Value-added tax is popular by the common economy- and trade-related short abbreviation VAT. This is the most basic consumption tax. VAT is paid to almost all commercial goods and services. The individual national legislation approach on taxation usually has its own determination on standard rate of VAT. It is a common principle for some sensitive goods and service types to obtain a different than the traditional VAT rate or reduced (drugs, books, postage stamps, home energy, fuel, children’s car seats, most food types, etc.). Value-added tax is a general tax that is added to a different stage of its current cycle to eventually be paid by the end user. Therefore, this is why it represents the classical indirect tax type. The obligation to charge VAT and transfer it to the state treasury, though, lies on the trader rather than on the end consumer.
How does VAT work?
VAT is levied on the gross margin at every stage of the supply chain, from manufacturing and distribution to sale. The tax is assessed and collected at each stage.
For example, let’s assume a cake is produced and sold in the imaginary country of Vacountia with a 10% VAT.
In that case, VAT works as follows:
- The manufacturer purchases raw materials for $4, plus a VAT of $0.40 payable to the government of Vacountia, for a total of $4.40.
- The manufacturer sells cake to a retailer for $10, plus a VAT of $1, for a total of $11. The manufacturer only pays Vacountia $0.60, which is the total VAT at that stage minus the prior VAT charged by the raw material supplier.
- The retailer then sells cake to consumers for $20, plus a VAT of $2, for a total of $22. The retailer pays Vacountia $1, which is the total VAT minus the previous VAT charged by the manufacturer.
