What is the Difference Between GST and VAT?
The Goods and Services Tax (GST) and Value Added Tax (VAT) are both indirect taxes that impact the cost of goods and services for businesses and consumers. In India, GST replaced VAT and several other indirect taxes in July 2017 to create a single unified tax system across the country. GST is charged on the supply of both goods and services, while VAT was mainly a state-level tax on the sale of goods. The design of GST aims to avoid the cascading effect (tax on tax), simplify compliance, and make interstate trade smoother, whereas VAT’s structure often results in higher costs and different rules across states.
What Is VAT?
Value Added Tax (VAT) was a state-level indirect tax levied in India primarily on the sale of goods at each stage of production and distribution. VAT is charged on the value added at each point, with businesses claiming credit for tax paid on earlier purchases. However, VAT did not cover services, and input tax credits were limited, especially where service tax was involved. It also varied across states, meaning different tax rates and laws depending on location.
Example: A manufacturer pays VAT on raw materials and passes that cost to a wholesaler. At each resale point, new VAT is added based on value, but often a lack of full input credit on services or interstate sales meant consumers could end up paying tax on tax.
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What Is GST?
Goods and Services Tax (GST) is a comprehensive, destination-based tax levied on the supply of goods and services across India, subsuming VAT, excise duty, service tax, and other levies. It operates in a dual model with CGST (central), SGST/UTGST (state/union territory), and IGST (interstate), collected at the point of consumption rather than origin. GST allows businesses to claim input tax credit (ITC) for tax paid on both goods and services, reducing the cascading effect and lowering overall tax cost.
Example: A retailer buys products and services for ₹1,000 with 18% GST. They can claim ITC for GST paid on inputs and offset this when paying GST on their sales, effectively taxing only the value added by the retailer. This avoids tax on tax that often occurred under VAT.
Key Differences Between GST and VAT
Basis of Taxation
- VAT: Levied only on goods at the state level.
- GST: Applies to goods and services across the entire country.
Input Tax Credit
- VAT: Credit is limited and often not available across tax types.
- GST: Seamless input credit on tax paid at earlier stages on both goods and services.
Uniformity and Compliance
- VAT: Different rates and laws in different states.
- GST: Uniform tax system nationwide with standardised processes and returns.
Cascading Effect
- VAT: Could cause tax on tax when the credit was limited.
- GST: Designed to eliminate cascading through the input tax credit mechanism.
Collection Mechanism
- VAT: Collected by state governments.
- GST: Collected by the central and state governments (CGST/SGST/IGST) based on consumption
These differences make GST a more streamlined and business-friendly tax system compared to the older VAT regime.
Benefits of GST over VAT
1. Eliminates Cascading Tax Burden
GST’s full input tax credit means businesses are not taxed on tax already paid, reducing the effective tax cost passed to consumers.
2. Simplified Compliance
Under GST, a business needs to follow one unified law and portal for registration, filing returns, and claiming credits, unlike multiple VAT laws for each state earlier.
3. Broader Tax Base
GST covers both goods and services, whereas VAT mainly covered goods, requiring a separate service tax earlier, making coordination easier under GST.
4. Encourages Interstate Trade
GST treats the country as a single market, reducing barriers and differences between states. This supports businesses operating in multiple regions.
5. Transparency and Efficiency
Standardised GST rates and digital compliance reduce tax evasion and improve transparency in how tax flows through the supply chain.
Practical Example
Under VAT:
- A product moves from manufacturer → wholesaler → retailer. Each adds tax to its sale price with limited credit for service taxes, leading to a higher final cost due to tax on tax.
Under GST:
- The same product and related services are taxed at each stage, but the business at each stage can claim full input tax credit for all GST paid earlier, so only the net value added is taxed, reducing overall tax cost and the final price for consumers.
Conclusion
While both VAT and GST are forms of consumption tax, GST is a modernised, unified, and more efficient tax system that replaced VAT and other indirect taxes in India. It broadens the tax base to include services, eliminates most cascading effects with seamless input tax credit, and simplifies compliance across states. Understanding these differences helps businesses adapt to GST’s streamlined structure and benefits both trade and consumers.