Value-added tax

Value added tax (VAT) is similar to a sales tax in that it is levied at the time of the sale of goods and services. In some countries, including Australia, Canada, New Zealand and Singapore, this tax is known as "goods and services tax" or GST. VAT is an indirect tax, in that the tax is collected from someone other than the person who actually bears the cost of the tax (namely the seller rather than the consumer).

VAT was invented by a French economist in the 18th century. Maurice Lauré, joint director of the French tax authority, the Direction générale des impôts, as taxe sur la valeur ajoutée (TVA in French) was first to introduce VAT with effect from 10 April 1954 for large businesses, and extended over time to all business sectors. In France, it is the most important source of state finance, accounting for approximately 45% of state revenues.

Personal end-consumers of products, consumers and services cannot recover VAT on purchases, but businesses are able to recover VAT on the materials and services that they buy to make further supplies or services directly or indirectly sold to end-users. 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. VAT was invented because very high sales taxes and tariffs encourage cheating and smuggling. It has been criticized on the grounds that it is a regressive tax.

VAT in the European Union

A common VAT system is compulsory for member states of the European Union. The EU VAT system is imposed by a series of European Union directives, the most important of which is the Sixth VAT Directive (Directive 77/388/EC). Nevertheless, some member states have negotiated VAT exemption or variable rates for regions or territories. The Canary Islands, Ceuta and Melilla (Spain), Gibraltar (UK) and Åland Islands (Finland) are outside the scope of the EU system of VAT, while Madeira (Portugal) is allowed to levy variable rates.

Under the EU system of VAT, where a person carrying on an economic activity supplies goods and services to another person, and the value of the supplies passes financial limits, the supplier is required to register with the local taxation authorities and charge its customers, and account to the local taxation authority for, VAT (although the price may be inclusive of VAT, so VAT is included as part of the agreed price, or exclusive of VAT, so VAT is payable in addition to the agreed price).

VAT that is charged by a business and paid by its customers is known as output VAT (that is, VAT on its output supplies). VAT that is paid by a business to other businesses on the supplies that it receives is known as input VAT (that is, VAT on its input supplies). A business is generally able to recover input VAT to the extent that the input VAT is attributable to (that is, used to make) its taxable outputs. Input VAT is recovered by setting it against the output VAT for which the business is required to account to the government, or, if there is an excess, by claiming a repayment from the government.

Different rates of VAT apply in different EU member states. The minimum standard rate of VAT throughout the EU is 15%, although reduced rates of VAT, as low as 5%, are applied in various states on various sorts of supply (for example, domestic fuel and power in the UK). The maximum rate in the EU is 25%.

The Sixth VAT Directive requires certain goods and services to be exempt from VAT (for example, postal services, medical care, lending, insurance, betting), and certain other goods and services to be exempt from VAT but subject to the ability of an EU member state to opt to charge VAT on those supplies (such as land and certain financial services). Input VAT that is attributable to exempt supplies is not recoverable, although a business can increase its prices so the customer effectively bears the cost of the 'sticking' VAT (the effective rate will be lower than the headline rate and depend on the balance between previously taxed input and labour at the exempt stage).

Finally, some goods and services are "zero-rated". The zero-rate is a positive rate of tax calculated at 0%. Supplies subject to the zero-rate are still "taxable supplies", i.e. they have VAT charged on them. In the UK, examples include most food, books, drugs, and certain kinds of transport. The zero-rate is not featured in the EU Sixth Directive as it was intended that the minimum VAT rate throughout Europe would be 5%. However zero-rating remains in some Member States, most notably the UK, as a legacy of pre-EU legislation. These Member States have been granted a derogation to continue existing zero-rating but cannot add new goods or services.

When goods are imported into the EU from other states, VAT is generally charged at the border, at the same time as customs duty. "Acquisition" VAT is payable when goods are acquired in one EU member state from another EU member state (this is done not at the border but through an accounting mechanism). EU businesses are often required to charge themselves VAT under the reverse charge mechanism where services are received from another member state or from outside of the EU.

Businesses can be required to register for VAT in EU member states, other than the one in which they are based, if they supply goods via mail order to those states, over a certain threshold. Businesses that are established in one member state but which receive supplies in another member state may be able to reclaim VAT charged in the second state under the provisions of the Eighth VAT Directive (Directive 79/1072/EC). A similar directive, the Thirteenth VAT Directive (Directive 86/560/EC), also allows businesses established outside the EU to recover VAT in certain circumstances.

