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Did You Know/VAT was introduced to ensure clarity in tax collection
March, 17th 2012

Value added tax, or VAT, was introduced from 1 April 2005 to replace the central sales tax in a phased manner. However, while VAT has become applicable, sales tax of 2% also remains.


VAT is an indirect tax which is paid on the consumption of goods. Such a tax is basically collected from the final consumer, but not directly by the government, rather through an intermediary such as a retailer. The tax is added at every stage of value addition or change in product characteristics from production to consumption. This means that at every step when the basic raw material changes form, VAT is applicable. Thus, it is another form of sales tax but is collected at every stage of value addition in the product.

Lets say you buy a packet of biscuits on which VAT is 10%; so a price of Rs. 22 includes a VAT of Rs. 2. The tax collection starts at the beginning. When the biscuit maker buys the refined wheat from the supplier, he pays 10% VAT along with the price of the wheat. This amount of tax is collected by the supplier and given to the government.

Now the manufacturer sells the biscuit to the retailer and includes in the price a 10% VAT, which is paid by the retailer. The manufacturer will collect the tax and pay the difference (adjusting for the tax he has already paid to the wheat supplier) to the government. In the last step, the retailer will charge a 10% VAT from you when you buy the biscuit, the tax collected will be paid to the government after adjusting for the tax he has already paid to the manufacturer.


In case of simple sales tax, this entire amount is charged and collected at one point, but there was confusion as to which is the appropriate leg of the transaction to collect this tax. VAT was introduced to cut the confusion.

While there is no difference in the amount of total tax paid to the government or collected from you as the consumer, using VAT in place of sales tax ensures more clarity and efficiency in tax collection at various stages.

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