What is Value Added Tax and Its Types?

Value Added Tax is a consumption tax levied on value added at every step of production and supply chain of goods and services. 

Table of Contents 

• What is Value Added Tax?
• Scenario-Based VAT Example
• Value-Added Tax in India
• VAT Rate in India

What is Value Added Tax?

VAT is not levied on businesses but instead, it is paid by the consumer. Currently, it is levied as GST in India. Let us understand Value Added Tax in detail.

• Imagine a product being made from starting from the stage of production to reaching the final consumer. 
• At each stage, the value of the product increases. 
• VAT is applied to the value added at each stage, calculated as the difference between the selling price and the cost of materials and services purchased in the previous stage. 
• Businesses collect VAT from their customers and then deduct the VAT they paid on their purchases, remitting the difference to the government.

Scenario-Based Value Added Tax Example

Here's a scenario to illustrate how VAT is implemented, assuming a 10% VAT rate:

1. Wheat Production:

A farmer grows wheat and sells it to a mill for ₹100.

As a primary producer, the farmer doesn't charge VAT on the sale.

2. Flour Milling:

The mill processes the wheat into flour, adding value.

It sells the flour to a bakery for ₹150, charging 10% VAT (₹15).

The mill pays the ₹15 VAT to the government.

3. Bread Baking:

The bakery uses the flour to make bread, adding further value.

It sells the bread to a grocery store for ₹220, charging 10% VAT (₹22).

However, the bakery can deduct the ₹15 VAT it already paid on the flour, so it only remits ₹7 to the government.

4. Retail Sale:

The grocery store sells the bread to a consumer for ₹250, the consumer pays tax of 10% as VAT (₹25).

It can deduct the ₹22 VAT it paid on the bread, remitting ₹3 to the government.

Total VAT Collection:

The government collects ₹15 (mill) + ₹7 (bakery) + ₹3 (grocery) = ₹25 in VAT.

The consumer ultimately bears this cost, as it's embedded in the final price of the bread.

Types of VAT

The following are the types of VAT applicable across the world:

1. Standard VAT: This is the most common type, where a single rate (e.g., 15%, 20%) applies to most goods and services. This simplifies administration and promotes transparency.
2. Multi-rate VAT: Some countries have multiple tax rates applied to different categories of goods and services. This can be based on factors like essentiality, luxury, or environmental impact. For example, basic necessities might have a lower rate than luxury goods.
3. Zero-rated VAT: Certain goods and services, like exports, healthcare, or education, might be exempt from VAT altogether. This aims to promote specific sectors or cater to social needs.
4. Reverse-charge VAT: This mechanism shifts the responsibility of VAT collection from the seller to the buyer in certain situations. It can be used to prevent tax evasion or simplify compliance for businesses.
5. Differential VAT: Some countries might have different VAT rates for goods and services. This can be based on factors like domestic production versus imports or place of consumption.
6. Destination-based VAT: In this system, the VAT rate applied depends on the final destination of the goods or services, rather than the origin. This can be complex to administer but aims to ensure fair competition and prevent tax avoidance.
7. Small Business VAT: Many countries have simplified VAT schemes for small businesses to reduce their administrative burden. These might involve lower reporting requirements or fixed-rate VAT payments.

Value-Added Tax in India

Value Added Tax VAT is not directly applicable in India. Below is the timeline for VAT system.

• Before 2017: India had a complex tax system involving multiple indirect taxes, including VAT, central excise duty, service tax, and various state levies. This created administrative burdens, cascading tax effects (tax on tax), and distortions in pricing and business decisions.
• July 1st, 2017: The Goods and Services Tax GST was implemented, unifying all these indirect taxes into a single, nationwide system. This aimed to simplify tax compliance, reduce tax evasion, and boost economic growth.
  

• While VAT is no longer directly applicable, some of its principles are reflected in the GST system, such as value addition and tax credits.
• The GST implementation has brought many benefits, including simplified compliance, reduced tax burden for some businesses, and increased transparency in the economy.
• However, there have also been challenges, such as initial disruptions for businesses adapting to the new system and concerns about the impact on certain sectors.

VAT Rate in India

• The higher VAT rate in India or Goods and Services Tax (GST) of 28%. It applies to air conditioning, automobiles, consumer durables, cement, chocolate and accommodations above 7,500 INR. 
• Standard VAT rates are 18% and 12%.
• First Standard VAT Rate is 18%. It is applicable to banking, insurance, restaurants with alcohol licenses, telephones, televisions, gaming consoles, tickets for cultural events and cinema.
• Second standard VAT rate is 5%. It applies to advertising, tea and coffee, sugar, medicine and privately provided transport. 
• The reduced rate is 5%. 
• India also has some zero-rated goods that are not charged with VAT. However, the sale of these products must still be reported on your VAT return.
• These include newspapers, basic foods, books and postal services.