How to treat VAT in books of accounts

Part I: How VAT works

In a VAT registered person's books of account, VAT should not be included in income or expenditure account. This is because a VAT registered person is a collector of tax, which is neither his income nor expenditure.

Hence, VAT should be shown in the books of account under a separate liability account, which is ultimately reflected in the balance sheet under creditors. Like any other outward payment, VAT is also a liability. In some cases where VAT is overpaid, it will be shown as an asset under debtors.

Capital Goods

In the case of capital goods purchased for business, only the principal sum should be capitalized leaving the VAT element as a recoverable sum (Input Tax). For example, if machinery worth Rs 10 lakh was purchased and VAT amounting to Rs 1,25,000 paid on it, then only the original value of Rs 10 lakh is capitalized under 'machinery' account. The VAT amount of Rs 1,25,000 should be debited to the VAT account and ultimately reflected as Input Tax.

Unregistered Traders

In the case of unregistered traders, VAT paid will become part of their cost since they are not eligible to claim Input Tax. For them VAT will increase the cost of all goods as applicable. In particular, the VAT on fixed assets shoud be added to the cost of the fixed assets concerned. So in the above example, the capitalized machinery cost will be Rs 11,25,000 for an unregistered trader.

Loss of Goods in Transit

Sometimes goods for which Output VAT has already been charged are lost or destroyed in transit before reaching the premises of the purchaser.

If the goods are lost or destroyed while being transported by the supplier and before being delivered to his customer, and VAT has already been charged on those goods, then the supplier is entitled to issue a credit note to remove the VAT because a 'sale' has not taken place since delivery has not taken place.

If, however, the goods are lost or destroyed in transit already in the custody of the purchaser, the VAT, which had already been charged, must remain because a 'sale' had already taken place when the supplier handed over the goods to the customer or his transport agent.

VAT on Trade

VAT is charged on the supply of goods in India. It is charged on any supply of goods made or provided in India where it is a taxable supply made by a taxable person in the course of furtherance of any business carried on by him.

'Supply' includes:

Sale, supply or delivery of goods to another person.
Sale or provision of taxable supplies to another person.
Appropriation by a registered person to taxable goods for his own case.
Making of a gift of taxable goods.
Letting of taxable goods on hire, lease or other transfers.
Any other disposal of taxable goods.

Where sale takes place in the course of import of goods into or export of goods out of the territory of India, such sale shall not be liable to VAT. VAT is also not payable on sale of goods that takes place in the course of inter-sale trade or commerce.

VAT for Works Contracts

When a contractor starts a works contract, he buys building materials and other inputs for the project and pays VAT on these goods. He does not have to file a VAT Return although he has paid VAT on buying building materials for his works contract.

But if he receives an advance, he must pay VAT in the current or following tax period. When the work is going on and he receives a part payment, he has to file the VAT Return showing this amount and pay VAT accordingly. On completion of the contract, he is owed some retention amount for making good any defects. Where the retention amount is receivable after completion of works, VAT shall become payable in the tax period when retention money is due to be received.

In case the contractor has sub-contractors to carry out some part of the works, VAT is payable by the sub-contractor on his portion of sub-contract. On paying VAT to sub-contractor, the main contractor can claim it against the VAT payable on the amount received by him on its portion of the main contract.

Is VAT payable if he builds his own house or builds for his staff? Where a person puts up his own building, whether for office or for residential use, the purchases made by him thereof are for purpose of use/ consumption in the building.

Since he is not making any sale, he is not liable to pay VAT in such a case. However, for the purchases he makes from a registered dealer, the dealer will collect VAT from the owner of the building. So he cannot claim his VAT.

What happens to his VAT payments when he has not been paid by government agencies? VAT is payable on consideration received or receivable on sale of goods. It is payable by seller of goods irrespective of the fact whether the seller receives VAT amount from purchaser or not.

Even where VAT is not collected from purchaser of goods, it is still payable to the government by the seller. The same would also apply even in case where purchaser is a government agency.

Under the previous Sales Tax laws, a contractor could use two methods of calculating Sales Tax. One method consisted of calculating the price and the quantity of building materials (cement, steel, timber, hardware and electrical goods to name the major ones) and to arrive at the total value of these inputs.

Then the current rate of Sales Tax was applied and the total figure was arrived at. The second method was the composition method. Here Total Contract Value 'TCV' was charged at 4 per cent Sales Tax.

Another alternative of the composition method was termed 'Abatement for Labour' as in Karnataka. The value of labour input is fixed at 30 per cent and the balance of 70 per cent is taxable at the rate of 4 per cent.

Delhi has separate laws for works contracts.

Under VAT, two options have been proposed:

VAT on the materials value of Works Contracts with Input Credits.
Composition tax of 4 per cent on works contracts without Input Credits. This is more likely to happen.

Zero Rating

Under the VAT laws, certain supplies or goods or persons are taxed at zero rate. No tax is charged on such supply. In all other aspects it is treated as 'a taxable supply' and accordingly, the rate of tax charged on it is nil.

Subject to the satisfaction of the Commissioner for VAT, the following supplies are taxed at zero rate:

The export of goods.
The supply of goods to designated foreign aid/ funded capital investment projects where the agreement specifically provides for tax exemption, provided that the supplies are acquired prior to payment of taxes.
The supply of goods to a Special Economic Zone (SEZ) eligible for duty and tax free importation.
The supply of goods to any person or organization specified in the VAT Act such as embassies, UN bodies and other multinational organization.
Ship stores supplied to international sea and air carriers on international voyages or flights;
The supply of goods to exporters under conditions prescribed by the Commissioner.
The supply of taxable goods under a contract to an official aid funded project where the agreement specifically provides for remission of tax.

Supplies Made in Preparation of Goods for Exports

Some manufacturers of wrapping or packaging materials who pack goods for export and some clearing and forwarding agents who handle goods for local exporters argue that no VAT should be charged on such materials because exported goods are zero-rated.

These arguments are not legally valid as these are two different supplies. These traders export nothing in these circumstances. They merely make taxable supplies in India for local traders in the export business. Their supplies are, therefore, taxable.

The issue of zero-rating only arises when an exporter exports the goods out of India. If the exporter chooses to apply for registration and is duly registered, he will reclaim the ITC or Input Tax Credit or VAT charged to him by these traders in which case the goods will go to the export market free of VAT. If, however, he chooses not to be registered for VAT, then he cannot reclaim ITC.

Zero-rated status has been given to numerous public bodies, privileged persons and institutions. Taxable goods are zero-rated when imported or purchased before clearance through the customs or purchased before the imposition of tax by or on behalf of the specified public bodies, privileged persons and institutions subject to the limitations specified.

Zero-Rated Goods

These are mainly essential goods. However, the list of these goods must be referred to for any specific query.

Input Tax Deduction Exclusions

If you become a registered tax person, you are entitled to ITC for VAT paid on inputs relating to your taxable supplies. However, such deductions can only be made if you are in possession of a tax invoice showing VAT charged to you by your supplier or a customs entry for imported goods.

How To Deal With VAT by Kul Bhushan