TAX LAW - II

ASSIGNMENT ON :

Background and
Concept
of VAT,
Advantages of VAT.
SUBMITTED TO:
Maam Raveena Naz
SUBMITTED BY :
Ishraque Zeya Khan
B.A.,LL.B. (H.)
SEMESTER VII
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ACKNOWLEDGEMENT
I have successfully completed my Tax Law project with lots of learning
experience.

I would like to extend my gratitude towards my concerned teacher, Maam

Raveena Naz, for providing us the basic guidelines and for providing me her
helping hand whenever necessary.

Last but not the least, i would also like to thank my friends without whose
suggestions my assignment would have been an incomplete one.

-ISHRAQUE ZEYA KHAN

CONTENTS

Introduction
Statement of Problem
Research Objectives
Research questions
Significance of the study
Background and concept of VAT
- History
- At central level
- At state level
- VAT rates in India
- How to calculate VAT
- Methods of calculating VAT
Advantages of VAT
Disadvantages of VAT
Conclusions and Findings
References

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INTRODUCTION
VAT (Value Added Tax) is a form of indirect tax imposed only on goods sold within a
particular state, which essentially means that the buyer and the seller needs to be in the same
state. Only when tangible goods and products are sold, VAT can be imposed.
Value Added Tax or VAT is a broad based tax levied at multiple stage with tax on inputs
credited against taxes on output. The origin of VAT can be traced as far back as the writing of
F V on Siemens, who proposed it in 1919 as a substitute for the then newly established
German turnover tax. Since then numerous economists have recommended it in different
contexts.
VAT is a tax, which is charged on the increase in value of goods and services at each stage
of production and circulation. It is also chargeable on the value of all imported goods. It is
charged by registered VAT businesses/persons/taxpayers. VAT has replaced a number of other
taxes and its introduction has not resulted in either increased prices to final consumers or
reduced profitability of business. VAT is levied on the difference between the sale price of the
goods produced or the services rendered, and the cost thereof that is, the difference between
the output and the input.

STATEMENT OF PROBLEM
The issue of this research is Background and concept of VAT and its advantages. The
research helps in understanding the origin of the concept of VAT, how it has solved the
problems of taxation and the benefits of VAT.

RESEARCH OBJECTIVES

To understand why VAT has been introduced.

To understand why VAT is necessary.
To learn to calculate VAT.
To learn the benefits of VAT.

RESEARCH QUESTIONS

Why VAT has been introduced?

Is VAT a State or a Central subject?
How VAT helps to avoid double taxation problems?
How to calculate VAT?
What are the advantages of VAT?

SIGNIFICANCE OF THE STUDY

The significance of this study is to learn that how VAT was introduced in the Indian Sales Tax
Structure. It helps us to understand what is meant by VAT and how to calculate it. The study
also mentions the advantages and disadvantages of VAT.

BACKGROUND AND CONCEPT OF VAT

One of the important components of tax reforms initiated since liberalization is the
introduction of Value Added Tax (VAT). Value-Added Tax, one of the most radical reforms
proposed for the Indian economy, could finally become a reality after years of political and
economic debate. Introduction of State VAT is an important and recent reform measure at
State level. The State VAT has replaced the earlier Sales Tax systems of the States. VAT or
Value Added Tax was introduced into the Indian taxation system from 1st April 2005.
VAT is a multi-point destination based system of taxation, with tax being levied on value
addition at each stage of transaction in the production/ distribution chain. The term 'value
addition' implies the increase in value of goods and services at each stage of production or
transfer of goods and services. This is a kind of consumption tax which get imposed on
products or services at different stages of manufacturing and at final sale. This is a multipoint process of levying tax on value addition which is collected at different stages of sale
with a provision for set-off for tax paid at the stage of tax paid on purchase. So VAT is a tax
to be paid at every stage of transaction of Purchase and Sale.
Let us take an EXAMPLE:

