Value Added Tax, or VAT, is levied on top of the cost of a product or service and generates revenue for a government.
Value Added Tax, popularly known as ‘VAT’, is a special type of indirect tax in which a sum of money is levied at a particular stage in the sale of a product or service.
In 1954, the value added tax system was initiated by the then joint director of the tax authority of France, Maurice Laure. VAT came into effect for the first time on 10th April, 1954.
From its inception, the value added tax system was imposed on all major sectors of France - the first country to use this system. Once instituted, it was immediately clear that revenues collected from the VAT system constituted a substantial share of the government’s revenue in the French economy.
Not surprisingly, due to the ease of payment and ready comprehensibility, the value added tax system has been adopted by different nations across the world.
VAT is intended to be levied - or charged - whenever there is some value addition to raw material. The taxpayers on the other hand, will get credit for the amount of tax paid off at the stages of procurement. The value added tax system has proven to be effective in avoiding problems that normally might arise out of the double taxation of goods and services.
The value added tax system is designed to address various problems associated with the conventional sales tax system. In sales tax, there is no provision for input tax credit, which means that the end consumer may pay tax on an input that has already been taxed previously. This is known as cascading and leads to increases consumer tax and price levels, which increases the rate of evasion and can be detrimental to economic growth.
The value added tax system deals with these problems quite efficiently. As VAT is imposed on value addition - at every single stage - there is no incidence of cascading. In this way, the final consumers bear the burden of paying value added tax. This system involves absolute transparency at every stage of taxation, thereby making the tax system quite comprehensible and simple.
In some countries like India, the system of VAT has been designed to change the existing system of sales taxation. Value added tax is different from the conventional system of sales tax, because VAT is charged at every stage of value addition - whereas sales tax is imposed on final value of transaction only.
The value added tax system allows for input tax credit, or ITC, on the amount of tax levied at the preceding stage of the value addition chain. The allowance for ITC is normally appropriated from the value added tax liability imposed on the following stage of the sale of the product.