Vat

ACADEMY OF COMMERCE (STUDIES) PVT. LTD.
73-75, 2nd Floor, Mall Road, Kingsway Camp, Delhi – 110 009
Ph.: +91-11-4752 8100/01
VALUE ADDED TAX

(Weightage 25 Marks)
Concepts and General Principles
Introduction
Tax on value addition : VAT paid on inputs purchased will be allowed as a credit and will be allowed
to be set off against the tax liability on sales of the output commodity.
VAT #1# CA. Pankaj Saraogi

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Historical Background
• First time introduced in France in 1954.

• First time proposed by Dr. Wilhelm Von Siemens for Germany in 1919.
• In India, VAT was introduced in 1986 in a different way under the name of Modified Value
Added Tax (MODVAT), which covered excise duty only.
• Later renamed as Central Value Added Tax (CENVAT), which covers services also.
• Pakistan adopted VAT in 1990, Bangladesh in 1991, and Nepal in 1997 while Sri Lanka in 1998.
• Today, about 130 countries have adopted the VAT.
Calculation of VAT Liability
Different Stages of VAT

VAT is a multistage tax
levied as a proportion/percentage of the
value added (sales – purchase)
value added = wages, interest, other costs & profits.
Product X Product Y Wholesaler B

SP = Rs. 400 SP = Rs. 400 SP = Rs. 1600
Gross VAT = Rs. 50 Gross VAT = Rs. 16 Gross VAT = Rs. 200
Net Vat = Rs. 50 Net Vat = Rs. 16 Net Vat = Rs. 75
{Rs. 200 – 125}
Manufacturer A Retailer C
SP = Rs. 1000 SP = Rs. 2200
Gross VAT = Rs. 125 Gross VAT = Rs. 275
Net Vat = Rs. 59 Net Vat = Rs. 75
{Rs. 125 – (50+16)} {Rs. 275 – 200}

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Operation of VAT
A (trader)
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A’s liability for

VAT
B (manufacturer)
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B’s liability for

VAT
C (wholesaler)
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C’s liability for

VAT

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D (retailer)
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D’s liability for

VAT
Total recovery
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Variants of VAT
Gross product variant Income variant Consumption variant

• Tax is levied on all sales and • Tax is levied on all sales • Tax is levied on all sales
• deduction for tax paid on • with set-off for tax paid • with deduction for tax paid
inputs • on inputs and • on all business inputs
• excluding capital inputs • only depreciation on (including capital goods)
• is allowed capital goods
GPV : No allowance for taxes on capital goods in year of purchase or in year of depreciation. Capital
goods carry a heavier tax burden as they are taxed twice. Modernization and upgrading of plant
& machinery is delayed (due to higher cost of machinery and hence longer depreciation period).
IV : Many difficulties connected with specification of any method of measuring depreciation, which
basically depends on the life of an asset as well as on the rate of inflation.
CV : This form is neutral between the methods of production (capital intensive or labour intensive).
Tax is also neutral between the decision to save or consume.
CV is widely used because of following reasons:

i. Neutral between the methods of production.
ii. Obviates need to distinguish between purchases of intermediate and capital goods on the one
hand and consumption goods on the other hand, and hence convenient in administration.

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Methods of Computation of Tax
Addition method Invoice method Subtraction method
• Aggregating all the • Deducting tax on • Direct

factor payments and inputs from tax on • Intermediate
profit sales
Direct subtraction method

• Deducting aggregate value of purchase exclusive of tax from the aggregate value of sales
exclusive of tax
Intermediate subtraction method

• Deducting tax inclusive value of purchases from the sales and taxing differnce between them
Addition method : It is mainly used with income variant. Drawback – it does not facilitate
matching of invoices for detecting evasion. Further, intermediate goods once
exempt from VAT, remains permanently exempt from VAT.
Invoice method : It is most common & popular method. Under this method, tax credit cannot be
claimed unless & until the purchase invoice is produced. In case, in a chain, if
any transaction is kept out of books, still department will be in a position to
recover the full tax at the next stage. Possibility of tax evasion is reduced to
minimum. Also called Tax Credit Method or Voucher Method.
Subtraction method : Tax is charged only on the value added at each stage of the sale of the goods.
Since, the total value of goods sold is not taken into account, the question of
grant of claim for set-off or tax credit does not arise. In this method, tax is not
charged separately i.e. tax is not shown separately in invoice.

