Value-Added Tax (VAT) is used as an extensively used system of taxation globally especially in Europe, Latin America, and Asia. This is in form of consumption-based tax in that it is imposed at every level of production and distribution process which implies that it is imposed progressively as the product proceeds throughout the supply chain. The tax is incurred by the end user but it is businesses that pay and remit the tax to the government.
Value-Added Tax (VAT) is to many just like a black box that, when viewed, we are quick to submit to the fact that it is complicated, yet when we familiarize ourselves with the concept and the many advantages it has to offer, we can see why it has received much popularity among many nations. As a business owner, as an entrepreneur or even as someone who wants to know about taxes, you should most likely know about VAT and its potential benefits.
This article will be dismantled to explain what Value-Added Tax (VAT) is, how it functions and above all the advantages of Value-Added Tax (VAT) to the business and the consumer. We will also present some practical examples to have a better vision of the topic. After reading this article, you will be assured of being able to talk competently about VAT and its position in the contemporary economy.
Value-Added Tax (VAT), What Is It?
Simply explained, Value-Added Tax (VAT) is an indirect scheme introduced on goods and services at each point of sale in the chain of supply. The notable aspect of VAT is that it is contributed in installments by the businesses, and the consumer pays them when he/she uses the product or service.
The VAT is charged at every stage of the goods production and distribution whereas sales tax is only applied when we sell the product at the final point to the consumer. This implies that all the businesses that take part in the supply chain will be charged the VAT on the value added along the way.
What is the Mechanism of Value Added Tax (VAT)?
Suppose you purchase an item in the store, which you are purchasing is subject to the VAT tax. The company which sells it to you will give you the tax and the government will receive it. But every business within the production chain i.e. manufacturer, wholesaler, retailer will be subjected to VAT based on the product they purchase and it will be sold at a higher cost than the previous level of the supply chain.
Let us take a simple supply chain of a smartphone:
The phone is manufactured and sold to a wholesaler by the manufacturer using a sale of 200 dollars including 20 dollars VAT.
The wholesaler sells this to a retailer at 250 dollars, and 25 dollars VAT.
Lastly, you get the phone which is sold to you by the retailer at 300 dollars, plus 30 VAT.
Here, as a consumer, you would give out the total amount of 330 dollars that would comprise of 30 dollars VAT. VAT is levied on each business in the chain who has already paid Value-Added Tax (VAT) on goods they have sold and they can estimate the VAT they have paid in their own purchases which prevents a case of dual taxation.
Pros of Value-Added Tax (VAT)
Although there may be a temptation to think of VAT as a mode of revenue generation by government alone, VAT has got a number of pluses that make it a very appealing tax to both a business and the government. So what are the main upsides? Let us see:
1. Effective Taxes Collection
Efficiency in terms of tax collection is probably one of the greatest advantages of VAT. Less opportunities to evade taxes are allowed since it has been charged at every phase of production and distribution. Every member of the supply chain is enticed to be compliant since all of them have the ability to reclaim the VAT they paid on their own supplies through a credit.
Take an example of a firm that produces and retails shoes. In case of buying raw materials such as leather or rubber products they pay VAT on such items. However, when the finished product is being sold, they collect VAT charges on the consumer. The business would then be able to recover Value-Added Tax (VAT) that they had paid on the materials such that the tax is only paid to the final consumer.
This establishes a new system of recording that is well monitored and all transactions are documented and businesses may find it hard to evade paying VAT.
2. Reduced Administrational Burden
Value-Added Tax (VAT) also decentralizes the tax-gathering duties because since it is taken at every point of the supply chain, it has the effects of distributing its bureaucratic settlement. The governments do not have to trace down every consumer but will just have to keep an eye on the businesses, and it is the businesses that actually have to pay the tax. This system has the tendency of needing less government interference and it is less complex to implement tax.
3. Promotes Investments and Increasing Businesses
Value-Added Tax (VAT) is a neutral tax, which implies that it does not skew business decisions as is likely to be the case with income taxes or taxes that are collected based on profits. This impartiality will promote engagement and expansion of businesses since the tax is not imposed on production and investment as a punishment. Also, since the amount of VAT paid by the businesses on their purchases can be recovered by the businesses, the tax does not place a new burden on the cost of doing business.
