I am interested to know all about Value addded tax aka VAT? How is it
different from the normal Tax system? Who benifits the most,
presumably the Government, but how? How are the sellers affected and
where does the consumer stand.

Dear Anshu, 

Wikipedia has more answers than what you need to know about this subject. 

How is it different from the normal Tax system?  
[...]
VAT differs from a conventional sales tax in that VAT is levied on
every business as a fraction of the price of each taxable sale they
make, but they are in turn reimbursed VAT on their purchases, so the
VAT is applied to the value added to the goods at each stage of
production. Since sales taxes are applied to the total price at each
stage of production, they tend to compound, growing into very high tax
rates on products with numerous stages of production done by different
economic units. This discourages specialization and, instead,
encourages integrated production units even when integration (e.g.,
from raw materials to final product) is less efficient."

How does the government benefit? 
[...] 
"In this way, the total tax levied at each stage in the economic chain
of supply is a constant fraction of the value added by a business to
its products, and most of the cost of collecting the tax is borne by
business, rather than by the state. "

Source and further information: 
Wikipedia: Value Added Tax
<http://en.wikipedia.org/wiki/Value_added_tax>

It's a Consumer Tax invented by the French and adopted by the European
Community, principally as a method of collecting revenue.

Businesses with more than a certain Turnover have to levy VAT on their
Sales within the EC. Businesses registered for VAT can recover VAT
that is charged to them and they account for the difference to their
Governments.

Consumers cannot recover VAT.

VAT rates vary from country to country and some items are exempted
from country to country.

Imported goods are also affected.

To add to the above pretty complete synopsis:

VAT is not charged on exports outside the EU
- also, interestingly one does not have to charge VAT to VAT
registered businesses within the EU - but only if they are not in your
Nation.

- however for that 'exemption' you need to fill in a quarterly return
giving your client's VAT numbers and total sums received from them (or
if they are Spanish total sums invoiced - the two will seldom match)

This leads to the interesting situation where one can be invoicing a
EU company and claiming back inputs in a different Nation.

My Father spent some years in that hilarious state of affairs, he was
getting a nett rebate each VAT period.

When he snuffed it the VAT Office sent increasingly menacing demands to:
   'John Smith (Deceased)'
- despite the fact that they actually owed him (or his relict) money.

Both of PB's and Frde's comments refer to EU VAT, but VAT is common in
other countries as well.

Businesses that export can actually benefit from VAT!

Here's how:

You set up two companies: Company A that supplies its 'local' market
and sells to Company B that exports outside the 'local' market.

Typically, Company A will have to pay its net VAT collections to the
Revenue and it opts do this quarterly.

Typically, Company B will have to recover its net VAT disbursements
from the Revenue and it opts do this monthy.

Wow!

The wikipedia entry is wrong in suggesting that VAT and sales tax both
apply at every stage in the economic chain, or it should have said in
which country/ies this is the case.
VAT is leveled at each sale, added to the invoice:  that of the steel
mill to the rolling mill, its to the car maker, its to an independent
dealer, and its to you.
Each of these  - except YOU - submit a tax return for VAT that allows
them to net the VAT paid with that received within the reporting
period.  In the long term, each company pays VAT on the net, the
"value added" by its production.  YOU, the consumer cannot recover
VAT, pay it all to the car dealer, but he only has to pay the state
the portion that he cannot net with that which was on the invoice from
"BMW".  Thus the state in the end only realizes the sum of what it
collects at each stage, which should equal what you paid.
If I ever knew, I have forgotten why this complicated system is
supposed to be more effective or efficient than a simple, final sales
tax.
In general, VAT is an alternative to a sales tax (wikipedia's error),
in some countries there may be an additional luxury tax on some items.

In a start up situation, with VAT, a company may actually get a real
cash refund from the state, since it reports the VAT it has paid, not
just for materials but also investments in production equipment,
furniture, anything it purchases.

Yes, this does result in fraud  - fictitious invoices ...
And there are possible situations for fraud with cross-border invoicing.

I won't try to reconcile this with what frde and probo have added, but
hope you get the picture.  The consumer pays. (but if you set up a
little company to manage your investments and rental income, then you
can also net the VAT for your BMW as a company car against any VAT
related income and offset the rest against tax the company pays).

Anshu, to all the excellent information already provided I pile on this crumb.

Since entity Y wants to recoup the VAT it paid to X on input materials
it needs a tax_id number that uniquely designates X. Presumably Y will
have many similar transactions with X and W and Z.  It is in the
economic interest of X
to seek similar tax_id numbers from all its suppliers so that the 
ultimate tax authority (UTA) recognizes these taxes incurred and credits entity Y.

But there are many entities like Y, all buying from X and W and Z.
By careful data mining the UTA can estimate the total revenue of X
from materials sold by X. Same for W and Z.  Using industry-specific
benchmarks the UTA can estimate the income of X and W and Z--> derive
Income Taxes Owed vs Income Taxes actually paid.