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Invoice Method (All inputs taxable under ONE rate)

Particulars Invoice Mat. Value VAT ITC Net
Inputs for A
Product X (@12.50%) 260
Product Y (@12.50%) 450
710
A sales goods to B 1125
B sales goods to C 1800
C sales goods to D 2250
D sales goods to E 2700
Final
Subtraction Method (All inputs taxable under ONE rate)

Particulars Invoice Pur. Price Value Added VAT @ 12.50%
Inputs for A
On input 710
Final
Invoice Method (Inputs taxable at different rates)

Particulars Invoice Mat. Value VAT ITC Net
Inputs for A
Product X (@4%) 260
Product Y (@12.50%) 450
710
Final

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Subtraction Method (Inputs taxable at different rates)

Particulars Invoice Pur. Price Value Added VAT @ 12.50%
Inputs for A
On input 710
Final
In case rate of tax differs for inputs, subtraction method gives different result as compared to Invoice
method. In case of same rate of tax for inputs, both methods give same results. Conversely, Invoice
method gives same result whether inputs are taxable at same rate or different rates, as compared to
Subtraction method.

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Merits and Demerits of VAT
MERITS
VAT # 10 # CA. Pankaj Saraogi

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DEMERITS
i. Not 100% elimination of cascading effects – Concessions like differential rates of VAT,
composition schemes, exemption schemes, exempted category of goods, etc. results into
distortions.
ii. Central VAT/CST – CST not integrated with VAT, and hence neutrality confined only to local
purchases.
iii. Increase in accounting costs
iv. Increase in working capital requirements – Since tax is imposed at each stage, investment in
stock increases and hence the working capital requirement.
v. Regressive for poor - VAT is a form of consumption tax. Since, the proportion of income spent
on consumption is larger for the poor than for the rich, VAT tends to be regressive (like other
consumption taxes).
vi. Increase in administration cost – As the number of dealers to be administered will go up

significantly, administration cost to the State can increase.

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VAT in Indian Context
CENVAT
The Finance Act (No. 2), 2004 marked a beginning for an integrated goods and service tax system
wherein the duties of excise paid on inputs/capital goods and service tax paid on input services could be
adjusted against a manufacturer’s excise duty liability or a service provider’s service tax liability. At
present, the CENVAT scheme is governed by CENVAT Credit Rules, 2004.
WHITE PAPER ON STATE-LEVEL VAT IN INDIA

The Empowered Committee of State Finance Ministers brought out a White paper on 17.01.2005, which
provided a base for the preparation of various State VAT legislations. Since VAT is a State subject, the
States will have freedom for appropriate variations consistent with the basic design. White Paper
consists of the following:
a) Justification of VAT and Background
b) Design of State-Level VAT
c) Steps taken by the States
PRESENT POSITION
Finally State-Level VAT was introduced on 01.04.2005 by majority of the States. State-Level VAT
legislations are modeled on the draft model VAT law and principles of State-Level VAT as contained in
White Paper. It is further proposed to phase out the CST.
Audit Provisions under VAT
Under the VAT system a major thrust is to be laid on the ‘self-assessment’ and tax payers will not be
called to substantiate the tax liability shown by them in the returns by producing books of accounts and
other relevant material.
Particulars furnished by the tax payers can be verified by an independent auditor in minute details by:
going through the books of account and
analyzing and interpret the provisions of the Sate-Level VAT laws and
reporting the under-assessment, if any, made by the dealer requiring additional payment or
reporting any excess payment of tax warranting refund to the tax payer.
Some states have incorporated the audit provisions since inception while others may provide for in due
course of time.

