VAT: Overview

What does VAT (Value Added Tax) mean?

Taxes form an integral part of a country’s economic structure. They are very important to run a country smoothly and without any road-blocks. Different taxes are imposed at various stages while selling different types of goods and services. One such type of widely consumed tax structure that has a global reach is Value Added Tax or VAT system. Now the question arises what is vat?  When a person purchases a certain kind of product, a special tax is added at every stage where a certain amount of ‘value is added’ to the product, as well as at the final sale of that particular item. This Income tax falls under the category of indirect tax because it is paid by the taxpayer to the Government indirectly through the producers of various goods and services.

The basic concept of VAT was originally proposed by Dr. Wilhelm von Siemens who was an industrialist of German origin. This proposal was laid down in the year 1918 but was adopted years later on 10th April 1954 by Maurice Laure who was the Joint Director of the France Tax Authority, the Direction Generale des Impots. Based on the calculative data of 2014, a total of 160 countries out of 193 countries employ VAT system. This number includes all the members of the Organisation for Economic Co-operation and Development (OECD) only including the United States.  VAT is levied on both local as well as imported goods and services and any individual whose business earns an annual turnover of more than Rs. 5 lacs is eligible for VAT Registration.

VAT Tax Calculation

VAT, falling under indirect tax, is payable to the Government only through the manufacturers of various goods and services. As it is not a type of direct tax, a proper and precise calculation of VAT for a transparent tax payment procedure becomes important. There is a simple formula through which VAT can be easily calculated by subtraction the input tax from the output tax. Input tax is the tax that is payable by the seller of the goods and services for purchasing raw materials required in the manufacturing process. On the other hand, output tax is the tax that the seller receives at the time of sale of goods and services. So we can easily conclude that:


This formula easily acts as a VAT calculator. In order to understand the calculation of VAT more properly, let me outline an example that will make the VAT calculation more clear. Suppose Raju is the owner of a hotel. He bought raw materials worth Rs 1, 00,000 and an input tax of 10% was imposed on the raw materials. Therefore, the total input tax incurred by him becomes 10% of Rs. 1, 00,000, that is, Rs. 10,000. Now after selling food that was made using those raw materials, he was able to earn a total of Rs. 2, 00,000. If we consider the total output tax to be 10% of the earnings, then the total output tax becomes 10% of 2, 00,000, that is, 20,000. So, we can easily ascertain the total VAT payable by Raju by deducting the input tax from output tax. Therefore, VAT= 20,000-10,000, that is Rs. 10,000.

Features of VAT

We all know that VAT system is not a voluntary tax system, but still it holds a special importance in the tax payment structure. It raises a total of about one fifths of the tax revenue collected globally. It is a multi-stage tax that is imposed at various stages of purchase and sale of goods and services. The different features of VAT system are as follows:

  • As VAT is imposed at different levels of purchase and sale of goods and services, any chances of errors are eradicated. Thus, it enables a more transparent and uniform tax payment process.
  • Through the transparent tax payment process, the chance of tax evasion on the part of the taxpayer becomes almost zero. This helps in encouraging acceptance in the minds of the taxpayers.
  • In VAT system, similar types of goods and services are taxed on the same level. Like for example, refrigerator under different brand names will be taxed on the same levels as they fall under the same category.
  • Any kind of tax fraud is completely avoided as this is a multi-stage tax system and the goods are taxed even at the smallest levels.

Benefits of VAT

Not many countries recognize VAT as a type of tax. Only India is one of the few countries that have given VAT the status of tax. Previously, businessmen used to exploit the process of tax as per their wishes and a uniform tax payment process was far from reach. But with the introduction of VAT, goods and services are taxed even at the tiniest levels, thus, a transparent tax payment process is established. Though it is not voluntary on the part of the taxpayer, but still one cannot avoid its various uses. Let us have a look at the various advantages of VAT system in India:

  • As VAT is levied at all levels of purchase and sale of goods and services, any form of tax evasion becomes extinct thus, helping in encouraging transparency.
  • VAT when applied uniformly forms a large part of the revenue collection. It strengthens the tax policy and solves the fiscal policy deficit.
  • A total of 160 countries out of 193 follow the VAT system for taxation. This means that VAT is a globally accepted tax system. Thus, it encourages a good relation of India with other countries in performing foreign trade practices.
  • VAT keeps a thorough check on all the transactions that take place, thus the tax payment process becomes more efficient as well as easy.

