Added Tax (VAT) Part II
How it works
In the first part
of this article published last week we noted that there is increasing
pressure on policy-makers around the world for a system of taxation which
encourages rather than penalises effort which taxation of income and savings
is claimed to do. We also noted that a number of countries have indeed
sought to tax expenditure rather than income.
There are a number
of reasons why these attempts were not as successful as they could be, among
which is the ease with which income tax may be withheld at source, as in the
case of PAYE on emoluments and withholding tax on bank interest.
proper have failed badly in the few countries where they have been tried,
principally in Asia, and have all but been abandoned. The next best
alternative to the expenditure tax - sales taxes - has proved immensely
popular and last week we identified a number of forms of sales taxes and
discussed their merits and de-merits.
Today we address
what is now regarded as the best form of sales taxes - Value Added Tax - and
in a closing article next week we will identify its strengths and
Value Added Tax (VAT)
Value Added Tax,
which has become known popularly by its acronym, VAT, has the unique feature
of being able to extend through all channels of production and distribution
from the initial production of materials to the final sale to the consumer,
each seller paying on his value added only. It is immediately apparent that
the base of the tax is exactly the same as that of a retail sales tax, since
the retail selling price equals the sums of values added at all stages of
production and distribution. However the impact of the payment of the tax is
spread throughout the economy, unlike a retail sales tax which is charged
only at the point of sale, a system in which both the seller and the buyer
gain by the understatement of the tax.
Scope of VAT
VAT is a cumulative
consumer tax on the commercial supply of goods and services and also on the
importation of goods, whether by way of business or not. It is a multi-stage
tax collected, in the case of goods, at all stages in their passage from raw
material to finished article throughout the chain of primary producer,
manufacturer, wholesaler, retailer and eventually final consumer, which is
the general public upon whom the entire burden of the tax falls. In the case
of services it is chargeable when the service is rendered, although in
practice it is charged when the invoice is issued.
Like other taxes
VAT is subject to abuse and evasion, though as we shall see later it
provides a system of cross audit that mitigates the incidence of evasion.
Also, like other forms of taxes VAT may be selectively applied consistent
with government's fiscal, economic and social policies, including the
control of the cost of living through certain reliefs consisting of zero
rating and exemption.
In the case of
zero-rated goods or services the effect is that a taxable supplier charges
VAT on them, but since the rate at which VAT is chargeable in those cases is
nil, those goods are effectively free of VAT.
He will have no
output tax but is able to recover his input tax. This is in contrast to the
case of goods or services which are exempt. The person supplying them cannot
charge VAT to his customers and therefore VAT on supplies to him such as
electricity, telephone, etc, are effectively a cost which he cannot recover
except by an increase in his prices.
How the system works
The system requires
the registration of persons dealing in chargeable goods and services
although in practice the small retailer and artisan are exempt.
and renders more effective other systems and laws which require registration
such as the National insurance and Income Tax Acts which require all
employers to register. An integral part of the system is the VAT
registration number and the use of a VAT invoice which offers consistency
The essence of the
tax lies in the right of each taxable person to recover from the tax
chargeable on his sales, called 'output tax,' taxes paid by him on goods and
services which he bought, called 'input tax.'
At the end of each
accounting period, which may vary according to circumstances, he will pay to
the VAT authority the total amount of tax which he has charged to his
customers on the supply to them of goods or services, or for which he has
become accountable in respect of imported goods, less his input tax. If the
latter figure exceeds the former he is entitled to be reimbursed to the
extent of that.
Depending on the
balance, the whole or any part of any reimbursement may be permitted by law
to be held over to be credited in the subsequent accounting period either at
his option or in accordance with general or special decisions given by the
Incidence of VAT
normal taxable person who buys and sells goods or who receives and supplies
services, all in the course of his business, is the one person in the scheme
of the tax who does not bear the burden of it.
Instead, he is an
unpaid tax collector who charges tax on supplies of goods and services by
him in the course of business and, whether he is paid the amount of the tax
so charged or not, accounts for it at the end of each accounting period to
the VAT authority which is usually the Customs and Excise Department.
There are two other
situations where the business person 'bears' the cost of VAT, meaning that
he cannot be reimbursed.
1. In the case of
exempt goods and services the business person is charged tax on his
purchases, but he is unable to recover such input tax, and is also not
required or permitted to charge tax on his sales. He is therefore in the
same position as a member of the general public and bears the burden of the
2. Those persons
such as small retailers whose annual turnover of taxable supplies is less
than some minimum figure will have to bear the burden of the tax because
they are outside the system.
The principle of
VAT is, of course, easily stated, but its application is far from simple.
However, proper planning, education, a simple structure and a single rate
with as few exemptions as possible will certainly help in its
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