Value Added Tax

Vat is not a new tax but improved version of sales tax levied at every stage of sale with a provision for set off taxes paid by a dealer on his purchases against tax payable on his sales during tax period

The basic problem is that the sales tax is levied on the gross value without allowing any set-off for the taxes paid on inputs(i.e. tax levied on gross value).Consequently,it tends to create the phenomenon of cascading resulting in increased consumer prices by an amt higher than wht accrues to the exchequer by way of revenue from it.

Second,the existing system results in an uncontrolled incidence of tax.The total effective incidence on any given final product at the end of the chain of production distribution process would be fortuitous.This phenomenon of cumulative incidence resulting from chain of taxes makes exact calculations of tax incidence impossible.

Example of how vat works

B purchases from A at price Rs. 1000+VAT@12.5% i.e. Rs.125(total Rs.1125) & sells it at Rs.1200+VAT@12.5%i.e. Rs. 150(total Rs.1350).The customer pays Rs. 1350 to B.In this transaction,B gets input tax credit of Rs.125 on his purchase which can be set-off against his tax liability of Rs.150.B pays to govt.(Rs.150-Rs.125=Rs.25). In other words,he pays tax to the govt. only on value addition/mark up by him.