If you like to shop while traveling internationally, there’s a good chance that you’ve seen the term ‘VAT included’ on price tags, but what does VAT included mean?
While most of us know that it stands for value-added tax, let’s take an in-depth look at what exactly it is and how it works.
What is VAT?
The value-added tax or VAT is a consumption tax levied on the value that’s added to goods and services. Customers pay this tax whenever they buy any product or services. It is added to the value of the product or service at each stage of the business. Thus, VAT begins from the point of production to the point of sale.
VAT collects tax on all goods, offline and online. It helps prevent businesses from evading taxes and increases the revenue of the government. It raises about one-fifth of the total tax revenue collected worldwide.
The total amount of VAT a consumer has to pay depends on the cost of the product/service. It does not include the cost of materials that have already been taxed. Here is a breakdown of what the VAT actually is:
A General Tax: The VAT is a general tax that applies to all commercial activities the involve the production and distribution of products and services. However, businesses with an annual turnover less than that threshold limit don’t have to charge the VAT on their sales.
A Consumption Tax: The VAT is a consumption tax as it is to be borne by the final consumer of the products or service. Businesses don’t have to pay this tax. It is also charged as a percentage of the price of the product/service. The actual tax burden is spread over each stage of the production and distribution chain.
Paid to Authorities by the Business: While the VAT is collected through customers, it is to be paid to the authorities by the seller of the goods or services. Therefore, it is an indirect tax.
Different countries follow different VAT rates. Click here to find out the VAT rates by countries.
Difference Between a VAT and Sales Tax
While VAT and sales tax may generate the same amount of income for the government, who pays the money and when it is paid, makes the two different.
Sales tax is to be paid only when a product/service is sold. The government waits for the goods and services to be purchased to collect the sales tax. No tax revenue is received if the product/service never gets sold.
Another difference between sales tax and VAT is that only the end seller has to pay the tax to the government. It is regardless of whether they added any value to the product/service or not. On the other hand, VAT is paid by businesses across the supply chain when they add value to a product or service. A company that doesn’t add much value to the final product/service doesn’t have to pay a lot in taxes.
Hence, VAT applies to different players in the supply chain irrespective of whether the product/service is sold or not. Every company that adds value to the product/service has to pay the tax. This helps the government generate revenue at each step of a business, from manufacturing until it is bought by the customers.
The VAT in Different Countries
Value-added tax is used in more than 160 countries of the world. It is also sometimes known as GST (Goods and Services Tax) and is preferred to sales tax in many countries. The United States of America is the only notable OECD (Organization for Economic Co-operation and Development) member country that doesn’t use the value-added tax system.
Different countries have different rules when it comes to the value-added tax. You will have to refer to the details of each country to understand their rules and laws about the VAT.
Since the VAT doesn’t tax the business’s income, it is considered a highly controversial taxation system.
The VAT is applied at the same rates to every consumer regardless of their financial condition. This has garnered different schools of thoughts. Some people are in favor of the VAT while others are against it.
The opponents of VAT debate that since the equal VAT rate applies to every purchase, different income groups are affected differently by it. The high-income group benefits from it the most. However, low-income groups have to spend more on VAT. This makes it difficult for families who live from paycheck to paycheck. Hence, they term it as a regressive tax.
The advocates of VAT claim that it raises the revenue of the governments without punishing wealth as other forms of taxation does. It’s also more standardized and straightforward as compared to a traditional sales tax. There are fewer compliance issues with the VAT.
Some experts also criticize that the value-added tax increases the final price for the customers. However, a recent study in Canada revealed that the prices of goods/service including a VAT actually fall by 0.3%-0.49% when replaced by the traditional sales tax.
Example of Value-added Taxation
A simple way to calculate the VAT amount to be paid by a business or consumer is to subtract any previously taxed material costs form the cost of goods/service. Here’s an example to help you understand it better.
There is an electronic components manufacturer who purchases raw materials from a dealer. The cost of each raw material is $1. The dealer also charges 10 cents at the rate of 10% VAT and pays it to the government.
The manufacturer then adds value to these raw materials and creates electronic components with it. It sells these components to a laptop manufacturing company. The cost of each component is $2. The electronic components manufacturer then adds 20 cents as the VAT at the rate of 10%. 10 cents are paid to the government while the remaining 10 cents are reimbursed for the VAT that was previously paid to the dealer.
The laptop manufacturer then adds more value to the components and manufactures laptops with them. These laptops are sold for $3 to the retailer with a VAT of 30 cents. 10 cents go to the government, while 20 cents are reimbursed for the VAT that was paid to the components manufacturer.
Finally, the laptops are sold to the customers at $5 each with a VAT of 50 cents. 20 cents go to the government as VAT.
It is clear from this example that a 10% value-added tax is levied at each sale point across the supply chain for the value-added by each party.
What Does VAT Included Mean?
When you see ‘VAT Included’ written on the price of a product or service, it simply means that the cost of the product or service includes the value-added tax. The value-added tax for each stage of production and distribution is included in the final price of the product/service.
VAT – What Does It Mean for Businesses?
As mentioned before, the VAT is an indirect tax that is to be paid by the business to the revenue authorities. All businesses have to report and pay the amount to the authorities. Here’s everything you need to know about it.
VAT Threshold: The VAT threshold is different for businesses in different countries. For example, it is £85,000 in some European countries. Businesses can only charge a value-added tax is they are registered with the authorities.
VAT Number: Businesses are given a VAT number once they register with the authorities. The VAT number is mentioned on the VAT registration certificate. The due date for VAT return is also mentioned on the certificate.
VAT Responsibilities of a Business
It is the responsibility of every VAT registered business to charge a VAT on all their products and services. The VAT is calculated on the full value of your products or services. In addition to this, a VAT can also be claimed on the products and service purchased for the business. These include:
- Staff travel
- Vehicles that are used only for business purposes
- Accessories, maintenance, and fuel for business vehicles
- Mobile service plans that are used only for business purposes
- Utility bills if you run a home-based business
Businesses must also apply VAT if they are working on a part-exchange or exchange basis. If you don’t charge the customers for VAT, the price of your product/service will still be considered inclusive of VAT by the revenue authorities.
Exemptions from VAT
Some goods and services are exempt from VAT. These include the following:
- Charitable fundraising
- Finance services
- Insurance services
- Postage stamps
A business is not required to register for the VAT if it only sells exempt goods and services.
This was quite a lot on VAT and what VAT included means! Let us know if it helped you understand VAT any better.