What is it about?
VAT is one of the several types of taxes levied by the respective governments of a country for funding various public expenditures. Value-added tax abbreviated as VAT also known as Goods and services tax is levied incrementally i.e. it is charged at each stage of production, distribution, or sale of goods or services to a consumer be it individual or businesses. For example, a consumer of Coffee pays VAT for procurement, distribution, and processing of coffee beans. It is a destination-based taxation system meaning it changes depending upon the location of the consumer. More than 160 countries which are permanent members of the United Nations employ VAT as one of the taxes.
History of VAT:
Implementation of VAT was first done during world war I years by Germany and France in the form of general consumption taxes. The modern version of VAT was designed independently by Dr Wilhelm Von Siemens, German industrialist in the early 20th Century. Following this many European countries Like France and Netherlands implemented VAT in the subsequent years. The beliefs and purpose behind the implementation of VAT were different in countries, for example, Europeans used VAT to reduce sales tax while Americans found VAT to be a better version of corporate taxes.
Methods of VAT Computation:
1. Credit Invoice or Invoice-Based Method:
In this method sales, transactions are taxed and businesses receive credit for VAT paid on input material and services.
VAT payable= Tax on sales Bill – Tax on purchase bill
2. Subtraction or Accounts-Based Method:
In this method, a business calculates the value of all taxable sales then subtracts the sum of all taxable purchases and the VAT rate is applied to the difference obtained.
Taxable Turnover= Sales excluding taxes-purchase excluding taxes
VAT Payable = Taxable turnover* tax rate
How Does it Work?
Suppose Choco candy is a premium brand in candy manufacturing and sold in India. India has a 10% value-added tax.
Choco candy manufacturer buys the raw materials for Rs.2.00, plus a VAT of 20 paise—payable to the government of India—for a total price of Rs.2.20.
The manufacturer then sells Choco candy to a retailer for Rs.5.00 plus a VAT of 50paise for a total of Rs.5.50. However, the manufacturer renders only 30paise to India, which is the total VAT at this point, minus the prior VAT charged by the raw material supplier. Note that the 30paise also equals 10% of the manufacturer’s gross margin of Rs.3.00.
Finally, the retailer sells Choco candy to consumers for Rs.10 plus a VAT of Rs.1 for a total of Rs.11. The retailer renders 50paise to India, which is the total VAT at this point (Rs.1), minus the prior 50paise VAT charged by the manufacturer. The 50paise also represents 10% of the retailer’s gross margin on Choco candy.
Value-Added Tax vs Sales Tax:
VAT and sales taxes raise nearly the same amount of revenue, the difference lies in at what point the money is paid and by whom. Here is an example that assumes a VAT of 10%:
A farmer sells wheat to a bakery for 30paise. The bakery pays 33paise; the extra 3paise represents the VAT, which the farmer pays to the government.
The bakery uses the wheat to make bread and sells a loaf to a local supermarket for 70paise. The supermarket pays 77paise, including a 7paise VAT. The bakery pays 4paise to the government, the other 3paise were paid by the farmer.
Finally, the supermarket sells the loaf of bread to a customer for Rs.1. Of the Rs.1.10 paid by the consumer, or the base price plus the VAT, the supermarket sends 3paise to the government.
With a traditional 10% sales tax, the government receives 10paise on an Rs.1 sale. The VAT differs in that it is paid at different stages along the supply chain; the farmer pays 3paise, the baker pays 4paise, and the supermarket pays 3paise.
Advantages of VAT:
Restricting Tax Loopholes
The proponents of VAT argue that it has significantly eased the complex tax structures as it makes it difficult to avoid paying taxes. VAT collects taxes on all purchases of goods and services rendered including online purchases.
Incentive to Earn
If VAT replaces income taxes it discourages complaints against the progressive tax system. Citizens can keep more of the money they earn and are only levied when paying for goods and services. It encourages savings and thus subsequent investments and discourages frivolous spending.
Higher Costs for Businesses
Opponents find many potential drawbacks of a VAT, including increased costs for business owners throughout the chain of production. As VAT is calculated at every step of the sales process, bookkeeping itself results in a big burden for a company, which then passes on the additional cost to the consumer. It becomes more complex when transactions are not limited to local but international. Different countries have different interpretations of how the tax is calculated. This not only adds another layer to the bureaucracy, but it also results in unnecessary transaction delays.
Encouraging Tax Evasion
While a VAT system is simpler to maintain, it is costlier to implement. Tax evasion can continue and even widespread if the public does not give it its support. Micro and medium businesses, in particular, can evade paying VAT by asking their customers to not take a receipt, consequently, the price of the product or service being purchased is lower if no official receipt is issued.
Conflicts with State and Local Governments.
The Federal form of government VAT could also create conflicts with state and local governments across the country, which set their own sales taxes at varying rates.
Higher Prices Especially for Low-Income Consumers
Critics state that consumers typically end up paying higher prices with a VAT. While the VAT spreads the tax burden on the added value of a good as it goes through the supply chain, from raw material to final product, in practice the added costs are typically passed on to the consumer.
1. Does the VAT that I Pay Reach to the Government as a Tax Amount?
Yes. Any state in which VAT is levied and implemented, the sum of VAT paid by the end-user goes to the government. That means you are indirectly funding the tax as well as buying a product or service.
2. Is the Compliance Rate of VAT Safer than Sales Tax?
Yes. The sole purpose of introducing VAT is to bring clarity in the taxation process. And also, to decrease the exploitation of sales tax, that was one of the major problems in India.
3. Why Do We Pay VAT?
The VAT is Value Added Tax, and it is the sum of fees we need to pay the government for functioning in the country's territory. This is kind of an indirect income tax that is important to pay as a respective citizen of a country.