VAT vs GST
Goods and Services Tax (GST) system was launched on 1st July 2017 in India which revolutionized the way we pay our taxes. As Indian citizen, it’s our responsibility to know how GST impact our lives and to understand the changes made in the previous tax system, Value Added Tax (VAT).
Before knowing about VAT and GST, we need to know about two terminologies.
• Value Addition
• Multi Stage Transaction
Value Addition is a process where the value of the product gets added on the each stage of its transaction.
For example, if a manufacturer buys a yarn and manufactures it into a shirt, the value of the yarn gets increased. As the same way, when the distributor buys the shirt from the manufacturer and stick brand labels in it, the value of the shirt gets increased. This is known as Value Addition.
Multistage Transaction is the process where a product goes for a multiple stages in its transaction cycle.
The image depicted below shows the stages a product goes till it reaches the end customer.
Now let’s understand the VAT system with an example.
Let’s assume the cost of the yarn is Rs.100 and the percentage of the VAT paid by the manufacturer to buy the yarn is 10%. So, the manufacturer pays (Rs.100 + Rs.10 (10% of 100) = Rs.110) for buying the yarn.
After that, the manufacturer manufactures the shirt and adds value to the yarn. Let’s assume the manufacturing cost is Rs.40. Now the manufacturer cost becomes,
Manufacturer cost = Raw material cost + manufacturing cost = 110 + 40 = Rs.150
Then the distributor buys the shirt from manufacturer.
Cost to distributor = Manufacturer cost + 10% of VAT = 150 + 15 =Rs.165
Then the distributor sticks the brand labels and adds values to the shirt. Let’s assume the brand label cost is Rs.30. Now the distributor cost becomes,
Distributor cost = cost to distributor + brand label cost = 165 + 30 = Rs.195
Then the retailer buys the shirt from distributor.
Cost to retailer = Distributor cost + 10% of VAT = 195 + 19.5 = Rs.214.5
Then the retailer adds inventory, rent, marketing etc… cost and adds the value. Let’s assume that cost is Rs.50. Now the retailer cost becomes,
Retailer cost = Cost to retailer + Marketing/Inventory cost = 214.5 + 50 = Rs.264.5
Then, the customer buys the product from retailer in retail outlets.
Cost to customer = Retailer cost + 10% VAT = 264.5 + 26.45 =Rs.290.95
So, the total cost paid by the customer for buying a shirt in VAT is Rs.290.95.
Now, let’s look into the Goods and Services Tax (GST) system. In GST, the tax is calculated separately at each stages.
For example, let’s assume the cost of the raw material is Rs.100
Manufacturer buys the raw material by paying,
Cost to manufacturer = raw material cost + 10% of GST = 100 + 10 = Rs.110
Manufacturer manufactures the shirt and adds value Rs.40
Manufacturer cost = raw material cost + manufacturing cost = 100 + 40 = Rs.140
Then the distributor buy the shirt by paying,
Cost to distributor = manufacturer cost + 10% of GST = 140 + 14 = Rs.154
The distributor sticks brand labels and adds value Rs.30
Distributor cost = manufacturer cost + brand label cost = 140 + 30 = Rs.170
Then the retailer buy the shirt by paying,
Cost to retailer = Distributor cost + 10% of GST = 170 + 17 = Rs.187
The retailer adds inventory, rental, marketing etc… cost and adds value Rs.50
Retailer cost = Distributor cost + marketing/inventory cost = 170 + 50 = Rs.220
Then the customer buy the shirt by paying,
Cost to customer = Retailer cost + 10% of GST = 220 + 22 = Rs.242
So, the total cost paid by the customer for buying a shirt in GST is Rs.242.
This is amount is marginally lesser than the amount paid by the customer in VAT.
Finally, we calculate the amount of tax paid to government at each steps.
1. Tax paid to government by the manufacturer = Tax Amount included in (cost to distributor) – Tax Amount included in (cost to manufacturer) = 14 – 10 = Rs.4
2. Tax paid to government by the distributor = Tax Amount included in (cost to retailer) – Tax Amount included in (cost to distributor) = 17 – 14 = Rs.3
3. Tax paid to government by the retailer = Tax Amount included in (cost to customer) – Tax Amount included in (cost to retailer) = 22 – 17 = Rs.5
The main idea of the Indian government to implement the GST is to develop the Indian economy and to create a nationwide market.
Let’s wait and watch how it progress!