What is VAT and How it Works
VAT is a Tax, which is levied on Sale of Goods. Value Added Tax is imposed on Intra-State Sale that is the sale of goods within a State. VAT is Known as Tax on Value Added or Value Added Tax as it is imposed on the amount of value addition made, where VAT Calculation is made by using the given formula.
Value Added Tax = Sale Price – Purchase Price
Taxes paid on Value Addition since tax paid on purchases is allowed as a set-off against payable on sales.
3 Methods for Computation of VAT
There are 3 Methods available for the computation of VAT. By using these methods of Value Added Tax, the assessee can check whether he is liable to pay VAT Tax or not. They are
- Addition or Income Approach Method.
- Invoice or Tax Credit or Voucher Method.
- Subtraction or Product Approach Method.
Addition or Income Approach Method
In Addition Method, VAT Liability is based on
- Aggregate all factor payments like wages, rent, interest etc. and including profits to arrive at the total value addition.
- Apply the rate of VAT on the aforesaid amount to calculate the tax.
Here the formula for calculating rate of tax is
VAT Liability = Value Added x Tax Rate
Value Added = All Factor Payments + Profits
Invoice or Tax Credit or Voucher Method
- Compute the tax to be imposed at each stage of sales on the entire sale value.
- Set-off the tax paid at the earlier stage that is at the stage of purchases in set-off.
- The differential amount that is Step 2 – Step1 is required to be paid.
Here the formula for calculating rate of tax is
VAT Payable = VAT on Sales – VAT on Inputs
Subtraction or Product Approach Method
To determine the Value Addition the assessee can use either of the following methods. There are 2 types of Subtraction Methods.
1. Direct Subtraction method
Value Added = Total value of sales – Total value of purchases (both exclusive of tax)
2. Intermediate subtraction method
Value Added = Total value of sales – Total value of purchases (both inclusive of tax)
Finally, the Value Added Tax liability is calculated by the Formula
VAT Liability = (Rate of VAT/100% + Rate of VAT) x Taxable Turnover
Input Tax Credit (ITC)
Input Tax Credit is a Credit for tax which is paid on inputs by the businessmen or shopkeeper at his first instance. These are the following conditions to which ITC is allowed.
- ITC is allowed to a registered Dealer.
- It is allowed only if purchases are made from a registered dealer.
- It is allowed on VAT paid on purchases including the Purchase of Capital Goods.
- It is allowed to both manufacturer’s and Traders.
- Input Tax Credit is allowed on Intra-State purchases only it means no ITC shall be allowed of purchases made from outside state.
- It is set off against output tax that is tax paid on Sales.
- ITC is allowed period wise i.e., generally, the ITC on purchases made within a month can only be utilized against the tax to be paid on sales made during the month.
- Set off shall be allowed against the tax payable on sales with the state VAT or outside state (CST).
Inter-State Stock or Branch Transfers do not involve Sale and hence, they are not liable to sales tax or VAT. However in case of inputs used in the manufacture of finished goods which are stock/ Branch transferred or goods which are Stock/ Branch transferred then the tax paid will be available as ITC after retention of 2% out of such tax by the State Government.
VAT Paid on Goods Commonly used for Taxable Good/ Tax Free:
VAT Credit is allowed in respect of those goods or inputs which are used in manufacture or processing, etc of taxable goods. Hence, the dealer is not allowed to avail the credit of VAT paid on inputs used for Tax Free Goods.
Special Scheme for Small Dealers:
The white papers specifies that registration for VAT is not compulsory for dealers having annual turnover upto threshold limit of 5 Lakhs. Thus, the small dealers opting for such exemption are not required to obtain VAT Registration and not liable to pay any Value Added Tax on sales made by them. Such dealers are not allowed to claim the credit of Value Added Tax paid by them on the purchases.
The dealers having an Annual turnover of higher than the threshold limit of 5 lakhs but upto 50 Lakhs have the option to discharge their VAT liability under composition Scheme.
VAT Liability in form of Composite Tax:
VAT liability = Gross Annual Turnover x Composite Rate of Tax as prescribed by State Government
However, such dealer shall not be entitled to any VAT Credit on Inputs.
Stock Transfer Form
Download the Stock Transfer Form which is available in PDF Format here from the link given below.
Example on VAT Calculation
Que: Inputs used for the production of output ‘G’ are ‘I’ and ‘J’ respectively. The following are details of inputs:
|Input||VAT Rate||Invoice Price (Inclusive of VAT)|
These are following details of Sales and the rate of VAT applicable for the output ‘G’ is 12.5%
|Name of the Seller||Name of Pruchaser||Invoice Price|
Here the Assessee can check the example for VAT Calculation and follow the steps for calculating VAT.
Computation of VAT at each stage following Invoice Method
|Particulars (1)||Invoice (2)||Net of VAT (3)||Output VAT (4) = (2-3)||Input tax Credit (5)||Net Payable (6)|
|Inputs for A
Product X (@12.5%)
Product Y (@ 4%)
|Net of VAT
(4) = (2-3
|Input tax Credit
|Sale by A to B||153000||136000||17000||12000||5000|
|Sale by B to C||225000||200000||25000||17000||8000|
|Sale by C to D||360000||320000||40000||25000||15000|
|Sale by D to E||450000||400000||50000||40000||10000|
|Sale by E to Consumer||540000||480000||60000||50000||10000|
|Total Vat Payable||60000|
VAT Calculation at each stage following Subtraction Method
|Particulars||Invoice||Material Value||Vat||Input Tax Credit|
|1||2||3||4||5 = 4*12.50/112.50|
|Sale by A to B||153000||142000||11000||1222|
|Sale by B to C||225000||153000||72000||8000|
|Sale by C to D||360000||225000||135000||15000|
|Sale by D to E||450000||360000||90000||10000|
|Sale by E to Consumer||540000||450000||90000||10000|
|Total VAT Payable||56222|
In the illustration explained above the total collection under Subtraction method and invoice method, differs due to a difference in rates of inputs and outputs.