VAT is imposed at each stage of the supply chain when value is added.

Taxes like value-added tax (VAT) or goods and services tax in some countries are assessed incrementally. At every stage of production, distribution, or sale to the consumer, it is incorporated into the price of the product or service.

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Value Added Tax: What is it?

A consumption tax known as VAT is imposed at each stage of the supply chain when value is added. Both products and services are included. The price of the goods less any components that were taxed previously determines how much VAT a user must pay. It is an indirect tax that is paid by customers or end-users of a good or service to the government through the producers of such goods or services.

VAT is charged on national as well as international goods or services.

Value Added Tax: How is VAT collected?

According to the method of value-added tax collection, the process of collecting VAT can be categorised into the following categories:

Account-based

Tax is calculated on value-added, rather than sale receipts, under the account-based collection method. The value-added is the difference between revenues and allowable purchases.

Accrual-based

In the accrual-based collection, revenues are matched with the period during which they are earned, and costs of raw materials and expenses are matched with the period in which they are incurred. This method is extremely complex when compared with cash-based VAT collection. In addition, it provides valuable insight into businesses.

Cash-based

Accounting based on cash is simpler than accounting based on accruals. There is more emphasis on the cash being handled than on whether all the bills have been paid. The date of receipt of funds is recorded whenever a payment is received.

Invoice-based

When invoice-based VAT collection is used, sale receipts or invoices are used to calculate the corresponding VAT. Traders who sell their goods and services offer separate invoices containing details of the VAT that has been collected. Today, the majority of countries collect VAT through invoices.

The timing of VAT collection can also be used to classify VAT collection.

Value Added Tax: How is VAT calculated?

Calculating VAT is as simple as subtracting the input tax from the output tax.
The seller of goods and services is responsible for paying input tax on the raw materials they purchase.
The seller receives output tax at the time of sale.

Therefore, we can easily conclude that:

VAT = OUTPUT TAX – INPUT TAX

The formula can easily be used as a VAT calculator.

Let’s take an example to understand how VAT is calculated. Let’s say A owns a hotel. Raw materials worth Rs.10,00,000 were purchased, and an input tax of 10% was imposed on them. As a result, he paid a total input tax of Rs 10,000, or 10% of Rs 10,00,000, in total.

Now, let’s assume that he has sold food made from those raw materials, he has earned a total of Rs. 2,00,000. Taking 10% of the earnings as the total output tax, the total output tax becomes 10% of Rs.2,00,000, which is Rs.20,000.

The total VAT owed by A may be simply calculated by deducting the input tax from the output tax. Therefore, VAT is 20,000 – 10,000, or Rs. 10,000.

Value Added Tax: How is it different from sales tax?

The retailer collects sales tax when the final sale in the supply chain is made. The end consumer pays sales tax when they purchase goods or services. Businesses can issue resale certificates to sellers when buying supplies or materials that will be resold and are not liable for sales tax. Tax jurisdictions do not receive tax money until the sale is completed to the end consumer, and sales tax is not collected until the sale is made to the ultimate consumer.

As opposed to that, all sellers in the supply chain are responsible for collecting VAT. VAT is collected by suppliers, manufacturers, distributors, and retailers on all taxable sales. The VAT is also paid by suppliers, manufacturers, distributors, retailers, and end consumers.

Businesses must track and record the VAT they pay on their purchases in order to be eligible for a tax credit for it. A VAT system allows tax authorities to collect taxes not just at the time of sale but also along the whole supply chain.

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