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CA SUDHIR HALAKHANDI: - Good Morning Students! Now after going through the first two classes we are going study today the following:-
1.     Merits and Demerits of VAT
2.     Input credit
3.     Composition scheme
4.     VAT in Indian context.
Are you ready students


CA SUDHIR HALAKHANDI:-Vat is a scientific and logical taxation system in which the last consumer knows about his contribution to the tax. We have some merits of the Taxation system as a whole and also from the age old sales tax system of taxing the sales of goods. Let us start the merits of the VAT and these are:-
1.No tax evasion
2. Neutrality
5. Better revenue collection and stability.
6. Better accounting system.
7. Effect on retail price.


Let us first have the No tax evasion and since in VAT the tax is payable on sales at each stage and out of which the tax paid by the seller on his purchases is deducted then if at any stage of sell tax is not paid then it will not affect the revenue because in that case no deduction is available to the seller and he has to pay the whole tax. Hence the possibility of evasion of tax is very remote.
See an example: - X purchases goods worth Rs. 1000.00 after paying tax of Rs. 40.00 @ 4% and sold these goods at 1250.00 by applying tax @ 4%. The amount of Tax is Rs. 50.00. If he has no valid bill of purchases of goods then no credit is allowed to him and revenue will get Rs.50.00 from him hence if at any point in the series of sales tax is not paid it will not affect the revenue hence it is said that there will be no tax evasion in VAT.
The second benefit is Neutrality and it means that the taxation system does not interfere in the choice of the purchaser and this is because of systems inbuilt “anti cascading effect”. If there are two raw materials for production of single finished goods and A raw material is 4% taxable and B raw material is 12.5% taxable. Naturally the manufacturer will go for 4% Taxable raw material but in VAT it will not make any difference and choice of the manufacturer has noting to do with the rate of tax because if the tax is paid at 12.5% then the manufacturer will get the credit of the same and if the tax is paid @ 4% he will get the credit @ 4%. Hence he has to consider the other merits excluding the rate of tax while selecting the raw material. This is the Magic of VAT.
The third merit is certainty and in the VAT the system of payment of VAT is simple and certain. Collect the tax on sales and deduct out of this the tax paid on purchases. Vary simple and certain. No need to go for definition of Sales, turnover, purchases. What are sales in common business practice is sales and what is purchase in common business practice is purchases? Every thing connected with the payment of tax is certain hence certainty is the one more important merit of VAT.
Buyer knows what he is contributing to tax is the transparency. In earlier system, tax is paid on first point and in the series of sales the last consumers did not know what amount has been included in the price of goods towards Tax.
I have mentioned while discussing the first merit of VAT that there is very little possibility of tax evasion under VAT and the positive effect of this first merit is the fifth merit of VAT i.e. The Better collection of Tax to the revenue. This in turn makes the VAT stable and flexible source of revenue. Stable in the sense that Government will get tax without evasion and flexible in the sense if the price increased then government will get the higher amount of tax.
See here in the age old sales tax system if one commodity is purchases by the dealer by paying Rs.100.00 as cost and Rs.4.00 as sales Tax but there is a sudden spurt in prices and the commodity is sold at Rs.200.00 but since the system of tax was single point then no further tax is payable but in VAT the revenue will get tax on whole Rs.200 hence this system is called stable (Govt. will get tax on every transaction of sales) and flexible also (Government will get tax on increased price also. One more benefit of flexibility of the system is that consumer will have to pay less tax if the prices got a negative turn.
To get the credit of input tax and also calculate the out tax (Both are essential for calculating the tax liability of the dealer) , the dealer has to prepare proper accounts within scheduled time limit hence it will certainly promote the better accounting system amongst the dealers.
The last merit which though we are including in the merits is a explanation to the misinformation that VAT , since it has to be paid on final price of the product, will increase the burden of tax on the consumer but since it has “ inbuilt anti cascading effect” hence the threat of increase of price will neutralize to certain extent.
Students do you understand the merits of VAT

AMIT: - After going through the merits of VAT we have understood the characteristics of VAT properly, sir is this system has some demerits and shortcomings also?

CA SUDHIR HALAKHANDI: - Nothing is perfect in the world. But in case of Vat the demerits of VAT are mainly not the demerits of the basic VAT system but these demerits are attributed to the way in which system is applied in a particular country. See in India VAT is not centrally applied and it is handled by the states independently, there are more than one rate of tax, there are composition schemes, the central sales tax  hence this distorted form of Vat will effect the merits of the system.

