7.3 - Sales Tax, Value Added Tax, Goods and Services Tax

In this subtopic, we explore how taxes are applied to goods and services. Taxes like Sales Tax, Value Added Tax (VAT), and Goods and Services Tax (GST) play a major role in determining the final price of products and services. These taxes are calculated on the cost price of goods and services and are important in understanding the overall cost structure in real-life scenarios.

1. Sales Tax

Sales tax is a tax levied by the government on the sale of goods and services. It is usually calculated as a percentage of the sale price of the product. Sales tax is generally paid by the buyer to the seller, and the seller then passes it on to the government.

The formula for calculating the amount of sales tax is:

Sales Tax = (Rate of Sales Tax × Cost Price)

Where:
Sales Tax is the amount to be paid as tax,
Rate of Sales Tax is the percentage rate applied by the government,
Cost Price is the price of the product before tax.

2. Value Added Tax (VAT)

Value Added Tax (VAT) is a type of indirect tax that is applied at each stage of production or distribution of goods and services. Unlike sales tax, which is applied only at the final sale, VAT is collected on the value added at each step of the manufacturing process.

In a VAT system, businesses can deduct the tax they have already paid on their inputs from the tax they charge on their outputs. This makes the VAT a tax on the value added at each stage of the production process, rather than the total price of the product.

The formula for VAT is:

VAT = (Output Tax - Input Tax)

Where:
Output Tax is the tax collected from customers,
Input Tax is the tax paid on raw materials and inputs.

3. Goods and Services Tax (GST)

Goods and Services Tax (GST) is a comprehensive indirect tax that replaces multiple taxes like VAT, service tax, excise duty, and others. It is levied on the supply of goods and services and is applicable at each stage of production or distribution, with credits for taxes paid at earlier stages. GST is a single tax for the entire country in India and helps simplify the taxation system.

The GST is divided into three types:
- CGST (Central Goods and Services Tax)
- SGST (State Goods and Services Tax)
- IGST (Integrated Goods and Services Tax) for inter-state transactions.

The formula for calculating GST is:

GST = (Tax Rate × Cost Price)

Where:
Tax Rate is the applicable GST rate (in percentage),
Cost Price is the price before GST is applied.

4. Comparison of Sales Tax, VAT, and GST

While sales tax is applied only at the final point of sale, VAT is applied at every stage of production and distribution. GST, on the other hand, combines the features of both sales tax and VAT and applies to both goods and services. GST is more efficient in terms of input tax credits and helps in reducing the cascading effect (tax on tax) seen in previous systems.

5. Examples

Let’s consider a simple example:

If a product costs ₹1000, and the sales tax rate is 10%, the sales tax amount will be:

Sales Tax = (10% × ₹1000) = ₹100

So, the total price after tax will be ₹1000 + ₹100 = ₹1100.

Similarly, if the GST rate is 18%, the GST amount on ₹1000 will be:

GST = (18% × ₹1000) = ₹180

The total price including GST will be ₹1000 + ₹180 = ₹1180.

This gives an understanding of how taxes affect the final price of products and services.