Value-Added Tax, What Is It, and Who Pays It?
What Is Value-Added Tax?
Value can be added to goods and services at various supply chain stages. These stages cover everything from gathering raw materials to shipping the final product (for goods). Value-added tax can be applied at every stage any value is added to the products/services.
Who Pays Value-Added Tax?
Both consumers and businesses pay Value-added tax, though businesses can pass it on to the consumer. They may also ask for a refund if the VAT they paid exceeds the VAT they have collected. The ultimate burden of VAT is on the final consumer. It’s one of the reasons why it’s called a tax on consumption.
What Should Business Owners Know About VAT
About 170 countries in the world rely on VAT to generate a significant portion of their tax income. The rates vary drastically – from 5% VAT (GST) in Canada to 21% in some EU countries. The US doesn’t have VAT administered and imposed on a federal level. However, states may impose their own version of the VAT or sales tax, and the rates vary from around 3% to 7.25%.
As a business owner, you have to collect VAT from the end consumer though only when your income increases beyond a certain threshold in some countries. This requires you to register your business for VAT and receive your VAT number, which indicates that you are permitted by law to apply VAT to your goods and services. The threshold also exists in some E
U countries, but there is also an option to voluntarily register your business for VAT and obtain a VAT number, even if your sales income is below the threshold.
There are both pros and cons to this strategy. Applying VAT to your products and services will lead to an automatic price hike, which may discourage your buyers. However, the impact may be minimal if you apply VAT from the beginning instead of transitioning to it and raising your prices once you already have a healthy consumer base.
As a business owner, it’s important to understand that you may be paying VAT on many of the products/services you will be purchasing from other businesses/vendors. You don’t have to worry about the layers of VAT that were applied to the goods and services before they reached you since they would all be priced into the cost you will bear.
There is also something called Export VAT within the EU. Products and services produced and sold within the EU may be applicable for VAT tax, even when they are traded between countries. However, you may not charge VAT for products and services you are exporting, though it does apply to imports. The VAT laws in the country you are operating from and the countries you are selling your products and services in may differ, so make sure you understand and adhere to those laws.
Example – How VAT Is Applied
VAT is applied on every layer of the supply chain in which value is added to the product, and there can be several stages in a supply chain. For example:
- Company A is a smelting company that buys iron ore from a mining company. The mining company charges them VAT because they added value to it by extracting it.
- Company A extracts iron from the ore and sells palettes to company B, charging VAT along with the cost of their services.
- Company B turns these pallets into steel sheets and sells them to Company C, again charging VAT along with the cost of steel production.
- Company C develops car parts that are sold in their own showrooms. A consumer buys this part and pays the VAT that has been accumulated over three preceding layers.
VAT laws differ from country to country, and each country may have its own list of products and services that are either VAT exempt or qualify for a reduced VAT. The exact list may differ, but they are mostly products necessary/beneficial to the end consumer. Products that fall under the category of discretionary spending are rarely exempt.
Understanding the specific VAT laws and how or why you might be eligible for a VAT refund can be important to your finances and bottom line. Adhering to VAT regulations is crucial to stay financially compliant in each country where you operate.
VAT’s Socio-Economic Impact
Valued-Added Tax or VAT is also called a consumption tax because it’s proportional to an individual’s consumption rather than their income (like the income tax). The more goods they buy and services they use, the more they will pay towards VAT as per the rates applicable in their country. This is one of the reasons why many people oppose VAT because it hits everyone alike – from people in lower socio-economic levels to richer individuals. In contrast, the income tax is proportional to the wealth and income of an individual, and lower tax rates at low-income levels offer relief to the financially challenged population segments. However, the governments also strive to curtail the negative financial impact of VAT as well, though the efforts vary from country to country. The two main methods of arresting the VAT’s impact are:
- Financial products like insurance, finance, and credit are exempt from VAT in the UK. Education and training products and services are also exempt. Similarly, a lower VAT rate is applied to certain products and services.
- Countries like Canada offer GST (a VAT equivalent) credit to individuals/families with a lower income threshold.
Financial experts well-versed in a country’s tax laws may be your best resource for developing a comprehensive understanding and developing a VAT strategy. It’s about more than compliance and may have important considerations for your product pricing.
The same goods created in your home country being sold in a country with a 5% VAT and in another country with a 20% VAT may require two completely different pricing strategies. You also have to understand VAT laws pertaining specifically to imports, exports, and international businesses, in order to remain compliant. As a business owner, expanding your operations globally can be a daunting task, especially when it comes to navigating the complex world of taxes. This is where Aadmi comes in – a global expansion service that specializes in helping businesses understand and comply with Value Added Tax (VAT) regulations.
Aadmi’s team of experts can help you navigate the complex VAT regulations in different countries, ensuring that you are compliant with local laws and regulations. This can save you time and money in the long run, as non-compliance can result in hefty fines and penalties.