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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What is VAT?
Value added tax (VAT) is a comprehensive indirect tax imposed by more than 170 countries on sales or exchanges and imports.
It is imposed at every stage in the supply chain, often at rates exceeding 20%, and therefore represents a significant transaction cost.
It is a fast-changing tax, with rates, compliance, and enforcement mechanisms in flux. Businesses must keep abreast of new VAT rules, as governments extend their tax nets.
VAT is referred to in some countries as the “goods and services tax” (GST) and the two terms are broadly interchangeable.
Key VAT concepts
Most businesses and individual traders are “taxable persons” responsible for registering, collecting, and remitting VAT, regardless of whether they’re resident or nonresident in the taxing country. In many countries, resident taxable persons are only subject to these obligations if their taxable turnover exceeds a specified registration threshold.
Place of supply
VAT is imposed by the country in which the transaction occurs, the so-called “place of supply.” Different countries have different rules on whether cross-border transactions are taxed in the country of the supplier, the country of the recipient, or elsewhere (e.g., place of use). Mismatches in rules between countries create the risk of incorrect or double taxation.
VAT paid on goods and services purchased by a registered taxable person, in connection with its business.
VAT calculated and charged on the sale of goods or services by a registered taxable person.
VAT credit or deduction
Businesses that account for VAT are generally eligible for a credit or deduction for their input VAT. This credit offsets their output VAT to determine their net VAT liability to the tax authority.
Most jurisdictions require transactions to be supported by an invoice (or similar document) showing the amount of VAT due, and other key information. VAT credits are generally contingent upon the taxpayer retaining duly completed, timely VAT invoices that conform to strict formal requirements.
Foreign suppliers may be able to avoid VAT obligations on specific types of transactions with local business purchasers if the purchasers are required to account for the VAT under the reverse charge rules. These rules often apply to inbound business-to-business services.
Download: Indirect Tax on B2C Digital Services Roadmap
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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.
Insight: Navigating the Complex World of EU E-Invoicing
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)||Sales Tax|
|Single vs. Multi-Stage||Imposed at every stage in the supply chain.||Imposed at the retail stage, only.|
|Creditability||Creditable by businesses but not final customers.||Generally, not creditable by businesses or final customers.|
|Administrability||Invoicing, reporting, and crediting systems promote compliance.||Greater opportunities for evasion.|
|Rates||Often imposed at rates above 10%, and even 20%.||Generally imposed at rates below 10%.|
|Applicable Jurisdictions||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.|
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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
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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.”
Download: OnPoint – Electronic Invoicing and Value Added Tax
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
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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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The VAT Navigator provides global coverage of VAT, GST, and sales tax, and summarizes essential topics about each country’s rules, including case law, administrative guidance, and planning points.
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A searchable database that includes forms for registration, reporting, and making various elections.
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