LUVKESH: - Sir, if VAT is imposed in its true sense and without compromising on its basics then there will be no demerits?

CA SUDHIR HALAKHANDI: - Yes, but see every country has some limitations like ours hence there are some demerits practically attached with VAT which we are discussing in the following paragraphs, OK.


In India, we have the federal system of Governance in which both state and central have the right to impose tax hence the benefit of neutrality is restricted to the purchases within the sate and not applicable from the purchases from out side the state during the interstate transaction since no credit of interstate purchases is available.
 VAT is a complicated system hence it increase the accounting cost. This burden is more on small traders and firms. Further since the tax is paid at each stage hence it increases the working capital requirement.
VAT is consumption tax and since the ratio of expenditure to income is more in the case of poor as far as consumption is concerned than the rich   hence to that extend it can be termed that VAT is any poor taxation system. This drawback of Vat can be neutralized by taxing the necessities at lower rate and luxuries at higher rate. 
And the last drawback of VAT is that it increases the administrative cost and this is automatically be compensated by increased revenue.

(Most important part of VAT)

CA SUDHIR HALAKHANDI: - Students! Now our next aspect of VAT is detailed study on input credit of Tax. See that there are two important dimensions of Tax liability in VAT. The tax liability is calculated as under (We have already understood this aspect in my first class):-
Tax due :- Out put tax – Input tax credit
Where Tax due is: - Tax payable by the dealer.
Out put tax:- tax collected from the buyers by the dealer
Input tax credit:- Tax on purchases of the dealer which is eligible for set off against the out put tax
Now the most important factor out of these three terms is Input tax credit.

RONIT: - Sir, How can we understand Input credit in simple words?

In common meaning Input tax credit more popularly known as ITC means the tax paid by the seller within the state on his purchases. Here see all the purchases are not eligible for ITC hence only eligible purchases are taken into account in the ITC. One thing here should be noted that the purchases should be within the state.
First we should understand the concept of ITC in the form of an example before taking our discussion to other sides of the ITC
EXAMPLE: - X and company has purchases raw material worth Rs. 1.00 lakh @ 4%, procession material @ 12.5% worth Rs. 0.25 Lakhs. Calculate the input credit of X and company on these purchases.
Raw Material
Processing material
Total ITC
Now Let us have a look at eligible ITC.

Goods purchased for making the following sales shall be eligible for ITC:-

Goods purchased for Sales within the state- Seller is from Mumbai (Maharashtra) and Purchaser is from Pune (Maharashtra) – Both seller and purchasers are from the same state. This is called sales within the state and in that case the dealer of Mumbai who sale goods to the dealer of Pune and collect tax from him and out of this tax he will deduct ITC on his own purchases which he has paid on his own purchases in the state of Maharashtra.
Goods purchased for Interstate sales- More popularly known as CST sales. For example the seller is from Rajasthan and the purchaser is from Maharashtra. The sales is called interstate sales i.e. sales between two states and please note here that though it is called CST sales because it is governed the Central sales tax Act, but the revenue goes to the state government of the selling dealer.
The selling dealer will get the ITC on purchases made by him within the state if the Goods are sold in interstate sales since the revenue from interstate sales is also received by the state Government of the selling dealer and if the selling dealer has paid some tax in the state on his purchases to be sold in interstate sales , the same will be eligible for ITC.
Raw Material ,Packing Material, Consumable stores required for manufacturing of taxable Goods or packing of the same for sale within the state (as mentioned in one above) or sale during the sate ( as mentioned in two above).
Goods purchased to be used in execution of works contract: - See here that in case of works contract such as construction of a Building etc. the material is used and the property (ownership) of the material is transferred to the awarder (who give the contract) by the awardee (i.e. the contractor) and to the extent of transferred of property in the material used in execution of works contract it is called sale and taxable under the VAT. If the tax is paid by the contractor while purchasing the goods then the same shall be eligible for ITC.
Capital goods to be used in manufacture or resale of taxable goods- See capital goods means plant, machinery , furniture etc. and all these are taxable . If these capital goods are used for manufacturing of goods or are used for sale of goods then the ITC (i.e. tax paid within the state on purchase of capital goods) shall be allowed.
The goods such as raw material, capital goods, consumable stores and spares and packing material which is used for manufacturing/packing of goods to be sold during the export shall also be eligible for input credit.
Purchases for making the Zero rated sales:-

SANAJAY: - Sir, if the purchases are made for a particular Raw material which can be used for making taxable goods as well as tax free goods and actually the manufacturer used the raw material for both the purchases then how ITC will be allowed?

