What is VAT (Value Added Tax)?

In order to do away with anomalies of sales tax structure in different states in the country Govt. of India decided to introduce VAT (value added tax)to be adopted all over the country by all the states.

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Value-added-tax will be a tax added at each stage of sale of a commodity in place of the single point sales tax. For example, tax is added when a product passes from some manufacturer to a whole seller and again from the whole-seller to the retailer. As a result, under VAT tax is to be paid at every stage in the value addition chain and every step in liable for input tax credit. The proposed VAT act will enable a dealer to claim credit known as input tax for the tax paid on the goods that he purchases from a dealer registered in the state making it a more transparent process by reducing the number of transaction in the parallel economy. All business will come under VAT except micro-business whose income is so low that state governments exempt them from tax payment.


For the present it is proposed to replace on the local tax, state sales tax including turn over tax and surcharge by VAT. The central sales tax will also be phased out over the next three years on a scale of 2%, 1% and 0% reduction.

VAT rates are proposed to be 0% on food and life saving drugs, 1% on gold, silver, jeweler’s items and gems, 4% on intermediate goods or normal inputs, Information technology products Edible Oils and Electrical etc. and 12.5% on goods such as Tea, Coffee, LPG, Cosmetics, Air Coolers etc.

Advantages of VAT for the government will be increase in the tax revenue and prompt revenue collection, reduction in evasion of tax, ease in enforcement and self assessment. Also uniform rates will curl interstate rivalries.

For the consumers VAT will provide a fair and more transparent system of taxation. Also the paid by the consumers will go to the government and will not be pocketed by business persons who either evade tax payment or under declare their turnover.


For the business houses.VAT will replace multiple local taxes and will cut down the tax maze.VAT rates will be uniform all over the country.VAT allows retailers and manufactures to claim credit for taxes paid on inputs whether bought from within a single state or from any other state which has adopted VAT tax. This squaring up of credits can be done on a monthly basis which means better flow of funds. Tax credits are not locked up for a year before they can be claimed.

Alongside with the above mentioned advantage there are certain disadvantages also of VAT. For the government VAT has procedural problem as in case of all direct and indirect taxes. For the consumers an increase in prices of some products will be a problem. Some goods subject to only 8% sale tax will be subjected to 12.5%VAT.This will make the goods costlier. Medicines may cost more all over the country. Retailers and manufactures currently under report their business turn over. This will not be possible with the introduction of VAT as the chain would be easily traceable under VAT and it would be difficult to cheat the taxman. Also record keeping system and procedures will have to be strengthened in order to claim input tax credits. The current system of invoicing and accounting will have to be dismantled and a new system of invoicing and accounting will have to be dismantled and a new system will have to be adopted.

Chief Minister from 28 states had primarily agreed to introduce VAT from April 1, 2003 but after stiff opposition from traders and business community most of them backed out hence the Central Govt. had to defer the introduction of VAT from the stipulated date i.e. April 1, 2003. According to the Ministry of Finance the introduction of VAT in a patch work from by individual states without corresponding action by the neighboring states will not be workable.

Hence the government is going ahead with the process of putting in place the fiscal infrastructure needed to support the implementation of vat in states. on may 6, 2003 the parliament passed the constitutional amendment bill which would authorize the center to levy taxes on services as a specific item of taxation and give power to both the center and the states of collect and appropriate the proceeds, according to the Finance Minister the amendment will facilitate reform in the tax system and increase tax revenue of states which will implement VAT. Eventually the vat on commodities will have to be integrated with vat on services. it was also stated that the center has agree to give 100% compensation to states in the first year i.e. 2003-2004 for revenue losses, if any on watching over to VAT. The rate of compensation would be 75% and 50% respectively in the ensuing two years.

It is yet to be seen how the states respond to the constitutional amendment and how the business community receives it. For the present the attitude of the traders and business community is negative and the consumer is looking towards both.

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