VAT definition

A value-added tax (VAT), known in some countries as a goods and services tax (GST), is a type of tax that is assessed incrementally, based on the increase in value of a product or service at each stage of production or distribution. VAT essentially compensates for the shared services and infrastructure provided in a certain locality by a state and funded by its taxpayers that were used in the elaboration of that product or service. Not all localities require VAT to be charged and goods and services for export may be exempted (duty free). VAT is usually implemented as a destination-based tax, where the tax rate is based on the location of the consumer and applied to the sales price. Confusingly, the terms VAT, GST, consumption tax and sales tax are sometimes used interchangeably. VAT raises about a fifth of total tax revenues both worldwide and among the members of the Organisation for Economic Co-operation and Development (OECD). As of 2018, 166 of the world's approximately 193 countries employ a VAT, including all OECD members except the United States, which uses a sales tax system instead.

There are two main methods of calculating VAT: the credit-invoice or invoice-based method, and the subtraction or accounts-based method. Using the credit-invoice method, sales transactions are taxed, with the customer informed of the VAT on the transaction, and businesses may receive a credit for VAT paid on input materials and services. The credit-invoice method is the most widely employed method, used by all national VATs except for Japan. Using the subtraction method, at the end of a reporting period, a business calculates the value of all taxable sales then subtracts the sum of all taxable purchases and the VAT rate is applied to the difference. The subtraction method VAT is currently only used by Japan, although subtraction method VATs, often using the name "flat tax", have been part of many recent tax reform proposals by US politicians. With both methods, there are exceptions in the calculation method for certain goods and transactions, created for either pragmatic collection reasons or to counter tax fraud and evasion.

 

EU VAT vs. USA Sales Tax

VATs and sales taxes can raise the same amount of revenue; the difference lies in at what point the money is paid – and by whom. For an example: Again, assume a VAT of 10 percent. A farmer sells wheat to a baker for 30 cents. The baker pays 33 cents; the extra 3 cents represents the VAT, which the farmer sends to the government. The baker uses the wheat to make bread and sells a loaf to a local supermarket for 70 cents. The supermarket pays 77 cents, including a 7 cent VAT. The baker sends 4 cents to the government; the other 3 cents were paid by the farmer. Finally, the supermarket sells the loaf of bread to a customer for $1. Of the $1.10 paid by the customer, or the base price plus the VAT, the supermarket sends 3 cents to the government.

As with a traditional 10 percent sales tax, the government receives 10 cents on a $1 sale. The VAT differs in that it is paid at different stops along the supply chain; the farmer pays 3 cents, the baker 4 cents and the supermarket 3 cents. However, a VAT offers advantages over a national sales tax. It is much easier to track. The exact tax levied at each step of production is known; with a sales tax, the entire amount is rendered after the sale, making it difficult to allocate to specific production stages. Additionally, because the VAT only taxes each value addition and not the sale of a product itself, assurance is provided that the same product is not double-taxed.

With value added tax shall be levied:

1. any delivery of good or service against payment;

2. any inter-community acquisition against payment with a place of performance on the

territory of the state, carried out by a person, registered under this law or by a person, for whom an

obligation for registration has occurred;

3. any inter-community acquisition of new vehicles against payment with a place of

performance on the territory of the state;

4. any inter-community acquisition of excise goods against payment with a place of

performance on the territory of the state, when the recipient is a tax liable person or a tax non-liable

legal person, who has not been registered under this law;

5. the import of goods.

The taxable amount is the amount in respect of a taxable transaction on which VAT is chargeable (usually, the price of the goods or services). 
In the simplest situation, if A sells goods over the counter to B for EUR 50, then the taxable amount is EUR 50, on which A must charge B VAT at the appropriate rate, and B pays A EUR 50 plus the VAT.
In order to cover more complicated transactions and circumstances, the VAT Directive contains a set of provisions defining and clarifying what constitutes the taxable amount. It distinguishes between three different kinds of transaction:

  • Supply of goods or services

  • Importation of goods

  • Intra-EU acquisition of goods

Supply of goods or services

 The basic rule

The taxable amount in case of supply of goods and services shall include 
everything which constitutes consideration:

  • obtained or to be obtained by the supplier in return for the supply
  • from the customer or a third party, including subsidies directly linked to the price of the supply.

(Article 73 of VAT Directive)
Thus, if a plumber charges a customer a fee for servicing a washing machine plus the cost of travel to the customer’s premises, the taxable amount includes, along with the fee for the service, the recharge of travel costs.

What must be included and what not included in the taxable amount?

Included in the taxable amount

Not included in the taxable amount

  • Taxes, duties, levies and charges, excluding the VAT itself ;
  • incidental expenses, such as commissions, packing, transport and insurance costs that the supplier recharges to the customer;
  • subsidies directly linked to the price of the supply.
  • Price reductions by way of discount for early payment;
  • price discounts and rebates granted to the customer and obtained by him at the time of the supply; or
  • amounts received by a taxable person from the customer, as repayment of expenditure incurred in the name and on behalf of the customer, and entered in his books in a suspense account.

(Article 73, 78, 79 VAT Directive)

 

Currency considerations

If a foreign currency is used in the documents required for calculation of the taxable amount, the exchange rate will be the latest recorded selling rate at the time the VAT becomes due on that EU country’s most representative exchange market(s). EU countries may also use a rate determined by reference to that market (s).
Businesses may use instead the European Central Bank’s latest published exchange rate (using euro exchange rate for conversion between currencies other than euro). EU countries may require notifying them about using this option.
For certain categories of transactions or certain categories of taxable persons EU countries may decide to use the exchange rate based on EU customs rules for calculation of the customs value.
(Article 91 VAT Directive)

Basic legal VAT framework

EU VAT legislation is based mainly on directives. A directive is binding upon each Member State to which it is addressed, but leaves the choice of form and methods to the national authorities who transpose it into national legislation.

The main piece of VAT legislation is the VAT Directive (2006/112/EC).

Other legislation includes:

Directive 2008/9/EC (VAT Refund – EU business)

Directive 86/560/EEC (VAT Refund – non-EU business)

Directive 2009/132/EC (VAT-free importation)

Directive 2006/79/EC (private consignments)

Directive 2007/74/EC (travellers' allowances)

Binding implementing measures to ensure uniform application of the VAT Directive can be found in the VAT Implementing Regulation (Council Regulation (EU) No 282/2011). Those measures are directly applicable without transposition into national law.

In addition Member States, to prevent fraud or simplify procedures for collecting VAT, may be authorised to derogate  from the VAT Directive (see the list of derogations).

Each Member State is responsible for the transposition of these provisions into national legislation and their correct application within its territory although it is bound by implementing measures adopted at EU level. The primary responsibility for informing about the interpretation and application of these provisions rests with Member States.

 

© 2019 VAT Service. All Rights Reserved. Designed By Stan
Cookies make it easier for us to provide you with our services. With the usage of our services you permit us to use cookies.
More information Ok Decline