Following changes introduced on 1 July, 2003 (under Directive 2002/38/EC), non-EU businesses providing digital electronic commerce and entertainment products and services to EU countries are also required to register with the tax authorities in the relevant EU member state, and to collect VAT on their sales at the appropriate rate, according to the location of the purchaser. Alternatively, under a special scheme, non-EU businesses may register and account for VAT on only one EU member state. This produces distortions as the rate of VAT is that of the member state of registration, not where the customer is located, and an alternative approach is therefore under negotiation, whereby VAT is charged at the rate of the member state where the purchaser is located.

The differences between different rates of VAT was often originally justified by certain products being "luxuries" and thus bearing high rates of VAT, whereas other items were deemed to be "essentials" and thus bearing lower rates of VAT. However, often high rates persisted long after the argument was no longer valid. For instance, France taxed cars as a luxury product (33%) up into the 1980s, when most of the French households owned one or more cars. Similarly, in the UK, clothing for children is "zero rated" whereas clothing for adults is subject to VAT at the standard rate of 17.5%.

Rules on pricing within the EU

• Where most of the trade is business-to-consumer, prices must include VAT.
• Where most of the trade is business-to-business, prices do not have to include VAT.

Value Added Tax in India : In India, VAT replaced sales tax on 1-4-2005. Though some States did not opt for VAT (for political reasons), majority of the States embraced VAT, progressive States like Andhra Pradesh taking the lead. The Empowered Committee, constituted by Govt. of India, provided the basic framework for unifom VAT laws in the States.

VAT - The A.P experience : The Andhra Pradesh Value Added Tax Act, 2005 came into force on 1-4-2005 and contains six Schedules. Schedule I contains goods generally exempted from tax. Schedule II deals with zero rated transactions like exports and Schedule III contains goods taxable at 1%, namely jewellery made from bullion and precious stones. Goods taxable at 4% are listed under Schdule IV. Majority of foodgrains and goods of national importance, like iron&steel are list under this head. Schedule V deals with Standard Rate Goods, taxable at 12.5%. All goods that are not listed elsewhere in the Act fall under this head. The VI Schedule is the bread and butter of all the State Govts. This Schedule contains goods taxed at special rates (more than 50%), like liquor and petroleum products. There are thus three rates of taxes in India, namely 1%; 4% and 12.5%.

The Act prescribes threshold limits for VAT registration - dealers with a taxable turnover of over Rs.40.00 lacs, in a tax period of 12 months, are mandatorily registered as VAT dealers. Dealers with a taxable turnover, in a tax period of 12 months, between Rs.5.00 to 40.00 lacs are registered as Turnover Tax (TOT) dealers. While the former category of dealers are eligible for input tax credit, the latter category of dealers are not eligible for input tax credit. A VAT dealer pays tax at the rate specifed in the Schedules. The sales of a TOT dealer are all taxable at 1%. A VAT dealer has to file a monthly return disclosing purchases and sales. A TOT dealer has to file a quarterly return disclosing only sale turnovers. While a VAT dealer can buy goods for business from anywhere in the country, a TOT dealer is barred from buying outside the State of A.P.

The A.P VAT Act appears to be the most liberal VAT law in India. It has simplified the registration procedures and provides for across the board input tax credit ( with a few exceptions)for business transactions. A unique feature of registration in A.P is the facility of voluntary VAT registration and input tax credit for start-ups.

The A.P VAT Act also provides for transitional relief(TR) for goods on hand as on 1-4-2005. However, these goods ought to have been purchased from registered dealers between 1-4-2004 to 31-3-2005. This is a bold step compared to the 3 months TR provided by several developed countries.

The APVAT Act not only provides for tax refunds for exporters (refund of tax paid on inputs used in the manufacture of goods exported), it also provides for refund of tax in cases where the inputs are taxed at 12.5% and outputs are taxed at 4%.

The VAT Act in A.P is administered by a highly professional team of officers who were well trained by the PMT(Project Management Team) before the Act came into force. The Commercial Taxes Department ( department to collect VAT and other taxes)has also put in place a software pacakage called VATIS(developed by TCS) with intra net on line connectivity to all the offices in the State. All the documents and forms received from the dealers are acknowledged and fed in VATIS to generate registration certificates and tax demand notices.

