What is VAT?

VAT is not a cost of doing business

VAT is a consumption tax of up to 25% that is levied on both goods and services. Although the goal of VAT is the same as sales tax, the mechanism for levying and collecting VAT is different.

In the sales tax system, the tax is charged at the point of purchase as a percentage of the price for goods or services. In the VAT system, all businesses in the supply chain charge taxes on their sales, but they are also refunded for the amount of VAT charged by their suppliers.

This way, the total tax levied at each stage in the chain of supply is a constant fraction of the value added by a business to its products. Hence the name “Value Added Tax”.

Value Added Tax is:

  • a general tax that applies, in principle, to all commercial activities involving the production and distribution of goods and the provision of services.
  • a consumption tax because it is borne ultimately by the final consumer. It is not a charge on businesses.
  • charged as a percentage of price, which means that the actual tax burden is visible at each stage in the production and distribution chain.
  • collected fractionally via a system of partial payments whereby taxable persons (i.e., VAT-registered businesses) deduct from the VAT they have collected the amount of tax they have paid to other taxable persons on purchases for their business activities. This mechanism ensures that the tax is neutral regardless of how many transactions are involved.
  • paid to the revenue authorities by the seller of the goods, who is the “taxable person.” However, it is actually paid by the ultimate buyer to the seller as part of the price. It is thus an indirect tax.
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