Transhipment - A redefinition
Let me explain with an example about movement of goods and value addition with a very simple explanation. A shop keeper sells Cake. He gets cake from Baker. Baker makes cakes with flour which he buys from a Miller. Miller buys wheat from Farmer.
Again to make you easily understand on VAT and GST, I simplify the above example by mentioning 4 stages of examples. I hope, this will help you to understand about VAT and GST very easily. All examples for understanding purpose only. Let us split the above example as below:
Stage:1. The Farmer produces Wheat.
Wheat is produced by farmer. For the purpose of producing wheat, the farmer undertakes all farming process. He buys raw materials also. Ok, let us assume, the farmer buys inputs for Rs. 10.00. After completing all the process of farming the wheat is ready for sale to Miller to make flour. He sells wheat for Rs.30.00 by keeping a profit of Rs.20.00.
Stage:2. The wheat becomes flour by milling
The miller purchases wheat from farmer for Rs.30.00. He mills wheat and sells flour to Baker for Rs.50.00 with a margin of Rs.20.00 again.
Stage:3. The baker makes cakes with flour
The baker who bought flour for Rs.50.00 from miller makes cakes and sells for Rs.90.00. Here, he keeps a margin of Rs.40.00
Stage:4. The Shop keeper sells cakes
Finally, the shop keeper buys cakes from the baker for Rs.90.00 and sells for Rs.100.00 with a profit of Rs.10.00.
I hope, the above 4 stages of explanation are very simple to understand.
Now let us come back to VAT. What is Value Added Tax (VAT)?
Let us presume central excise tax or Sales tax rate is 10%. As you know, this tax is levied on the output. In the first stage, output is Rs.30.00. So, central excise/sales tax is Rs.3.00 (10% of Rs.30.00). In the second stage, Central excise/ sales tax rate at 10% works out to Rs.5.00 (10% of Rs.50.00 output). Rs.9.00 would be the central excise/ sales tax rate under 3rd stage of this example (10% on output of Rs.90.00) and in 4th stage, the shop keeper pays Rs.10.00 as central excise/sales tax as his output is Rs.100 (ie. 10% of Rs.100.00). And the total excise/sales tax becomes Rs.27.00, if you add all stages. So this is the tax liability in all these stages under the central excise/sales tax regime.
Do you notice a problem here? The problem is that on the input, ie, when the raw material at 1st stage is taxed, the output became Rs.30.00. Again the raw materials are taxed at the second stage, and again at 3rd stage and finally at 4thstage.
Here tax is imposed on tax paid. That means tax on tax. This is the present Central excise/Sales tax regime which carries a major problem and stupidity.
What happens here when tax on tax are imposed? Simple, the cost of production increases.
So the Central government realized this issue and decided to eliminate central excise and decided to replace central excise with Value Added Tax (VAT). In turn, the central government asked the state governments to replace sales tax with VAT (Value Added Tax). Click here to continue reading : What is Goods and Service Tax Part 2
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