Ph.: +91-11-4752 8100/01
Role of CA/ICAI in VAT
ICAI has brought out Guidance Notes for accounting for CENVAT as well as State-Level VAT. Further,
ICAI also brought out a comprehensive study on State-Level VAT in India.
Record keeping
Tax planning
Negotiations with suppliers to reduce price
Handling the audit by departmental officers
External audit of VAT records - Karnataka, Andhra Pradesh,

Maharashtra, etc. provides for audit by CA in specific conditions

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Input Tax Credit
Concepts of Input Tax and Output Tax
Input Tax
is the tax paid or payable in the course of business on purchases of any goods made from a
registered dealer of the State.
is the tax a dealer pays on his local purchases of business inputs, which include the goods that he
purchases for resale, raw materials, capital goods as well as other inputs for use directly or
indirectly in his business.
Output Tax
means the tax charged or chargeable under the Act, by a registered dealer on the sale of goods in
the course of business.
is the tax that a dealer charges on his sales that are subject to tax.
Input Tax Credit (ITC)
Input tax credit

in relation to any period
means
setting off
the amount of input tax
by a registered dealer
against
the amount of his output tax
Essence of VAT is in providing set-off for the tax paid earlier, and this is given effect through the
concept of input tax credit/rebate.

Ph.: +91-11-4752 8100/01
Scope
i. Allowed to registered dealer for purchase of any goods made within the State from a registered
dealer.
ii. ITC is given to both manufacturers and traders.
iii. Sale may be local as well as interstate.
iv. ITC available irrespective of when inputs will be utilized/sold.
v. For stock transfer/consignment transfers/branch transfer of goods out of the State, input tax paid
in excess of 4% (now 2%) will be eligible for tax credit.
VAT Liability
The VAT is based on the value addition to the goods, and the related VAT liability of the dealer is
calculated by deducting ITC from tax collected on sales during the payment period.
e.g.
Net tax is the difference between output tax and tax credit.
Excess VAT credit

e.g.
Eligible purchases for availing ITC
Taxable goods should be purchased for the following purposes:

I. for sale/resale within the State
II. for sale to other parts of India in the course of inter-State trade or commerce

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III. to be used as –
a. containers or packing materials
b. raw materials
c. consumable stores
required for purpose of manufacture of taxable goods or in the packing of such manufactured
goods intended for sale in the State or in the course of inter-State trade or commerce
IV. for being used in the execution of a works contract
V. to be used as capital goods required for the purpose of manufacture or resale of taxable goods
VI. to be used as –
a. raw materials
b. capital goods
c. consumable stores
d. packing materials/containers
for manufacturing/packing goods to be sold in the course of export out of territory of India
VII. for making zero-rated sales other than those referred to in clause VI above
Common goods used for taxable goods and tax-free goods

ITC shall be allowed proportionate to the extent the purchases are used for the purposes specified above.
Purchases not eligible for ITC

ITC may not be allowed in the following circumstances:
≠I. purchases from unregistered dealers
≠II. purchases from registered dealer who opt for composition scheme
≠III. purchase of notified goods
≠IV. purchase of goods without invoice or non-availability of purchase invoice
≠V. purchase of goods where invoice does not show the amount of tax separately
≠VI. purchase of goods which are being utilized in the manufacture of exempted goods
≠VII. goods in stock, which have suffered tax under an earlier Act but under VAT Act they are covered
under exempted items
≠VIII. purchase of goods used for personal use/consumption or provided free of charge as gifts
≠IX. high seas purchases (imports)
≠X. inter-State purchases

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Carrying over of ITC
If goods exported, refund of ITC shall be granted within 3* months from the end of month in which
export takes place.
SEZ are granted either exemption from payment of input tax or refund of input tax paid within 3
months.

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ITC on Capital Goods
• Capital goods include plant and machinery, furniture, fixture, electrical installations, vehicles, etc.
• Capital goods may be self-constructed.
• Definition of capital goods may vary from state to state.
Impact of allowance/non-allowance of ITC on Capital Goods

Non-allowance of ITC on CG violates the basic principle of VAT of avoiding cascading effect. In other
words, non-allowance of ITC will result into cascading effect of tax on goods.
e.g.
Policy in White Paper

• ITC on CG allowed to both traders and manufactures.
• State Governments can provide to give set off on a staggering basis, at the most in 36
installments.
• There is a negative list for capital goods on which ITC is not allowed. e.g. air-conditioners, motor
cars in Delhi
Procedural requirements
• Bifurcation of CG as per negative list
• Maintenance of tax invoice
• If allowance in installments, then accordingly set off to be claimed
• If prior permission required, then prior permission
• ITC on CG is part of normal set off, i.e. no special treatment of ITC on CG
In any case, set off under VAT cannot exceed the tax received on same goods in Govt.
Treasury. This creates liability on dealer to look into credentials of the vendor.

