VAT or GST? Choosing the Right Tax System for Your Business
Updated on : March 17, 2023 - 6 p.m. 17 min read.
Goods and Services Tax (GST) and Value Added Tax (VAT) are two of the most common types of indirect taxes levied by governments around the world. Both of these taxes are similar in nature, but there are several differences between them. In this blog, we will discuss the major differences between GST and VAT.
What is VAT?
VAT stands for Value Added Tax, which is a type of consumption tax that is applied to the value added to goods and services at each stage of production or distribution. VAT is a tax that is ultimately paid by the end consumer of the goods or services, but it is collected and remitted to the government by businesses at each stage of production or distribution.
In a VAT system, businesses are required to register with the government and charge VAT on their sales. They can then deduct the VAT they paid on their inputs (such as raw materials or supplies) from the VAT they collected on their sales. The difference is then remitted to the government.
VAT is used in many countries around the world, including the European Union, where it is a common form of taxation. The rate of VAT can vary depending on the country and the type of goods or services being taxed.
Disadvantages of VAT
- Cascading tax
- No ITC on services
- Varied state rates
- Diverse state laws
- Non-adjustable CST/VAT inputs
What is GST?
GST stands for Goods and Services Tax, which is a consumption tax similar to VAT. It is a tax on the final consumption of goods and services and is collected at each stage of the supply chain, but ultimately paid by the end consumer.
GST is designed to replace multiple indirect taxes that were previously levied by the central and state governments in India. The implementation of GST in India in 2017 was a major tax reform that aimed to simplify the taxation system and create a unified market across the country.
What is the difference between VAT and GST
GST brings a range of advantages over VAT that were not possible under the previous tax system. These include the simplification of the tax system, greater transparency, improved efficiency, harmonization across the country, and a broadened tax base that includes both goods and services. These benefits have led to a more streamlined and effective tax system, reducing the burden on businesses and promoting economic growth. Additionally, the implementation of GST has led to the creation of a common market across the country, allowing businesses to operate more easily across state borders and promoting greater economic integration.
Benefits of GST Implementation
- Simplification: GST replaces multiple indirect taxes with a single tax, reducing the compliance burden on businesses.
- Improved efficiency: GST reduces the cascading effect of taxes and enables businesses to claim input tax credits, resulting in a lower tax liability and improved cash flow.
- Broad tax base: GST includes both goods and services, providing a broader tax base and enabling the government to generate more revenue.
- Harmonization: GST creates a common market across the country, reducing barriers to inter-state trade and promoting economic integration.
- Transparency: GST's IT system enables businesses to easily register, file returns, and claim input tax credits, promoting greater transparency and reducing the scope for tax evasion.
Difference between gst and vat with examples
Consider a consultant providing services to his clients for Rs. 1,00,000.
Under the VAT regime, assuming a service tax rate of 15%, the consultant would have charged Rs. 15,000 as service tax on the services provided. Now, if he purchased office supplies for Rs. 20,000, paying 5% VAT which would amount to Rs. 1,000, he had to pay Rs. 15,000 output service tax without getting any deduction of Rs. 1,000 VAT already paid on office supplies. His total tax outflow would be Rs. 16,000.
Under GST, assuming a GST rate of 18%, the consultant would charge Rs. 18,000 as GST on the services provided. Now, subtracting the GST paid on office supplies (Rs. 20,000 x 5%) = Rs. 1,000, the net GST liability to pay is Rs. 17,000. As a result, the consultant would pay a lower amount of tax under GST compared to VAT, saving Rs. 1,000 in this case. Additionally, the input tax credit mechanism under GST allows the consultant to claim a credit for the GST paid on the office supplies purchased, which was not possible under VAT.