Value-added Tax (VAT)

Meaning of Value-added Tax

A value added tax (VAT) can be explained as a type of consumption tax. From the buyer’s perspective, it is a tax on the purchase price. On the other hand, from a seller’s perspective, it is a tax levied on the “value added” to a product or service. The difference between these two amounts is remitted to the government by te manufacturer and the rest is retained by him to compensate the taxed which have been paid previously on the inputs.

In simple words, the value added to a product by any business is actually the sale price charged from the customer, less the cost of materials and similar taxable inputs. A Value Added Tax is somewhat similar to a sales tax in the fact that eventually only the end consumer is taxed. However, unlike a sales tax (which involves the customer being taxed only once), the value added tax involves collections and remittances to the government, as well as credits for already paid taxes occurring every time products are purchased by a business in the supply chain.

Principle of Value Added Tax

The basic principle to implement a Value Added Tax involves presuming that a business be obligated with some percentage on the product price less all taxes paid previously on the goods. For instance, if VAT rates were 10%, a fruit juice maker would pay 10% of the £5 per liter.

Basis for Value Added Tax

As per the method of collection, VAT can be invoice based or account based. The invoice based method of collecting VAT involves each seller to charge VAT rate on the output and passes a special invoice, indicating the amount of tax, to the buyer. Moreover, the buyers subject to VAT on their own sales regard the tax on purchase invoices as input tax and can also subtract the amount from their own VAT liability and the difference thus obtained is paid to the government.

The account based tax does not involve use of any specific invoices. Rather, the tax is estimated on the value added, quantified as a difference between revenues and allowable purchases.