METHODS OF COMPUTATION OF VAT



Methods of computation of VAT

VAT can be computed by adopting three different methods. These are (i) Addition method, (ii) Subtraction method, and (iii) Tax-credit method. These methods can be used to arrive at the VAT liability.

Addition method:


This method is based on the identification of value-added which can be estimated by summation of all the elements of value-added (i.e. wages, profits, rent and interest). This method is known as addition method or income approach. This is in line with the income method of calculating national income
.


Subtraction method:

The subtraction method estimates value-added by means of difference between outputs and inputs [(i.e. T = t (output-input)]. This is also known as product approach and has further variants in the way subtraction is attempted from among (a) direct subtraction method, (b) intermediate subtraction method and (c) indirect subtraction method. Direct subtraction method is equivalent to a business transfer tax whereby tax is levied on the difference between the aggregate tax-exclusive value of sales and aggregate tax-exclusive value of purchases. Intermediate subtraction method is based on deduction of the aggregate tax-inclusive value of purchases from the aggregate tax-inclusive value of sales and taxing the difference between them
.


Tax-credit method:

The indirect subtraction method entails deduction of tax on inputs from tax on sales for each tax period, [i.e., t (output) t (input)]. This method is also known as tax credit method or invoice method. In practice, most countries use this method and employ net-consumption VAT. A comparative picture of the three methods of calculating VAT is presented in Table 2.

Sl. No.
Methods
Manufacturer
Wholesaler
Retailer
Total Economy


1
2
3
4
1
Addition method
a.     Wages
b.    Rent
c.     Interest
d.    Profit
e.    Value Added (a+b+c+d)
f.      VAT
150
50
25
25
250
25
300
100
75
25
500
50
200
20
20
10
250
25
650
170
120
60
1000
100
2.
Substraction method
a.     Sales
b.    Purchases
c.     Value added (a-b)
d.    Vat
350
100
250
25
850
350
500
50
1100
850
250
25
2300
1300
1000
100
3.
Invoice method
a.     Sales
b.    Tax on Sales
c.     Purchases
d.    Tax on purchases
e.    VAT (b-d)
350
35
100
10
25
850
85
350
35
50
1100
110
850
85
25
2300
230
1300
130
100


Table 2

Although all the methods are identical, these are not likely to yield the same revenue when tax rates vary according to commodities. That is, the rates are different for inputs and that for outputs. As shown in Table 3, the yield would be Rs.30 under the subtraction method while it is Rs.25 only under the invoice method when the tax rate is 15 percent at wholesale stage, keeping 10 percent at all other stages.

The invoice method is widely used in most VAT countries because of its inherent advantages in calculating tax liability. First, it makes crosschecking of tax paid at earlier stages more amenable, as dealers are required to mention the amount of tax on invoices. Second, tax burden being dependent upon the tax rate at the final stage, dealers at intermediate stages do not have any incentive to seek special treatment in tax rate. And finally, it facilitates border tax adjustments. If exports are zero-rated, it is very easily done with this methods.




Calculation of VAT
Manufacturer
Wholesaler
Retailer
Total Economy
1.    a. Sales
2.    b. Purchases
3.    c. Value added (a-b)
Rate of VAT is 10% on all stages
VAT under Subtraction method
Invoice method
Rate of Vat is 15% at wholesaling level and 10% at all other stages
Subtraction method
Invoice method
100
100
10
10-0=10
10
10-0=10
200
100
100
10
20-10=10
15
30-10=20
250
200
50
5
25-20=5
5
25-30=5
550
300
250
25
55-30=25
30
65-40=25