The Concept of VAT is a very popular system of Taxation which emerged in European Countries. The VAT system is adopted by most of the countries to bring about user-convenience and transparency in the entire system of taxation. The working system of VAT is simple to follow, implement and administer.
VAT stands for Value Added Tax. In this system, the tax is levied on the value of the good and charged at every level of Value addition i.e., on the Value added portion of goods at each level.
The earlier system of Taxation was allowing the levy of tax on tax. This ultimately lead to wrong assessment of Tax liability and tax evasion. The concept of VAT resolved the cascading effect of Taxes resulting in prevention of Tax evasions.
The VAT system levies tax on every level of Value addition to the product or good. At the same time the tax paid for acquiring this product or good will be allowed as tax credit and can be used for payment of VAT at the time of selling the product or good to the immediate dealer. The net effect of tax will be only on the portion of Value added by the seller. The following example clearly explains the flow of VAT system and its effect on the Selling price.
Example: Mr. A, a registered dealer purchased a good at Rs. 1,000 by paying 4% tax on it, i.e., Rs. 40. The tax paid by him can be claimed as input tax credit. On the good purchased, he did some value addition worth Rs. 500. The VAT liability after such value addition amounted to Rs. 60, i.e. 4% on Rs. 1,500. Since there is a credit of Rs. 40 on the initial purchase made, the same can be adjusted against Rs. 60. Only the balance amount of Rs.20 needs to be paid to the department.
The tax paid on inputs purchases is termed as Input Tax and VAT payable on the goods after value addition is called as Output Tax. The input tax paid can be taken as Input Tax Credit. The VAT liability of the dealer will be arrived at as given below:
VAT Payable = Output Tax – Input Tax
If the tax paid on purchases (Input tax), is more than the tax payable (output tax), the same can be either carried forward to next return period or claimed as refund. The tax amount carried forward will be accounted as Input tax credit for the next return period. In the subsequent periods, this credit can be utilized for payment of any liability to the department like output tax, Interest, penalty etc., subject to the provisions or restrictions as specified in VAT Rules.