VAT - The complete story

Basics of VAT After having explained it to too many people ..... finally decided to write about it so I can ask them to read this first and then get back if they have doubts.

What is VAT?
VAT(Value Added Tax) is an indirect tax (2 types of taxes : direct(Eg:income tax) and indirect (custom duties, sales tax))with the following objectivesmake the country a common market (i.e. reduce disparity due to state/decentralized taxes and have just federal taxes)simplify the tax structure, reduce loopholes and hence fraudulent practices.

How does it work?
In the existing system, each time the goods leave the factory, the manufacturer pays excise.For example, when you buy a shirt, you have paid excise on a pro rata basis over the entire chain of production. When cotton is spun into yarn and leaves the factory, the factory pays Rs 100 as excise.When the mill leaves the yarn into cloth and sells it to the shirt maker, he pays Rs 200 as excise; when the shirtmaker sells it to the wholesaler, he pays Rs 400 as excise; and whenyou buy the shirt at Rs 300, you have paid proportionately for the entire chain of excise paid, plus sales tax. A VAT will tax only the value addition in the final product. The cloth maker will get a refund of Rs 100 for the tax he paid to the yarn manufacturer. He in turn pays only Rs 100 as tax. The shirt maker will get a credit of Rs 200, and his net outgo is Rs 200 and so on. The customer may get this benefit passed on in a competitive market.

Why is VAT necessary?
VAT makes it necessary for traders and businessmen to keep proper records of their sales and purchases. Under the system, no exemptions will be given and a tax will be levied at each stage of manufacture. At each stage of the value-addition, the tax levied on the inputs can be claimed back from the tax authorities. VAT avoids the problem of under-valuing (to evade taxes) as all stages of production and distribution are subject to tax.

Why protests?
1. Small businessmen and traders fear the VAT as many of them have thrived on the loopholes in the current system and have avoided paying taxes.
2. Being a complex system it may create confusion initially.States are protesting as they fear the loss of revenue.
3. A centralised tax can mean less income for the states (Reason why states are delaying the implementation of VAT).

Why protests (a different perspective)?
1. Corrupt Government Departments fear a loss of revenue (primary bribes as everyone’s records are clear).
2. VAT for most goods will be 4% but for how long? VAT would be increased to 12%
3. Implementation issues.

There exists different ways to implement VAT but the main issue faced is: 'Revealing profit margins'[Adding tax on the Value Addition].

Hence this leads to only one solution... Tax paid by any one in the chain (trader, manufacturer or raw-material supplier) is equal to 'Tax Collected On Sales - Tax paid on Purchases'.

Hence eliminating the problem of revealing profits and cascading effect of tax.