Budget Classroom: Underestanding Value Added Tax (VAT)
Value Added Tax (VAT) is the most important indirect tax levied on SMEs, since it is a part of almost every sale and purchase of goods they make. VAT related announcements in the recent years have gone hand in hand with overall economic conditions. Since the Indian economy, especially the industrial sector, has seen severe slowdown in 2012-13, SMEs should look keenly at VAT related announcements, since they can impact their costs as well as prices charged.
What is VAT?
VAT is a tax charged at each point of trade in goods. The charge is levied only on the difference between the value of a product and the cost of producing it, so that there is no duplication in tax calculation. Thus, as an SME, you will have to pay VAT when raw material is bought by your business, and you have to charge VAT to your customers or clients when a sale is made. Note that VAT is applicable only on physical products, and not on services. For services, a separate indirect tax, known as the service tax is levied.
How is VAT levied in India?
At the level of the centre, a Central Value Added Tax (CENVAT) or Excise duty is charged, the rate of which was increased to 12% from 10% in the last budget. Then there is the State VAT, which is essentially a sales tax charged by the State Government. State VAT varies across different states, and being a state subject, changes in these are not announced in the Union Budget. As an SME, you should thus watch out for changes to CENVAT in the forthcoming budget.
What are the advantages of VAT for SMEs?
VAT has evolved in India overtime, from the excise duty structure, where taxes were not charged on the “value added” at each stage of production, but on the entire good. As a result, the system led to price increases and double taxation, which has been removed by moving to a VAT structure. As an SME, you can now avail of what is known as the CENVAT credit on the excise duty that needs to be paid, serving a major advantage over the previous structure. The CENVAT credit is essentially a claim for deduction for the VAT already paid on inputs. This lowers your overall costs, not only because you can claim credit but also because the inputs now cost lesser.
What are the disadvantages of VAT for SMEs?
However, VAT still has disadvantages as it is still remains relatively complex since additional duties and surcharges are outside its ambit, state VAT does not always account for CENVAT already charged on goods, CENVAT still does not cover production processes before manufacturing, and since services are taxed separately, it is not always efficient taxation when a production involves both production of a good and service. To resolve this and other issues, a move towards a more comprehensive Goods and Services Tax (GST) is now being planned.
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