Value Aadded Tax

Dr. Ravikumar G
 The Scenario and Structure of Sales Tax

• The Sales Tax levied by State Government on

intra state sale & purchase transactions

• The Sales Tax levied by Central Government

on inter state sale transactions

 Weaknesses - Taxation Scheme
• Lack of uniformity
• Multiplicity of Rates
• Heavy reliance on first point taxation
• Cascading effect of tax in relation to
manufacturing activity
• Revenue loss due to incentives
• Lack of mechanism for tax compliance
• Lack of transparency in the system
 Reforms Slated
PLAN PARTICULARS STATUS
• Phase I – Uniform Sales Tax Rates of Partially
wef 01.01.2000 commodities in all the States and implemented
Union Territories
– Phasing out all sales Tax based
incentive Schemes

• Phase II – Introduction of Value Added Postponed to

wef 01.01.2001 Tax (VAT) System by all 01.04.2002
states and Union Territories
– for North East States 01.04.2003
• Phase III – Amendments to CST Act so as Postponed to
wef 01.04.2002 to fall in line with VAT system 01.04.2003
with reference to Interstate or thereafter
Sales & Stock Transfers
 VAT
The Concept
 VAT - Definition
As per the European Union:

“Value Added Tax (VAT) is a general

consumption tax assessed on the value
added to goods and services.”
• VAT is an indirect tax which is charged on

the increase in value of goods and services

at each stage of economic activity.

• with provision of set-off of tax paid on

earlier stage.
Evolution of VAT
 Evolution of VAT
• VAT system was introduced in Europe in
early 50’s

• Due to simplicity in its operation and

implementation, it is the most accepted form
of commodity taxation worldwide except in
America & India
Where does VAT exists?

VAT Non VAT

 Value added tax

• Over 130 countries worldwide have introduced

VAT over the past three decades and India is

amongst the last few to introduce it.

• VAT has been introduced in Indian Taxation

System from April 1, 2005.

 Characteristics of VAT
VAT is an indirect tax applied on goods and
services.
VAT is levied on only value addition
 Consumption tax
 VAT is levied on the value of goods and
services at each stage of production until it
reaches the final consumers
 Have option for tax credit
Effective and efficient tool for resources
mobilization
Zero rate is applicable in VAT systems
 VAT is imposed at Import stage, Production
Stage, Wholesale and Retail stage
Have option for exemption of goods (Schedule-
1) and Services (Schedule-2)
 VAT Terminology
Output VAT: Amount received by a seller as a
percentage of the gross sale price of goods or
services

Input VAT:Amount paid by a buyer as a

percentage of the gross purchase price for
goods or services used in production.
Zero Rated:Transactions in which the seller
collects no output tax and the
corresponding input tax is fully refundable.
Exports are zero rated

Exempt :Transactions in which the seller collects

no output tax but the corresponding input tax
is non-refundable and absorbed by the seller.
Financial services are commonly exempt.
 Value Added
Stages Producer Product i/P O/P Value added VAT Excise&Sale

1 Farmer Wheat 10 30 20 2 3

2 Miller Flour 30 40 10 1 4

3 Bakery Cake 40 90 50 5 9

4 Shops Sale 90 100 10 1 10

170 260 90 9 26
Why VAT is popular? State point of View
• Regular stream of income for the State
• Higher revenue for the state
• Full economic Value Addition is taxed
• Low cost of collection
• Ensures self sustaining Audit trail
• Brings the entire trade chain to the books
• Greater emphasis on compliance
 VAT - in a nutshell
In nutshell VAT as it prevails in the world is:
• A tax on all transactions
• Covers goods & Services
• Tax applicable on the gross consideration
• Credit available for tax paid on inputs or at
earlier stages
• Effective tax on value added at each stage
• In most countries VAT replaces all other
Indirect Taxes and exists as National Tax
 How VAT Operates
B C
Manufacturer Wholeseller
Sales Value Rs. 200.00 Sales Value Rs. 300.00
Gross VAT 10%, Rs 20.00 Gross VAT 10%, Rs 30.00
Net VAT Rs 20-10 = Rs 10.00 Net VAT Rs 30-20 = Rs 10.00

