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Value added tax
Value added tax (VAT) is a sales tax levied on the sale of goods and services. In some countries, including Singapore, Australia, New Zealand and Canada, 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.
Personal end-consumers of products 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.
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 VAT.
Finally, some goods and services are "zero rated" (otherwise known, in the Sixth Directive, as exempt with the right to deduct input VAT). This means that no VAT is charged on the supply of those goods and services (i.e. they are effectively exempt), but the supplier is still able to recover input VAT attributable to these supplies. This effectively provides a governmental subsidy for these supplies. In the UK, examples include most food, books, drugs, and certain kinds of transport. Similar treatment applies to goods and services which are "exported" from the EU.
VAT is generally charged as a customs duty when goods enter the EU from other states. "Acquisition" VAT is payable when goods are acquired from another EU member state. 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 ubder the provisions of the Eigth 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, but the rates of VAT charged to the customer must be those applicable in 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%.
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. Since sales taxes are applied to the total price at each stage of production, they tend to compound, growing into very high tax rates on products with numerous stages of production done by different economic units. This discourages specialization and, instead, encourages integrated production units even when integration (e.g., from raw materials to final product) is less efficient.
Without a VAT
- A widget manufacturer spends $1 on raw materials 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 VAT
Adding on a 10% VAT:
- The manufacturer pays $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 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 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. 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).
With a U.S.-style sales tax
With a 10% sales tax:
- The manufacturer pays $1.00 for the raw materials.
- The manufacturer charges the retailer $1.20, leaving the same profit of $0.20.
- The retailer charges the consumer $1.65 and pays the government $0.15, leaving the same profit of $0.30.
So the consumer has paid 10% ($0.15) extra. 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. Supplier and manufacturers are unaffected by the tax.
|Argentina||11.0 %||10.5 % or 0%|
|China||17.0%||6.0 % or 3.0 %|
|India||12.5%||4.0%, 1.0% or 0%|
|New Zealand||12.5 %|
|Norway||25.0 %||11.0 % or 7.0 %|
|Romania||19.0 %||9.0 %|
|Russia||18.0 %||9.0 % or 0 %|
|Serbia and Montenegro||18.0%||8.0%|
|South Africa||14.0 %||7.0 % or 4.0 %|
|Sri Lanka||15.0 %|
|Switzerland||7.6 %||3.6 % or 2.4 %|
|Ukraine||20 %||0 %|
|Austria||20.0 %||12.0 % or 10.0 %|
|Belgium||21.0 %||12.0 % or 6.0 %|
|Cyprus||15.0 %||5.0 %|
|Czech Republic||19.0 %||5.0 %|
|Estonia||18.0 %||5.0 %|
|Finland||22.0 %||17.0 % or 8.0 %|
|France||19.6 %||5.5 % or 2.1 %|
|Germany||16.0 %||7.0 %|
|Greece||18.0 %||8.0 % or 4.0 % (normal 11%, reduced 3% in islands)|
|Hungary||25.0 %||15.0 % or 5.0 %|
|Ireland||21.0 %||13.5 % or 4.4 %|
|Italy||20.0 %||10.0 % or 6.0 % or 4.0 %|
|Latvia||18.0 %||5.0 %|
|Lithuania||18.0 %||9.0 % or 5.0 %|
|Luxembourg||15.0 %||12.0 % or 9.0 % or 6.0 % or 3.0 %|
|Malta||18.0 %||5.0 %|
|Netherlands||19.0 %||6.0 %|
|Portugal||19.0 %||12.0 % or 5.0 %|
|Poland||22.0 %||7.0 % or 3.0 %|
|Slovenia||20.0 %||8.5 %|
|Spain||16.0 %||7.0 % or 4.0 %|
|Sweden||25.0 %||12.0 % or 6.0 %|
|United Kingdom||17.5 %||5.0 %|
- Goods and Services Tax (Australia)
- Goods and Services Tax (New_Zealand)
- gross price
- GST (Canada)
- Jaffa Cake - in the UK, that was a court case enquiring whether Jaffa cake was a cake (non-VAT) or a biscuit (VAT)
- net price
- Revenue On-Line Service
- Sales tax
- VAT 3
- VAT registered
- European VAT rates by service type.
- VAT/GST sales tax rates in over two hundred countries around the world
- Consolidated version of the Sixth VAT Directive (398k pdf)
- HM Customs and Excise
- VAT (Value Added Tax) Refund Specialists - INSATAX
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