Value Added Tax

What is value added tax (VAT)?

Value Added Tax (VAT) is an indirect tax levied on the incremental value added to goods or services at each stage of production, distribution, and sale. Unlike older sales tax regimes, where the same value could be taxed repeatedly at every stage, VAT ensures that only the “value-added” is taxed at every stage of the supply chain.

VAT creates a transparent taxation system ¹². VAT ensures that the tax is ultimately borne by the end consumer. Value added tax prevents double taxation¹ and ensures a fair and transparent taxation process.

Why was VAT introduced in India?

In 1995, the Union Government decided to replace the General Sales Tax (which was in place since 1957) with a Value Added Tax system. The goal of introducing VAT was to improve tax administration, ensure fair competition, and reduce the overall tax burden by removing multiple taxation points⁸.

VAT was introduced to make the tax system simpler and more transparent, benefiting the government, businesses, and the general public. Instead of tax authorities conducting annual assessments, dealers would now assess their own taxes, with the Commercial Taxes Department checking for accuracy through audits when needed⁸

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Before the introduction of Value Added Tax (VAT), India followed a sales tax regime that had several drawbacks. Tax cascading was a major issue, as taxes were applied on already taxed amounts, inflating costs. The system also lacked uniformity, with different states imposing varying sales tax rates, leading to inconsistencies and inefficiencies. Additionally, the process was opaque, offering little transparency to consumers and businesses⁴

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What does VAT look like today in India?

While GST has replaced VAT for most goods and services, certain sectors remain outside GST’s purview. Value added tax continues to apply to these sectors: ²

1. Petroleum products:

   Items like petrol, diesel, and natural gas are taxed under VAT by individual states, as they are excluded from GST. Each state sets its own VAT rates for these products.
   

2. Superior Kerosene Oil (SKO):

   SKO has also moved under the purview of 5% GST¹⁰.
   

3. LPG:

   The Government removed VAT from LPG on 1st January 2025⁷. There is a 5% GST¹⁰

   For consumers, this means that while most goods and services are now covered under GST, if you’re buying petrol, diesel etc you’re still dealing with VAT. For businesses in these sectors, understanding and complying with VAT rules remains important.

Challenges of VAT

While VAT has many benefits, it also comes with its share of challenges, both for businesses and consumers. Here are some of the key issues associated with value added tax:

1. Compliance responsibility:

   Managing detailed paperwork, invoices, and Input Tax Credit (ITC) claims can overwhelm businesses, especially smaller ones. Delays in credit processing also strain cash flow.

2. Regional differences:

   Different VAT rates, exemptions, and the lack of a unified mechanism for inter-state trade lead to pricing inconsistencies and higher costs for businesses operating across states. ²

3. May have Risk of tax evasion:

   Limited enforcement in the informal sector creates opportunities for tax flexibility, which can impact government revenue¹¹.

Conclusion

Summing up, having a good understanding of value added tax can help you make better decisions about how much you’re paying and how taxes affect prices. Instead of seeing VAT as outdated, use this knowledge to manage your expenses smartly and plan ahead. Understanding how VAT works may seem irrelevant, but recognising its ongoing relevance to fair and transparent taxation is essential.

FAQs

1. How does VAT work?

   ⁹
   

   Take a look at the steps of how VAT works:

   • Step 1:

     VAT is collected at every stage of the supply chain (manufacturing, wholesale, retail) based on the value added.

   • Step 2:

     Businesses can claim credit for the VAT that is already paid at earlier stages. This process ensures that only the net value added is taxed.

   • Step 3:

     While businesses collect and remit VAT, the ultimate tax burden falls on the end consumer.

   
   

2. Are GST and VAT the same?⁶

   
   

   Both Good And Services Tax and VAT are important taxes but are different. GST is applicable to goods and services and their supply. On the other hand, value added tax is applicable on the sale of goods at the time of sale. While VAT is different in each state, GST rates are uniform all over the India.

References:

1.https://www.munich-business-school.de/en/l/business-studies-dictionary/financial-knowledge/vat

2.https://ppac.gov.in/prices/vat-sales-tax-gst-rates

3.https://cleartax.in/s/gst-input-tax-credit

4.https://epwrf.in/includefiles/c10552.htm?t&utm

5.https://cleartax.in/glossary/value-added-tax-vat

6.https://cleartax.in/s/differences-between-gst-and-vat

7.https://x.com/ZimTreasury/status/1884979125334503487/photo/1

8.https://cag.gov.in/uploads/StudyReports/SR-StudyReports-05de75c18e2e379-28804851.pdf

9.https://cag.gov.in/uploads/media/Manual-on-VAT-20200914191313.pdf

10.https://ppac.gov.in/prices/vat-sales-tax-gst-rates

11.https://www.investopedia.com/terms/v/valueaddedtax.asp#:~:text=Cost%20of%20Doing%20Business%20May,additional%20cost%20to%20the%20consumer.

12.https://www.stockgro.club/blogs/personal-finance/understand-the-basic-concepts-of-vat/#:~:text=VAT%20is%20collected%20at%20multiple,is%20both%20transparent%20and%20uniform.