A D
Raw Material Producer Retailer
Sales Value Rs. 100.00 Sales Value Rs. 400.00
Gross VAT 10%, Rs 10.00 Gross VAT 10%, Rs 40.00
Net VAT Rs 10.00 Net VAT Rs 40-30 = Rs 10.00

Total VAT Collected at four points Rs 10+10+10+10 = Rs 40

 Methods of calculating VAT
Addition Method Substraction Method Invoice Method
Sales 250 Sales 250 Sales 250
Purchases Purchases VAT on sales @ 10% 25
Raw Material 100 Raw Material 100
Value addition Purchases
Wages (a) 50 Raw Material 100
Rent (b) 50 VAT on Purchases @ 10
Interest (c) 20 10%
Profit (d) 30
Value Added Value Added
(a)+(b)+(c)+(d) 150 Sales - Purchases 150
VAT @ 10% 15 VAT @ 10% 15 VAT (25-10) 15
 VAT
It’s Implications
 VAT - its Implications
• The concept of Resale will be no more valid.
Sales Tax will be applicable on each point of
sale.
• This will lead to minimization of Chain of
Distribution.
• To keep the incidence of VAT to its
minimum, goods will have to be sourced
from Manufacturers.
• The level of Documentation has to be
improved to avail proper credit of VAT paid
on procurement.
 VAT - its Implications
Goods will be cheaper for Manufacturers.
Particulars Before After
VAT VAT
Raw Material 100 100
Purchase Tax 10 10
Landed Cost 110 110
Add Processing cost 50 50
Cost of Manufacture 160 160
Less Setoff / VAT Setoff 6 10
Effective cost of Manufacture 154 150
 VAT - its Implications
There will be no impact of VAT on the
margins of Traders Community.
Particulars Before After
VAT VAT
Purchase Cost 100 100
Purchase Tax 10 10
Landed Cost of Purchases 110 110
Add cost of Distribution & margins 50 50
Sales Price 160 160
Less VAT Setoff 0 10
Effective sales price (Stage I) 160 150
VAT 0 15
Cost to ultimate customer 160 165
 VAT - its Implications
If the VAT set-off is not passed on to the Consumer
Particulars Before VAT After VAT
Manufacturing Cost 154 150
Sales Tax 15 15
Landed Cost for Wholesaler 169 165
Add cost of Distribution & margins 30 30
Cost of Sales for wholesaler 199 195
Add Sales Tax (II sales) 0 (VAT) 20
Landed Cost for Retailer 199 215
Add cost of Distribution & margins 50 50
Cost of sales for Retailer 249 265
Add Sales Tax (II sales) 0 (VAT) 27
Effective Cost for Consumer 249 292
 VAT - its Implications
If the VAT set-off is passed on to the Consumer
Particulars Before VAT After VAT
Manufacturing Cost 154 150
Sales Tax 15 15
Landed Cost for Wholesaler 169 165
Add cost of Distribution & margins 30 30
less VAT Set-off 0 15
Cost of Sales for wholesaler 199 180
Add Sales Tax (II sales) 0 (VAT) 18
Landed Cost for Retailer 199 198
Add cost of Distribution & margins 50 50
Less VAT Set-off 0 18
Cost of sales for Retailer 249 230
Add Sales Tax (II sales) 0 (VAT) 23
Effective Cost for Consumer 249 253
 Indian Experience on VAT
• Modvat for the purpose of Central Excise was
introduced wef 01.03.1986.
• Modvat was replaced by CENVAT in the
budget of 2000 - 01.
• State VAT was introduced in:
– Andhra Pradesh wef 01.04.95
– Maharashtra wef 01.10.95
– Madhya Pradesh wef 01.04.97
• State VAT was subsequently withdrawn by the
states due to non economic consideration
 Why State VAT failed in India
• Multiplicity of Legislation
– Central Sales Tax Act
– State Sales Tax Act
– Entry Tax Act
– Works Contract Tax
– Lease/Hire Purchase Tax Act
– Luxury Tax
– State Excise on Liquor
• Lack of Computerisation in Sales Tax
Administration
• No uniformity in Tax Rates across the states
leading to shift of trade.
 Advantages of VAT:
• Coverage
• Revenue Security
• Co-ordination of VAT with direct
taxation
• Simplification
• Adjustment of tax paid on purchased
goods
• Transparency

