In India the Tax regime of indirect taxation was ruled by the Sales tax as the Final tax to the consumers on sales of goods. But a lot of problems were attributed the sales tax system. The world recognized a new principle called VAT that is Value Added Tax. Initially a lot of protests were held by businessmen and consumers as they felt it would lead to cascading effect. But later on when the government explained the concept very clearly then the protests died down. Through VAT a lot of goods which escaped tax net were brought into it and thus it helped government ramp up its revenues.
What is VAT?
A value added tax (VAT) is a form of consumption tax. From the perspective of the buyer, it is a tax on the purchase price. From that of the seller, it is a tax only on the “value added” to a product, material or service, from an accounting point of view, by this stage of its manufacture or distribution. 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. The “value added” to a product by a business is the sale price charged to its customer, minus the cost of materials and other taxable inputs. A VAT is like a sales tax in that ultimately only the end consumer is taxed. It differs from the sales tax in that, with the latter, the tax is collected and remitted to the government only once, at the point of purchase by the end consumer. With the VAT, collections, remittances to the government, and credits for taxes already paid occur each time a business in the supply chain purchases products.
Principle of VAT
The standard way to implement a VAT involves assuming a business owes some percentage on the price of the product minus all taxes previously paid on the good. If VAT rates were 10%, an orange juice maker would pay 10% of the Rs.5 per litre price (0.50p.) minus taxes previously paid by the orange farmer (maybe 0.20p.). In this example, the orange juice maker would have a 0.30p. tax liability. Each business has a strong incentive for its suppliers to pay their taxes, allowing VAT rates to be higher with less tax evasion than a retail sales tax.
Difference Between VAT And Sales Tax
Value added tax (VAT) in theory avoids the cascade effect of sales tax by taxing only the value added at each stage of production. For this reason, throughout the world, VAT has been gaining favour over traditional sales taxes. In principle, VAT applies to all provisions of goods and services. VAT is assessed and collected on the value of goods or services that have been provided every time there is a transaction (sale/purchase). The seller charges VAT to the buyer, and the seller pays this VAT to the government. If, however, the purchaser is not an end user, but the goods or services purchased are costs to its business, the tax it has paid for such purchases can be deducted from the tax it charges to its customers. The government only receives the difference; in other words, it is paid tax on the gross margin of each transaction, by each participant in the sales chain.
In theory, sales tax is normally charged on end users (consumers). The VAT mechanism means that the end-user tax is the same as it would be with a sales tax. The main difference is the extra accounting required by those in the middle of the supply chain; this disadvantage of VAT is balanced by application of the same tax to each member of the production chain regardless of its position in it and the position of its customers, reducing the effort required to check and certify their status..
A general economic idea is that if sales taxes exceed 10%, people start engaging in widespread tax evading activity (like buying over the Internet, pretending to be a business, buying at wholesale, buying products through an employer etc.) On the other hand, total VAT rates can rise above 10% without widespread evasion because of the novel collection mechanism.
Types of VAT
By the method of collection, VAT can be accounts-based or invoice-based. Under the invoice method of collection, each seller charges VAT rate on his output and passes the buyer a special invoice that indicates the amount of tax charged. Buyers who are subject to VAT on their own sales (output tax), consider the tax on the purchase invoices as input tax and can deduct the sum from their own VAT liability. The difference between output tax and input tax is paid to the government (or a refund is claimed, in the case of negative liability). Under the accounts based method, no such specific invoices are used. Instead, the tax is calculated on the value added, measured as a difference between revenues and allowable purchases.
By the timing of collection, VAT can be either accrual or cash based. Cash basis accounting is a very simple form of accounting. When a payment is received for the sale of goods or services, a deposit is made, and the revenue is recorded as of the date of the receipt of funds no matter when the sale had been made. Cheques are written when funds are available to pay bills, and the expense is recorded as of the cheque date — regardless of when the expense had been incurred. The primary focus is on the amount of cash in the bank, and the secondary focus is on making sure all bills are paid. Little effort is made to match revenues to the time period in which they are earned, or to match expenses to the time period in which they are incurred. Accrual basis accounting matches revenues to the time period in which they are earned and matches expenses to the time period in which they are incurred. While it is more complex than cash basis accounting, it provides much more information about your business. The accrual basis allows tracking receivables (amounts due from customers on credit sales) and payables (amounts due to vendors on credit purchases). The accrual basis allows matching revenues to the expenses incurred in earning them, giving you more meaningful financial reports.
Effects after registration for VAT
Once registered for VAT, VAT will have to be paid on all business purchases and VAT will have to be charged on all sales.
The standard rate of VAT from 4th January 2011 is 20% (this was temporarily reduced to 15% between 1 December 2008 and 1 January 2010).
How to keep VAT sales records
- As soon as registration for VAT is done the Person will need to include the appropriate rate of VAT on the invoices.
- The VAT invoices must show the rate and amount of VAT charged together with the VAT number given to the business at the time of Registration.
- The copies of all VAT invoices sent must be kept safely for a minimum of six years.
- A separate record of the amount of VAT charged by the person is to be kept.
How to keep VAT purchases records
- A VAT invoice for all the purchases is a must to be able to reclaim any VAT paid.
- All VAT invoices received must show the rate and amount of VAT charged together with the supplier’s VAT number otherwise it would not be possible to reclaim the VAT paid.
- The copies of all VAT invoices received must be kept safely for a minimum of six years.
- A separate record of the amount of VAT paid needs to be maintained.
VAT is a very good taxation procedure and method if followed very strictly and diligently. And it is not as evil as thought although when VAT was implemented prices did rise but that was because then more goods which were illegally escaping tax were brought into its net and thus Black money was also controlled. So according to the opinion of the researcher VAT is a good system and a successful one.
Fourth year student, Department Of Law,
University Of Calcutta, Kolkata.
[Submitted as an entry for the MightyLaws.in Blog Post Writing Competition, 2011]