How VAT works

VAT -- Value-Added Tax -- is the biggest tax reform in the last 50 years of independent India and will change forever the way traders do their business.

But do you understand VAT? Don't you need advice on the new VAT laws and how they affect your business? No need to worry, help is at hand.

Kul Bhushan, a newspaper editor -- with over 30 years of experience -- who specialises in presenting complicated economic and business issues in simple, reader-friendly language, has come up with a book -- How To Deal With VAT -- which addresses all the questions you may have about this tax.  The book has a foreword by Finance Minister P Chidambaram.

Here's an extract from the book explaining how VAT works.

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Some VAT registered traders may overcharge their customers because they do not understand the correct workings of VAT on prices or are deliberately using VAT as an excuse for increasing prices.

A trader registered for VAT effectively pays VAT only at one stage when he sells his goods.

This tax is the only amount, which has an effect on his selling price which includes VAT. The VAT that he has paid as a part of his purchase price is charged on him by his suppliers.

This is not a cost to him because he gets it back by deducting it from tax on his sales (Output Tax). Therefore, VAT should have a minimum impact on his selling prices.

If you supply designed goods and your annual 'taxable turnover' is more than Rs 5 lakh, you become a taxable person and must register for VAT.

Your taxable turnover is the total value of all taxable supplies (including 'zero-rated supplies') made in India or imported into India while increasing your business. 'Exempt supplies' do not count towards your taxable turnover. Both 'zero-rated supplies' and 'Exempt supplies' are listed in the VAT Schedules.

If you supply Vatable goods, the 'taxable turnover' that must be taken into account is the combined turnover of both these activities.

If you are a Vatable person, you must charge VAT whenever you make a taxable supply. The supply is your output and the tax you charge is your Output Tax. Similarly, the purchase is your input and the tax you pay is the Input Tax.

VAT Returns

VAT Returns are filed every month or every quarter depending on the amount of VAT you pay. The normal rule is that if you pay less than Rs 15,000 for VAT every month, a VAT Return is to be filed every quarter.

It is all at the discretion of the VAT officer. At monthly or quarterly intervals on your VAT Return, you should subtract your Input Tax (attributable to taxable supplies only) from your Output Tax and pay the difference to the VAT Commissioner.

If your Input Tax is greater than your Output Tax you can carry over the difference as a credit to your next VAT Return. In certain circumstances, the Commissioner may pay you any excess if he is satisfied that suchan excess is a regular feature of your business.

Issuing Tax Bills and Invoices

According to VAT law, you cannot sell any goods without a sales document. This document can be a small cash memo or a cash sale or a bill for cash transactions issued at, or before, the time when the cash is received.

The prices mentioned on these sale documents should include VAT and the words 'Price includes VAT' must be printed on them. These documents are suitable for retailers such as grocers and chemists.

You must give the original to the customer and keep a duplicate. At the end of each business day, you can total the cash sales and enter it in your Sales Ledger.

For selling on credit, you are required to provide the purchaser with a tax invoice at the time of supply in respect of that supply. When you receive a deposit as advance payment for a booking, a tax invoice should be issued at the time such deposit is received.

All tax invoices should be serially numbered and issued in serial number order. They must include the following information:

• Your name, address, TIN.
• Serial number of the invoice
• Date of the invoice
• Date of the supply, if different from invoice date
• Name and address of the person to whom the supply was (will be) made
• Description, quantity and price of the goods and services being supplied or to be supplied (in case of deposit)
• Rate and amount of VAT charged on each of these goods and services
• Details of whether the supply is a cash or credit sale
• Details of cash or other discounts, if any, that apply to the supply
• The total value of the supply and total amount of VAT charged
• Number of the vehicle transporting these goods, if applicable
• The customer's PAN must be shown if the sale is over Rs 50,000.

However, if you are a retailer or you are primarily supplying taxable goods to unregistered persons, you will be required to issue a simplified tax invoice.

Simplified Tax Invoices

All simplified tax invoices shall be serially numbered and shall be issued in the order of the serial number. They must include the following information:

• Your name, address and TIN
• Serial number of the invoice
• Date of the invoice
• Brief description of the goods and services supplied.
• Total amount charged to the customer including VAT and
• A clear statement that the price includes VAT.

Value for Tax

The value for tax of a supply is the consideration or money paid. Consideration for a supply includes payment in money and / or in kind for the supply. The value for tax will be:

The full money value paid for the supply where consideration is wholly an amount of money, i.e., the value less any discounts allowed. Instalment payment do not affect the tax value or the point. Tax is due in full at the time of supply on the full (net) value of the article in question.

Open market value of the goods in question where consideration is not wholly an amount of money. This is the price, excluding VAT, which customers ordinarily have to pay for a supply if money was the only consideration.

Value for duty plus the duty -- for imported goods at the time gods – cleared for use into the country or at the time of removal from warehouse.

Financial charges incurred by a person who purchases taxable goods on hire purchase business are excluded from the taxable value.

Similarly, interest incurred from late payment of the price of a taxable supply of goods is excluded from taxable value.

How VAT is Misused

Let us take two examples to understand the working of VAT.

Example A shows the pricing structure of a trader who uses VAT as an excuse for overcharging his customers.