VAT Implementation

VAT system is imposed by the State Government and it is levied on different levels of manufacturing of goods and services. VAT in India is completely different from one state to another as the rules, regulations and laws are different for different states. Each state lays down its unique set of guidelines for implementing VAT. For instance, in Uttar Pradesh, the UP VAT rules are followed which was implemented in the year 2007. The UP VAT return is filed based on these rules. Thus, VAT implementation, rates, collection and return filing are varied for different states. Based on these differences, VAT can be broadly divided into four different rates which are applicable. They are as follows:

  • Nil VAT rate– in many Indian states, there are local vendors and many unorganised sectors that sell goods in their basic and raw form. The way they are obtained from nature, the same way they are sold in their natural form. Thus the vendors do not impose any kind of VAT on those items. Few examples of such items on which not VAT is imposed are salt, khadi, jute etc.
  • 1% VAT rate– there are many items that are already very expensive in nature like jewellery, expensive stones, gold , silver, etc. Imposing an added VAT on them would make them more expensive and would thus reduce their demand. So, to solve this dilemma, most Indian states have fixed the VAT rate for these kinds of articles at 1%. This rate is kept this low in order to encourage individuals to purchase such expensive items without hesitation.
  • 4%-5% VAT rate– there are many articles that are consumed on a daily basis by consumers. Objects like tea, coffee, oil, medicines etc fall under this category. So various Indian states have placed these articles under daily consumption goods and levy a VAT of 4%to5% on these goods.
  • General VAT rate– products that cannot be categorized into the above mentioned categories fall under the general VAT rate category. The Government has full liberty to charge varied VAT on certain articles which can be 12% to 13% in a particular state and as high as 15% in another state. Articles like liquor, cigarettes, tobacco, etc. fall under this category.

VAT Registration

VAT is a globally accepted tax system. The guidelines laid down by the Government vary from one country to another. For example, the VAT rate in India is 12.36% whereas the UK vat rate is 20%. Generally, the countries that follow VAT system require their businesses to be registered. These businesses can be either a legal entity or a natural person. The amount of turnover required for VAT registration also differs from one country to another. In India, if a business holds an annual turnover of more than Rs. 5 lacs by buying and selling goods and services, they must register their business under VAT. Upon successful registration, they become eligible to start paying VAT. Upon proper registration, the trader receives a special 11 digit registration number known as the vat number that helps him to make the necessary communication regarding VAT payment and VAT filings.

Documents Required for VAT Registration:

When a trader wishes to register their business for VAT, they are supposed to submit a list of documents that must be proper in nature. These documents are:

  • PAN card photocopy.
  • The proof of address of the business that needs to be registered.
  • The proof of identity of all the promoters of the concerned business.
  • Extra security deposit or security of some kind.

Upon proper submission of all the required documents to the State Government, it generally takes 15-20 days for the registration process to be complete. But again, this term of duration can be different for different states as the guidelines for each state differs.

VAT Collection

VAT is implemented on businesses based on a few guidelines. Not all businesses implement VAT. In India, a business having a turnover of more than Rs. 5 lacs qualify to implement VAT. VAT can be implemented taking into account that the business owes some amount of money on the product price after subtracting all the taxes that were paid on the goods and services beforehand.  Generally, the process of tax collection can be sub-headed into four categories. They are as follows:

  • Account-based– under account-based VAT collection system, the tax is computed on the value that was added to the product rather than the sale receipts. It is measured by finding out the difference between revenues and allowable purchases. Not all countries use this tax collection method with Japan being an exception.
  • Invoice- based– as opposed to account-based method, invoice-based method uses sale receipts to measure VAT. When traders make a sale of goods and services, they present the buyer with details of the VAT collected. Presently, most of the countries worldwide use this method of tax collection.
  • Accrual- based– this tax collection method is based on the timing of the collection. It is a complex form of tax collection where it matches the revenue at the time when they were earned to the expenses at which they were incurred.
  • Cash- based– it is a very simple form of accounting based on timing. It lays more stress on the cash in transaction rather than the bills. Whenever a payment is received, that particular date is recorded as the date of receipt of funds without considering whenever the sale is made.

VAT Return

VAT is levied on both local as well as imported goods and VAT filing can take place both online as well as offline. Filing returns online is called VAT e filing system and it helps the trader to keep a track of all the taxation processes. This method of vat payment online is very easy and can be done anywhere anytime. Each trade registered under the VAT Act 2003 is provided with a specific id and password by the Directorate of Commercial Taxes for vat online payment. Using this id and password, the trader can easily access the VAT e filing system to carry out online vat payment.

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