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Value Added Tax

Taxes can be confusing, especially for first-time filers. This article explains key concepts of the Indian tax system, focusing on the Income Tax Act of 1961 and Value Added Tax (VAT). It covers important definitions, taxable income types, and who needs to pay taxes. The article also discusses how VAT works, its calculation, and its recent replacement by GST for most goods and services. ...Read More

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What is VAT?

What is Value Added Tax (VAT)?

What is Value Added Tax (VAT)?
January 11, 2025

Table of Content

 

HDFC Life explains definition and meaning for Service Tax which is a type of indirect tax collected by the Indian Government.

What is VAT?

VAT or Value Added Tax is a type of tax that is charged by the Central Government on the sale of services and goods to the consumers. VAT is paid by the producers of services and goods, but it is finally imposed on the consumers who purchase the services and goods when they pay for it.

What is VAT registration?

Registration of VAT is mandatory for all manufacturers who are solely involved in the production of goods and services. The registration process means listing the company with the Government as a corporation eligible for return of VAT. Sales tax and VAT are different, the former is charged only when the end user purchases the services or goods, whereas VAT is applicable at different stages of the production process, which is also known as a multipoint tax. According to the VAT registration Act, it’s mandatory for all business organizations to be registered for VAT payments. With the advent of Digital India, VAT registrations can be done online too and is proving to be a boon to business entrepreneurs as it’s convenient and time-effective.

VAT has been subsumed into Goods & services Tax with effect from 1st July 2017. Only a few items like alcohol for human consumption, petroleum products etc, are still governed under the VAT law.

Value Added Tax - Meaning and Definition

VAT, also known as Value Added Tax, is a type of consumption tax that is imposed on sale of goods and certain services at different stages of the supply chain, starting from the production phase and continuing until the final sale. The VAT amount paid by the taxpayer is determined by subtracting any previously taxed material costs from the overall product cost.

For example, if a manufacturer sells goods to a retailer for Rs 100 with a 10% VAT, the manufacturer pays Rs 10 to the government. Similarly, when the retailer sells the goods to a consumer for Rs 150 with a 10% VAT, the consumer pays Rs 165. The retailer pays  Rs 5  to the government after claiming Rs. 10 as the input tax credit.

How VAT Works

Value Added Tax (VAT) is the tax imposed on the gross sale price of a product at every stage of its production, distribution, and sale. Each step is evaluated and taxed.

VAT vs. Sales Tax

The main difference between Value Added Tax (VAT) and a sales tax is how and when the tax is paid. In a sales tax system, the tax is paid by the retail customer at the initial sale, whereas VAT is collected and remitted to the government at each value addition or sale. This difference in payment structure affects the timing and responsibility for paying the tax.

As an example, let's assume that India has a 10% VAT:

The farmer sells wheat to the baker for Rs 30, including a Rs 3 VAT. The baker then sells a loaf to the supermarket for Rs 70, including Rs 7 VAT. The baker remits a total of Rs 4 to the government, which includes the Rs 3 from the farmer's VAT. Suppose a supermarket sells bread for Rs 110, Rs 3 of that amount goes to the government.

The VAT, or value added tax, is distributed throughout the supply chain, with the farmer contributing Rs 3, the baker Rs 4, and the supermarket Rs 3. This means that the government ultimately receives a total of Rs 10 on a Rs 100 sale, even though it is collected in different increments along the way. 

VAT in India has advantages such as easier tracking as the tax at each production step is precisely known, while a sales tax collected after the sale poses challenges in allocation to specific production stages. The VAT also prevents double taxation by only taxing value additions.

Advantages and Disadvantages of VAT

Advantages

Disadvantages

A VAT would close tax loopholes by replacing other taxes, such as income tax.

Businesses are faced with higher costs due to VAT.

In comparison to a progressive income tax, VAT offers a greater incentive for people to earn more income.

There is a possibility that it can encourage tax evasion.

 

Passing along of costs results in higher prices, especially for consumers with low incomes.

How is VAT Calculated?

