What is VAT?
VAT (value-added tax) is a type of indirect consumption tax imposed on the value added to goods or services, specifically during different stages of the supply chain, which may include production, wholesale, distribution, supply, or any other stages that add value to a product.
VAT is commonly used by governments around the world as one of their main sources of revenue, and accounts for approximately 20 percent of worldwide tax revenue. It is the most common consumption tax in the world and is enforced in more than 160 countries. All countries that are part of the European Union (EU) are legally required to enforce a minimum VAT rate, and since its introduction in the 20th century, European VAT rates have consistently increased. The US is the only developed country in the world that doesn't use VAT.
VAT Differences between Countries
While all countries follow a general VAT blueprint, there are a lot of differences in the finer details of their respective implementation. The VAT in one country will not be the same as the VAT in another. Differences between countries include the taxes imposed on specific goods or services, whether the taxes apply to imports or exports, and rules regarding filing, payment, and penalties.
For example, in the Philippines, senior citizens are exempt from paying VAT for most goods and some services that are for personal consumption. In China, besides the standard VAT rate, there is a reduced rate that applies to certain products such as books and oils. Many countries do not impose a VAT for certain goods ranging from education to foodstuffs, health services, and government charges.
GST (Goods and Services Tax)
A GST, or goods and services tax, can be the alternative name of VAT in some countries such as Australia and Canada. In addition, the terms are commonly used interchangeably (sometimes even with "sales tax"), even though GST and VAT in their respective countries can differ tremendously. No country has both a GST and a VAT.
Simplified Example of the Process of VAT
The following is an explanation of VAT applied to coffee sold by a coffee shop owner in a shop that contains coffee beans roasted by a nearby roaster with beans grown by a local farmer. Assume a VAT of 10%. Each person or business involved in the chain must complete VAT government paperwork:
- The Farmer: Fresh coffee beans first come from the local farmer. If the roaster pays a total of $5.00 per pound of fresh coffee beans, the VAT which is $0.50 ($5.00 × 10%), is added to that cost, so the farmer receives a total of $5.50 from the roaster for each pound of coffee beans.
- The Roaster: The roaster roasts the coffee beans and charges the coffee shop owner $10.00 per pound of roasted coffee beans. This means that the shop owner must pay a total of $11.00 per pound, $10.00 for the roasted coffee beans, and 10% VAT which is $1.00. However, because the farmer already paid the first $0.50 to the government, the roaster only has to pay $0.50 in VAT to the government.
- The Coffee Shop Owner: The coffee shop owner can use each pound of roasted coffee beans to sell 5 cups of coffee at $4.00 each for a total of $20.00. For every 5 cups of coffee sold, the shop owner receives a total of $22.00 from customers who buy his coffee, $20.00 and $2.00 VAT. However, because a total of $1.00 in VAT has already been paid to the government by the farmer and roaster before, the shop owner only pays $1.00 to the government.
VAT vs. Sales Tax
A sales tax is a consumption tax paid to a government on the sale of certain goods and services. Usually, the sales tax is not collected during the different stages of the supply chain. Only during the final stage, the vendor collects the sales tax from the end consumers as they make purchases.
As seen in the example above, VAT functions differently from sales tax, and is a bit more complex. Sales tax is only imposed once when the consumer of the product pays the vendor. VAT is superior to sales tax in regards to preventing tax evasion or malpractice because taxes are applied during the entire process of production and distribution, rather than as a single instance at the end. However, because of the intricate paper trail that VAT requires, it tends to be costly to administer compared to sales tax.
Even though VAT is imposed at multiple instances for any good or service, double taxation (tax paid on tax) does not occur. Because VAT is only imposed on any value added, any tax applied during preceding stages can be deducted, preventing a cascading effect. On the other hand, double taxation can happen with sales tax.
The Formulas
Depending on which two values you provide, the calculator applies different mathematical formulas to find the remaining data:
Gross Price = Net Price + (Net Price × (VAT Rate / 100))
To calculate Net Price from Gross Price and VAT Rate:
Net Price = Gross Price / (1 + (VAT Rate / 100))
To calculate VAT Rate from Net and Gross Price:
VAT Rate = ((Gross Price - Net Price) / Net Price) × 100
Frequently Asked Questions
You need to enter exactly two values into the calculator. The calculator is designed to automatically determine the remaining two missing values regardless of which two you provide.
The net price is the base cost of a good or service before any taxes are applied. The gross price is the final total price that includes the original net price plus the applied Value Added Tax (VAT).
Unlike sales tax, which is only collected once at the final point of purchase, VAT is assessed at every stage of the supply chain where value is added. However, businesses can typically deduct the VAT they've already paid, meaning the end consumer still bears the ultimate cost, but the collection is fractionalized to prevent tax evasion.
Generally, yes. Goods and Services Tax (GST) is simply an alternative name for VAT used in countries like Canada, Australia, and New Zealand. While the specific rules and exemptions vary by country, the fundamental mechanics of the tax remain the same.
No, double taxation (paying tax on tax) does not typically occur with VAT. Because VAT is only imposed on the "value added" at each specific stage, any tax applied during preceding stages can be deducted, which prevents a cascading tax effect.