VAT, or Value Added Tax,
is a system of indirect taxation.
In this quick VAT tutorial, I will walk you through
the concept and definition of how
VAT works, run you through a VAT example
with a Value Added Tax calculation, and discuss
the different VAT categories in use.
VAT is used in around 140 countries in the world.
These are the basics of a VAT system:
VAT is a system of indirect taxation on the
sale of goods and services to final consumers,
in other words VAT is a tax on consumption.
VAT is collected in stages through what is called
"the chain of supply", as you see in
the picture on the right.
I will illustrate this "chain of supply" concept
with numbers in the next part of the video.
VAT registered businesses charge VAT on their sales
(this is called output tax)
and recover VAT on their purchases and expenses
(this is called input tax),
and settle the difference
with country tax authorities.
VAT is not a cost to businesses themselves,
they collect and pay it
"on behalf of the government".
VAT rates and rules are subject to change,
so check with your local country tax authorities
or tax advisor for any country-specific applications
of the general idea,
and any exceptions to the rule.
Let's visualize the concept of VAT
with a VAT example that includes numbers.
We start on the left with a producer.
Let's say this is a company where the owner
walks on the beach to collect a bag of sea shells
and brings them by foot
to a jewellery manufacturer.
She sends an invoice for the goods of 100 Euro,
and charges VAT of 20, making the invoice
total 120 Euro.
The manufacturer of the jewellery converts
the sea shells to beautiful jewellery, and
sells them for 200 Euro to a distributor.
On top of the 200 Euro for the goods, she charges
40 Euro in VAT, and the invoice total
is 240 Euro.
The distributor supplies these jewels to stores
in many locations, and sells the jewels for
300 Euro, with 60 Euro VAT.
The retailer then sells these jewels to consumers
at 400 Euro, with 80 Euro VAT.
Value gets added along the way in the chain of supply:
each company provides specific
expertise and skills.
Each company sells at a higher price
than what they purchased the goods for.
Here is how the collection
in stages by the government works:
The producer on the left has charged
to the manufacturer 20 Euro output VAT and has no
input VAT, so settles 20 Euro
through a payment to the government.
The manufacturer has charged 40 Euro output VAT
to the distributor, and has 20 Euro input VAT,
so pays a net amount of 20 Euro
to the government.
The distributor has 60 Euro output VAT
and 40 input VAT, so another net 20 to the government.
The retailer has 80 Euro output VAT and 60 input VAT,
for the last net 20 Euro VAT going
to the government.
4 steps of 20 Euros VAT each equals a total of 80 Euro.
As you can see, VAT is really a tax
that impacts consumers, as they are the ones ultimately
paying the 80 Euro that is embedded
in the retail price of 480 Euro.
VAT is not a cost to businesses themselves,
they collect and pay it "on behalf of the government"
over the various stages of the chain of supply.
Let's go through the VAT categories and rates
for the UK, as an example.
The standard rate for most goods and services is 20%.
The reduced rate for things like children's car seats
and home energy is 5%.
Some items, such as most foods and children's clothes,
are taxable, but at a rate of 0%.
There is a category of services, more specifically
medical, financial and postal services, that
is exempt from VAT.
There are also transactions that are out of scope:
donations to charity
and tolls for a public road.
The first three categories (standard rate,
reduced rate and zero rate) are considered
taxable goods and services.
Even though at first glance the zero rate category
and the exempt category look the same,
there is a big difference on the input tax side!
The seller of exempt goods or services (like a bank)
is not entitled to reclaim VAT on
business purchases, whereas the seller of
goods and services rated at 0% is entitled
to reclaim VAT on business purchases.
The European Union is very well known
for having a well-functioning VAT system.
Please be aware that although
many VAT related legislation
is largely standardized across
the EU member states, the standard rates differ widely,
and what goes into the standard versus
the reduced rate category can also differ
from country to country.
In this globalizing world with lots of
cross-border transactions, how does VAT work
in an international context?
How about the Dutch training company
of your Finance Storyteller that delivers training
services in other EU countries?
How should he apply VAT?
The main rule is that the place of supply
of business-to-business services provided
between two VAT-entrepreneurs within the EU,
will be the country where the recipient of
the services is established.
So does that mean that this training services company
has to register for VAT in all EU countries
where it supplies its services?
For most companies, fortunately not!
There is a solution for this situation
and it is called "Reverse charge" VAT!
In reverse charge VAT,
there is no VAT on the invoice itself.
The recipient of the invoice self-assesses
local country VAT in their monthly or quarterly
VAT filing, and deducts that same amount
in that VAT filing, effectively leading to a
VAT charge of zero, but with two line items.
Both supplier and customer file a separate form
of cross-border transactions, detailing
"counterpart" VAT number and amount.
That's how reverse charge VAT works!
It greatly simplifies my administrative life.
Here's what your Accounts Payable staff
should look out for when receiving
"reverse charge VAT" invoices.
The VAT amount on the invoice should be zero.
The VAT number of the supplier
and the VAT number of the (correct) invoiced
legal entity are mentioned.
The supplier has mentioned
"Reverse charge" (in English) /
"Umkehrung der Steuerschuldnerschaft"(in German) /
"Autoliquidation" (in French) or "BTW verlegd" (in Dutch)
on the invoice.
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