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Composition Scheme
Principles in White Paper
“Small dealers with annual gross turnover not exceeding Rs. 50 lakhs who are otherwise liable to pay
VAT, shall however have the option for a composition scheme with payment of tax at a small percentage
of gross turnover. The dealers opting for this composition scheme will not be entitled to input tax
credit.”
Further, registration not compulsory for dealers below Rs. 5 lakhs turnover (now 10 lakhs) and will have
optional and simple composite scheme of taxation of a small percentage of gross turnover.
i.e. composition scheme is for dealers having turnover exceeding Rs. 10 lakhs but upto Rs. 50
lakhs.
Composition scheme is optional.
Dealer in such case can not claim ITC and can not issue vatable invoices.
Minimum rate prescribed for States is 0.25%. It can be now levied on taxable turnover instead of
gross annual turnover.
Different composition schemes may be notified for different classes of retailers.
Features
a) Composition scheme is optional and will be an individual decision.

b) Saves lot of labour and effort in keeping records.
c) Simplifies calculation of tax liability of a dealer.
d) A very small tax will be payable.
e) Simple return form to cover longer return period.
f) Dealer can not avail ITC and can not issue tax invoices in order to pass on tax credit.
g) Dealers desirous of availing ITC on their purchases may not prefer to buy from composition
dealers.

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Eligibility
Every registered dealer

who is liable to pay tax under the State VAT Act and
whose turnover does not exceed Rs. 50 lakhs in the last financial year
is entitled for composition scheme
Following are not eligible for composition scheme:

manufacturer/dealer selling goods in the course of inter-state trade or commerce
dealer selling goods in the course of import into or export out of the territory of India
dealer transferring goods outside the State otherwise than by way of sale or for execution of
works contract
Exercising of Option
• Optional
• Option should be exercise in writing
• Should be addressed to Commissioner
• Dealer need not maintain any statutory records except purchase, sales, inventory
• On the date of exercise, stock should not include goods brought from outside the State
• Dealer shall not use any goods brought from outside the State after date of exercise
• No ITC on goods lying in stock on date of exercise
VAT Chain under Composition scheme
Loss to the seller

Dealer can not avail ITC and further can not pass benefit of such ITC further. This ITC will form part of
cost.
Loss to the purchaser

Purchaser can not avail ITC of tax borne by the dealer. Further, purchaser can not take benefit of tax
paid by dealers in chain prior to such dealer.
Resulting, VAT chain gets broken as soon as a dealer opts for the composition scheme.

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VAT PROCEDURES
Registration
Eligibility
Compulsory for dealers with gross annual turnover above Rs. 5 lakhs (now increased to Rs. 10
lakhs).
Voluntary for other dealers but satisfaction of Commissioner required.
Existing dealers will be automatically registered.
Application for registration should be made to the VAT Commissioner within 30 days from the
date of liability to get registered.
All sales or purchases of goods made within the State except the exempted goods would be subjected to
VAT.
A dealer means any person, who consequent to, or in connection with, or incidental to, or in the course
of his business, buys or sells goods for a consideration or otherwise.
Compulsory registration
Commissioner may compulsorily register a dealer (if dealer fails to obtain registration). Failure to get
registration attracts penalty and forfeiture of eligibility to set off all ITC related to the period prior to the
compulsory registration.
Cancellation of registration
Registration can be cancelled on:
discontinuance of business
disposal of business
transfer of business to a new location
annual turnover falling below the specified amount

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Tax Payer’s Identification Number (TIN)
TIN is a code to identify a tax payer.