VAT, to be successful, relies on voluntary tax compliance. Since VAT believes in self assessments, dealers are required to maintain proper records, issue tax invoices, file correct tax returns etc. The opposite seems to be happening in India. Businesses are still run on traditional lines. Cash transactions are order of the day. The unorganised sector dominates the market. The hope of higher tax compliance and lesser evasion is still a far cry in A.P. This is reflected in the high % of return defaulters ( 14%), a high % of crdit returns (35%) and a high % of nil returns (20%). That is, roughly 70% of VAT dealers are presently not paying any tax. Filing of credit returns is rampant among FMCG, Consumer Durables, Drugs&Medicines and Fertilizers. The margins are low in this sector( ranging between 2 to 5%). The value addition is not enough to yield revenue as of now. Credits offered by manufacturers compounds the problem. The question is - in a typical WallMart like purchases and sales scenario, can there be more output tax than input tax? When purchases consistently exceed sales, can output tax exceed input tax? If a VAT dealer can balance his/her purchases and sales, can there be a net tax to the State? Is there a mathematical model or paradigm which can give value added tax and which can reduce the % of credit returns. There are no rady answers for these queries. The only remedy seems to be the restriction of input tax to the corresponding purchase value of goods put to sales. In fact a two tier system can be adopted to counter the credit returns - allow full input tax to manufacturers and restrict input tax to the purchase value of goods put to sale to traders. Restricting input tax to 4% in the case of inter state sales and in the case of products taxable at 12.5% seems to be another solution.

Comparison with a sales tax== 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.

Sales taxes are normally only charged on final sales to consumers: because of reimbursement, VAT has the same overall economic effect on final prices. The main difference is the extra accounting required by those in the middle of the supply chain; this disadvantage of VAT is balanced by application of the same tax to each member of the production chain regardless of its position in it and the position of its customers, reducing the effort required to check and certify their status. When the VAT has few, if any exemptions such as with GST in New Zealand, payment of VAT is even simpler.

Example

Consider the manufacture and sale of any item, which in this case we will call a widget.

Without any sales tax

• A widget manufacturer spends $1 on raw materials and uses them to make a widget.
• The widget is sold wholesale to a widget retailer for $1.20, making a profit of $0.20.
• The widget retailer then sells the widget to a widget consumer for $1.50, making a profit of $0.30

With a U.S.-style sales tax

With a 10% sales tax:

• The manufacturer pays $1.00 for the raw materials, certifying it is not a final consumer.
• The manufacturer charges the retailer $1.20, checking that the retailer is not a consumer, leaving the same profit of $0.20.
• The retailer charges the consumer $1.65 ($1.50 + 10%) and pays the government $0.15, leaving the same profit of $0.30.

So the consumer has paid 10% ($0.15) extra, compared to the no taxation scheme, and the government has collected this amount in taxation. The retailers have not lost anything directly to the tax, but they do have the extra paperwork to do so that they correctly pass on to the government the sales tax they collect. Suppliers and manufacturers are not affected by the tax, though they have to check their customers' status.

With a VAT

With a 10% VAT:

• The manufacturer pays $1.10 ($1 + 10%) for the raw materials, and the seller of the raw materials pays the government $0.10.
• The manufacturer charges the retailer $1.32 ($1.20 + 10%) and pays the government $0.02 ($0.12 minus $0.10), leaving the same profit of $0.20.
• The retailer charges the consumer $1.65 ($1.50 + 10%) and pays the government $0.03 ($0.15 minus $0.12), leaving the same profit of $0.30.

So the consumer has paid 10% ($0.15) extra, compared to the no taxation scheme, and the government has collected this amount in taxation. The businesses have not lost anything directly to the tax, but they do have the extra paperwork to do so that they correctly pass on to the government the difference between what they collect in VAT (output VAT, an 11th of their income) and what they spend in VAT (input VAT, an 11th of their expenditure).

Note that in each case the VAT paid is equal to 10% of the profit, or 'value added'.

The advantange of the VAT system over the sales tax system is that businesses cannot hide consumption (such as wasted materials) by certifying it is not a consumer.

Limitations to Example & VAT

In the above example, we assumed that the same number of widgets were made and sold both before and after the introduction of the tax. This is not true in real life.

The fundamentals of supply and demand suggest that any tax raises the cost of transaction for someone, whether it is the seller or purchaser. In raising the cost, either the demand curve shifts leftward, or the supply curve shifts leftwards. The two are functionally equivalent. Consequently, the quantity of a good purchased, and/or the price for which it is sold, decrease.

This shift in supply and demand is not incorporated into the above example, sor simplicity and because these effects are different for every type of good. The above example assumes the tax is non-distortionary.

A VAT, like as any other tax, distorts what would have happened without it. Because the price for someone rises, the quantity of goods traded decreases. Correspondingly, some people are worse off by more than the government is made better off by tax income. That is, more is lost due to supply and demand shifts than is gained in tax. This is known as a deadweight loss. The income lost by the economy is greater than the government's income; the tax is inefficient.

A Supply-Demand Analysis of a Taxed Market

In the above diagram, the area of the triangle formed by the tax income box, the original supply curve, and the demand curve represents the deadweight loss, whilst the grey area represents the governments tax income.