Lets say, when a refrigerator is manufactured by a company the manufacturer requires

various raw materials and parts. For this he has to buy the raw materials and parts from other
various suppliers When the supplier sends these raw materials and parts to the manufacturer,
the manufacturer get charged a value-added tax on all of these supplies from the suppliers for
producing the refrigerator. Once the refrigerator is completely built and reaches to the
showroom, the consumer who purchases it must pay the value-added tax that applies to
him/her.
If we look at from the point of a buyer, VAT it is the tax on the purchase price, but if we look
through the point of a seller, this is the tax on the value added to a product (as per above
example,

value

added

by

suppliers for

making

of

refrigerator),

material,

or

service received from the suplier or distributor. The manufacturer remits to the government
the difference between these two amounts, and retains the rest for themselves to offset the
taxes they had previously paid on the inputs.
VAT is a tax on the final consumption of goods or services and is ultimately borne by the
consumer. It is a multi-stage tax with the provision to allow 'Input tax credit (ITC)' on tax at
an earlier stage, which can be appropriated against the VAT liability on subsequent sale. 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. It is given for all manufacturers and
traders for purchase of inputs/supplies meant for sale, irrespective of when these will be
utilised/ sold. The VAT liability of the dealer/ manufacturer is calculated by deducting input
tax credit from tax collected on sales during the payment period (say, a month). If the tax
credit exceeds the tax payable on sales in a month, the excess credit will be carried over to
the end of next financial year. If there is any excess unadjusted input tax credit at the end of
second year, then the same will be eligible for refund.
VAT is basically a State subject, derived from Entry 54 of the State List, for which the States
are sovereign in taking decisions. The State Governments, through Taxation Departments, are
carrying out the responsibility of levying and collecting VAT in the respective States. While,
the Central Government is playing the role of a facilitator for the successful implementation
of VAT, the Ministry of Finance is the main agency for levying and implementing VAT, both
at the Centre and the State level.
In India's prevalent sales tax structure, there have been problems of double taxation of
commodities and multiplicity of taxes, resulting in a cascading tax burden. For instance, in
this structure, before a commodity is produced, inputs are first taxed, and then after the
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commodity is produced with input tax load, output is taxed again. This causes an unfair
double taxation with cascading effects. Hence, the VAT has been introduced to replace such
sales tax structure. Moreover, it seeks to phase out the Central Sales Tax (CST) and several
efforts are being made in this regard.
CENTRE
At the Central level, there is Central Value Added Tax (CENVAT) which pertains to the
rationalisation of Central excise duty structure in India. At present, there is a uniform rate of
CENVAT of 16 per cent on most of the inputs and final products. The CENVAT has been
introduced to end all the disputes that were taking place due to classification of various types
of inputs as rates were different on different varieties. Accordingly, the CENVAT Credit Rules
have been notified and amended, from time to time, which are as follows:The Cenvat Credit Rules, 2004
The Cenvat Credit Rules, 2002
The Cenvat Credit Rules, 2001
Under these, a manufacturer or producer of final products and a provider of output service is
allowed to take credit (known as CENVAT credit) of the duty of excise, as mentioned in the
Rules, paid on specified inputs and capital goods used in or in relation to the manufacture of
specified final products. The CENVAT credit so allowed can be utilized for payment of :- (i)
any duty of excise on any final product; or (ii) an amount equal to CENVAT credit taken on
inputs, if such inputs are removed as such or after being partially processed; or (iii) an
amount equal to the CENVAT credit taken on capital goods, if such capital goods are
removed as such; or (iv) service tax on any output service, as per the conditions laid down in
the rules. In the latest budget, it is proposed to reduce the general CENVAT rate on all goods
from 16 per cent to 14 per cent in order to give a stimulus to the manufacturing sector.
STATE
At the State level, the Empowered Committee of State Finance Ministers have finalized a
design of VAT to be adopted by all the States/ UTs. This basic design of VAT retains the
essential features of VAT and keep them common for all the States/ UTs, like, the rates of
VAT on various commodities are kept uniform for all. At the same time, it provides a measure
of flexibility to the States/ UTs so as to enable them to meet their local requirements.

