GST are as follows:
1. GST applies to goods and services, while VAT applies only to goods.
2. The input tax credit in GST can be claimed for goods and services, while in VAT, it can only be claimed on goods.
3.In GST, the threshold limit is uniform for all states, while in VAT, it is variable.
24 January 2025
5 mins read
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