VAT is an acronym for Value Added Tax. In some countries it is the goods and services tax (GST). VAT is a consumption tax assessed on the surplus value of goods and services. It is a method used by more than 166 of the world’s nations to raise government revenue. The United States is an exception as it uses a sales tax system rather than VAT.
Calculation of the VAT
There are two basic methods of calculating VAT, namely the credit-invoice or invoice-based method and the accounts-based method. Under the invoice-based method, application of tax is on sales transactions. Customers receive information on the amount of VAT paid while businesses receive credit outlining the VAT paid on the input materials and services. Except for Japan, most countries use the invoice-based method of VAT calculation. On the contrary, an account-based VAT is one calculated at the end of a reporting period. The process begins by having the total taxable sales calculated then subtracted from the total taxable purchases. The VAT rate is then applied on the difference. This method is largely used in Japan.
A Brief History of VAT
The countries that first implemented VAT were France and Germany. The tax was in the form of general consumption tax during the World War I era. However, France championed the modern use of VAT in the 1950s by the initiative of Maurice Laure, the Joint Director of the French Tax Authority in 1954. The concept of VAT came about in 1918 through the proposal of the German industrialist called Dr. Wilhelm von Siemens. At first, the tax targeted large businesses only. Later on, the government expanded it to include all business sectors. Today, VAT amounts to 50% of the French government’s revenue.
Comparison of VAT with Sales Tax
The first difference is that VAT is charged on exports while the sales tax is not. Secondly, the basis of the payment of sales tax is upon the full amount of imports. However, VAT payment is only applied on the value added to the commodity by both the importer and reseller. Thirdly, it is the final consumer who pays the sales tax while all purchasers pay VAT. Fourthly, under sales tax, resellers grant vendors exemption certificates and thus do not tax the resold items. However, the resellers pay taxes to the vendor under VAT. In addition they are at liberty to reclaim any VAT for taxes paid on business inputs. Finally, under VAT tax receipts are received by tax authorities before the sale of goods. On the contrary, tax authorities have access to the tax revenue only after the goods are sold to the final consumer in the case of sales taxes.
Advantages and Limitations of VAT
There are three main advantages of using VAT to collect revenue. Firstly, compared to other taxes it minimizes tax evasion. Secondly, it is simple to administer. Thirdly, since VAT is based on the value added on goods, it does not affect the price of the goods. On the other hand, the limitations of VAT include the fact that it is relatively complex to understand. In addition, it is quite expensive to implement.