What is Value-Added Tax?

Value-Added Tax is a type of tax levied in India, which is charged on final goods and services. It is a tax on the sale or purchase of goods, and is collected separately by each State government for the sales made within their State. Hence the rates of VAT may vary between states. However, it still forms an important part of India’s GDP.

Goods and services often go through a long production chain, where value is added at each level. For example, a woodcutter may cut down timber and then sell it to a carpenter. This carpenter will then shape the wood into a chair. After that, he may further sell it to a furniture store, where cushions and linings may be added to the chair. Then, the completed chair will be sold to a consumer. At each stage in this process, certain valueis added to the product. The carpenter adds value to the wood by carving it and then sells it to the furniture store. The price for which he buys the wood will be much lower than the price for which he sells the chair, and this is the measurement of value.

Value Added Tax does not tax the profit, but the value added to the product at each stage of this chain. Hence the tax is multi-staged.The exact VAT to be paid by each intermediary in the production chain is calculated through the following formula:

VAT = Output Tax – Input Tax.

Input tax is the tax that the supplier pays while procuring some sort of good or raw material. For example; the carpenter who purchases the raw wood may be paying Rs. 500 for this wood, out of which the actual cost of the wood is Rs. 450 and the Input tax is Rs. 50. When the carpenter finally sells the furniture, he may sell the chair for Rs. 1000, out of which Rs. 900 is the actual cost of the chair and Rs. 100 is the VAT which he will receive from the furniture shop. This Rs. 100 is the Output tax.

The carpenter will then subtract the tax he paid (Rs. 50 to the woodcutter) from the tax he received (Rs. 100 from the furniture shop owner.) The remaining quantity (Rs. 100 – Rs. 50 = Rs. 50) is the final amount of VAT that he is required to pay. Hence the carpenter is liable to pay a VAT of Rs. 50.

VATis an extremely transparent system since it collects tax from each supplier at every level of the chain and makes compliance easier, as well as reducing the possibility of evasion.The general rule is that any person or firm who earns an annual turnover (sales income) of more than Rs. 5 lakhs by supplying goods or services is required to register and pay VAT. However, since VAT is under individual State governments, the requirements may differ.

Value-Added Tax is  an indirect tax. This means that even though the suppliers/producers of the products are paying the tax, the actual economic burden is on the final consumers of the goods. This means that the last person who purchases the good or service without reselling it is the one who bears the burden. Final consumers pay VAT to the producers/suppliers, who then later pay the same tax to the government. Hence even though the tax is being paid by the producers, they are not the ones actually paying it and the burden is on their customers.

For example:

If the percentage of VAT is 10%, then we can look at the following example.

The woodcutter in this case sells the wood for Rs. 1000, of which 10% is 100. Hence the woodcutter will charge 1100 from the carpenter. The woodcutter pays Rs. 100 VAT from the amount he received from the carpenter, not out of his own profits.

Next, the carpenter may create a chair out of the wood that cost him Rs. 1100. He then sells the good for a price of Rs. 2000, of which 10% is 200. Hence the carpenter will charge 2200 from the customer. He will pay a VAT of (200-100) 100, out of the money he receives from the final customer.

The final customer, here, has paid Rs. 200 VAT. While the woodcutter and the carpenter passed on the burden of their VAT to the next person in the production chain, the final consumer cannot do the same. Hence he bears the burden of the Rs. 200 VAT himself. This is how VAT is an indirect tax, where the tax is paid by the producers but the burden is borne by the final producer.

How VAT is applicable depends on both the State which is levying VAT, as well as the product/service on which it is levied. Certain states have higher VAT rates. Similarly, there are many items on which no VAT is charged such as salt and khadi. Precious stones may have a very low rate of VAT such as 1%. Luxury items often have high VAT rates. These rates are set by the States and vary from time to time.

Author: This blog is written by  Ms. Sweta Pochiraju, student of National Law University-Delhi, a passionate blogger & intern at  Aapka Consultant.

How Aapka Consultant can help you:-

• Get free expert consultancy from experts.
• We available every time to solving your legal queries.
• Get one stop solution for all legal compliances.
• Process application within 24 Hours.
• Trusted by Most Valuable Startups.
• We Understand Startup Budget & their needs.
• Get quality services at pocket price.

Visit: Aapka Consultant to get Online Services of CA CS & Lawyers.