CA SUDHIR HALAKHANDI: - Yes, very good question Sanjay! I was just near to explain this situation but I think you are very well prepared yourself before the class! Nice thing!
When eligible purchases are made and used  partially for making of taxable goods and partially for making of tax free goods then the ITC shall be allowed propionately. See the example in this respect:-
X and company has purchased 1000 K.G of raw material amounting to Rs. 10 Lakhs by paying Vat @ 4% i.e. Rs. 40000.00 . Now 75% of the material is used for making tax free goods and 25% for taxable goods. The ITC will be allowed for Rs. 10000.00 only (25% of the tax paid) since only 25% is used for making the taxable goods.

FAIYAZ: - Sir, can you explain the concept of input credit on capital Goods in detail. Sir, my uncle “also a CA” told me that it is not available to traders and further there are certain restrictions also on ITC on capital Goods.

CA SUDHIR HALAKHANDI: - Yes, the all the capital goods are not eligible for ITC in all the states. The states have decided their own law in this respect and since I explained earlier that VAT is a state law hence each state has its own provisions and especially for ITC on capital Goods the provisions differs from state to state. 
Some states have allowed ITC on all the capital goods and to all the dealers including the traders but others have only allowed the same to the manufacturers and further in some states the ITC on capital goods are available only on machinery and plants used for the purpose of manufacturing.

FAIYAZ: - Is their any difference in timing of allowability of ITC on capital goods.

CA SUDHIR HALAKHANDI: - Some states allow it at once but the others in installments. The maximum time period as suggested by White paper is 36 Months.
See in Maharashtra it is allowed at once but in My state Rajasthan ITC on capital goods for bill up to Rs. 1 lakh is allowed at once but if the bill is more than Rs. one lakh then it will be allowed in 2 installments and one is in Sept and other one is in March.
So provision differs from state to state.

JYOTI: - Sir, you have mentioned “White paper” here. Sir, what is it?

CA SUDHIR HALAKHANDI: - Yes, during the process of introduction of Vat , the Government has appointed a committee of Fiannce Ministers of all the states and since in Vat ,the central Government was only a guiding factor and states have to formulate law and implement Vat so a Guidance paper was issued by the Central Government covering all the important matters on VAT in consultation with the Sates. This Guidance paper was called white paper covered various procedural aspects of Vat also. It was issued with agreement to the states finance Ministers but on matters certain states took different stance to suit their conveyance and local needs.


CA SUDHIR HALAKHANDI: - Now we, after seeing what is eligible for input credit, can easily make a negative list i.e what type of purchases are not eligible for ITC and further some of the purchases which are otherwise disallowable as per the basics of the VAT. Let us see the List :-
1. Purchases from unregistered dealers: - Purchase from dealers who are not registered under the VAT law of the state and since they are not registered they are not paying tax hence the purchases for such dealers are not available for ITC.
2. Purchase from dealers who opt for composition scheme: - The small dealers who instead of going for Vat, opts for composition scheme by paying a certain percentage (decided by state up maximum of 1%) of his turnover. If the dealer opts for composition scheme then the purchase from such dealer is not eligible for ITC.
3. States have the right to restrict any purchases being eligible for ITC and while dealing the VAT in particular state one has to go for special provision of that state to see what type of purchases are not eligible for ITC.
4. The purchases for which the purchasing dealer does not have the proper invoice and further if there is evidence that the same is not issued by the selling dealer then ITC will not be allowed. In the VAT invoice the tax should be separately charged and if the amount of tax is not separately shown in the invoice then the same will not be eligible for ITC.
5. Purchase of goods which is used for manufacturing of exempted goods. Exempted here means Tax free Goods.
6. Purchase of goods which are not sold as taxable goods i.e. which were used for personal purpose or distribute as Gifts to the customers or dealers.
7. Goods purchased from outside the state (already explained) which includes the interstate purchases and purchases during the course of import from other countries.
These all purchases are not eligible for ITC. Further if goods are sold outside state on which no tax is paid or payable to the state in which purchases are made then the input credit is allowed to the extend of tax paid in excess of 4% .
This is very important and complicated provision and very important for your examination purpose also so please try to understand this very well.
See first what are sales out side the sate? Since it is called SOS or consignment sale or depot sale also. If the seller is made a outright sale then he will make a bill, charge tax (CST) in the case of interstate sales and deposit the same. Now suppose one dealer of “A” state has sent his goods to dealer of the another state “for sale” i.e. on consignment sale or to his own depot to sold there then this is not interstate sales and it is called consignment sales or branch transfer on which no tax is payable.
Let us try to understand this with the help of an example: - A dealer of state of “A” has sent his goods for consignment sale to a dealer of State “B” since it is not a sale and merely a transfer of goods hence it is not taxable and if it is not taxable then state “A” will not get any tax on it. Hence no ITC will be allowed on its purchases of goods which are sent for consignment sales to other stats.
Though a provision has been suggested in the white paper that the restriction is only applicable up to the tax paid on 4% rate and if tax is paid @ 12.5% then ITC will be allowed over and above 4% of the Tax i.e. 8.5% of the purchase price of goods will be allowed as ITC but if the tax paid is only 4% then No ITC will be allowed.
I think the point is clear.

