Value added tax is a tax on the value which traders add to their purchases of raw materials, goods and services prior to resale. The theory of value added can be illustrated by reference to a simplified profit and loss account showing the four basic elements used in its calculation, namely—
It will be seen that value added can be calculated by two methods represented by the following formulae—
Value Added = Profit + Wages and Salaries
Value Added = Outputs – Inputs
Tax can be expressed in either nominal or effective rates. A nominal rate is one that is charged on the tax-exclusive value of supply. An effective rate is one that is expressed as a fraction of the tax-inclusive value, and is known as the “VAT fraction”.
The common system of value added tax adopted by the European Union is based on Outputs minus Inputs and member states use nominal rates. However, this is subject to the special schemes provided for in Directive 2006/112/EC and derogations in respect of simplified procedures.
The principle of the common system of value added tax involves the application to goods and services of a general tax on consumption exactly proportional to the price of the goods or services, whatever the number of transactions which take place in the production and distribution process before the stage at which tax is charged. On each transaction, value added tax—calculated on the price of the goods or services at the rate applicable to such goods or services—is chargeable after deduction of the amount of value added tax borne directly by the various cost components. The common system of value added tax is applied up to and including the retail stage.
Example: X Ltd, a woodworking company, builds furniture for resale to the public from timber and other materials which it purchases from suppliers. It incurs costs of £1000 plus VAT on its purchases, and charges £3000 plus VAT on its sales. The rate of VAT is 20%.
The charge to VAT is calculated as follows—
|VAT due on goods sold at the applicable rate of 20%||£600.00|
|VAT borne on cost components (timber, glue, etc)||£200.00|
The rate in force from time to time has been as follows:
|04/01/2011 onwards||20 per cent|
|01/01/2010–03/01/2011||17.5 per cent|
|01/12/2008–31/12/2009||15 per cent|
|01/04/1991–30/11/2008||17.5 per cent|
|18/06/1979–31/03/1991||15 per cent|
|29/07/1974–17/06/1979||8 per cent|
|01/04/1973–28/07/1974||10 per cent|