At present, there are 2 basic rates of VAT, namely, 4 per cent and 12.5 per cent, besides an
exempt category and a special rate of 1 per cent for a few selected items. The items of basic
necessities and goods of local importance (upto 10 items) have been put in the zero rate
bracket or the exempted schedule. Gold, silver and precious stones have been put in the 1 per
cent schedule. There is also a category with 20 per cent floor rate of tax, but the commodities
listed in this schedule are not eligible for input tax rebate/set off. This category covers items
like motor spirit (petrol, diesel and aviation turbine fuel), liquor, etc. Some of the other
features of VAT in the State (as finalized by the Empowered Committee) are:As per provision for eliminating the multiplicity of taxes, all the State taxes on purchase or
sale of goods (excluding Entry Tax in lieu of Octroi) are required to be subsumed in VAT or
made VATable.
A provision has been made for allowing 'Input Tax Credit (ITC)' which is the basic feature of
VAT. However, since the VAT being implemented is intra-State VAT only and does not cover
inter-State sale transactions, ITC is not to be available on inter-State purchases.
Haryana became the first State in the country to introduce Value Added Tax (VAT). Till 2007,
VAT has been introduced by more than 30 States/UTs, including Tamil Nadu (implemented
VAT from January 1, 2007) and the UT of Puducherry (implemented VAT from April 1,
2007). From January 01, 2008, the Government of Uttar Pradesh has made VAT effective in
the State. Some of the other States/ UTs which have implemented VAT are:- Andhra
Pradesh, Chhattisgarh, Delhi, Goa, Gujarat, Jammu and Kashmir, Jharkhand, ,
Odisha, Rajasthan, West Bengal .
Over the years, the experience of implementing VAT in India has been very encouraging, with
the Empowered Committee constantly reviewing the progress of implementation. The
revenue performance of VAT-implementing States/UTs has also been very significant. During
2006-07, the tax revenue of the 31 VAT States/UTs had collectively registered a growth rate
of about 21 per cent over the tax revenue of 2005-06. During 2007-08, the tax revenue of 32
VAT States/UTs showed a further growth of 14.6 per cent during the first six months of 200708 (April-September) as compared to the corresponding period of last year.

VAT RATES IN INDIA

The VAT Rates in India will differ based on the type of goods and from State to State.
However, VAT Rates in India can be divided into three main categories, which are common
for many states:

1. VAT Exempted Category / NIL VAT Rate

In many states, items that are sold by the unorganized sector in natural or unprocessed format
and basic goods for the poor are listed under the VAT exempted category. Some of the items
that may be VAT exempt in many state include: aids used by handicapped persons, glass or
plastic bangles, condoms, firewood, khadi, salt, etc.,
2. 1% VAT Rate
In many states, 1% or 2% VAT Rate is applied for precious stones, precious metals like silver,
gold and platinum, bullions, jewellery, etc.,

3. 4% or 5% VAT Rate
Many states have adopted a VAT Rate of 4% or 5% for a large number of basic necessity
goods. Some of the goods included in this category in many of the States include coffee, coir,
cotton, edible oils, medicines, drugs, agricultural implements, etc.,

General VAT Rate

In addition to the above VAT Rates, many states also have other levels of VAT based on the
Goods. Very high VAT Rate of over 20% is usually levied for goods such as imported liquor,
cigarettes, etc., Many states also have a General VAT Rate of around 12.5% which is meant as
a catch-all for goods not falling in any of the listed category. This category of goods not
falling in any of the other category are usually taxed at 12.5% or 13.5% or 14% depending on
the State.

HOW TO CALCULATE VAT?

