Taxes are broadly classified into direct and indirect taxes, which ensure that the onus of their payment only falls to those who are eligible for them. During the pre-GST era, the indirect taxation system of India was split into a number of layers. Each of these layers, including VAT and CENVAT, ensured a methodical tax collection by the government at various stages of production of goods and services.
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VAT or Value Added Tax belongs under the umbrella of consumption tax levied on a product, upon addition of a value at different stages of its supply chain, starting from its production to the point of sale. The Government of India applies a VAT on each point’s gross margin in the manufacturing to the sales process of a given product.
So, suppliers, manufacturers, distributors and retailers collect this VAT on taxable sales. As a result, tax jurisdictions collect tax revenue across the entire supply chain as opposed to at the sale to end-consumers.
VAT was introduced into the Indian taxation system on April 1st, 2005. It replaced the pre-existing Sales Tax, with an intention to make India a single integrated market. On June 2nd, 2014, this tax was set in force in all the states and union territories of India, except Lakshadweep Islands and Andaman and the Nicobar Islands.
Through the imposition of VAT as a substitute for other taxes, the government of India aimed to close loopholes by avoiding the cascading effect of the tax.
Central Value Added Tax or CENVAT allows a manufacturer to utilise the credit of excise duty/additional duty paid for the procurement of input services to pay-off the excise duty on his/her final product or output services. It was introduced as a modification to the previously functioning Modified Value Added Tax or MODVAT.
During the course of manufacture of final products, the raw materials travel through various stages of production, wherein a duty is levied on every value-added at each stage. CENVAT, therefore, eliminates this double taxation, thereby simplifying taxation for manufacturers, and consumers at large.
In 2004, The government established ‘The CENVAT Credit Rules’ in order to implement CENVAT across the country and offer Indian manufacturers of final products certain tax credits on the excise duty payable by them.
CENVAT credit refers to the set-off available to manufacturers if they utilise some specific inputs for manufacturing their products. A manufacturer can claim CENVAT credit on the following cases:
- Excise duty on a final product: For manufacturers and producers of final products
- Service tax on output services: For providers of taxable and exempted services
- Inputs and capital goods: If these goods are being partially processed
Difference between VAT and CENVAT
VAT and CENVAT were both essential sources of revenue for the government, prior to the advent of the GST regime in 2017. The table below provides a rundown on the difference between VAT and CENVAT:
|Context of differentiation||CENVAT||VAT|
|Purpose of taxation||Prevent duplication of tax.||Elimination of the cascading taxing effect.|
|Authority of collection||Central Government of India||Respective State governments wherein the transaction takes place.|
|Available credit||CENVAT credit||VAT credit|
|Implementing agency||Central Board of Excise and Customs||State Commercial Tax Departments|
|Nature of tax||Excise/Service||Sales|
|Tax rates||Varies based on the raw material used in the process of manufacture||Varies between states and products|
|Applicability||Applicable to the inputs/raw materials used in manufacturing a final product.||Applicable on every value addition to a commodity.|
VAT and CENVAT – A Case in Point
The example discussed below elaborates on the difference between VAT and CENVAT, focusing on the variance in their practical application:
- A manufacturer produces cricket bats and procures wood as raw material, which is affixed with a 5% VAT. He purchases this raw material for Rs. 2,000 and pays Rs. 100 as VAT. This amount becomes his VAT credit. On completing the production of cricket bats, this manufacturer sells his products for Rs. 8000, with a VAT of 5%. This final VAT, therefore, amounts to Rs. 400. However, since this manufacturer’s VAT credit stands at Rs. 100, he is entitled to pay a final VAT of Rs. 300 (Rs. 400 – Rs. 100).
- Now, assume that this particular manufacturer was to pay excise duty at a rate of 14%. So, on the purchase of raw material worth Rs. 2,000, this manufacturer pays an excise duty of RS. 280. On the sale of products for Rs. 8000, he then charges an excise duty of 14% on the final price, which is Rs. 1120. However, the amount he is liable to pay as excise duty is Rs. 840 (Rs. 1120 – Rs. 280).
Substitution of VAT and CENVAT
On July 1st, 2017, the Government of India ruled out the previous indirect taxation system in force by introducing a major reform for the country. An integrated Goods and Services Tax or GST replaced the pre-existing multiple tax structures of Centre and State taxes, including VAT and CENVAT.
Presently, it subsumes all indirect taxes with a single comprehensive tax levied on production and distribution of goods and services. GST remains a single domestic indirect law for the entire country, thereby establishing transparency, neutrality and parity within India’s taxation system.