Concept and Meaning of Value Added Tax

What is Value Added Tax?

Value Added Tax (VAT), also known as goods and services tax in other jurisdictions, is a tax charged on the supply of most goods and services in a number of countries such as those in the European Union.

It should also be pointed out that some persons and business es are exempted, and these include those with low levels of turnover.

This tax is kind of a subtle tax to many  consumers who rarely think about it when buying their goods. This is because goods have to clearly indicate the total price to pay. Therefore the final consumer rarely notices the VAT component in the total price.

Though simple in most cases, it can be a headache to orgianisations that are involved in goods and services which attract different rates and some exempt goods. These organisations have to be careful so as not to charge wrong rates.

History of VAT in the UK

It is easy to forget that VAT is a relatively new tax in the United Kingdom. It came into being with the United Kingdom entry into the European Union in 1973.

Before this the UK had a tax called the Purchases tax which was only applied to manufacturers and wholesalers whose goods were liable to this tax.

This tax was operational from 1940 to 1973. It was initially created to raise funds for the war effore during the Second World War.

Because of VAT wide application, many organisations overnight discovered  that they had to worry about VAT returns to be completed every quarter i.e. every three months. There was initially an uproar from many business that were not subject to the old Purchases tax.

Who Pays VAT

Ultimately the underlying VAT is paid by the final consumer of the goods. However, the tax like income tax, is based on the increase in value for a product or service at each stage of production or distribution. Therefore everyone in the supply chain must account for and settle up the net amount of VAT they have received in the VAT tax period, usually three months. 

This means that if they have received more VAT than they have paid over that period they pay the difference to HMRC if a United Kingdom resident. If however they have paid more than they have received they will be reimbursed the difference.

When the goods or services reach the final consumere the intermediate stages VAT payments will be cancelled out. Therefore if you review the stages you will see that only the ultimate consumer actually paid any VAT without claiming anything in return.

Value Added Tax Exempt Goods in UK

There are a few goods and services that are exempt in the United Kingdom as shown below:

• Insurance, finance and credit.
• Education and training
• fundraising events by charities.
• Subscriptions to membership organisations.
• Selling, leasing and letting of commercial land and buildings.

The above are known as exempt goods and services and should not be included in taxable turnover for VAT purposes.

VAT Rates in the United Kingdom

The standard rate for VAT in the United Kingdom is currently at 20%

The standard rate has changed over the years. In 1973 it was at 10% then it was reduced to 8% in 1974. In 1991 the rate was raised to 17.5%.

The reduced rate of VAT is currently at 5%. Besides this there is also the zero rate of VAT.

The reduced rate usually applies to a few products like children car seats at the moment.

An Example of a standard rate of tax application:

A supermarket sells groceries worth £100 to a customer.

The sales receipt will show the following:

Price                100

VAT @20%      20.

Total Price       120.

In this case the supermarket at the end of the quarter report will pay £20 to HMRC. Ofcourse this will be included with all the VAT  collected during that period which will be netted off from the VAT they have paid to their suppliers.

In this case the accounting for this transaction is as follows.

Credit  Sales 100

Cr       VAT 20

Dr       Cash 120

However if it was a credit sale, which is rare when dealing with supermarkets, it will be accounted for as follows:

Cr Sales   100

Cr  VAT    20

Dr Debtors 120

What is Output VAT?

The value of goods and services supplied by a business are know as outputs. The VAT on such goods and services is known as Output VAT.

What is Input VAT

The value of goods and services bought or procured is known as inputs.The VAT on inputs is known as Input VAT.

VAT Exempt Businesses

Some business are exempted from accounting fore VAT and therefore exempted from registering for VAT. These business do not therefore  charge VAT and cannot claim the VAT charged on their purchases.

The exempt business include small businesses  within a specified range of turnover as set by parliament. These can however choose to register in that case they will be subject to the requirement of the act and be able to charge and claim VAT.

Some businesses do not have to add VAT on their goods and services. These include banks which cannot charge VAT on bank charges etc.

Zero Rated Businesses

These businesses do not have to add VAT to the selling price of their products or services but are able to obtain a refund of all VAT paid on purchases of goods and services.

This is an advantage for these zero rated businesses as they can claim the input VAT whereas exempt businesses cannot.