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What is the Difference Between GST and VAT

Updated on :  

08 min read.

The Goods and Services Tax (GST), which has replaced the Central and State indirect taxes such as VAT, excise duty and service tax, was implemented from 1st July 2017. 

In this article, you can understand the differences between VAT and GST and their implications. GST has eliminated the cascading effect of taxes on the economy.

Meaning of cascading effect of tax

Cascading effect is when there is a tax on tax levied on a product at every step of the sale. The tax is levied on a value that includes tax paid by the previous buyer, thus, making the end consumer pay “tax on already paid tax”. Let us now understand what the Value Added Tax (VAT) is and how it impacted the Indian economy. 

Watch this video on cascading effects of erstwhile tax structure:  

What is VAT?

Value Added Tax (VAT) is an indirect value added tax which was introduced into Indian taxation system on 1st April 2005. 

A value-added tax (VAT) is a consumption tax levied on a commodity whenever it adds value at any point in the supply chain, from production to sale. The amount of VAT that the consumer pays is based on the cost of the product, minus any previously taxable costs of products used in the product.

As a taxation concept, VAT replaced Sales Tax. VAT was introduced to make India a single integrated market. However, it was introduced at state-level. On 2nd June 2014, VAT was implemented in all states and union territories of India, except Andaman and Nicobar Islands and Lakshadweep Islands.  

For interstate supplies, CST or Central Sales Tax was imposed. CST applies on the sale of goods levied by the Central Government. It is collected and retained by the state where the tax is collected. 

Disadvantages of VAT

  • Cascading effect of taxes
  • It was not possible to claim Input Tax Credit (ITC) on service under VAT
  • Different VAT rates in different states
  • Different VAT laws in every states
  • Input of CST cannot be adjusted against VAT and vice versa

What does GST bring in that VAT could not?

Designed to be a single, comprehensive, destination-based taxation concept, Goods and Services Tax (GST) unifies the entire country in terms of how the tax is collected. GST has revolutionized the Indian taxation system. GST intends to further eliminate the concept of “tax on tax”.  

Benefits of GST Implementation

  • Removal of cascading effect of tax
  • Simple online procedure
  • Lesser compliances
  • Defined treatment for e-commerce companies

Let us look at an example  

Consider a consultant providing services to his clients. 

Under VAT regime: The consultant would have charged 15% service tax on services of Rs. 70,000. So, his output tax was Rs. 70,000 x 15% = Rs.10,500. Then, if he purchased office supplies for Rs. 25,000 paying 5% as VAT which would amount to Rs. 25,000 x 5% = Rs. 1,250. He had to pay Rs. 10,500 output service tax without getting any deduction of Rs. 1,250 VAT already paid on stationery. His total tax outflow is Rs. 11,750. 

Under GST: GST on service of Rs. 70,000 @18% = Rs. 12,600. Now, subtract GST on office supplies (Rs. 25,000 x 5%) = Rs. 1,250. Therefore, the net GST liability to pay is Rs. 11,350  

Conclusion

By implementing GST on goods and services, the economy is improving through the elimination of the cascading system of tax and streamlining the business process in India.  

Learn everything about GST

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