VAT criticisms

The "Value added tax" has been criticized as the burden of it relies on personal end-consumers of products and is therefore, as any sales tax based on the consumption of essentials, a Regressive tax (the poor pay more, in comparison, than the rich). French President Jacques Chirac has often pleaded for a reduction of European VAT concerning catering, in order to win favour from this sector.

VAT Rates

Non-EU countries

Country	Rate		local name
	Standard	Reduced
Argentina	21%	10.5% or 0%	IVA = Impuesto al Valor Agregado
Australia	10%		GST = Goods and Services Tax
Bosnia and Herzegovina	17%		PDV = porez na dodatu vrijednost
Bulgaria	20%		DDS = Данък Добавена Стойност
Canada	7% or 15%1	4.5%	GST = Goods and Services Tax
Chile	19%
People's Republic of China2	17%	6% or 3%
Croatia	22%	0%
Dominican Republic	6%	12% or 0%
Ecuador	11%
Iceland	24.5%	14%
India3	12.5%	4%, 1%, or 0%
Israel	16.5%
Japan	5%
Kazakhstan	15%
	10%
North Macedonia	18%	5%
Malaysia4	5%
Mexico	15%	0%
New Zealand	12.5%		GST = Goods and Services Tax
Norway	25%	11% or 7%	MVA = Merverdiavgift (informally moms)
Philippines	12%5
Romania	19%	9%	TVA = Taxă pe valoare adăugată
Russia	18%	10% or 0%	НДС = Налог на добавленную стоимость
Template:SER	18%	8% or 0%	PDV = Porez na dodatu vrednost
Singapore	5%		GST = Goods and Services Tax
South Africa	14%	7% or 4%
South Korea	10%
Sri Lanka	15%
Switzerland	7.6%	3.6% or 2.4%
Thailand	7%
Turkey	18%	8% or 1%
Ukraine	20%	0%	ПДВ= Податок на додану вартість
Venezuela	16%	8%

Note 1: Some Canadian provinces collect 15% for harmonized sales tax, a combined federal/provincial VAT. In the rest, the federal GST is 7% and if the province charges sales tax it is separate and is not a VAT. No real "reduced rate" but rebates are generally available for new housing effectively reducing the tax to 4.5%

Note 2: These taxes do not apply in Hong Kong and Macau, which are financially independent as special administrative regions.

Note 3: VAT is not implemented in 8 of India's 28 states.

Note 4: In the 2005 Budget, the government announced that GST would be introduced in January 2007. Many details have not yet been confirmed but it has been stated that essential goods and small businesses would be exempted or zero rated. Rates have not yet been established.

Note 5: The President of the Philippines has the power to raise the tax to 12% after January 1, 2006. The tax was raised to 12% on February 1.

EU countries

Country	Rate
	Standard	Reduced
Austria	20%	12% or 10%
Belgium	21%	12% or 6%
Cyprus	15%	5%
Czech Republic	19%	5%
Denmark	25%
Estonia	18%	5%
Finland	22%	17% or 8%
France	19.6%	5.5% or 2.1%
Germany	16%	7%
Greece	19%	8% or 4% (reduced by 30% to 13%, 6% and 3% on islands)
Hungary	20%	15% or 5%
Ireland	21%	13.5% or 4.8%
Italy	20%	10%, 6%, or 4%
Latvia	18%	5%
Lithuania	18%	9% or 5%
Luxembourg	15%	12%, 9%, 6%, or 3%
Malta	18%	5%
Netherlands	19%	6%
Portugal	21%	12% or 5%
Poland	22%	7% or 3%
Slovakia	19%
Slovenia	20%	8.5%
Spain	16%	7% or 4%
Sweden	25%	12% or 6%
United Kingdom	17.5%	5% or 0%

See also

• Gross price
• Jaffa Cake – Its non-VAT status was challenged in a UK court case to determine whether Jaffa Cake was a cake or a biscuit.
• Net price
• Revenue On-Line Service
• Sales tax
• VAT 3
• VAT registered
• Pretax
• Income Tax
• FairTax
• NESARA
• Flat Tax
• Channel Islands VAT loophole – A loophole that enables companies to avoid paying VAT on low value products.

External links

• What is VAT?: General overview
• EUROPE: Dont' you mind the tax burden? The optimal Direct/indirect tax mix: The Irish experiment
• Irish VAT law
• European VAT rates by service type
• VAT/GST sales tax rates around the world
• Consolidated version of the Sixth VAT Directive (398k pdf)
• HM Revenue & Customs
• UK VAT Threshold Rates
• Experts stumped by leap in trade gap, Guardian, September 10, 2005, discusses "missing trader fraud" and "carousel fraud".
• Indian VAT