It is the registration number of the dealer.
Will consist of 11 digit numerals.
First two characters will represent the State Code.
Next nine characters will be different in different States.
It will facilitate computer applications viz., detection of stop filers, delinquent accounts, etc.
It will help cross-check information on tax payer compliance
VAT Invoice/Tax Invoice
Invoice is a document listing goods sold with price, tax charged and other details as may be prescribed
and issued by a dealer authorized under the Act.
Provisions relating to tax invoice do not apply to dealer availing composition scheme, i.e.
composition scheme dealer cannot issue a tax invoice.
Following provisions are mandatory, and failure to comply with these attracts penalty:
i. Every registered dealer whose turnover of sales exceeds the specified amount shall issue to the
purchaser a serially numbered tax invoice, cash memo or bill with the prescribed particulars.
ii. The tax invoice shall be dated and signed by the dealer or his regular employee, showing the
required particulars.
iii. The dealer shall keep a counterfoil or duplicate of such tax invoice duly signed and dated.
Importance of VAT Invoice

A VAT invoice
i. helps in determining the ITC
ii. prevents cascading effect of taxes
iii. facilitates multi-point taxation on the value addition
iv. promotes assurance of invoices
v. assists in performing audit and investigation activities effectively
vi. checks evasion of tax

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Contents
A tax invoice should have the following contents:
a) the words ‘tax invoice’ in a prominent place
b) name and address and registration number of the selling dealer and purchasing dealer
c) pre-printed or self-generated serial number
d) date of issue
e) description, quantity and value of goods sold
f) rate and amount of tax charged
g) signature of selling dealer or his representative
Format of Tax Invoice

Not prescribed by law. A sample format may look like as:
TAX INVOICE
ORIGINAL – BUYER’S COPY
Seller’s Name ………………………………. Tax Invoice No. ………………………………

Address ………………………………………. Date …………………………………..
……………………………………………………..
Phone No. ……………………………………. Challan No. and date ……………………………..

VAT Registration No. (TIN No.) …………… Buyer’s Name & Address ………………………..
CST Registration No. ………………………. Buyer’s VAT Registration No., if any ………..
S.No. Quantity Description Price per Value VAT Tax Amt. Total
of Goods unit (Rs.) Rate (Rs.)
TOTAL _________
Rupees in figures
E. & O.E.
Signature
(of selling dealer)

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Records
Following records should be maintained:

a. Purchase records
b. Sales records
c. VAT account
d. Separate record of any exempt sale
e. Copies of all invoices issued, in serial number
f. Copies of all credit and debit notes issued, in chronological order
g. All purchase invoices, copies of customs entries, receipts for payments of customs duty or tax
h. Details of the amount of tax charged on each sale or purchase
i. Total of output tax and input tax in each period and net total of tax payable or excess carried
forward at the end of each month
j. Details of goods manufactured and delivered from the factory of the taxable person
Records should be maintained for specified period.
Returns
• Returns alongwith payment challans are to be filed monthly/quarterly/annually as per State
Acts/Rules.
• It should be accompanied with details of output tax liability, value of ITC, payment of VAT, etc.
• Revised returns can be filed.
• Scrutiny provisions also prescribed.
Objective of Return filing procedures:

i. Reducing the compliance costs incurred by the businesses in completing and filing their returns
ii. Encouraging businesses to comply with their obligations to file returns and pay VAT through the
application of penalties
iii. Ensuring the effective processing of the data included in the returns
Assessment
VAT system based on self-assessment mechanism.
Scrutiny may be done in selected cases only.
System of cross-checking of information will be introduced, not only intra-VAT but with Central
Excise, Income-tax, etc.

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Audit
Provision of departmental audit on selective approach basis.
Previous years’ records may be taken for audit in case taken for audit in current year.
Auditors may visit the business place of the dealer.
Selected dealers may be required to get their accounts audited by a CA.
Tax Rates
Exempted Category : There are about 50 commodities comprising of natural and unprocessed products
in unorganized sector, items which are legally barred from taxation and items
which have social implications. Included in this exempted category is a set of
maximum of 10 commodities flexibly chosen by individual States from a list of
goods which are of local social importance for the individual States without
having any inter-State implication.
4% VAT category : There are largest number of goods, common for all the States, comprising of items
of basic necessities such as medicines and drugs, all agricultural and industrial
inputs, capital goods and declared goods.
12.5% category : The remaining commodities, common for all the States, fall under the general
VAT rate of 12.5%
1% category : The special rate of 1% is meant for precious stones, bullion, gold and silver
ornaments etc.
Non-VAT goods : Petrol, diesel, ATF, other motor spirit, liquor and lottery tickets are kept outside
VAT. The States may or may not bring these commodities under VAT laws.
However, it is agreed that all these commodities will be subjected to 20% floor
rate of tax.

