Merits and Demerits of Value Added Tax (VAT)- Indirect Tax Laws | Indirect Tax Laws - B Com PDF Download

Sr. No 

MERITS

Demerits

1

Reduced Tax evasion: Even if tax is evaded at one stage, the transaction gets caught in next stage of production or distribution

Distortions in case of exemptions/concessions: The merits accrue in full measure only where there is one rate of VAT and the same applies to all commodities without any question of exemptions whatsoever. Once concessions like differential rates of VAT, composition schemes, exemption schemes, exempted category of goods etc. are built into the system, distortions are bound to occur.

2

Increased tax compliance: VAT acts as a self-policing mechanism as the buyer can get credit of tax paid only if the seller issues the invoice showing tax and thus, the buyer insists on getting the invoice from the seller, thereby acting as a police for the seller.

Increased compliance cost: The detailed accounting and paper work required for complying with the VAT system increases the compliance cost which may not always commensurate with the benefit to traders and small firms.

3

Certainty: VAT brings certainty owing to its simple tax structure and minimum variations

Increased working capital requirements: Since tax is to be imposed or paid at various stages and not on last stage, it increases the working capital requirements and the interest burden on the same. Thus, it is considered to be non-beneficial in comparison with single stage-last point taxation system.

4

Transparency: As the tax charged has to be shown clearly in the invoice, the system becomes transparent with no hidden taxes

Consumption favoured over production: Since, VAT is a consumption based tax, it is collected by the State consuming the goods. Thus, States where consumption is higher tend to get more revenue than States where production is higher.

5

Cheaper Exports:  Exports get cheaper as taxes paid at earlier stages could be availed as credit or refunded in cash.

Tax evasion through bogus invoices: Since ITC can be availed on the basis of invoices; dealers try to claim tax credit on the basis of fake invoices – where no purchases have been made – thereby causing loss of revenue to the exchequer.

6

Better accounting systems: Since the tax paid at earlier stage is to be received back, the system promotes better accounting systems.

Regressive tax:  Burden of VAT falls disproportionately on the poor since the poor are likely the spend more of their income than the relatively rich person.

7

Neutrality: Since tax credit of both inputs and capital goods is available, there is no distinction between labour intensive and capital intensive industries.