1 Value Added Taxes (VAT)

Updated on July 19, 2022

Topics covered in this chapter include:

“Tax Categories” in Section 1.1

Tax Calculation Exemple in Section 1.2

At each stage of manufacturing and distribution, a tax is collected on the additional value that is being added to the product,

called a value-added tax (VAT).

The firm must pay VAT on the additional value it adds to a product (for example, packaging a product) (the value of the packaging).

Taxes are levied on the difference between the selling price of the packaged product and the cost of materials and services used to make the product.

When a firm sells a product, it is responsible for collecting the applicable VAT.

Note:

In this guide, “VAT” refers to all types of value-added taxes.

To avoid confusion, the guide does not utilize country-specific phrases like VAT in Belgium or GST in Singapore.

1.1 Tax Categories

Most actions and purchases are subject to VAT, or value-added tax (VAT).

Only a few solutions are exempt from taxes or are not taxed at all.

It is possible to categorize items and services into three categories:

Taxable. VAT refunds are available to consumers who purchase taxable products (purchases of materials that make up the product).

Tax-exempt. To obtain a tax credit, a corporation must be selling tax-exempt goods.

Costs may rise due to unrecovered VAT on purchases.

All financial institutions that offer loans, mortgages, savings plans, and property insurance fall under this umbrella phrase.

Adjectives with a bad rap (tax-free).

To claim a tax credit for VAT paid on purchases, a business that solely sells zero-rated products and does not collect VAT on its sales may do so. Two examples of this type of company strategy are basic food growers and exporters.

Tax-free purchases and taxable or zero-rated expenses must be recorded separately for each of the following businesses.

1.2 Tax Calculation Example

A simple VAT example for the production and sale of a book is shown below:

Producer / Consumer Purchase Price Paid Purchase VAT Purchase Total Sales Price Charged Sales VAT Sales Total Sales Paid to Govt*
Forester (log) 0.00 0.00 0.00 10.00 .70 10.70 .70
Mill (paper) 10.00 .70 10.70 15.00 1.05 16.05 .35
Printer (book) 15.00 1.05 16.05 30.00 2.10 32.10 1.05
Wholesaler 30.00 2.10 32.10 35.00 2.45 37.45 .35
Retailer 35.00 2.45 37.45 40.00 2.80 42.80 .35
Consumer 0.00 0.00 0.00 0.00 0.00 0.00 0.00
Total Tax to Government

 

Sale VAT minus purchase VAT is the amount that must be paid to the government.

Taxpayers in the example above must follow these steps to compute and pay an additional 7% VAT.

Make sure that VAT is reflected in the selling price of the goods or services.

For example, when the mill sells paper, it adds 1.05 (7% of the 15.00 price charged) to the 15.00 sale price and sells the paper for 16.05.

Add all VAT paid to suppliers. For example, the mill paid . The forester will pay 70 VAT.

For the current tax period, subtract the sum of the VAT amounts paid (step 2 above) from the sum of the VAT amounts received (step 1 above). In other words, this is the amount of VAT that you owe the government. The mill, for example, pays the tax authority.35 (1.05 added to its selling price less .70 paid to the forester).

If a company’s calculations result in a negative balance, it may be eligible for a government rebate.

The company may or may not be able to take advantage of all three processes, depending on the product category (taxable, tax-exempt, or zero-rated).

A business can add 7% of the selling price (step 1) only for taxable products. A business can subtract the sum of the VAT paid to its suppliers from the VAT owed on the value added (steps 2 and 3) only for taxable products and zero-rated products.