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How VAT works
 
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May 11, 2005

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.


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:

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:

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:

 

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.

Part II: How to treat VAT in Books of Accounts

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