The VAT Tax is coming. Learn, Adapt, Survive.
The Value Added Tax – Its History and Other Significant Facts
A value added tax (VAT) belongs under the consumption tax category. It is therefore a tax on people’s purchases rather than on their individual earnings, savings or investments.
From the buyer’s point of view, VAT is a tax on the purchase price, while on the seller’s perspective, it is a tax considered only on any “value added” to a specific product or service.
It is a fee being assessed against businesses for every stage of the manufacturing and distribution processes where a certain product or material is resold or there is a “value added” to it. It is usually passed on to the consumers in the form of a price increase.
VAT is the sales price charged to consumers, minus the costs of materials and other inputs that are subject to tax.
History of VAT
Dr. Wilhelm Von Siemens, a German industrialist, proposed the value added tax concept in 1918 as a replacement to his country’s turnover tax. Although quite the same as the vat system, the turnover tax did not give rebates for any taxes being paid at each stage.
It was only on April 10, 1954 that it was first introduced by Maurice Lauré, Joint Director of the French Tax Authority. France therefore was the first country to implement the value added tax as a partial replacement to its own turnover tax system.
Michigan in the United States adopted a modified type of VAT and called it a Business Activities Tax. Such tax system was used for 14 years.
Many European countries followed suit, until the 1990s that is was introduced also to the former Soviet republics and some Asian nations like China, Thailand, the Philippines and Bangladesh.
VAT was initially directed at big businesses, until it was later extended to cover all of the business sectors. In France, it is considered to be the most vital source of state finance that accounts for nearly 50% of its state revenues.
It has become a major source of tax revenue in most developing countries especially in Europe. Except the United States, all countries that comprise the Organization for Economic Cooperation and Development (OECD) are using a value added tax on consumer expenditures.
VAT Versus Sales Tax
Both taxes are forms of consumption tax that give the end consumers the incentive to avoid the tax, although each functions differently.
(A)Sales Tax – A sales tax charges the end consumer, that is, it is a tax that is being collected and consequently remitted to the government at one time only, specifically at the point of purchase by the ultimate end consumer.
It offers the buyer a tax fraud mechanism whereby the seller has to decide whether the former is really the final consumer or not. The seller is not legally bound to collect the tax nor has he any direct economic incentive in doing so.
(B)Value Added Tax (VAT) – A value added tax, on the other hand, involves the process of collecting, remitting to the government, and crediting the taxes being paid each time one business makes a purchase of products from another business that comprises the supply chain.
VAT is introduced partly because it makes stronger collection incentives than a sales tax. It provides the seller a direct financial stake to collect the tax, therefore eliminating the burdensome decision whether to consider the buyer as the end consumer or not.
Even though it is more complicated than a sales tax, it provides more checks against tax evasion because of the tax assessment at several points in the distribution process.
3 Types of Value Added Tax
There are at least three types of value added tax being imposed globally, and each one has different characteristics.
(1)Consumption Method – This method allows each business entity to deduct immediately the whole value of taxes paid on any capital purchase. This is the most favored among the three methods for the main reason that it equally taxes income from capital and labor, and it likewise promotes capital formation.
(2)Net Income Method – This method allows a gradual deduction of the VAT paid on the capital purchase over the allowable period of several years.
(3)Gross National Product (GNP) Method – This method gives no allowance for taxes paid on a capital purchase with the tax base approximately equal to the private GNP.
The Assessment Process
The value added tax assessment is a seven-step process detailed below:
1)The producer/manufacturer adds value to his product. The amount of value added is arrived at by deducting the cost of the materials employed in making the product from the price charged to the consumer/wholesaler.
2)The producer/manufacturer pays the value added tax and includes it in the purchase price charged to the consumer/wholesaler.
3)The producer/manufacturer then receives a rebate from the government for the VAT paid on the materials he used.
4)The consumer/wholesaler in turn pays a VAT on the value which is the difference between what he pays to the producer/manufacturer and the price he sells to the consumer/retailer. The tax therefore is included in the price being charged to the consumer/retailer.
5)The consumer/wholesaler gets a rebate from the government for the VAT paid to the producer/manufacturer.
6)The consumer/ retailer pays the VAT on the value which is equivalent to the price charged to him minus the wholesale cost. The tax is included in the product’s final sales price. In other words, the retail price includes all VATs collected at every stage of the process.
7)The consumer/retailer collects the VAT from the person who purchases the product and gets a rebate for the VAT paid to the consumer/wholesaler.
Conclusion
The value added tax system has been implemented in over 120 countries worldwide, with tax rates ranging from 5 to 25 percent. Its dramatic taxation development has reached the end of the twentieth century and continues onwards.
It has proven to have substantially helped world economies in Europe, Asia and other regions as it ushers in vital revenues to finance various government expenditures.