Value-Added Tax (VAT)

Reviewed by Annapoorna | Updated on Aug 27, 2020

Introduction

A value-added tax, popularly known as VAT, is a tax added to a product at every stage in the supply chain and is based on the value added. It is already being implemented widely across the globe under various names, including goods and services tax (GST) in India.

Until 2017, VAT was a significant source of tax revenue for all Indian states and union territories excluding Andaman and Nicobar Islands and Lakshadweep. Each state government levied VAT until GST replaced it in July 2017. Now, GST is charged by the Centre under various heads Central GST (CGST), State GST (SGST), and Integrated GST (IGST), and later distributed to the respective consuming states. In addition to this, the Central Government compensates most Indian states for the revenue shortfall due to change. The compensation extends for a couple of years. Although VAT is not being charged currently, the litigations may be pending before various district-level, and state-level forums and courts.

What is VAT in India?

VAT is charged on the gross margin at each point in the sale of goods. Tax is assessed and collected at every stage, beginning from the manufacturer up to the retailer. It is in contrast to the erstwhile sales tax, which was assessed and paid by the consumer at the end of the supply chain.

A dealer usually collects tax on his sales, reduces the tax paid on his purchase, and deposits the balance to the government. It is also known as a consumption tax since the final consumer ultimately bears it. The tax paid passes along the chain to the buyer and not considered as a charge for the dealer. Instead, VAT is a multipoint tax system with provision for collection of tax paid on the purchases at every point of sale. Thus, it removes the cascading effect of taxes or the tax-on-tax effect.

The VAT law differs for every state and union territory. Moreover, the threshold limit for exemption and the list of goods exempted also varies from state-to-state. The compliance mostly involves the taxpayers reporting the sales and purchases along with the details of exports before the state VAT department every month. The information submitted shall be verified by the tax officials and also be subject to VAT audit once every year.

How is VAT computed?

There are two components of VAT—the output VAT and the input VAT. The output VAT is charged on the sales made by the dealer to the customer. The dealer or seller can be either a manufacturer, a wholesaler, or a retailer. It is chargeable on all the taxable sales for a given tax period, usually every month. On the other hand, input VAT refers to the VAT paid on the eligible purchases made by the dealer. Accordingly, VAT liability, to be paid in cash to the state government for a particular month, equals the amount of output tax as reduced by the input tax.