What is Value Added Tax (VAT)?

If you are not aware of the Value Added Tax (VAT), first thing you can do is when ever you go for shopping, please read your bills carefully. There should be one extra component “VAT” at the end of the bill which is added with some specific percentage mentioned in the bill. After 50 years of independence, it is one of the major change in the tax system in India. Value Added Tax (VAT) is introduced in the year of 2005.

Earlier this tax is known as sales tax and there is lot of complication on implementing the sales tax. Sales Tax is collected on each state and it is not uniform across the states, it leads to double taxation and difficult for the traders to move the goods across different states. After the arrival of VAT, it become uniform across the states to use the same tax system. This article explores VAT and how it is calculated. If you are interested in receiving the articles update, please subscribe here or link our facebook fans page.


What is VAT?

Value Added Tax (VAT) is earlier known as Sales Tax. This tax is imposed on consumers. It is one type of indirect tax collected by government. Whatever the applicable taxes are applied to the goods till it reaches to the customers, will be collected from the consumers. This tax is collected by the seller or trader from the customers and paid to the state government which the customer bought the goods. Over 120 countries in the world have already introduced VAT and Indian has recently launched this system.

VAT in India is levied at two levels. One is at centre and another one is at state level. Central Value Added Tax (CENVAT) is levied at 12%. Also this rate would vary for some other products.

There would be two basic slabs of 4 percent 12.5 percent in which most of the goods will get covered. Apart from this a very few items shall have 1% and 20% tax rate. Essential items like foodgrains etc. shall be exempt.

How VAT Works?

It is little difficult to understand how VAT works. There are two major components involved in the VAT is Input tax and Output tax. As we have understood from the explanation, VAT is collected by the supplier and paid by the purchaser at every stage. Whenever there is a trading, it happens to be adding the VAT at every stage. The below example would provide some clarity of the VAT tax system.


VAT Input Tax & Output Tax

Input is normally goods purchased for running a business or manufacturing. While business purchases raw materials for manufacturing the goods it has to pay the VAT for the purchased goods. This is known as the Input tax to the trader. This amount is an expenses for the business owner and would recover from the consumers by selling goods.

For VAT, trader has to maintain two books of account which is Sales Book and Purchase Book. This book is important for the trader to submit the balance tax to the government. The following is the formula for paying the VAT to the government.

VAT = Output Tax – Input Tax

If there is any excess amount or balance after deducting the input tax from the output tax is paid to the government. In cases where input tax is higher, the difference is carry forward to the next year for the adjustment. In some business govt. approves the carry forward with reasons.

Misuse of VAT

VAT is most reliable tax system compare to the sales tax which is used prior to the VAT. However, traders can misuse this tax system to increase the price of goods. Also there are many traders not aware of calculating the VAT and charges more than  needed for a product which means consumers has to pay more to buy a product.

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