Value Added Tax
Peter Marshall Bsc (Econ) BA MBIM is a Fellow of the Society of Business Teachers, and an experienced educator in business subjects. He is also a prolific author and his books have been translated and sold worldwide. He lives in London, UK.
A tax on purchases
Value Added Tax (or VAT) is very different from income tax and corporation tax. The last two are claimed at the point of income—VAT is claimed at the point of purchase. Also, a business is a source of taxation for income tax and corporation tax, but for VAT it is simply a kind of collector. A taxable firm has to collect VAT on the sale price of all its goods and services from its customers, and pay it over to HM Customs and Excise as output tax. Of course, the firm is also a customer of other firms, because it needs to buy goods and services itself. But the VAT it pays on these purchases (input tax) can be set against the VAT it has collected from its customers; it only has to pay the balance (difference) to HM Customs and Excise. (If the balance is a negative one, then HM Customs and Excise refund the balance to the firm.) So in the end, it is only private individuals who actually pay VAT—plus firms too small to have to register for VAT (though they can still register if they wish).
There are a number of VAT statuses falling into two main categories:
In the second category there can be an infinite number of different tax rates applying to different kinds of goods or services. The rate can be zero percent, or any number of positive rates. ‘Zero rated’ does not mean ‘exempt’. They are two different things. For a long time the basic rate was 15%, but from 1991 it was increased to 17 ½ %.
There are several ways of keeping VAT records—a basic one used by most types of business, and various special schemes for particular kinds of business. We will consider the basic one first.