Difference Between GST and VAT Explained

Why GST Was Introduced in India

Goods and Services Tax (GST) was introduced in India to replace the multiple indirect taxes that existed earlier, such as VAT, service tax, excise duty, and entry tax. Under the earlier VAT regime, taxes were levied at different stages of the supply chain, often leading to a cascading effect of tax on tax, increasing the final cost of goods and services.

GST was implemented with the objective of creating a uniform, destination-based tax system across the country. It allows seamless input tax credit across goods and services, ensuring that tax is charged only on the value added at each stage. This simplified compliance, reduced tax inefficiencies, and helped create a single national market by removing state-level tax barriers.

What is a Value Added Tax (VAT)

Value Added Tax (VAT) was integrated into India's tax system on April 1, 2005, replacing Sales Tax. It aimed to unify India's market. Implemented nationwide by June 2, 2014, VAT operates similarly to GST as an indirect tax remitted to the Indian government. However, unlike GST, VAT applies within states, not centrally. Manufacturers pay VAT at each stage of production, contributing to the product's value chain. VAT varies across states, applied to different goods and services, unlike GST's uniformity. For interstate transactions, Central Sales Tax (CST) was applicable, levied by the Central Government and collected by states.

Differences Between GST and VAT

Key Differences Between GST and VAT

Considerable Differences:

●    GST offers a more convenient tax application method compared to VAT. However, VAT is still applicable to certain goods like liquor and cigarettes not covered by GST.
●    For investors, taxes may not apply to profits made through a demat account or upcoming IPO investments, but intraday transactions in trading are subject to GST.
 

Why India Replaced VAT with GST

India introduced the Goods and Services Tax (GST) to overcome the limitations of its earlier indirect tax regime, under which the value-added tax (VAT) operated alongside a host of other levies such as excise duty, service tax and central sales tax. This patchwork of taxes often led to a “tax-on-tax” or cascading effect, where tax was levied on top of other taxes, making goods and services more expensive and compliance complex for businesses. 

GST simplified the system by unifying these multiple taxes into a single, destination-based tax structure, creating a more seamless national market, reducing compliance hurdles and removing barriers to inter-state trade. It also introduced mechanisms like input tax credits, which help prevent double taxation and lower the overall tax burden for businesses and consumers. 

Example of GST vs VAT Calculation

The key difference between GST and VAT can be understood clearly through a simple example.

Under the VAT System

• Cost of goods (manufacturer): ₹100
• VAT @10%: ₹10
• Selling price to wholesaler: ₹110
• The wholesaler sells the product to the retailer at ₹150:
• VAT @10% on ₹150: ₹15
• Final price: ₹165

In this system, VAT is charged on the entire value at each stage, leading to tax on tax, which increases the final price.

Under the GST System

• Cost of goods: ₹100
• GST @10%: ₹10
• Selling price to wholesaler: ₹110
• Wholesaler sells to retailer at ₹150:
• GST @10%: ₹15
• Input tax credit available: ₹10
• Net GST payable: ₹5
• Final price to the consumer: ₹165

While the final price may appear similar in this simplified example, GST ensures that tax is applied only on the value addition, and the input tax credit mechanism eliminates cascading, making the tax system more transparent and efficient.

Calculations of GST and VAT

Under GST (Goods and Services Tax):
●    GST Calculation:
●    Output Tax: Tax collected on sales (output supplies).
●    Input Tax: Tax paid on purchases (input supplies).
●    Tax Calculation Method:
●    Tax on Output: Calculate tax on the selling price at applicable GST rates.
●    Tax on Input: Deduct input tax credit (ITC) from the output tax payable.
●    GST Calculation Formula:
●    GST Payable = Output GST - Input GST

Under VAT (Value Added Tax):
●    VAT Calculation:
●    Tax is levied at each stage of production and distribution.
●    Tax is calculated on the value added at each stage of the supply chain.
●    Tax Calculation Method:
●    Output VAT: Calculated on the value added to the product at each stage of sale.
●    Input VAT: Tax paid on purchases can be used to offset the output VAT.
●    VAT Calculation Formula:
●    VAT Payable = Output VAT - Input VAT
 

Conclusion

The implementation of GST (Goods and Services Tax) on goods and services in India has led to significant improvements in the economy. One of the primary benefits is the elimination of the cascading tax system, where taxes were levied on top of already taxed inputs, leading to inflated prices and inefficiencies in the tax system. With GST, taxes are now applied only on the value added at each stage of production and distribution, thereby reducing the tax burden on businesses and consumers.

Additionally, GST has streamlined the business process by replacing multiple indirect taxes with a single, unified tax regime. This simplification has reduced compliance burdens for businesses, as they now deal with a standardized tax system across the country. Moreover, the introduction of GST has facilitated easier movement of goods across state borders, promoting interstate trade and fostering economic growth.

Overall, the implementation of GST has contributed to the modernization and efficiency of the Indian economy, making it more competitive on the global stage.