Methods of computation of VAT. (a) Addition Method. (b) Subtraction Method. (c) Tax credit or Invoice Method. Methods of calculation of VAT. As mentioned earlier VAT is nothing but a form of sales tax only and is charged at each stage of sale on the value added to the goods. "Value Added" is the difference between sale and purchase of a business. A straight forward way to compute the base of a VAT for a given period, say a quarter, is, in the case of a manufacturer, to educt the total cost of the inputs used in production from the amount for which the manufactured goods are sold.
VAT is computed by adopting three alternative methods. These are i) Addition method it) Subtraction method iii) Tax Credit or Invoice method. In Addition method, value added could be determined by summation of all the elements of value added i. e. wages, profits, rent and interest. The subtraction method estimates value-added by taking the difference between the value of outputs and inputs. Under the Tax Credit Method, the tax on inputs is deducted from the tax on the sales to arrive at the VAT payable by the dealer.
VAT payable = Total tax charged - Total tax paid to the outputs or sales suppliers on inputs or purchases on the Tax Credit or Invoice Method has been adopted universally because of the inherent advantages in the credit method of calculating tax liability. The other methods namely addition method and subtraction method are not workable in the case of a anufacturer when the rate of tax is different in respect of inputs and outputs.
Advantages and Adoption of Tax Credit Method. (1) It makes cross-checking of tax paid at earlier stage, more amenable, as dealers are required to state the amount of tax in invoices. (2) Tax burden being dependent upon the tax rate at the final stage, dealers at intermediate stages do no have any incentive to seek treatment in tax rate. (3) Under the invoice method exports can easily be relieved of domestic indirect taxes through zero rating of exports.