Updated on May 29, 2022
Value-added Tax (VAT)
For products and services, VAT is an indirect tax that is charged at every stage of the production or distribution process from raw materials to final retail purchase. On April 1, 2005, VAT was implemented. In this system, the amount of value added at each stage is first determined and then taxed. Buyers at previous stages of production receive reimbursements of tax they have paid. In the end, the final consumer pays the full VAT when purchasing items. VAT is a consumption tax as well, because it is entirely borne by the end user.
In order to properly implement and tax VAT in each state, each state has its own set of rules and regulations. According to their implied legislation, different states have varied VAT rates.
Why was VAT introduced?
By implementing VAT, the then-existing sales tax structure hoped to be rid of the double taxation and cascade effect. When a tax is applied to a product at each stage of the sales process, it has a cascading effect. Because the tax is assessed on a value that includes a previous buyer’s tax, consumers are forced to pay additional taxes on money they have already spent.
The VAT system does not allow for any exemptions. Enforcing taxation at each level of the manufacturing process promotes greater compliance and reduces opportunities for tax evasion.
Disadvantages of VAT
There are also some drawbacks to VAT. The cascading effect of taxes was supposed to be eliminated, but that hasn’t been the case. Services provided under the VAT regime are not eligible for an input tax credit (ITC). Variations in state VAT rates and legislation make it the most complicated taxation system ever devised.
Has GST totally subsumed VAT?
The Goods and Services Tax (GST) was implemented in July 2017 by the Union government to eliminate the tax cascade and simplify the indirect tax structure. Some commodities are still exempt from the new GST regime despite the fact that it has replaced VAT on the majority of them. Such commodities continue to be subject to VAT taxation.