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What is Value Added Tax? Research Team | Posted On Saturday, October 17,2009, 10:20 PM

What is Value Added Tax?



What is Value Added Tax?

Value Added Tax is a multi-point sales tax. It is basically a tax on the value addition of the product. The burden of tax is ultimately borne by the consumer who purchases the goods. In many features it is similar to last point sales tax. Value Added Tax in India is one of the most important components of tax reforms. VAT is referred as a multi point destination based system of taxation. Value Added Tax is charged at every step of transaction in the supply chain.

VAT is actually a state subject in India; states have the authority in making decisions. State governments ensure the levy of VAT in each state with the help of tax departments in their respective states. The Central government is influential in guiding the state government with respect to execution of VAT. The department of revenue under the Ministry of Finance is given the complete authority to have control with respect to direct and indirect taxes, through two statutory boards such as;

  • Central Board OF Direct Taxes (CBDT)

  • Central Board Of Customs and Central Excise (CBEC)

The sales tax division of revenue department is responsible for levying VAT. Previously India had a problem of double taxation. Goods were taxed two times, before manufacturing and again after manufacturing. This had a negative impact on the economy.Therefore, to avoid such double taxation, VAT has been introduced.

See Also: How To Calculate Your Taxable Income?

VAT Collection

Value Added tax (VAT) can be collected in two different methods:

In first method, tax is charged both on the basis of the tax which is paid on purchase and the tax that is payable on the sale(shown separately in the invoice).Finally the difference between the tax paid on purchase and the tax paid on sale as per the invoice is VAT.

VAT = Tax paid on Purchase - Tax paid on Sale

In the Second method tax is collected and charged on the cumulative value of the tax paid on sale and purchase, by applying the rate of tax applicable to the goods. Which means the difference between the sale price and purchase price is VAT.

VAT = Sales Price – Purchase Price

The value added tax is based on the value addition to the goods, and the related VAT liability of the dealer is calculated by deducting input tax credit from tax collected on sales during the payment period (say a month). The essence of VAT is in providing set-off for the tax paid earlier, and this is given effect through the concept of input tax credit/ rebate. This input tax credit in relation to any period means setting off the amount of input tax by a registered dealer against the amount of his output tax.

For example; Input worth Rs. 10,00,000/- is purchased and sales are worth Rs. 20,00,000/- in a month, and input tax rate and output tax rate are 4% and 10% respectively, then input tax credit/set off and calculation of VAT will be as shown below:

  • Input purchased within the month: Rs.10, 00,000/- courtesy

  • Output sold in the month: Rs.20, 00,000/-

  • Input tax paid: Rs.40, 000/-

  • Output tax payable: Rs.2,00,000/-

  • VAT payable during the month after set-off /input tax credit [(d) - (c)]: Rs.1, 60,000/-

Benefits of VAT

The main benefit of VAT execution is:

  • Reduces tax evasion.

  • Put an end to multiple taxes such as turnover tax, surcharge on sales tax, additional surcharge etc.

  • Advocated an internal system of self assessment for VAT liability.

  • Tax structure becomes easier and more visible.

  • Enhances tax compliance and results in higher revenue growth.

  • Encourages competitiveness of exports.

State Value Added Tax

VAT and its implementation are confined only to the State. All the States are drafting their separate Value Added Tax Act and as per the present position, every State has their own VAT Act with different provision not parallel with each other. It is proposed that there would be Two tax rate slabs on which tax would be levied. The first one would be 4% and would cover all essential items. The second one is 10% and all luxury items would be covered. In addition special rate slabs are also proposed which are 1% for bullion and jewellery, 20% for Non Essential Goods and exemption to certain goods like agricultural produce etc. Petroleum products are not included in VAT rates. Separate rate would be notified for them.

See Also: History of TAX

Set off in VAT

At present the set off would be available on the goods locally purchased within the State only. No set off would be available to the goods purchased in the course of interstate trade and commerce. It is necessary to produce the tax invoice to claim set off. The tax should have been charged in the invoice.

VAT in India

  • Manufacturer

  • Trader

  • Issue of Invoice

  • Declaration Form

  • Accounting

  • Stocks

  • Capital Goods

  • Export

  • Registration

  • Security Amount

  • Penalties

  • Works Contract and Leasing

Manufacturer VAT

The manufacturer would be required to purchase raw material after paying full tax on the rate applicable on such material. Unlike the present system wherein the manufacturer can purchase the goods at a concessional rate of tax against declaration form, no declaration form will be required to be issued by the Manufacturer. The input tax suffered by him would be adjusted set off from the sale of the finished product. The tax adjustment of input credit of the goods purchased within the State would be available on the sales made within the State and also on the interstate sales subject to the tax payable. No adjustment would be available of the input credit in case of branch transfer, consignment sale.


The trader would be required to collect tax on the sales made by him and the tax liability would be set off which is adjusted from the purchase or input tax credit of the goods purchased locally in that State.

Issue of Invoice

Under the proposed Value Added Tax Act, issue of invoice would be mandatory. No set off input credit would be allowed unless the original tax invoice is produced as tax would be clearly mentioned in the invoice.

Declaration Form

Use of declaration form of purchase of goods on concessional rate of tax or NIL rate of tax under the State Act would be completely over. There would be no requirement of declaration form under the proposed Value Added Tax. However, the Road Permits like ST 18 A and ST 18 C declaration forms ,Declarations forms of CST Act would also continue.


The basic account books which would be required for the purpose of VAT Act are Purchase and Sale Register. The basis for both the registers would be calculation of payment of tax .The normal practice of entering the gross value of Purchase bill would change. The assessee should enter the value of goods in the goods Ac and the amount of tax in the Tax Ac separately.

VAT on Stocks

Stock statements are required to be furnished as prescribed for the quarter ending and monthly from January to March. Set off would be given for tax paid stocks. Tax paid stocks as on March ending would be the basis for claiming set off under the new VAT Act. However, no set off would be available for the tax paid stock purchased before 1.4.2005.

VAT on Capital Goods

Set off would also be available on the tax paid goods at the time of purchase for capital goods under the VAT Act. However, basis of set off is yet to be declared. It is presumed that set off would be available within a span of 3 years from the date of production.

VAT on Export

Tax paid on raw material used in manufacture of goods for export would be refunded by the State Government in cash or adjustment. The exports would become more competitive in the world market as there would be no tax on raw material used for manufacture of goods mainly for export.

VAT on Registration

All Importers, Manufacturers, Exporters and Dealers having CST registration should be registered under the new VAT Act. The existing registered dealers are required to fill a FACT SHEET notified by the department within a stipulated time which is at present 15.02.2006 and then it is not required to seek fresh registration. There would be two types of registration.

  • VAT dealers registration

  • Composition scheme dealer registration 

The dealers opting under composition scheme would not be able to charge tax in the invoice and he would pay lump sum fee as composition. For retail traders, the expected limit of turn over for option under composition scheme is maximum Rs. 15 lakhs.

VAT on Penalties

Penalties had been increased in the new VAT Act. As per discussion, draft on VAT Act circulated, there is emphasis on penalties. 

Works Contract and Leasing

No clarification, provision or guidelines has been issued by the department  on works contract and leasing transaction. The continuation of existing composition scheme or by what method they would be taxed in future has not been informed yet.

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