Value-added tax or VAT is an indirect tax that is a way to implement a consumption tax. It was introduced into the taxation system in India on 1st April 2005 replacing the Sales Tax. As of June 2014, all states and UTs in India except the Andaman and Nicobar Islands and Lakshadweep were implementing VAT. The sales tax was paid by the end consumers on any purchase made for their own consumption. The tax authorities receive tax revenue only when the final sale is made to the end-consumer. In the case of VAT, tax is collected by all the sellers in the supply chain from the manufacturer to the end-consumer. That is, tax is collected by the seller in each stage of value addition to the product/service.
VAT encourages better tax compliance and reduces evasion. This is because in the case of sales tax, the seller had to make sure that the purchaser of his goods was not the end-consumer, because there is no sales tax. In the case of VAT, each purchase has a tax levied. Basically, the manufacturer pays a VAT to the seller of his raw material. Now, he also charges his customer, who is the retailer, a VAT. The manufacturer now pays to the government the difference between what he gets from the retailer as VAT and what he pays to the producer of raw material as VAT. So, there is more paper work for the businesses but also better compliance. Another advantage of VAT is that it does away with the cascading effect of sales tax. The government has now replaced the VAT and other sales taxes with the GST.