What is VAT? A brief guide to consumption tax

Value-added tax can be tricky, especially in international trade. How does it differ compared to other taxes? Here are the basics.

Taxes based on consumption and directed towards end-consumers are commonly known as VAT, Value-Added Tax. This specific tax is generally added to the price of particular goods or services and deductible for companies and most organizations. In some countries, it comes by the name of GST, Goods and Services Tax.

VAT differs from sales taxes as it’s imposed in every step of the production and distribution chain. Sales taxes on the other hand are only imposed on the consumer. This is a significant difference as companies act as tax collectors for the government.

Brief history

Despite widespread implementation, it hasn’t been around for that long. In the early 20th century, two people proposed the basic concept, independently. An American tax expert and economic advisor named Thomas S. Adams proposed it as being a more refined version of the corporate income tax. Wilhelm von Siemens, a German businessman, suggested at the same time that a consumption tax addressed to the end-consumer could be a more easily administered form of a gross turnover tax and sales taxes.

Germany and France were the first countries to implement VAT, shortly after World War I. Ever since it’s popularity among national and local governments has increased rapidly. OECD reports that among the world’s 199 countries a whopping 166 have implemented the tax in one form or another, with the notable exception of the United States.

VAT is tricky

Despite being an efficient tax for governments, VAT is often a huge source of headache and capital leakage for companies and organizations. Not at least in international trade. There are several reasons for this.

1. Despite huge harmonization efforts driven by the EU, there are vast differences in local regulations. Various tax rates, dates, and reporting routines quickly become overwhelming. Especially for small businesses without the resources of an accounts payable department.
2. The ever-changing landscape is a big cause for concern. From the EU court of justice and commission to national and local regulations – it takes effort to keep track of new regulations.
3. Despite all available sources, from taxation levels to precedents, there are sometimes uncertainties. Not at least when new rules and regulations are implemented.