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Miscellaneous
Stock Transfer
Inter-State transfers do not involve sale and, therefore they are not subjected to VAT.
However, the tax paid on:

i. inputs used in the manufacture of finished goods which are stock transferred; or
ii. purchases of goods which are stock transferred
will be available as ITC after retention of 4% (now 2%) of such tax by the State Governments.
Sales Tax vs VAT

Sales Tax VAT
1 Tax levied at stage of first sale or at final Tax levied and collected at every point of sale
stage
2 Successive sales do not attract tax Tax collected at every point of sale subject to ITC
3 Subsequent dealers file NIL returns Subsequent dealers file returns for VAT paid
4 Computation of tax liability is complex Transparent & easier
5 Returns and challans are filed separately Filed together
6 Large number of forms required A few forms are required
7 Tax on goods only Tax on goods and services both
8 Assessment by department Self-assessment by dealers
9 Penalties not strict Stricter penalties
Zero rated sales and exempted sales

Zero Rated Sales Exempted Sales
1 VAT @ 0% VAT @ NA
2 ITC can be availed No ITC
3 Refund available No refund at all
4 Dealer in VAT Chain Dealer is out of VAT Chain

Vat

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ACADEMY OF COMMERCE (STUDIES) PVT. LTD.

VALUE ADDED TAX

Concepts and General Principles

VAT #1# CA. Pankaj Saraogi

• First time introduced in France in 1954.

Calculation of VAT Liability

Different Stages of VAT

Product X Product Y Wholesaler B

VAT #2# CA. Pankaj Saraogi

A’s liability for

VAT #3# CA. Pankaj Saraogi

B’s liability for

C’s liability for

VAT #4# CA. Pankaj Saraogi

D’s liability for

VAT #5# CA. Pankaj Saraogi

Gross product variant Income variant Consumption variant

CV is widely used because of following reasons:

VAT #6# CA. Pankaj Saraogi

Methods of Computation of Tax

Addition method Invoice method Subtraction method

• Aggregating all the • Deducting tax on • Direct

Direct subtraction method

Intermediate subtraction method

VAT #7# CA. Pankaj Saraogi

Invoice Method (All inputs taxable under ONE rate)

Subtraction Method (All inputs taxable under ONE rate)

Invoice Method (Inputs taxable at different rates)

VAT #8# CA. Pankaj Saraogi

Subtraction Method (Inputs taxable at different rates)

VAT #9# CA. Pankaj Saraogi

Merits and Demerits of VAT

VAT # 10 # CA. Pankaj Saraogi

iii. Increase in accounting costs

vi. Increase in administration cost – As the number of dealers to be administered will go up

VAT # 11 # CA. Pankaj Saraogi

VAT in Indian Context

WHITE PAPER ON STATE-LEVEL VAT IN INDIA

Audit Provisions under VAT

VAT # 12 # CA. Pankaj Saraogi

Role of CA/ICAI in VAT

Negotiations with suppliers to reduce price

Handling the audit by departmental officers

External audit of VAT records - Karnataka, Andhra Pradesh,

VAT # 13 # CA. Pankaj Saraogi

Input Tax Credit

Concepts of Input Tax and Output Tax

Input Tax Credit (ITC)

Input tax credit

VAT # 14 # CA. Pankaj Saraogi

Excess VAT credit

Eligible purchases for availing ITC

Taxable goods should be purchased for the following purposes:

VAT # 15 # CA. Pankaj Saraogi

Common goods used for taxable goods and tax-free goods

Purchases not eligible for ITC

VAT # 16 # CA. Pankaj Saraogi

Carrying over of ITC

VAT # 17 # CA. Pankaj Saraogi

ITC on Capital Goods

Impact of allowance/non-allowance of ITC on Capital Goods

Policy in White Paper

VAT # 18 # CA. Pankaj Saraogi