SUTDENTS: - Thanks sir!
Ronit: - Only one more thing sir! Why input credit is not allowed on CST purchases? 

Ronit , please go to my Class-1 and you will get the answer but I know this problem is very relevant here also and when you have the full knowledge of input credit and basic aspects of VAT then you are now in a better position to understand this particular situation of Vat so I am reproducing here again for the benefit of other students:-
The reply of this question is very simple. The CST is collected by the selling state and naturally the tax collected by the other sates cannot be adjusted in another state. Let us try to understand this with the help of an example. A dealer of Punjab has purchased goods worth Rs.100000.00 from a dealer of Delhi after paying CST of Rs.4000.00 during the course of interstate sales against 4% against form C. He sold these goods in his own state after charging LST of Rs. 13750.00. His tax paid is Rs.4000.00 and he wants to take credit of Rs.4000.00 CST paid by him. This credit of CST paid by him will not be available to him. The tax paid by him has been charged by the state of Delhi and it will not be possible for his own state Punjab to give credit of tax received by another state.


CA SUDHIR HALAKHANDI: - Students! Input credit is the main term of VAT so I think to explain it to you I have taken a little extra time. So we will take “Composition Scheme” and procedural aspect of VAT in my Next class.

 Visit Class 2 and Class 1 here
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Pratik K

Pratik K (Student)     31 May 2009

Pratik K
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thanks sir,

I was waiting for the class3

Can I give prints of your class notes to my friens?



 582 likes  12131 points

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You can give the prints to as many as friends as you like!! For one friend you will get one good wish from me and if you give it to 100 friends then you will certianly do a good work.

Please do it! It is a mission!!

I request all the members to provide the information of VAT class to as many as studnets as possible!!

Further after posting my IV class I will also provide in my concluding class a set of 50 or more questions to cover the whole IPCC VAT course.

1 Like
CMA KNVV Sri Vidya - Sri Kanth

CMA KNVV Sri Vidya - Sri Kanth (C.A.Final (New) ICWAI FINAL (New))     31 May 2009

CMA KNVV Sri Vidya - Sri Kanth
C.A.Final (New) ICWAI FINAL (New) 
 757 likes  11254 points

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 Thanks a ton 


really its a great work         


BALU.... (CCI STUDENT....)     31 May 2009

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The Dude

The Dude (Specialist- Finance)     01 June 2009

The Dude
Specialist- Finance 
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 Sir, u are really great...waiting for Class 4 n all the model questions....Thanx a lot!!!

Sumit Jain

Sumit Jain (CA)     01 June 2009

Sumit Jain
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thanx sir
CA CS CIMA Prakash Somani

CA CS CIMA Prakash Somani (Landmark Group)     01 June 2009

CA CS CIMA Prakash Somani
Landmark Group 
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Its nice to see your contribution to CAClubindia.

One suggestion if you are agree with: you can keep font size little small.

Thanks & regards

CA Prakash Somani

Mukund Patel

Mukund Patel (Student)     01 June 2009

Mukund Patel
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thank you sir. we get very imporant information from your subscripttion.


RAVI JAIN (STUDENT)     02 June 2009

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Sir, When you are posting the following:- 1. VAT questions 2. Service Tax classes I have read all you classes on VAT and found that the VAT has been made so easy by your unique style of teaching. Sir, I came to know from my friend that you are not a professional teacher then sir, your efforts should be respected more by the student and professional community. I have read lot of your articles on Service Tax and I think in the same way you will teach us service tax also. - With regiards RAVI JAIN STUDENT

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