Value Added Tax, which is a form of indirect tax paid to the government by the
producer/manufacturer, and the cost is passed on to the consumer. It is the consumer who has
to finally pay for VAT. The value added to any product may be calculated as the sales price
minus the cost of supply and the other taxable items.
The VAT charged on the purchase of the goods from the supplier by the manufacturer is
called the Input Tax and the the VAT chargeable on the sale of the goods to the customer is
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known as Output Tax. The goods purchase price would include an Input Tax paid at the time
of purchases from the supplier. Similarly, the goods sale would also include an Output Tax
collected at the time of sales to the Customer.
So, VAT would be calculated on the difference between the Output Tax collected at the Time
of Sales and the Input Tax paid at the Time of Purchases.

In short,

Value Added Tax (VAT) = Output Tax Amount Input Tax Amount

METHODS OF CALCULATING VAT

There are mainly two methods of calculation of VAT;
1. In the first method, tax is charged separately 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).
Therefore, the difference between the tax paid on purchase and the tax payable on sale
as per the invoice is the VAT.
2. In the second method, tax is collected and charged on the aggregate value of the tax
payable on sale and purchase, by applying the rate of tax applicable to the goods.
Therefore, the difference between the sale price and purchase price would be VAT. It
means VAT is the tax which consumers ultimately face, which is collected at each
stage.

ADVANTAGES OF VAT

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The main motive of VAT has been the rationalisation of overall tax burden and reduction in
general price level. Thus, it seeks to help common people, traders, industrialists as well as the
Government. It is indeed a move towards more efficiency, equal competition and fairness in
the taxation system.
The main benefits of implementation of VAT are: Minimizes tax evasion as VAT is imposed on the basis of invoice/ bill at each stage, so
that tax evaded at first stage gets caught at the next stage;
Abolishes multiplicity of taxes, that is, taxes such as turnover tax, surcharge on sales
tax, additional surcharge, etc. are being abolished;
Replaces the existing system of inspection by a system of built-in self-assessment of
VAT liability by the dealers and manufacturers (in terms of submission of returns

upon setting off the tax credit);

Tax structure becomes simpler and more transparent;
Effective Audit & Enforcement Strategies;
Improves tax compliance;
Minimum Exemptions;
Generates higher revenue growth;
Removal of Anomaly of First Point Taxation;
Promotes competitiveness of exports; etc.

DISADVANTAGES
The limitations of VAT are discussed hereunder.
Detailed Records:. Many small dealers maintain only primitive accounts and it is
very difficult for them to keep proper and detailed records required for VAT purposes.
Causes Inflation:
Increase in Investment:
No Credit for Tax paid on Interstate Purchases: The biggest problem of
introduction of VAT is the non-availability of credit for tax paid on interstate
purchases in initial years.

CONCLUSION AND FINDINGS

Value-Added Tax (VAT) is a tax on the consumption of products, Designed to incrementally
tax the value that is added to products throughout the production process, VAT is referred to
as an indirect tax because it is typically collected by intermediaries (e.g. manufacturers,
retailers, etc.), rather than collected directly by the government.
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Following are the findings from this research:

VAT or Value Added Tax was introduced into the Indian taxation system from 1st
April 2005.
VAT is a tax to be paid at every stage of transaction of Purchase and Sale.
VAT is a tax on the final consumption of goods or services and is ultimately borne by
the consumer.
VAT can be imposed only when tangible goods and products are sold.
VAT is basically a State subject, derived from Entry 54 of the State List, for which the
States are sovereign in taking decisions.
VAT Rates in India can be divided into three main categories: NIL NAT rate, 1% VAT
rate, 4 or 5% VAT rate.
Value Added Tax (VAT) = Output Tax Amount Input Tax Amount.
There are various benefits and limits of VAT (mentioned above).
To implement VAT successfully, customers need to be conscious, otherwise tax
evasion will be widespread.

REFERENCES
BOOKS:
Taxmanns Central Sales Tax Law and Practice by V.S.Datey
Textbook on Indirect Taxes by Dr. Ravi Gupta

INTERNET:

www.allindiantaxes.com/vat.php.
www.indiafilings.com
www.rediff.com.
persmin.gov.in/otraining/UNDPProject/undp.../vat%20module.PDF.
accountlearning.blogspot.com/.../advantages-and-disadvantages-of-value.

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