What is Value-Added Tax (VAT) and who pays it?
Value-added tax (VAT) is a consumption tax, meaning that it is a tax on the purchase of a product or a service. It is a form of taxation that focuses on how much an individual consumes opposed to how much that individual contributes to the economy (income tax).
Value-added tax is paid by residents of any country in the European Union. Both consumers and businesses are liable to pay VAT when purchasing services or products. When a manufacturer creates a product, it is liable to pay value-added tax on the components purchased in order to create goods. The VAT that the consumer pays when the product comes on the market applies to the cost of the product, minus the cost of the components which have already been taxed.
Value-added taxation rates are set by the member states individually. The minimum rate of VAT as directed by the European Union is 15%. There is no maximum limit on value-added taxation. Member states are also at liberty to choose certain products and services to be subject to a reduced rate of VAT or to be exempt altogether.
All imports are charged at the VAT rate of the European state in which the product is being sold. European Union Directive 77/388/EEC stipulates that companies selling electronic goods and eServices that are based outside of the European must submit VAT taxes to the European Union state where their customers reside. Only business-to-customer sales are applicable for a VAT charge. Business-to-business sales may be exempted.
Many support the use of a VAT over income tax because they believe it punishes spending instead of earning (income tax). The Investopedia article does a good job describing the EU’s version of this tax.
Generally speaking, a good way to think about the tax is there is a tax applied to any value added to a product or service. Generally, the tax is not applied twice. If my son buys a piece of wood to carve for $10, he pays VAT on that $10. If he then makes on his county fair winning pigs and sells it for $30, the person buying the wooden pig would then pay tax on $20 ($30-$10).
I hope this helps!
Mark Struthers CFA, CFP®