VAT Simplified

From a consumer point of view, the VAT is an added amount based on the percentage VAT imposed to the original price of a good or service. This changes the perception of the budget as the good and/or service become marginally higher in price. The simplicity of the example is referred to the initial statement on our home page; the VAT is a “pay as you go” tax. A person can choose the amount he is willing to contribute to the local economy by simply spending or economizing. By spending more on products and services, the person will automatically be paying additional tax. Alternatively, by buying a Honda, for example, the subject will be paying far less VAT than a person acquiring a Bentley.

From a business point of view, the tax may increase the margins by a small degree, but when applied rigorously by the government, it will not create a competitive advantage by itself across the economy; Tax Fraud and evasion should be heavily penalized.

Consider the below illustration:

From a Government point of view, the tax is levied on each of the transaction cycles, whether it is collected or charged.

Assuming that the initial stage is at a vegetable producer level, it is presumed that the producer did not pay tax on purchases to minimize the complexity of the example. Once the producer sells the produced output to a wholesaler, a VAT should be levied “output tax” (in this case 3,750) and must be paid to the authorities.

The second step refers to the process at the wholesale level. He was charged 3,750 as VAT “input tax” by the producer and collected a VAT of 5,000 “output tax” by invoicing the retailer; hence, he should pay the authorities (5000-3750) 1,250.

The process becomes more interesting at the retailer level since a part of the produce bought from the wholesaler was destined for export (export outside GCC is not taxable). The retailer can levy taxes on the products sold locally (125,000 x 5%) 6,250 and should pay the authorities (6,250 – 5,000 that was charged by the retailer) 1,250/-

From the Government point of view, each level of the supply chain contributed to the VAT “cascading effect”. A thorough examination of the numbers will yield an interesting fact; the computation of the amounts collected and refunded back equals exactly the amount of VAT charged by the retailer to his local clients.

Thus, a simple conclusion deduces the role of the government in accumulating tax in a correct manner, avoiding double counting and error in computing value added tax in the supply chain. Authorities are well qualified to identify taxable components and thus separate each taxable item in the supply chain and the distribution network. Although the process of calculating VAT by governments in the real world is not a simple task, the stratification of goods and services, in terms of those items taxable or non-taxable, help governments categorize all goods and services in the economy. Secondly, the difficulty of dealing with VAT, its calculation and avoiding double counting, is offset by the fact that governments treat each sector separately. In other words, from a manufacturing point of view, governments set VAT at the beginning of the process by charging VAT on primary raw material and record it. Once the item is completed in the primary stage, it moves to the secondary stage where it increases in costs. In the secondary stage of production, only the difference in costs is VAT taxable. Consequently, when the good or service reaches the final tertiary stage, costs increase again and only that increase is taxable. In conclusion, the final VAT paid is computed sequentially in terms of marginal costs and the consumer will eventually pay VAT on the tax-differentiated process the end of the supply chain.

Our example illustrates a glimpse of the real world and how authorities deal with valuing taxable amounts in the supply chain. The good news is, with automation in databases and accounting, such as using special tax-tailored-accounting software, governments rely on their auditors to detect any double-counting or error in valuing tax, as well as ensuring the legitimacy of tax imposition on sellers. Thus, the VAT implementation and imposition shall be a fair and smooth process.

Finally, the simplest aspect of imposing VAT is that imposed on resellers of goods and services. Should a retailer be a reseller, he/she will carry the VAT from the distributor and only adds additional VAT on the difference between the buying price and the reselling price. This way, the double counting is eliminated in terms of adding VAT only on the profit occurring in the reselling process throughout the distribution network.