Introduction to Value Added Tax (VAT)

Meaning of VAT
Value Added Tax (VAT) is a general consumption tax assessed on the value added to goods and services. It is a general tax that applies, in principle, to all commercial activities involving the production and distribution of goods and the provision of services. It is a consumption tax because it is borne ultimately by the final consumer. It is not a charge on companies. It is charged as a percentage of price, which means that the actual tax burden is visible at each stage in the production and distribution chain. It is collected fractionally, via a system of deductions whereby taxable persons can deduct from their VAT liability 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. ... Read More

Types of VAT
There are three types of VAT namely:
(i) Consumption type
(ii) Income type
(iii) Gross produced
(i) Consumption type:
Capital goods purchased are treated like any other purchases of input i.e. Full credit of input tax are given. This type of VAT is practiced in Kenya, Uganda, Tanzania, Singapore and South Africa.
(ii) Income type:
Input tax paid on the purchases of capital a goods is spread over the life span of the products or Assets. The input tax credit with capital purchases against the liability in a particular tax period will take into account the depreciation portion only. This type of VAT is practiced in Argentina and Peru.
(iii) Gross product type:
Completely denies input tax deduction on capital goods against the firm VAT liability. VAT is computed by subtracting from the firms sales only purchases apart from capital goods. This type of VAT is practiced in Finland, Morocco and Senegal.
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Advantages of VAT

VAT is perceived to have a very wide coverage and represents an important instrument against tax evasion and is superior to a business tax or a sales tax from the point of view of revenue security for three reasons:
1. Coverage If the tax is carried through the retail level, it offers all the economic advantages of a tax that includes the entire retail price within its scope, at the same time the direct payment of the tax is spread out and over a large number of firms instead of being concentrated on particular groups, such as wholesalers or retailers. 

If retailers do evade, tax will be lost only on their margins because customers that are registered firms gain nothing if their suppliers fail to collect tax, except delay in payment; they will pay more to the government themselves. Under other forms of sales tax, both seller and customer gain by evading tax. One particular advantage is that of the widening of the tax base by bringing all transactions into the tax net. Specifically, VAT gives the government the opportunity to bring back into the tax system all those persons and entities who were given tax exemptions in one form or another by the previous regime.... Read More

Disadvantages of VAT
VAT suffers from various disadvantages, first it is regressive, second it is too difficult to administer, third it is inflationary and fourth it favors the capital intensive firm. It is claimed that the tax is regressive, ie its burden falls disproportionately on the poor since the poor are likely to spend more of their income than the relatively rich person. There is merit in this argument, particularly if it attempts to replace direct or indirect taxes with steep, progressive rates. However, observation from around the world has shown that steep tax rates lead to evasion, and in the case of income tax, it is a disincentive to effort.

Further, there is now a tendency in most countries to reduce this progressivity of taxes as has been done in Guyana where a flat rate of income tax has been introduced. In any case VAT recognises and makes room for progressivity by applying no or low rates of tax on essential items such as food, clothes and medicine. In addition it allows for steep rates of tax on luxury items, although this can create problems for administration and open opportunities for evasion by way of deliberate misclassification, a problem incidentally not peculiar to VAT, and which takes place extensively in the area of customs duties.... Read More

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