This can be explained by way of example, that in case a small business imports the materials, in order to manufacture goods, he/she can claim the VAT he/she has paid on those materials which further cuts down his costs and helps him to reinvest in business easily.
4. Minimizes the chances of Tax evasion
Given that every business within the supply chain charges VAT and has the ability to recover VAT on their purchases this has the effect of giving the businesses that make up the supply chain a financial motivation to make sure that the amount of tax they are paying is accurate. Otherwise, their suppliers might not entertain their claims on VAT to fund in this case leading to loss of money. This minimizes the chances of tax evasion as opposed to those collection systems dependent on collection of taxes by end consumers.
5. The way of Government Revenue Increasing
Value-Added Tax (VAT) generates a lot of funds to the governments because of the fact that it is collected at every level in the supply channel. It is usually more difficult to evade as compared to other types of tax, like tax on sales or even tax on income since the businesses are expected to record and report every purchase they make. The effect of this is the decentralization of revenue stream and making it be more stable and predictable to governments.
6. Makes International Trade easy
International trade is another benefactress of VAT since the majority of the countries having a VAT system do not collect VAT on export. This promotes export competitiveness in an overseas market because the tax in effect returns to the business that exports commodities.
7. Fair and Open
There is a strong tendency to consider VAT a fairer tax since it is applied in equal measures across the various sectors and companies. VAT is charged at each stage of the production process of every business and it is clear to the consumer on how much money he/she is paying during purchase.
A Preliminary Guide on Value-Added Tax (VAT) to Business Owners
To this end, a simple step by step guide to VAT which is presented below would help business in understanding how VAT really works in practice:
Step 1: Find out Whether Your Business Has to Be Registered to Pay VAT
In countries it is different and one should (as usual) see local law.
Step 2: Get to know about the Value-Added Tax (VAT) Rates
The VAT rates are varying according to the countries. Become aware of the rates of VAT prevailing in your country.
Step 3: levying VAT on Sales
Upon registration, your business must add VAT on the goods and services that it issues. Make sure your invoices show clearly the sum you are charging by way of VAT, and your VAT registration number.
Step 4: Records of VAT Paid and collected
You are obliged to record the VAT you have received as received on the purchases made by customers together with the VAT you have paid on purchases made in your Business. This is the information you need in reclaiming back VAT on items you are spending your business on.
VAT returns: step 5
The majority of businesses are obliged to submit VAT returns in time (monthly, quarterly, or annually). In the course of this you make a claim concerning what VAT you have paid as well as what you have collected. Either you are going to pay the difference or you will get a refund.
Step 6: Make payment to Government of VAT.
Once you have submitted your VAT return, the tax authorities will owe you or you will have to pay them depending on whether you paid a lot of VAT when buying business items than you are getting on your sales.
FAQ Section
Q 1: What is Value-Added Tax (VAT)?
A1: Value-Added Tax (VAT), is a consumption tax that is imposed on goods or services at every level of production or distribution. The end consumer pays the tax whilst the businesses collect and pay the taxes into a government account.
Q2:What are the benefits of VAT to businesses?
A2: The VAT has a positive effect to businesses as they can claim back on the amount of VAT paid on business expenses hence reducing their level of taxes. It too promotes investment and growth because it does not punish businesses on production or investment.
Q3: What is the treatment of the Value-Added Tax (VAT) in businesses?
A3: Companies are required to get registered as VAT, account VAT applicable as tax in the sales, maintain VAT-related records and within a specific deadline to make VAT returns. They will be able to claim back VAT on their business charges and this means that only the last consumer will pay the tax.
Q 4- Are Value-Added Tax (VAT) same everywhere?
A4:No VAT rates and regulations will be different in various nations. There are countries which have fixed rates and others might have lower rates on some of the goods or services.
Tax Laws in USA, below there is more detailed advice and resources on Value-Added Tax (VAT).