Example B shows the pricing structure of a trader who does not use VAT as a tool for price escalation. For both examples, the relative data is:

• Basic purchase of goods: Rs 10,000
• 12.5 per cent VAT of the basic purchase price: Rs 1,250
• Overheads related to the goods: Rs 100
• Profit margin 20 per cent.

 

Example A	(Rs)
Basic purchase price	10,000
Add 12.5 per cent VAT	1,250
VAT inclusive purchase price	11,250
Add overheads	100
Total	11,350
Add 20 per cent profit margin	2,270
Basic selling price	13,620
Add 12.5 per cent VAT	1,703
VAT inclusive selling price	15,323

  

Example B	(Rs)
Basic purchase price	10,000
Add 12.5 per cent VAT	1,250
VAT inclusive purchase price	11,250
Less VAT input	1,250
VAT free purchase price	10,000
Add overheads	100
Total	10,100
Add 20 per cent profit margin	2,020
Total	12,120
Basic selling price	13,620
Add 12.5 per cent VAT	1,515
VAT inclusive selling price	13,635

The VAT of 12.5% is charged on the 'Total'. Thus the VAT inclusive selling price will be 'Total' + 'VAT.'

You will note that in Example A, the trader has overcharged his customer to the extent of Rs 1,688. Thus a trader is advised to adopt Example B as a guideline and nt overcharge the consumer. If he does, he will lose his customers before long.

VAT Account

You are required to maintain a VAT account as part of your records. This should have details of your Output Tax, Input Tax and under or over declaration in the previous VAT accounting period(s).

A specimen of such a VAT account is given below.

VAT Accounting for Filing VAT Return for April to June 2005 
 

Purchases (in Rs )
Period	Purchases	Input VAT paid Total	Total
April-June	100,000.00	12,500.00	112,500.00

 

Sales (in Rs )
Period	Purchases	Input VAT paid Total	Total
April-June	120,000.00	15,000.00	135,000.00

Hence, VAT to be paid is Output VAT less Input VAT or Rs 15,000 – 12,5000 = 2,500.

VAT Accounting with Opening Stock for April to June 2005
(As per the guidelines of VAT White Paper of 17 January 2005.)

 

Opening Stock on 1 April 2005	Rs 500,000
Less Tax Free Stock	Rs 300,000
Balance	Rs 200,000
Sales Tax @ 10% paid before VAT	Rs 20,000

This credit of Rs 20,000 has to be carried forward in VAT account shown below.
 

Purchases (in Rs )
Period	Purchases	ST paid	Input VAT paid
Opening stock	500,000.00	20,000.00	--
April-June	100,000.00	--	12,500.00

Sales (in Rs )
Period	Sales	Input VAT paid	Total
Opening stock	120,000.00	15,000.00	135,000.00

Hence, the credit of Sales Tax paid on opening stock (Rs 20,000) can be claimed in addition to Input Tax payable for VAT of 12,500.

This means the total tax paid (Sales Tax + VAT) will be Rs 20,000 + 12,500 = Rs 32,500.

In filing the VAT Return, the VAT payable is Rs 15,000 as per sales record.

This has to be deducted from the total tax paid of Rs 32,500, leaving a balance of Rs.17,500 to be claimed in the next VAT Return.

VAT Accounting For Inter-State Supplies and Taxes

Raw materials supplier in Mumbai sells to manufacturer in Delhi.
 

Delhi manufacturer	Rs
Cost Price	10,000
Central Sales Tax @ 4%	400
Total Cost	10,400

Delhi manufacturer cannot claim central Sales Tax @4% of Rs 400 against Form C. hence his cost price will increase by Rs 400.

 

	Rs
Manufacturer's Cost Price	10,400
Value Added	2,000
Selling Price	12,400
VAT	1,550
Cost	13,950

Manufacturer pays VAT of Rs 1,550.00.

 

	Rs
Wholesaler's Cost Price	12,400
Value Added	2,000
Selling Price	14,400
VAT @ 12.5%	1,800

Wholesaler pays VAT of Rs 250. This is arrived at by deducting Rs 1,550 that he paid to manufacturer from Rs 1,800 that he collected brown i.e., 1,800.00 – 1,550.00 = 250.00.
 

	Rs
Retailer's Cost Price	14,400
Value Added	2,000
Selling Price	16,400
VAT @ 12.5%	2,050

Retailer pays VAT of Rs 250. This is arrived at by deducting Rs 1,800 that he paid to manufacturer from Rs 2,050.00 that he collected, i.e., Rs 2,050-1,800 = 250.

 

	Rs
Customer Price	16,400
VAT @ 12.5%	2,050
Price with VAT	18,450

Cross Checking

Total VAT paid will be Rs 1,550 (Manufacturer) + 250 (Wholesaler) + 250 (Retailer) = Rs 2,050.

• * If the trader's turnover is between Rs 5 and Rs 50 lakh and he decides to pay one per cent Composition Tax instead of VAT, he cannot claim credit for the VAT paid by him. So this amount has to be added to his cost and his goods become more expensive as compared to a trader with a turnover of between Rs 5 and Rs 50 lakh who has registered to pay VAT. Thus more traders are encouraged to register for VAT.

Part II: How to treat VAT in Books of Accounts