A Detailed Guide to Value Added Tax (VAT)

Money

A Detailed Guide to Value Added Tax (VAT)

By Jupiter Team · · 5 min read

Taxes are important for the economic growth of a country. The money collected as tax is used towards smoothly running the nation without any issues.

While selling goods and services, different types of taxes are levied at various stages. One such tax is the value-added tax, read on to know more about it.

What is value-added tax?

When you buy a product, a special tax is added at every stage in the supply chain whenever some value is added to the item and also at the final stage in the sales cycle.

This tax is categorized as an indirect tax because consumers pay it indirectly to the government while buying different products and services.

Wondering what is value-added tax? Commonly known as VAT, it is a multi-stage tax levied during each stage in the production of products and services involving any sales or purchase.

It is applicable when the goods and services are provided when the buyer and seller are in the same state.

Value-added tax (VAT) rates in India

This tax is levied on the gross margins during the entire sales cycle. It is assessed and collected at every point beginning with the manufacturer and ending with the products reaching the retailer.

The multi-stage tax has a provision to collect tax on purchase at every stage and eliminates tax-on-tax.

The rules and guidelines regulating VAT in India vary between states and it is collected by the state governments. This indirect tax is categorized under four heads as listed below:

Nil

Exempted goods and services generally basic items like salt or khadi sold in the unorganized sector

1%

Levied on expensive goods like precious stones, silver, gold, and others

4% - 5%

Products used in day-to-day lives like medicines, cooking oils, and tea

General

All items listed in the general category are charged at 12% - 15% tax 

How is VAT calculated?

Since VAT is an indirect tax paid to the state governments, an accurate calculation for a clear and transparent procedure is important. The tax is calculated as the difference between the output and input taxes.

Input tax is paid by the sellers for procuring the necessary raw materials. And output tax is paid to the seller at the time of the sale.

Here is an example to understand the calculation of this indirect tax.

Assume that you paid INR 5 lakhs for buying raw materials for your products and the input tax was levied at 10%. This means you paid INR 50,000 as the input tax.

You sold the goods for INR 7.50 lakhs and the output tax is payable at 10% of the total income. Therefore, the output tax is INR 75,000.

The VAT is the difference between the two, which comes to INR 25,000 (75,000 – 50,000), which is payable to the government.

What are the features of VAT?

This tax is not voluntary, but it is an important component of the overall tax structure in the country. The features of this indirect tax are as follows:

  • Since it is levied at various stages in the sales cycle, the possibility of any errors is reduced.
  • Any type of tax fraud can be avoided because it is a mule-stage tax levied at each level of the cycle.
  • It provides a transparent and uniform tax structure.
  • Similar goods manufactured by different companies are taxed at the same rates, which increases the acceptance level among the taxpayers.
  • With transparency, the possibility of evading tax is almost negligible.

VAT registration: Online procedure

  • Visit the official website of the National Portal of India and once you log in, click the registration tab.
  • Fill in the relevant information and attach scanned copies of the necessary documents.
  • The company is provided with a temporary registration number.
  • Once the information and documents are successfully registered, the company is provided with a permanent VAT registration number.

Documents required for VAT registration in India

  • Permanent Account Number (PAN) card copy
  • Identity proofs of the promoters
  • Address proof for the business
  • An additional security deposit or surety

VAT collection in India

Companies with an annual turnover exceeding INR 5 lakhs are qualified to implement this indirect tax. The collection of this tax is classified under the following four categories.

Account-based collection

  • Tax is calculated based on the value addition and not on the sale value.
  • It is determined by calculating the difference between allowable purchases and revenue.

Invoice-based collection

  • The tax is calculated based on the sale value.
  • Sellers provide the buyers with accurate details on the tax collected.

Accrual-based collection

  • The tax is collected on the basis of its collection.
  • It is a slightly complex method as the revenue when earned is matched with the expenses when incurred.

Cash-based collection

  • Simple method where tax is determined based on cash transactions rather than the invoices.
  • The date of receipt of funds is recorded on the day the money is actually received and not when the sale occurs.

Difference between VAT and sales tax

  • VAT is computed at every stage and collected from the producers and the customers while sales tax is collected only from the consumers.
  • The former is generally levied at lower rates when compared to the latter.
  • For claiming input tax, VAT ensures more accurate invoicing than sales tax.

How is VAT beneficial?

Trade

Uniform rates increase trade and self-assessment reduces the need for taxpayers to visit the tax department.

Government

Since producers self-assess the tax liability, the government requires fewer resources, and the revenue department can focus on collection instead of spending time on administrative activities.

Customers

Eliminating tax-on-tax ensures the end-users pay lower prices for the products and services.

VAT implementation in India

This tax is implemented by state governments and levied at various levels of manufacturing goods and services. However, the rules and regulations vary from one state to another.

Each state levies its own guidelines for VAT payments and implementation. Based on the different rules, regulations, and guidelines, there are four rates that are applicable, which are nil, 1%, 4%-5%, and general rates (which have been discussed above).

Frequently Asked Questions (FAQs)

What is value-added tax?

It is an indirect tax levied on goods and services. It is paid to the government by the manufacturers while the actual tax is paid by the consumers who buy the goods and services.

Does the government receive VAT paid by consumers?

Yes, the state governments collect VAT payments online or offline based on the respective guidelines and then pay them to the Central Government.

Is VAT levied on all goods and services?

No, several state governments do not levy this indirect tax on necessary items like salt, jute, and khadi often sold in the unorganized sector.

Is the VAT compliance rate higher than sales tax?

Yes, since this tax is levied at every stage during the production cycle, the possibility of benefiting from any loopholes is lesser when compared with sales tax where the chances of tax evasion are slightly higher.

Does VAT increase the cascading effect of taxes?

No, it reduces the possibility of any cascading effect as the required indirect tax is levied at every stage of the production cycle.

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