hi there,
i know its long time no see. but couldnt help it. somehow i was busy and i had joined classes and the admits and others so just couldnt write on the blog. but today being the first day of the new financial year i would like to wake everyone up to the reality of Value Added Tax. to me we are witnessing one of the defining moves in indian economy and hopefully for the better. so rather than celebrating all fools days i would like to clear the concept of VAT so that atleast we in future dont oppose it as are some of the fools . coincidentally all fools day and BJP's opposition come on the same day
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VALUE-ADDED tax (VAT), which originated in France in 1954, is under implementation in more than hundred economies. VAT is perceived by many as means to promote neutrality and uniformity of tax burden and to provide incentives for increased productivity and industrialisation.
VAT is a tax on the value added at each stage of the production and distribution process and can be aptly defined as one of the ideal forms of consumption taxation since the value added by a firm represents the difference between its receipts and cost of purchased inputs.
VAT can be computed by using any one of the following methods:
The subtraction method: The tax rate is applied to the difference between the value of output and the cost of input.
The addition method: The taxable value is computed by adding all elements of value addition (wages, salaries, profit, overheads, interest payments, and so on).
Invoice credit method: Here, deduction of VAT paid on purchase is allowed against the VAT payable on sale.
The invoice credit method (the variant of which is practiced in most countries) may be defined as:
VAT = t (O) less t (I)
The invoice credit method (the variant of which is practiced in most countries) may be defined as:
VAT = t (O) less t (I)
Where t is the tax rate; O, the value of output; and I, the value of the inputs. The net value-added tax can be the difference between the tax payable on output sales and the tax paid on inputs.
VAT is one of the most radical reforms that have been proposed for the Indian economy after years of political and economic debate.
VAT is one of the most radical reforms that have been proposed for the Indian economy after years of political and economic debate.
The reasons for advocating VAT is that it will replace a complicated tax structure that will help curb tax evasion apart from doing away with other fraudulent practices.
Let us first understand how the conventional system of indirect taxation works. Say A manufactures certain items which form the raw material for the maufacture of another item manufactured by B who in turn sells his production to C who will use the item as raw material. Let us assume that A’s cost of production is Rs. 90, Excise Duty @ 10 % is Rs. 9 and the sale price is Rs. 110 (i.e. a profit of Rs.11).
B will purchase the item for Rs. 110 from A and use it in the Manufacturing Process. B incurs expenditure of Rs. 50 in the manufacturing process. Say Excise duty payable by B @ 10 % is Rs. 16 and the Selling Price is Rs. 200/- (i.e. a profit of Rs. 24).
C will purchase purchase the item for Rs. 200 from B and use it in the manufacturing process. C incurs expenditure of Rs. 40 in the manufacturing process. Say Excise duty payable by C @ 10 % is Rs. 24 and sells the final product to the consumer for Rs. 300/- (i.e. a profit of Rs. 36).
What has happened in the above system is that at each of the manufacturing stages, excise duty forms part of the cost and has inflated the cost to the final consumer. Out of the final price paid by the consumer, Rs. 49 (i.e. 16.33 % of price) is on account of excise duty alone even when the rate of excise duty is just 10 %. In other words, due to excise duty, there has been a cascading effect on the price of the final product.
In order to avoid such a cascading effect of taxation, the concept of VAT was created. Under VAT, the tax is not levied on the entire selling price of the product but only on the value addition made at each stage of manufacturing. If VAT was followed our example, the situation would be as follows :-
There will not be much change at the first stage of manufacture. A will pay VAT on the value added by him i.e. cost of production plus profit ( Rs. 90 + Rs.11). VAT is Rs. 9. Selling price is Rs. 110. B purchases the item from A at Rs. 110. However, B will not pay tax on his entire cost of production but only on his value addition, which is Rs.74 (Conversion cost of Rs. 50 plus profit of Rs.24).VAT @ 10 % is Rs. 7.40 (Say Rs. 8). Selling price will be Rs. 192 (Rs. 110+Rs. 74+Rs. 8). C will purchase the item for Rs. 192 and will pay VAT on his value addition of Rs. 76. VAT will be Rs. 7.60 (say Rs. 8) and the product will be sold to the final consumer at Rs. 276.
You will notice that the price at which the final consumer can buy the product reduces from Rs. 300 to Rs. 276 without the absolute profit of the manufacturer being affected. The total excise component in the final price is only 9 % of the final price. The rate of taxation has also been kept constant at 10 %
Advantages :
- VAT will encourage and result in a better-administered system. The system encourages taxpayers to keep proper records of their sales and purchases to optimise the benefits that accrue to them.
- In effect VAT is collected in all stages of a sale transaction in instalments (that is, on value addition at each stage). Unlike the current point sales tax system, one single dealer cannot evade paying VAT because the entire resale value will be subjected to VAT in the hands of the subsequent dealer.
- VAT avoids the problem of under valuing, as all stages of production and distribution are subject to tax. Under the VAT system, no exemptions will be given and tax will be levied at each stage of manufacture of a product.
- It does not distort the business decisions as it does away with cascading. For instance, only the market forces rather than tax structure will guide vertical integration decisions once VAT is implemented.
- Under the VAT regime, the dealer is allowed to assess himself and allowed to calculate and pay VAT. The manual assessment system and exemption/concessional rate system is done away with.
As a result, there will be minimum interaction with VAT authorities which will reduce harassment and corruption. - The invoice credit method encourages a system that ensures better tax compliance by generating a trail of invoices that supports effective audit and enforcement strategies.
As far as India is concerned, VAT, if enforced properly, could help in fiscal consolidation and create a free national market with uniform tax laws across the country. - Further, any globally accepted tax administrative system such as VAT will help India integrate better in the WTO regime
phew !!! was that long............
so the next time you meet someone who opposes VAT give him a dose of this
PS: maddy and hari om please comment since you guys are MBA experts.
