Monday, June 25, 2012

What is Value Added Tax (VAT) in India / A brief description of India Value added Tax (VAT) ?

VAT is a multi-stage tax levied at each stage of the value addition chain, with a provision to allow input tax credit (ITC) on tax paid at an earlier stage, which can be appropriated against the VAT liability on subsequent sale.

VAT is intended to tax every stage of sale where some value is added to raw materials, but taxpayers will receive credit for tax already paid on procurement stages. Thus, VAT will be without the problem of double taxation as prevalent in the earlier Sales tax laws.

Presently VAT is followed in over 160 countries. The proposed Indian model of VAT will be different from VAT, as it exists in most parts of the world. In India, VAT has replaced the earier State sales tax system.

One of the many reasons underlying the shift to VAT is to do away with the distortions in our earier tax structure that carve up the country into a large number of small markets rather than one big common market. In the earlier sales tax structure tax is not levied on all the stages of value addition or sales and distribution channel which means the margins of distributors/ dealers/ retailers at large not subject to sales tax earlier.

Thus, the sales tax pricing structure needs to factor only the single-point levy component of sales tax and the margins of manufacturers and dealers/ retailers etc, are worked out accordingly. internal trade and impeded development of a common market.

prices by an amount higher than what accrues to the exchequer by way of revenues from it. Also, there was the problem of multiplicity of rates. All the states, provided for plethora of rates. These range from one to 25 per cent. This multiplicity of rates increases the cost of compliance while not really benefiting revenue.

Heterogeneity prevailed in the structure of tax as well. Apart from general sales tax, most states used to levy an additional sales tax or a surcharge. In addition, the states levied luxury tax as also an entry tax on the sale of imported goods.

All these practices of heterogeneity in structure as well as rates cause diversion of trade as well as shifting of manufacturing activity from one State to another. Further, widespread taxation of inputs relates to vertical integration of firms, i.e., the earlier system of taxes militated against ancillary industries and encourages them to produce more and more of the inputs needed rather than purchase them from ancillary industries.

The earlier system of commodity taxes is non-neutral. It interferes with the producers' choice of inputs as well as with the consumers' choice of consumption, thereby leading to severe economic distortions.

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