• Fair and Equitable

• Procedure of simplification

• Minimize the Discretion

• Computerization
 Coverage
• If the tax is considered on a retail level, it offers
all the economic advantages of a tax of the
entire retail price within its scope.
• The direct payment of tax spreads out over a
large number of firms instead of being
concentrated only on particular groups, such as
wholesalers & retailers
 Revenue Security
• Under VAT only buyers at the final stage have
an interest in undervaluing their purchases, as
the deduction system ensures that buyers at
earlier stages are refunded the taxes on their
purchases.
• Therefore, tax losses due to undervaluation will
be limited to the value added at the last stage
 Co-ordination of VAT with direct
taxation
• Most taxpayers cheat on sales not to evade VAT
but to evade their personal and corporate income
taxes.
• Operation of VAT resembles that of the income
tax and an effective VAT greatly helps in income
tax administration and revenue collection.
 Simplification
• Under the CST Act, there are 8 types of tax
rates- 1%, 2%, 4%, 8%, 10%, 12%, 20% and
25%.
• Under the present VAT system, there would
only be 2 types of taxes 4% on declared goods
and 10-12% on RNR.
• This will eliminate any disputes that relate to
rates.
 Adjustment of tax paid on
purchased goods
• Under the earlier system , the tax paid on the
manufactured goods would be adjusted against
the tax payable on the manufactured goods.

• Such adjustment is conditional as such goods

must either be manufactured or sold.

• VAT is free from such conditions.

 Transparency
• The tax that is levied at the first stage on the
goods or sale or purchase is not transparent.
• This is because the amount of tax, which the
goods have suffered, is not known at the
subsequent stage.
• In the VAT system, the amount of tax would be
known at each and every stage of goods of sale
or purchase.
 Fair and Equitable

• VAT introduces the uniform tax rates across

the state so that unfair advantages cannot be
taken while levying the tax
 Procedure of simplification
• Procedures, relating to filing of returns,
payment of tax, furnishing declaration and
assessment are simplified under the VAT
system so as to minimize any interface
between the tax payer and the tax collector
 Minimize the Discretion

• The VAT system proposes to minimize the

discretion with the assessing officer so that

every person is treated alike.

 Computerization
• The VAT proposes computerization which
would focus on the tax evaders by
generating Exception Report.
• In a large number of cases, no processing or
scrutiny of returns would be required as it
would free the tax compliant.
 Disadvantages of VAT
• VAT is regressive.

• VAT is inflationary.

• VAT is difficult to operate from position of

both administration and business.

• VAT favors capital intensive firms.

 VAT is regressive
• It is claimed that the tax is regressive, i.e.,
its burden falls disproportionately on the
poor since the poor are likely to spend more
of their income than the relatively rich
person.
 VAT is inflationary.
• Some businessmen seize almost any
opportunity to raise prices, and the
introduction of VAT certainly offers such
an opportunity.
Reforms required for success of VAT
• Uniformity in Sales Tax Rates - commodity
wise - across the states
• Minimum No of tax rates
• Amendment of CST Act in the following
areas:
– taxation of Declared goods
– taxation of imports
– taxation of branch transfers