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Unit 5: Value Added Tax (VAT)
5.1 Definition and Background of VAT
VAT is a multi-stage consumption tax collected on the value added at each stage of production and distribution. Introduced in Nepal by the Value Added Tax Act 2052 (1996), replacing the sales-tax patchwork. Every seller charges output VAT and credits the input VAT already paid — the tax chain self-policing through tax invoices.
5.2 Principles of VAT
- Destination principle — consumption is taxed where it is consumed: imports taxed, exports zero-rated.
- Fractional payment — each firm pays only on its value added (output minus input).
- Invoice-based credit method — the tax invoice is the credit’s title deed.
- Neutrality — the chain’s total equals tax on the final price, whatever the production stages.
5.3 Merits and Demerits of VAT
| Merits | Demerits |
|---|---|
| Broad base, stable yield | Regressive on consumption basics (mitigated by exemptions) |
| Self-enforcing (buyer wants invoice) | Compliance burden on small business |
| Export-neutral (zero-rating) | Invoice fraud industry (fake/circular invoices) |
| Difficult to evade at every stage | Refund abuse and delayed refunds |
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