Value Added Tax (VAT) Indirect Tax Compliance
August 26, 2022
Value added tax (VAT) is imposed by most countries—not including the U.S.—on the value added to goods or services at each stage of the supply or import chain. As governments around the world expand their tax nets, international businesses must stay on top of shifting VAT rules, rates, and detailed reporting requirements in each country in which they operate, to ensure compliance and avoid costly penalties.
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Is VAT a direct or indirect tax?
VAT is a consumption tax, generally imposed on sales or exchanges and imports. At each stage of the supply or import chain, the tax is imposed on the value added to goods or services.
VAT is an “indirect” tax because it is generally collected and remitted by the seller. VAT is intended to be costless – or “neutral” – for businesses, because, although it is imposed at each stage of the supply chain, only the final customer bears the full cost. Businesses can offset the “output VAT” they collect from purchasers with “input VAT” they incur on their business-related purchases.
Imposing VAT at each stage of the supply chain doesn’t increase the total amount of tax collected, relative to an equivalent retail-level sales tax. However, because the compliance mechanisms involve an invoicing trail and detailed reporting requirements, VAT is easier than sales tax for authorities to monitor, and more difficult to evade.
Take a closer look at the requirements for complying with e-invoicing in the EU for businesses with cross-border operations, and at the changes we may expect to see over the next few years.
What are the difference between VAT and Sales Tax?
Most – but not all – countries outside of the U.S. impose a national VAT. No U.S. states impose a VAT. Instead, most U.S. states – and a minority of other countries – impose retail sales tax.
Key differences between VAT and sales tax
|Value Added Tax (VAT)
|Single vs. Multi-Stage
|Imposed at every stage in the supply chain.
|Imposed at the retail stage, only.
|Creditable by businesses but not final customers.
|Generally, not creditable by businesses or final customers.
|Invoicing, reporting, and crediting systems promote compliance.
|Greater opportunities for evasion.
|Often imposed at rates above 10%, and even 20%.
|Generally imposed at rates below 10%.
|Implemented in most countries outside the U.S.
|Applies in most U.S. states, many U.S. localities and Puerto Rico. Outside the U.S., sales tax applies in a minority of countries, e.g., Malaysia, the BES Islands and certain Canadian provinces.
Download: Wayfair, VAT, and DAC7 Compliance
Explore the indirect tax collection and reporting requirements that e-businesses must meet under Wayfair rules, VAT, and DAC7.
How is VAT applied to domestic sales?
Here’s an example of how VAT is applied to a domestic sale:
Factory and Retailer are both established in Country A and have taxable turnover exceeding the Country A registration threshold. Factory manufactures a desk, which it sells to Retailer for a VAT-exclusive price of 200 pounds. Retailer sells the desk to Final Customer for a VAT-exclusive price of 500 pounds.
- Factory and Retailer must both register for Country A VAT.
- Factory collects 40 pounds of Country A output VAT from Retailer and remits it to the Country A Tax Authority.
- Retailer takes a 40-pound input VAT credit for the VAT it remits to Factory and collects 100 pounds of output VAT from Final Customer.
- Retailer remits 60 pounds net VAT to the Country A Tax Authority (the difference between its output VAT liability and its input VAT credit).
- The tax burden ultimately falls on Final Customer, who pays 100 pounds in VAT and is not eligible for an input VAT credit.
- Country A Tax Authority receives 100 pounds in total: 40 pounds from Factory and 60 pounds from Retailer.
Download: Understanding the EU VAT Changes
Expert analysis and insights into the EU’s latest VAT changes for e-commerce.
What changes to VAT rules and exemptions do businesses need to be aware of to stay compliant?
- Rates and exemptions: Rates and exemptions shift as governments respond to economic and political pressures.
- Tax credits and deductions: In some countries, procedural requirements may be strict. However, there may also be opportunities to claim previously unclaimed credits in future tax years.
- Taxing jurisdiction: Many countries are amending their so-called “place of supply” rules, so that more cross-border transactions are taxed in the country of the customer, including digital supplies, consumer e-commerce purchases, and live virtual events. This may require suppliers to register and get up to speed with VAT practices in their market jurisdictions.
- E-commerce platform liability: More countries are encouraging or requiring digital platforms to report and withhold VAT on various e-commerce transactions. Underlying merchants can expect heightened scrutiny of their business activities.
- Electronic invoicing: More countries are requiring businesses to invoice electronically and even to obtain government approval digitally before issuing invoices, under the so-called “clearance model.”
This presentation provides an introduction to electronic invoicing and considers the trend toward compulsory electronic invoicing and the invoice clearance model. It also looks at case studies of the invoice clearance model, as implemented in Italy, Brazil, and China.
Is VAT a neutral cost for my business?
In theory, VAT systems are designed to be neutral (i.e., costless) for businesses, because of the crediting system. The expense should ultimately fall entirely on the final customer, who cannot deduct input VAT. In practice, however, VAT costs for businesses can be steep for several reasons, including:
- Uncreditable VAT expenses (e.g., in some countries, fuel or business entertainment)
- Cash flow mismatches between payments and refunds
- Compliance costs, fines, and penalties
- Advisory fees
How can my business reduce VAT-related costs?
Businesses may be able to reduce VAT costs by:
- Establishing systems to monitor and comply with filing deadlines, invoicing requirements, etc.
- Using VAT grouping to minimize intra-company VAT liabilities
- Structuring corporate groups to maximize VAT efficiency and secure the right to VAT deductions
- Taking advantage of import VAT deferral schemes to ease cash flow
- Developing robust in-house VAT capabilities to reduce advisor spend
Insight: Holding Companies and VAT Recovery
Recent court decisions are reinforcing the need for holding companies to provide evidence of their “intended economic activity” if they want to recover VAT incurred on costs related to refinancing, restructuring, and deal transactions.
VAT Research and Practice Tools
Bloomberg Tax brings expert context and unmatched content so that international tax professionals can navigate the nuances of VAT requirements with confidence. Access practitioner-authored analysis and interpretations in our Portfolios to help you develop and implement complex international tax strategies.
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