5

VAT - Concepts and General Principles

Learning objectives
After reading this chapter you will be able to understand: the basic concepts of VAT in relation to manufacture of and trading in goods and services. a brief historical background of VAT. calculation of VAT liability. development of VAT in the Indian context. merits and demerits of VAT. a brief overview of State !evel VAT in India.

1. Introduction
A really progressive and welfare oriented country should balance the re"uirements of direct and indirect taxes in a fair manner. Too much dependence on direct taxes will be repressive but at the same time passing heavy burdens to the general public by way of indirect taxes will constitute hardships to the common citi#en. Therefore$ economic administrators throughout the world have been constantly engaged in the exercise of lightening the burden of indirect taxes on the ultimate consumers. Suppose$ for manufacturing a product A$ the manufacturer has to purchase four types of commodities %$ &$ ' and ( on which he pays excise duty ). *hen ultimately he sells his manufactured product A on which he has to discharge his liability towards excise$ the excise duty leviable on such product will be on a tax base which will include excise duties paid by the manufacturer on products %$ &$ ' and (. Thus$ the final excise duty is a duty on duty$ which will increase the cost of production as well as the price of the final product. Suppose$ we find a method by which the excise duties paid on commodities %$ &$ ' and ( are allowed to be set off from the final duty liability on product A$ it is obvious that the manufacturer will not only be able to avoid payment of duty on duty but the cost of the product will also be reduced leading to a benefit to the consumer. This is the origin of Value added tax +VAT,.
(xcise duty is levied on the manufacture of goods. The concepts relating to excise duty shall be taken up in -aper .: Indirect Tax !aws at the /inal level.
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5.2

ervice Ta! " VAT

In simple words$ the tax will be levied and collected at each stage of manufacture only on the value added by the manufacturer represented by the purchase value and the value of the work performed on such purchased commodities. This will not only result in cost reduction but will also ensure e"uity. *hat we have talked about is a value added tax on manufacture. In the same way$ there can be a value added tax in respect of trading in commodities also. In other words$ the various taxes paid on inputs purchased will be allowed as a credit and will be allowed to be set off against the tax liability on the value of sales of the commodity. Thus$ there can be a system of VAT in respect of manufacture and in respect of sales. In the same way$ one can think of a system of VAT in dealing with input and output services. *hen the individual systems of manufacturing$ sales and services VAT are ultimately combined to form a grand system of VAT on goods and services$ such a VAT system will be applicable throughout the country as a common market.

2. #istorical bac$ground
(ver since )012$ when the tax on value added was introduced in /rance it has spread to a large number of countries. This tax was proposed for the first time by 'r. *ilhelm Von Siemens for 3ermany in )0)0 as an improved turnover tax. In )04)$ VAT was suggested by -rofessor Thomas S. Adams for the 5nited States of America who recommended 6sales tax with a credit or refund for taxes paid by the producer or dealer +as purchaser, on goods bought for resale or for necessary use in the production of goods for sales.6 VAT was also recommended by the Shoup 7ission for the reconstruction of the 8apanese (conomy in )020. 9owever$ the tax was not introduced by any country till )01:. /rance led the way in )012 by adopting a VAT that covered the industrial sector alone and the tax was limited up to the wholesale level. The tax was limited to the boundaries of /rance until the fifties. VAT has$ however$ been spreading rapidly since the sixties. The Ivory &oast followed /rance by adopting VAT in )0;<. The tax was introduced by Senegal in )0;) and by %ra#il and 'enmark in )0;=. The tax has gathered further momentum as it was made a standard form of sales tax re"uired for the countries of the (uropean 5nion +then (uropean (conomic &ommunity,. In )0;.$ /rance extended VAT to the retail level while the /ederal >epublic of 3ermany introduced it in its tax system. The ?etherlands and Sweden imposed this tax in )0;0 while !uxembourg adopted it in )0=<$ %elgium in )0=)$ Ireland in )0=4$ and Italy$ the 5nited @ingdom$ and Austria in )0=:. Af the other members of the (uropean 5nion$ -ortugal and Spain introduced VAT in )0.;$ 3reece in )0.=$ while this tax was adopted by /inland in )002. 7any other (uropean countries have adopted VAT. Similarly$ many countries in the ?orth and South America$ Africa and Aceania have introduced VAT. VAT has been spreading in the Asian region as well. The >epublic of Vietnam adopted VAT briefly in )0=:. +VAT was abolished soon but it was reintroduced in )000 in Vietnam., South @orea introduced VAT in )0==$ &hina in )0.2$ Indonesia in )0.1$ Taiwan in )0.;$ -hilippines in )0..$ 8apan in )0.0$ Thailand in )004$ and Singapore in )002 while 7ongolia has been implementing this tax since )00..

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VAT - Concepts and General Principles 5.% In the South Asian Association for >egional &ooperation +S7>&, region$ VAT has been considered in great depth in India. In )0.;$ India introduced VAT in a different way under the name of 7odified Value Added Tax +7A'VAT,. 5nlike the VAT system of other countries$ the Indian 7A'VAT system was designed to cover manufacturing of goods by giving credit of excise duty paid on inputs. The scope of 7A'VAT has been extended over the years and has since been renamed as &entral Value Added Tax +&(?VAT,$ which covers services also. -akistan adopted VAT in )00<$ %angladesh in )00)$ and ?epal in )00= while Sri !anka introduced VAT in )00.. As VAT is less distortive and more revenue productive$ it has been spreading all over the world. As on today$ about ):< countries have adopted the same.

%. Calculation o& VAT liabilit'

%.1 (i&&erent stages o& VAT ) The Value Added Tax +VAT, is a multistage tax levied as a proportion of the value added +i.e. sales minus purchase, which is e"uivalent to wages plus interest$ other costs and profits. To illustrate$ a chart of transactions is given below:
*anu&acturer A Sale price `:<< 3ross VAT `:=.1< ?et VAT `4) B`:=.1< +)4.1<C2, ./olesaler 0 Sale price ` 2<< 3ross VAT ` 1< ?et VAT `)4.1< +1< :=.1<,

Product + Sale price ` )<< 3ross VAT ` )4.1< ?et VAT `)4.1<

Product , Sale price ` )<< 3ross VAT ?et VAT `2 `2

Retailer C Sale price ` 1<< 3ross VAT ` ;4.1< ?et VAT ` )4.1< +;4.1< 1<,

Inputs &or -anu&acturer 1ote) The rate of tax is assumed to be )4.1D on the transactions relating to goods manufactured by A. /or a manufacturer A$ inputs are product E and product F which are purchased from a primary producer. In practice$ even these producers use inputs. /or example$ a farmer would use seeds$ feeds$ fertili#er$ pesticides$ etc. 9owever$ for this example their VAT impact is not considered. % is a wholesaler and & is a retailer. The inputs E and F are purchased at ` )<< each on which tax is paid G)4.1 D and 2D respectively. The manufacturer A would$ therefore$ take the credit for tax paid by him for the use of such inputs. The input price of ` 4<< plus tax would include wages$ salaries and other manufacturing expenses. To all this$ he would also add his own profit. Assuming that after the addition of all these costs his sale price is ` :<<$ the gross tax +at the rate of )4.1 per cent,

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