There are two components to VAT, namely:

  • VAT on output
  • VAT on input

VAT = Output Tax - Input Tax

VAT, which stands for Value Added Tax, consists of two main elements: the tax charged on the sales made by the dealer, known as output tax, and the tax paid on the purchases made by the dealer, known as input tax. The dealer, whether they are a manufacturer, wholesaler, or retailer, must register for VAT if their sales exceed a certain threshold. Once registered, the dealer is required to calculate and report their VAT liability for each tax period, typically on a monthly basis.

Procedure for VAT Online Registration?

Once you log in to the official VAT website, navigate to the registration tab and provide all the necessary information. Make sure to upload scanned copies of the required documents. Upon successful verification, your company will be assigned VAT registration number.

How Does VAT Benefit Government, Trade, and Consumers?

  • Consumers: Removal of tax on tax reduces the cost of goods for end consumers
  • Government: VAT has made the tax administration effective for government as dealers conduct self-assessments under VAT, so the revenue department can focus more on collection than administrative tasks.
  • Trade: Trade is enhanced by uniform VAT rates, and taxpayers can self-assess their taxes more easily.

What is VAT registration procedure?

In India, the  Income Tax  credit system is used to asses and collect VAT. The value ranges from 4% to 12.5% for different categories of products and services. Following are the basic steps required for VAT registration -

Online procedure for registration

  • The application required for VAT registration must be filled completely with proper information and submitted to your local VAT office along with all the required documents
  • Post submission of documents and application, the VAT office will conduct a thorough inspection of the premises. This will be done within 3 days of submission
  • Following approval of inspection, a deposit fee will be have to be paid to the VAT office
  • After paynment, a TIN number will be allotted and within a day the VAT certificate will be issued
  • Login to the official VAT website and click on the registration tab
  • Fill in your relevant details and also attach scanned copies of essential documents
  • The corporation may be allotted with a temporary VAT registration number
  • After verification of your application and documents, a permanent VAT registration number will be assigned to your company

Value Added Tax (VAT) Frequently Asked Questions (FAQ)

1. What is VAT and GST?

VAT (Value Added Tax) and GST (Goods and Services Tax) are consumption taxes applied at every stage of the supply chain, ensuring transparency and preventing multiple taxes. They aim to shift the final tax burden to the end consumer, making revenue collection on goods and services more efficient. However, with the implementation of GST with effect from 1st July 2017 VAT on goods (excluding alcohol for human consumption, petroleum products etc) is subsumed under GST.

2. How VAT is calculated? 

VAT (Value Added Tax) is calculated at each stage of the supply chain of a product or service by applying the designated percentage rate. Throughout the production and distribution process, the tax is levied on the incremental value that is created at each step. At the end of the supply chain, the final consumer pays the cumulative VAT incorporated into the product or service price. Understanding VAT is crucial, but it's equally important to be aware of your income tax obligations. Utilize an income tax calculator to get a clear picture of your tax liabilities.

3.  When did VAT start in India?

The Value Added Tax Act (and associated VAT rules) came into effect in many Indian states beginning April 1, 2005. Gujarat, Rajasthan, Madhya Pradesh, Uttar Pradesh, Jharkhand and Chhattisgarh initially excluded themselves from the VAT, but later adopted it. Each state has its own VAT legislation, rates, taxable base, and taxable goods list.

4.  Is VAT Legal in India?

VAT is still applicable in India after the implementation of the Goods and Services Tax (GST) on certain goods such as alcohol for human consumption, petroleum products etc.

Summary

A value added tax, also known as a VAT, is a widely used type of consumption tax that is applied at each stage of a product's production, starting from the sale of raw materials to the final purchase made by a consumer. It is imposed by more than 175 countries globally including India, making it one of the most prevalent forms of taxation on goods and services around the world.

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Francis Rodrigues Francis Rodrigues

Francis Rodrigues has a decade long experience in the insurance sector, and as SVP, E-Commerce and Digital Marketing, HDFC Life, manages the online sales channel, as well as digital and performance marketing. He has had hands-on experience in setting up sales channels and functional teams from scratch over a career spanning 2 decades.

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Note - Tax benefits & exemptions are subject to conditions of the Income Tax Act, 1961 and its provisions. Tax Laws are subject to change from time to time. Customer is requested to seek tax advice from his Chartered Accountant or personal tax advisor with respect to his personal tax liabilities under the Income-tax law.

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