VAT is a multi-stage tax. This means that VAT is to be paid at every step of the manufacturing process (while purchasing raw materials, processing them, etc). To offset the tax to be paid at every stage, there is a provision to allow input tax credit.
This input tax credit is the amount that is adjusted between the VAT paid by the consumer and the VAT already paid by the manufacturer. This input tax credit, in relation to any period, means setting off the amount of input tax by a registered dealer against the amount of his output tax. It is given for all manufacturers and traders for purchase of inputs/supplies meant for sale, irrespective of when these will be utilised/sold.
The VAT liability of the dealer/ manufacturer is calculated by deducting input tax credit from tax collected on sales during the payment period (a month). If the tax credit exceeds the tax payable on sales in a month, the excess credit will be carried over to the end of next financial year. If there is any excess unadjusted input tax credit at the end of second year, then the same will be eligible for refund.