How does vat tax work

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Popular Courses. Key Takeaways A value-added tax VAT is paid at every stage of a product's production from the sale of the raw materials to its final purchase by a consumer. Each assessment is used to reimburse the previous buyer in the chain. So, the tax is ultimately paid by the consumer. Opponents say it is unfair to lower-income consumers, who must spend a higher proportion of their income in VAT than wealthier consumers. Proponents say it discourages tax avoidance by providing a paper or electronic trail of taxes for every product.

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We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in our editorial policy. Compare Accounts. While the VAT theoretically spreads the tax burden on the added value of a good as it moves through the supply chain from raw material to final product, in practice, the increased costs are typically passed along to the consumer.

A value-added tax VAT is a flat tax levied on an item. It is similar in some respects to a sales tax, except that with a sales tax, the full amount owed to the government is paid by the consumer at the point of sale. With a VAT, portions of the tax amount are paid by different parties to a transaction. The federal government raises money primarily through the income tax system. The states and local governments establish and collect their own sales taxes. Local governments rely primarily on property taxes.

Wealthier consumers could ultimately come out ahead if a VAT replaced the income tax. In short, lower-income consumers would pay a much higher proportion of their earnings in taxes with a VAT system, critics including the Tax Policy Center charge. Yes, to some extent. A government can exclude certain basic household goods, food products, or medicines from the VAT, or it can charge a substantially lower VAT rate. It also can provide rebates or credits to low-income citizens to offset the effects of the tax.

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Popular Courses. Part Of. Filing Status. The way you manage this depends entirely on how you charge customers. If you work in retail, for example, and you put a price tag on your goods, then you simply include the VAT in the price of the product. When the customer buys the product, they pay for the cost of their goods — and the VAT as well.

If your business is a service provider, then you might opt to do this differently. When you supply an invoice to customers, you can include the standard costs of services and then include a separate VAT fee as well.

For most small businesses, you will need to charge the standard rate of VAT. There are two other kinds of VAT:. This rate applies to items considered a luxury necessity.

These include car seats for children, energy-saving activities, many fees for charities, and mobility aids for the elderly. You charge no VAT on sales for these items. You must record both of these rates on your VAT return — even zero rate products. These include items like medical services, finance and credit, and fundraisers operated by charities.

To see a full list of what items are reduced rate, zero rate, and exempt from VAT, you can visit the government website. Unlike self-assessment tax returns, a VAT return is not an annual statement but instead submitted every three months.

Like a self-assessment tax return, it is a statement of income submitted to HMRC for tax payments and record keeping. You can submit your VAT return online.

Can you give me an example? The example I always use is a loaf of bread you buy in a store for a buck -- so you have a farmer, a baker, and a supermarket along the production chain. Let's put the VAT at 10 percent. The VAT is 2 cents. The baker pays the farmer 22 cents, and the farmer sends 2 cents in VAT to the government.

The VAT is 6 cents. Now the supermarket pays the baker 66 cents, of which 6 is VAT. The baker sends the government 4 cents -- he pays 6 cents in VAT but receives a two cent credit from the government. The store sends the government 4 cents total - the 10 cents it collected in VAT on its sales, minus the 6 cents it paid to the baker in VAT, which it gets back in a credit.

In total, the government gets 2 cents from the farmer, 4 cents from baker, 4 cents from the store. That's 10 cents on a final sale of a dollar -- for a 10 percent VAT. Why isn't it easier to just implement a one-time retail sales tax?

It's easier to collect than the retail sales tax because it's got these various stages in it, built in paper work.