A guide for business owners

“VAT” on heaps of coins

Value Added Taxes (VAT), which are a type of consumption tax, are major sources of revenue for the countries of the Organization for Economic Co-operation and Development (OECD), among other regions. According to the Tax Foundation, VAT actually contributed one-third of tax revenues in OECD countries in 2019. In contrast, the United States is more dependent on property taxes and personal income taxes, with only about 17.6% of revenue from consumption taxes. Here’s what you need to know about VAT.

A financial advisor can help you with taxes and any other financial issues you may have.

How a VAT works

VAT is a consumption tax because it is based primarily on money spent rather than gain. It is levied on services and goods at every step of the supply chain.

The VAT tax system is popular in many countries, but it is more common in some parts of the world. For example, all European countries charge VAT, according to the Tax Foundation. However, the United States does not have such a system in place. Instead, it uses local or state sales taxes.

When a business sells the raw materials of a product to a factory, tax is added. Likewise, VAT is added each time the good or service gains value and exchanges hands. So, from factory to wholesaler, from wholesaler to retailer and from retailer to consumer, VAT is applied at every step of the process.

VAT is generally expressed as a percentage. For example, suppose a consumer buys a good for $ 50 with 10% VAT from the retailer. The consumer pays $ 55 in total and the retailer keeps $ 50. The rest goes to the government.

It is understandable for many people to think that VAT and sales tax are the same thing. But the VAT system sets up a tax at each level of production. Thus, anyone who engages in the creation of the product or service pays VAT. In contrast, a sales tax is only implemented at the last stage, when the consumer purchases the product.

Special considerations for business owners

The VAT system likely results in higher costs for business owners, and not just at the manufacturer or retailer level. It impacts each owner throughout the production chain. Indeed, each level of production must calculate the taxes required at its stage of the chain. This translates into more paperwork and bookkeeping.

VAT can also be difficult for businesses that work beyond a national scale. Indeed, global companies must take into account the tax regimes of each country through the supply chain.

However, in countries that use it, companies can usually reclaim VAT for tax-deductible business expenses.

Example of VAT

Sign for VAT refund

Sign for VAT refund

You can calculate the VAT paid at each stage of the production of an item by subtracting the previously invoiced VAT from the VAT of the most recent stage. For example, Britain’s standard VAT rate is 20% for most goods and services. Suppose there is a UK based jewelry maker. The group must buy raw materials, such as precious metals, from a reseller. As the seller during the trade-in, the dealer charges the manufacturer $ 5, including 20% ​​VAT. The dealer collects the payment and sends the VAT amount to the government.

After the maker creates the components for the jewelry, they sell the parts to an assembler for $ 10, including a $ 2 VAT. But the manufacturer only sends $ 1 to the government because it keeps the amount of VAT it has already paid to the seller of raw materials. Because manufacturing paid the seller of raw materials $ 1, it only pays the government $ 1 ($ 2 to $ 1) VAT, also known as incremental VAT.

Ultimately, all VAT is passed on to consumers, who pay the full amount of VAT, which previous buyers paid throughout the production process – but without the refund these previous buyers received. In the case of jewelry, let’s say the consumer bought a ring for $ 40. The VAT rate is still 20%, so the consumer pays VAT of $ 8 and a total of $ 48 for the ring.

Advantages and disadvantages of VAT

The pros and cons depend on who you talk to. For example, some advocates see a huge advantage for consumers when it comes to VAT. A VAT is generally considered a regressive tax system because the VAT percentage is the same for rich or poor, large companies or small startups. Unlike a progressive tax, like US income tax, VAT is a fixed rate. Thus, low wages technically pay more, in proportion to their income, than high wages. In effect, this makes goods and services more expensive and therefore less accessible to low-income groups. As a result, critics claim that the VAT system would lead to lower purchasing power for consumers.

However, supporters see the fixed percentage of a VAT as an incentive for consumers to work towards higher wages. The incentive, some argue, would increase overall gross domestic product (GDP). Supporters also say that since a VAT is part of the purchase. This means that the government increases revenue by minimizing tax evasion.

Takeaway meals

Asian business owner

Asian business owner

A value added tax is a flat tax levied on goods and services throughout the production process. Each buyer in this process pays the tax, but ultimately the consumer is responsible for the full amount of the tax because they do not receive a refund like everyone else in the production chain. Although the United States does not currently use VAT, some believe it could be advantageous, arguing that the flat rate could incentivize workers and increase government revenue. However, others say its costs would fall disproportionately on working poor. They would pay it more proportionately than their higher income counterparts.

Tax advice

  • While the United States does not have VAT, there are plenty more that the future retiree needs to worry about. A financial advisor can help you develop a tax strategy that protects your retirement income. Help is right at your fingertips with SmartAsset’s free matching tool. In five minutes, the program connects you with qualified local counselors. If you’re ready to work with a financial advisor, get started now.

  • Income in America is taxed by the federal government, most state governments, and many local governments. The federal income tax system is progressive, so the tax rate increases as income increases. Use this free calculator to get a good estimate of what your federal income tax will be.

  • The amount you pay in taxes depends in part on your state’s retirement facility. If your state uses stricter rules, consider moving to another with lower taxes, which could impact you as a retiree. However, if your condition is favorable for retirement, you may just have to move onto the streets. Downsizing to a smaller home can help minimize housing costs and associated property taxes.

Photo credit: © iStock.com / pcess609, © iStock.com / Stephen Barnes, © iStock.com / AsiaVision

The article Value Added Tax (VAT): A Guide for Business Owners first appeared on the SmartAsset blog.

About Natalee Broderick

Natalee Broderick

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