What is VAT? - Full-Form, Meaning & Objectives

Value-added tax (VAT) is one of the most common forms of indirect taxation in the world. Before the introduction of the Goods and Services Tax (GST) in India, VAT was the primary method of tax collection on goods and services at the state level. In India, VAT is still relevant in certain contexts, such as the sale of petroleum products, liquor, and certain supplies of goods and services to which the GST does not apply. Unlike other taxes, VAT has a set of defined objectives and working principles that need to be understood.

What is the Full-Form of VAT?

As the name suggests, Value Added Tax is imposed on the “value addition” which is made at each level of the production and distribution of goods and services.

What is the Meaning of VAT?

VAT, or Value Added Tax, is classified as a consumption tax, which is paid by the end user but remitted to the government by the business establishments. VAT is charged at every stage of the supply chain, irrespective of the manufacturer, the wholesaler, or the retailer, and only on the value added at that stage. This eliminates the issue of tax on tax, which was the case under the sales tax system.

An example would help explain the system better:

• A manufacturer purchases raw materials worth ₹1,000 and adds value by processing them into goods worth ₹1,500. VAT is charged on the added value of ₹500.
• The wholesaler then sells it to a retailer at ₹2,000, adding another ₹500 in value. VAT is charged again on this added value.
• Finally, the retailer sells to the customer at ₹2,500, with VAT charged on the last value addition.

As a whole, this tax system promotes monetary transparency and fairness.

Key Objectives of VAT

Consumers, as well as businesses, need to be careful to see that VAT is charged and invoices are adequately filled out. Businesses that fake bills or do not declare VAT open themselves to penalties and risk losing the input tax credit.

The key objectives of VAT are:

1. To Remove the Cascading Effect of Taxes

In the sales tax system, additional levies on top of the sales tax for goods increase the sales price. With VAT, additional value can only be charged on the added value at each stage.

2. To Guarantee Accountability 

The invoicing system of charging and paying Taxes pays Value Added Tax at every stage in the supply chain of an item, which increases the clarity of the Tax system.

3. To Enhance Government Income

This system of taxation pays taxes at every closing stage of the supply chain, which adds to the surplus for the Government, assures proper payment, and easily enhances the Government’s Income.

4. To Promote Systematic Tax Paying 

The Tax payment system encourages proper, orderly documentation. This Tax system helps in the proper order of collection of Income Tax and Value Added Tax.

5. To Promote Homogeneity In the Tax System

There is more consistency in the tax system instead of the previously unsettled, chaotic, and distorted tax system.

VAT vs. GST

The introduction of the Goods and Services Tax completely removed the Value Added Tax, which advanced the development of the Tax system. Goods and Services Tax is the first of its kind in India, and is more integrated and covers every corner of the nation. This is unlike Value Added Tax, which is more basic and state-oriented.

In India, Value Added Tax is still charged for natural gas, alcohol and diesel, petrol, and other unregulated items of the Goods and Services Tax.

Assume you buy a mobile phone from a retailer at ₹20000 with a VAT of 10%. Let’s see how that works. 

• The manufacturer sells to the wholesaler at ₹15000, VAT=₹1500. 
• Wholesaler sells to the retailer at ₹18000. VAT ₹300 (only added value). 
• Retailer sells to the consumer at ₹20000. VAT= ₹200 

VAT paid ₹2000 in total, but distributed fairly across the supply chain instead of being double-taxed. 

 

Did you know? The VAT system was developed in 1954 by France. Today, over 160 countries use VAT as their most important kind of indirect tax.

 

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FAQs on VAT

Even with the introduction of GST, is VAT still relevant in India?

Indirectly, yes. GST is VATS' replacement, but it is still true for petrol, alcohol, and natural gas.

What’s the difference between VAT and Sales Tax?

A unified currency with a VAT set in a particular rate range, bound to a set range of costs, priced per the country’s self-sufficient selling, with a customized export and import tax. VAT works only on the extra value added on the item in each of its final phases.

Why was VAT replaced by GST?

VAT internationally was a state and country-centered tax easily set for goods and services with very few forms of usage. Cross-state, country, and network tax collection and redistribution were made easier with unified set rates per country and then a unified system of goods and services tax.